--looming slow-down of the Chinese economy--
(the following will be a part of a book--join work-- to be published next year)

The "Beijing Consensus"is forever--Is it?

--looming slow-down of the Chinese economy--

Akio KAWATO

Visiting Professor, Business School, Waseda University

Once Churchill said, "Soviet Union---is a puzzle inside a riddle wrapped in an enigma, and the key is Russian nationalism". The same can be true with the Chinese economy (the key word here would be the "legacy"of the Chinese history and communism). Yet in spite of the opacity the world takes the Chinese economic growth for granted.

In the aftermath of the Lehman Brothers crisis tides may be changing for China, although it seemingly has overcome the crisis alone among major economies. The huge stimulus package of about 570 billion dollars[1], which initially prevented the economy from nose-diving, eventually caused inflation[2], overheated the realty market[3] and created a huge heap of potentially bad loans in major state banks[4]. Pictures are different in places, but cases of steep fall in realty prices are becoming more frequent[5].

In China loans are often not paid back or are simply written off. Loans are given on the basis of political considerations instead of on the virtue of projects. Nevertheless, if the bad loans ever come to surface, financing of construction--the mainstay of the Chinese economic growth[6]--, will be substantially hampered, which in its turn will slow down the whole economic growth.

Meanwhile the conditions for foreign direct investment are deteriorating. The Chinese authorities are abolishing favorable treatments toward foreign firms one after another, adding new burdens[7]. Accordingly, the labor cost is rising rapidly. The myth about the "endless supply of cheap labor forces from provinces" has already exhausted itself, and the current level of the wages in the coastal area does not justify the title of cheap labor country any more.

If the Chinese domestic market grows to make up for the stagnant export, the foreign firms will stay in China, but the lack of an open election system hampers more equal distribution of the wealth and leaves the portion of private consumption as low as 38.0%[8] in the Chinese GDP (in Japan it was 60.2% in 2006). In view of these factors foreign firms are now diversifying their destinations for investment: to Vietnam and other ASEAN countries and to Latin American countries.

The Lehman Brothers crisis was caused by mishandling of the printed money, dollar. China has similar experiences in its long history[9], where printed money caused inflation and eventual fall of dynasties. Moreover, excessive accumulation of power and wealth in the hands of the government tended to stifle private initiatives, which otherwise would bring about self-sustainable and dynamic economic growth.

The ostensibly remarkable growth[10] of China was made possible thanks to the capital and technologies from outside and forcible infrastructure construction within itself. The inflation and the excessive concentration of power may again play havoc with China's economy and society, as it happened many times in its history.

Does China possess conditions for a sustainable growth?

--in the light of the British experience of industrialization

Discussion on the prospect of China's development would need a thorough analysis on how the Industrial Revolution came into being in Britain. As it is the industrialization that brings higher standard of life for the general public, a comparison with Britain's past will enable us to judge whether today's China is gifted with all of the conditions for realizing sustainable economic development.

Before the Industrial Revolution the total value of the wealth on the earth grew very slowly. It was almost a zero-sum economy, and only victory in a war or plunder of treasure (the "discovery" of the gold in Peru by the Spaniards was nothing other than a plunder) brought additional wealth. When the supply of gold and silver became thin and the lucrative slavery trade was being forbidden in the 18th century, British merchants and gentries invested their money in mass-production of cheap cotton clothing, and sold them to Europe and India. India, once a monopolistic producer of the cotton products, was imposed a high import tariff into the British market. It was instead forced to buy the cheap cotton clothes made in Britain. The colony became a huge market for Britain with its wealth siphoned to the latter[11]. The industrial goods worked as instrument to transfer wealth from the colony to industrialized countries.

Now things are inversed. China has become a workshop for the entire world, and the erstwhile "industrialized" countries have turned into markets for the Chinese products. In other words a huge chunk of wealth is now constantly drained from the "advanced countries" to China with the latter's goods as instruments. It is ironical that Europe and the United States are even suffering from large influx of narcotics from abroad (not from China, though), just as China did in the 19th century. It is as if the history were playing vengeance on the West for the sake of ancient China.

Up until the Industrial Revolution China was the workshop for the entire world. Its porcelain, silk goods and other luxury items were much coveted in Europe. China's economy reached its apogee in the 11th century, when they organically integrated their southern half into the economy, even produced iron with coke, and invented paper, compass and gunpowder. During the Ming Dynasty they embarked on global navigation[12], and small workshops for manufacturing textile products and other goods were in the offing around large cities.

Nevertheless, all this did not develop into an industrial revolution--mass production with use of machines. China possessed sufficient conditions for a start of mass production: capital, technology and working force. Yet, the Chinese elite preferred to serve in the government, probably because it guaranteed a very high social status and lucrative incomes. Moreover, the domestic market was saturated with cheap hand-made goods, and the majority of the population were poor farmers and peasants. China did not have colonies abroad, either. Therefore there was no proper market for mass-produced goods in China. An industrial revolution would have been unprofitable for the Chinese elite.

How long will the Deng Xiaoping's magic--Beijing consensus helped by foreign capital--hold?

After the Ming Dynasty China attempted twice a leap forward to modernize its economy. Toward the end of the Qing Dynasty the government built European-type factories in the coastal area, but these attempts were overly government-led and oriented toward arms production. After the fall of the Qing Dynasty the new Republic of China continued the same endeavor[13], but this was stymied by the civil war and the Second Sino-Japanese War.

Shortly after Mao Zedong's death Den Xiaoping embarked on liberalization of economy; he first started with deregulation in agriculture and the related industries in 1979, and after the Tienanmen incident in 1989 Den Xiaoping went even further to announce in his speeches in 1992 that China would open up itself for foreign direct investment and would offer favorable treatments. Firms in Taiwan, Hong Kong and then Japan, suffering from rapid appreciation of their currencies after the Plaza Agreement in 1985, hurried to invest their money in China as a platform of their exports to the United States.

The West (including Japan) built factories in China, exported machinery and high-tech components to these factories only to have their final products assembled by the Chinese "cheap labor" and to export them abroad (the U.S. inter alia). The money earned from the export is largely invested in the treasury bonds of the U.S.

In this way a collusive comfortable economic symbiosis came into being between China and East Asia on one end and the United States on the other end. All members of this scheme were willing to maintain the political status quo in order not to disrupt the stability in the region, which was vital for free trade and investment.

The Lehman Brothers crisis halted this symbiosis at least for a while. China's export plunged from 337.8 billion dollars in 2008 to 296.4 billion dollars in 2009[14]. To make up for the loss the Chinese Government enacted a huge stimulus package of 4 trillion Yuan[15]. This large bonus on the one hand brought a respite for the Chinese economy[16], and the Chinese started to be more self-assertive in its relations with its neighbors and the U.S. However, the massive spending and loans caused speculation in real estates. "Housing loan slave" has become a buzz word to express the situation in which normal middle class people have been deprived of possibility to acquire decent houses.

The excessive printing of Renminbi has taken its toll on the macro-economy; CPI has risen 6.4% in June of 2011 on annual basis, and the local half-governmental financial "Platforms" have accumulated borrowings of 7~14 trillion Yuan for investment in construction[17]. Contrary to the notion that China alone has fared the global financial crisis, the country may be facing a belated serious disruption; another example in China's history of mishandling the printed money.

Thus, Deng Xiaoping's model for economic development with a heavy dependence on foreign investment and exports may be exhausting its potentials; as long as China's growth is sustained by transfer of wealth from abroad, its growth will be constrained within the limits of the wealth abroad, and if China ever attempts to switch to domestic-demand-driven growth, it will face inflation. If the Soviet Union collapsed in its attempt to realize a socialist economy in an archaic society, China may fail, attempting to superimpose a market economy on the legacy of its history: government-centric system and soviet-type "party-state[18]".

If the Chinese economy ever falls, then it will happen that all major economies, the U.S., the EU, China and Japan, will have recessions simultaneously. Are we on the threshold of the end of capitalism as predicted by Marxists? Will the rigorous centralized planned economy resurrect, in which the Western investments in China will be expropriated by the government just like in Russia after the Revolution in 1917?

Will the economic symbiosis between Eastern Asia and the U.S. be reinstated?
The global financial crisis in 2008 is now finally taking its toll on the Chinese economy with inflation and bad loans. But things in China may not be as apocalyptic as suggested above. China has many resources to absorb the bad loans. First of all major banks may be allowed to write off their loans to the local financial "Platforms". Second, a part of the huge foreign currency reserves may be shifted to major state banks to strengthen their capital bases[19]. Third, the Chinese government may infuse its budget money to major state banks, having the governmental bonds purchased by the People's Bank of China. The indebtedness of the Chinese government is still very low[20] in comparison to the Western populist governments. Lastly, China is entitled to invoke credits from the IMF, though China will hardly use this privilege. Their huge foreign currency reserves[21] are far larger than the capital of the IMF[22].

On top of that China's exports to the U.S. are rapidly regaining the past volume. In 2008 China's exports to the U.S. reached its apogee in 2008 with 337.8 billion dollars only to plunge to the level of 296.4 billion dollars in 2009. In 2010 it again rose to a record high 364.9 billion dollars (the U.S.' trade deficit vis-à-vis China reached 273.1 billion dollars--a record, too)[23] . It is true that the scale of China's trade surplus has gone down to 183 billion dollars in 2010 from its climax of 298.1 billion dollars in 2008, but this still ensures a large inflow of money from abroad. A big influx of money may eventually push up realty prices again, saving China out of bad loan problem, and ensuing higher rate for Yuan will mitigate inflation.

And if the U.S. economy starts rolling again, the symbiosis between Eastern Asia and the U.S. may well be reinstated, in which China will behave itself in international politics as well. As China's domestic consumption and wage level further rise, production and wealth will be more evenly distributed in the world, and all human beings will be able to share high standard of life.

But before making a rosy conclusion we have to address two fundamental questions: "Aren't we overestimating Chinese economic strength?" and "Can China continue its rapid growth with its authoritarian system and mentality?" As long as China's economic growth is sustained by export and construction, it remains "inedible". It is true that China's soft loans are welcomed all over the world, but if China observes all compliance criteria, it will lose its edge. China's military power is not sufficient to project their influence abroad. Therefore, the West should avoid overestimating China's power, because it only makes China feel bigger than real and more confident that it can go its own way.

China's growth model would not be sustainable. The absence of free election will make it difficult to eradicate corruption and staggering income gaps in the society, which keep the proportion of private consumption in GDP at a low level. But if they ever introduce free election, it may well end up with fierce battles among politicians and political parties for a lion's share in usurpation of the state properties as was the case in Russia after 1992.

One may argue that if Japan was able to develop its economy thanks to its strong "authoritarian" government, China will be able to emulate this. But besides the presence of free election in Japan there are stark differences between Japan and China; Japanese government (in principle) does not directly meddle in business (especially in manufacturing industry), the pools of personnel for the government and private firms are strictly separate, and private ownership of property is very well protected in Japan under rule of law.

The Lehman Brothers crisis allowed a reinvigoration of state enterprises in China[24], because many private firms lost their exports and because it was the state enterprises which could benefit from the official economic stimulus measures. In November 2009 almost all private firms were obliged to have Communists Party's sub-organization in themselves. And keeping an eye on the next Communist Party Congress (in 2012), where a new leader will be chosen, some politicians started to play cards of old communist ideologies[25]. All this may well stymie economic dynamism, and in extremity may even lead to eventual expropriation of foreign capitals just like the Bolsheviks did after 1917.

However, if populist politicians do not take upper hands, China will not follow such an extreme path. Most probably a median policy will continue to prevail, because China still needs the service of foreign firms. Nevertheless, in view of the fact that foreign firms are now shifting the direction of their direct investment from China to Vietnam, Indonesia, Latin America, India and even the U.S.[26], and in view of the fact that overdependence on construction in macro-economic growth is becoming more difficult, the tempo of Chinese economic growth will have to taper off.

All in all Asia will not be easily divided into two--withered Japan and prosperous China. Japan is a rare country which still enjoys a huge trade surplus vis-à-vis China[27]with its export of machinery and high-tech components and parts. It is true that Japan is rapidly moving its industrial production abroad, but this will make up for the decrease of working-age population in Japan[28]. Japan's revenue in dividends from affiliates abroad already surpasses the amount of trade surplus[29].

The economies of the East-Asian countries are becoming more and more intertwined. Firms of Japan, the U.S., the EU, China, India, South Korea, Taiwan, ASEAN countries have built a close network of division of labor. They may compete with each other, but in some occasions they cooperate with each other, even establishing joint ventures.

Nevertheless, if the Asian economy ever be divided into two, one group would belong to dynamic market economy and the other to stagnant state-oriented economy. As regards the problem of the global imbalances caused by the Chinese large trade surplus will start abating gradually but steadily, when foreign firms look for production platforms for export elsewhere, as the conditions for exports are deteriorating in China.

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[1] The Chinese State Council declared on Nov.9 of 2008 that 4 trillion Yuan will be allocated toward the end of 2010 to stimulate the economy. One third of it will be financed by the budget of the government.

(see: http://www.gov.cn/english/2008-11/09/content_1143763.htm)

[2] In June 2011 the CPI rose by 6.4% as compared to June 2010.

(see:http://www.stats.gov.cn/english/statisticaldata/monthlydata/t20110719_402740495.htm)

[3] An objective picture about the realty market prices is very hard to obtain. Christian Science Monitor for example reports on April 15, 2011 that those prices in Beijing rose 8 times in recent 8 years.

[4] Under the umbrella of the stimulus package published on Nov.9 of 2008 the "Local Financial Platforms" (地方融资平台), disguised financial bodies of local governments, actively borrowed money from state banks, and invested the money on development and construction.

About the sum of their total borrowings a spokesman of the People's Bank of China denied the rumors that the amount is around 14 trillion Yuan (2.22 trillion dollars).

(see:http://finance.sina.com.cn/money/future/fmnews/20110713/021910137511.shtml)

Japanese journal "Toa" (「東亜」) reported that the amount was more than 7 trillion Yuan as of the end of 2009 (page 4, April issue in 2010). Even this "smaller" sum corresponds to 15% of the entire lendings (47 trillion Yuan) by all financial institutions in China (from the same URL as above).

[5] Dow Jones Newswires on June 26 reported that the prices of new homes in Beijing plunged 26.7% month-on-month in March, referring to the Beijing News on June 21.

[6] According to 中国统计年鉴 ("China Statistical Yearbook", National Bureau of Statistics of China) 2007, "Investment on fixed assets" occupied 52% (an exorbitantly high level) of the total GDP of China in 2006. The amount of the investment on fixed assets grew by 23.9%.

(See http://www.stats.gov.cn/tjsj/ndsj/)

This means that the growth of the investment on fixed assets counted for as much as 78.5% of the economic growth of China in 2006 (GDP grew by 14.7%). Therefore, if financing of construction and investment be disrupted, it will severely affect the whole economy.

On July 5 of 2011 Asian stocks fell after Moody's Investors Service announced Chinese mainland lenders may hold more problem loans on their books than had been anticipated (Bloomberg on the same day). The next day the Singaporean official investment fund "Temasek Holdings" has sold 3.6 billion US dollars of the stocks of the Chinese main state banks.

[7] In January 2008 a new Labor Law came into force. Now even foreign firms are obliged to grant life-time employment to workers employed for more than ten years.

From Dec.1 of 2010 on all preferential treatments in taxation were to be abolished for the foreign firms in China (Nikkei Newspaper, October 23 of 2010).

Last but not least the gradual appreciation of Yuan coupled with the recent inflation raised the Yuan's rate effectively by more than 10% on annual basis (January 14, 2011, Treasury Secretary Geithner's White House briefing). This will work against the foreign firms which use China as a platform for exports to the U.S.

[8] For 2006. Author's calculation from中国统计年鉴 2007.

[9] The Northern Song Dynasty introduced printed money for the first time in the world history, but it caused inflation and led to its fall in 1127. The same happened with the mighty Yuan Dynasty.

[10] Japan continued two digital GDP growth (in U.S. dollar terms) for about thirty years in 1960s~1980s. China started a similar process in early 1980s.

[11] There is a controversy on who, Britain or India, benefitted more from the British rule.

[12] Zheng He's great voyages made in 1405~1433. According to "Míngshi", the length of the largest ship was about 140 meters.

[13] In order to make up for the decrease of imports from Europe Chinese investors built more than 600 factories in China during 1912~1919.

(page 142 "History of China" volume 5, by Michio Matsumaru and others, Yamakawa Publishing House, Tokyo, 2002.6)

[14] In 2010 the Chinese exports to the U.S. rebounded to the level of 364.9 billion dollars.

[15] See note 1

[16] Subsidy was given for purchasing electric appliances and automobiles. Thanks to this measure the sales of both items went up substantially.

[17] See note 4

[18] The "party-state" is a concept which Sun Yat-sen brought back from the new-born Soviet Union. Sun Yat-sen considered that the one-party dictatorship, in which government, army and economy are directly subjected to one party, would serve best for unification of the country and a quick economic development.

Incidentally, the party-state is very similar to the Chinese imperial rule with strong bureaucracy-- their tradition for more than one thousand years. This system is more congenial for the Chinese than the Western-type democracy.

[19] In December 2003 forty five billion US dollars were transferred from the foreign currency reserves to Bank of China and Construction Bank of China.

(People's Daily, http://j.people.com.cn/2004/01/07/jp20040107_35652.html)

Now, the total sum of the loans to the local real estate "Platforms" is estimated at 7~14 trillion Yuan (1~2 trillion dollars). Even if 50% of these loans become insolvent, it is well below the amount of China's foreign currency reserves.

[20] The Chinese government foresees less than 10% of financial deficit for 2011.

(Japanese "Economist", April 5, 2011, Hidetoshi Tashiro)

[21] At the end of March 2011 it exceeded 3 trillion U.S.dollars. This amount dwarfs the capacity of the IMF.

[22] The capital of the IMF is to be doubled to about 800 billion dollars only in autumn of 2012.

[23] Calculated by the US-China Business Council

(see http://www.uschina.org/statistics/tradetable.html)

[24] In China it is called 国进民退 (state firms go forward as private business goes back)

[25] For example in Chong-Qing the city government is promoting collective performance of old revolutionary songs.

[26] Volkswagen opened a new factory in Chattanooga, Tennessee in May, 2011.

(see http://www.vwjobschattanooga.com/)

[27] Japan's trade surplus vis-à-vis China was 33.1 billion dollars in 2009 and 55 billion dollars in 2010.

(JETRO, see http://www.jetro.go.jp/world/asia/cn/stat_01/)

[28] The Ministry of Health, Labor and Welfare of Japan foresees that the number of working-age population will decrease more than three million during 2004-20025.

(see: http://www.chusho.meti.go.jp/pamflet/hakusyo/h18/H18_hakusyo/h18/html/i3110000.html)

[29] Japan's trade surplus was 12.3 trillion yen in 2007 and 8.0 trillion yen in 2010. The surplus in Japan's income account was 16.3 trillion yen in 2007 and 11.7 trillion yen in 2010.

(MFO's statistics: see http://www.mof.go.jp/international_policy/reference/balance_of_payments/bp_trend/bpnet/sbp/s-1/s-1-1.csv)