The economic slowdown in
China is certainly a matter of great concern for global investors, and the
Chinese people themselves. The Chinese economic experiment has been a bold one
to say the least, and any setback certainly means a lot to a country that strives
to be a major global power. China’s downshifting after decades of double-digit
economic growth has rattled many countries of South America, Africa and
Australia, the economies of which, have in good measure, benefited from
shipping copper, iron ore and other raw materials to China at high prices.
Before delving into the
specific crisis China has been facing, it would be useful to take a broad
overview of the Chinese economy in general. Mao and Zhao en Lai’s ultra-leftist
economic approach, with the Great Leap Forward, resulted in a failure and China
faced famines. Since the 1970s, under the leadership of Deng, China adopted a
more pragmatic, rather than ideological, approach and became more and more open
to the free market, along with the state doing much in the spheres of public
infrastructure and social infrastructure (though the income disparity, though
better than earlier, still remains a topic of concern), a trend that has
persisted till date, with China indeed seeing unprecedented economic growth in
the last few decades. Most observers have come to accept that broadly speaking,
China’s economic rise has indeed been very real, and offers a very interesting
case of some sort of free markets under a dictatorial regime identifying itself
as Communist.
To quote Fareed Zakaria
from his book ‘The Post-American World’ –
“For a regime that is
ostensibly Communist, Beijing is astonishingly frank in its acceptance to
capitalism. I asked a Chinese official once what the best solution to rural
poverty was. His answer: ‘We have to let markets work. They draw people off the
land and into industry, out of farms and into cities. Historically that has
been the only answer to rural poverty. We have to keep industrializing’.”
As noted Indian commentator
Raghav Bahl points out in his book ‘Super Power?: The Amazing Race between
China’s Hare and India’s Tortoise’ –
“Frankly, it’s not too
bizarre to believe that China could be scripting a new economic logic. I would
venture a 50% wager on China actually trumping conventional theory. Why do I
say that? Because by investing on a scale hitherto unknown and untested, China
may have defined a new ‘escape velocity; of capital spending. Traditional
theory says that investment should be ‘sustainable’, that is, it should be
‘matched’ by rising consumption. But what if you pump so much capital into your
economy – similar to putting extra fuel into a rocket – that you ‘escape’ the
gravitational pull of low thresholds? Especially if the bulk of your capital is
spent on infrastructure (roads, railways, schools, hospitals, ports), as
against factories which produce toys and televisions? This could be the Chinese
masterstroke, the single discontinuity which could defeat 200 years of economic
wisdom. Big factories may create over-capacity, but mammoth infrastructure
could trigger higher productivity and the ability to create wealth. So it may
be a fatal mistake to look at China’s investment spree in a single lump of
factories-plus–infrastructure. Perhaps big factories create waste, while big
infrastructure, especially life-enhancing social assets, empowers people. By
rapidly educating your workforce, by brilliantly executing immensely large
projects, by importing expertise and dollars in a shrinking world, you could
create a ‘shower of wealth and productivity’ such that consumption ‘trickles
through’ quickly into the bubble. The sheer scale of your activities could end
up swelling the tide in which everybody and everything rises together; a new
model of ‘tidal wave investing’ could buoy the whole ocean to a much higher
watermark.
China’s final and ultimate
repudiation of conventional theory may be the apparent neutralizing of
democracy. Two hundred years of political economy have taught us that genuine
enterprise and innovation take place only when people are free, when individual
genius soars unfettered. Look around you – America, Europe, Japan, Israel,
South Korea, Brazil, India, Australia, the bulk of world’s wealth resides and
flourishes in a democracy.”
Indeed, while poverty
continues to be a major issue in countries like India and Brazil, poverty
levels have fallen owing to increased and more lucrative employment
opportunities offered by the private sector, and by all impartial accounts, the
standard of living has improved.
Bahl further says-
“Clearly, China is creating
a new economic wisdom which has stood textbook material on its head. It’s
spending unbelievable amounts of capital under an ‘escape velocity’ model as
opposed to the ‘sustainable investment’ theory of conventional economics. It is
using mandated prices of foreign currency, wages and land, as against free
market undiscovered prices.”
China’s economic growth has largely based itself on the
manufacturing sector, but its model of developing the same has been very
different from the mainstream Western model. In the Chinese model, the
objective is to essentially subsidize manufacturing capacity on a very large
scale. This causes the cost of manufacturing to drop below any realistic level,
thus creating international competitiveness. However, this could very quickly
bankrupt the government unless the government turned the export earnings
generated into a credit system for the world. Every economy that overspends
buys from China, and gives China US dollars. China, on the other hand, then
lends the money back to the governments of the countries that buy its goods.
They, in turn, use the money to buy more Chinese goods, and pay China with the
money that China lent them, and then, China lends them the same money again.
The result is the amount of money countries end up owing China goes huge,
China’s subsidized manufacturing gets an endless market, subsidized with the
money others have paid China to borrow it back from China. China’s central bank had
summed it up in the following words in 2004–
“The exchange rate is fully
determined by market supply and demand. The authorities endeavor to manage both
supply and demand in a manner that promotes the stable formation of the
exchange rate mechanism.”
Until 2013, the Chinese
economic logic was undoubtedly supposed to be a new chapter in the study of
public policy, but from 2014 onwards, this creditor model of distorting
international prices to keep the Chinese currency stable has come under
question, with a slowdown in the Chinese economy.
China’s excessive
investment in infrastructure, which is indeed necessary, has led to much public
debt in terms of budget deficits, which has slowed down economic growth.
By March 2014, the media reported that the ratio of the public
debt to the GDP had become extremely problematic (a report then in The
Telegraph, a British newspaper, cited China’s public debt to be 58% of
its £ 5.11 trillion economy), a trend that has still persisted. Also, China has
experimented with giving local bodies considerable role in managing the economy
at the local level, but without having given them the necessary budgetary
allocation. Local-government debt rose to 17.9 trillion yuan ($2.88 trillion)
in June 2013, compared with 10.7 trillion yuan at the end of 2010, according to
China’s National Audit Office.
As of January 2015, the Wall Street Journal reported a decline in
China’s real estate market, mentioning that
“(p)roperty accounts for 25% of China’s gross domestic product when
construction, appliances and related industries are included”. Towards the end
of August 2015, The Economist reported that about
$ 5 trillion had been wiped off global equity markets since the yuan had
devalued earlier that month, that Chinese exports had been falling and that the
stock market had lost more than 40% since peaking in June that year.
The relevant question,
therefore, is whether China can revive its high growth rates. While some
believe the recovery is impossible, many others believe that it can, and that
would entail not economic anarchism, but market forces being allowed to run
their course but with the right kind of regulation to keep the unscrupulous
elements at bay, as we have seen in many countries in the West, which have
managed to generate and sustain considerable income non-disparity as compared
to many countries that tried to follow textbook models of socialism. It has to
be accepted that private competition improves efficiency and generates
productive employment, and any exploitation (also possible in dictatorial
Communist regimes) can be offset by a strong rule of law with a vocal civil
society, which necessitates freedom of expression.
Of course, the Chinese
government would have to give money to foreign countries on credit very carefully,
under the current circumstances of declining growth.
The Chinese government
would undoubtedly have to bring about serious economic policy shifts yet again,
as they did in the days of Deng, and while bringing about an overhaul modifying
much of whatever they had stood for over the last few decades would indeed be
an uncomfortable transition, it would still be necessary. As The Economist puts
it-
“The party wants to make
state-owned firms more efficient, but not to expose them to the full blast of
competition. It would like to give the yuan more freedom, but frets that a
weakening currency will spur capital flight. It thinks local governments should
be more disciplined but, motivated by the need for growth, funnels credit their
way.”
Economist Alex Wolf has
described it as “the Chinese Trilemma” how China seeks to
simultaneously manage capital account opening, exchange rate stability and
monetary policy autonomy. However, the Chinese government has already started
taking some steps in the right direction.
The solution would have to
entail opening the yuan to the foreign exchange market even more. A step in
that direction was indeed taken in the middle of 2015 by scrapping the
loan-deposit ratio lending cap on banks. In July 2015, World Bank chief Jim
Yong Kim announced that China was headed in the right direction in terms of
giving more space to free markets.
The Chinese government had,
nearly two decades ago, massively invested in State owned Enterprises or SOEs.
But these State industries have lately been rocked by the volatile conditions
of the market and reforms are necessary. While many would say that the best
choice would be to move towards a more privatized economy by selling off some
SOEs to the private sector, the government for now is looking at other measures
including selling off part of the companies to the private investors to inject
fresh capital. Another major reform has been the placing of barriers between
the CEO level and their government owners so that the management of the
enterprises functions according to market conditions rather than government
interests. A few mergers between firms producing similar products have taken
place in order to avoid duplication of efforts and better capital support for
future innovations. However, China is still far from being a completely
privatized economy as a lot of the SOEs have strategic importance, which
justifies the reluctance of the government to hand them over to the private
sector.
A major role here has to be
played by provincial governments because out of the two different kinds of
government-owned enterprises, centrally owned and province-owned, the strategic
interests are largely concentrated on the centrally owned ones and many
provinces in China including Shanghai, Guangdong and others have even already
opened many of their enterprises to private investors in a bid to gain more
private capital.
However, the transition is
not going to be very smooth and opening the yuan to the fluctuations of the
foreign exchange market, which has even been partially carried out by the
Chinese government, and giving up the creditor system to whatever extent, will
mean a slow growing economy. However, that’s necessary to make it eventually
bounce back. An overhaul of the revenue-sharing with local government bodies
would also indeed be in order. China would also have to encourage private
entrepreneurship, something in which it lags behind even other developing
countries like India, and take initiatives to incentivise startups.
And it is not as though the
Chinese economy is showing no signs of good health. In 2015,
against the 10%
drop in global trade, China’s exports
had only declined by 1.8%. Chinese e-commerce portal
Alibaba has also made considerable gains of late, implying high consumption.
The Chinese have
demonstrated, over the years, their gritty resilience and it is possible that
this crisis too shall pass; so, it shall be very naïve to assume that their
growth story is now over. However, in facing this economic crisis, China may
have to curtail its geopolitical ambitions like provocatively claiming the
South China Sea. Also, in its infrastructure projects overseas, it should be willing
to engage local stakeholders, especially in volatile regions like parts of
Africa, failing which local angst can backfire on the Chinese, as it has
earlier. Eventually, more economic freedom could, and hopefully, would give way
to more civil liberties and democracy, in the wake of dissent having manifested
itself strongly in places like Wuhan and the limited enfranchisement at the
local level having already come about. This transition could actually be
smoother if the economy is managed well and if the Communist Party can read the
writing on the wall when the time actually comes. That would also have to
entail more autonomy for Tibet and Xingjiang.
The author would like to thank his friend Akash Arora for his
inputs.
Originally published on Khurpi.
