China: The New Engine Of World Growth?

2003

Dr Deborah Johnson

International business is focussed on China as the new engine driving world growth. This was according to a China Update held in Canberra on 25 September hosted by the China Economic and Business Program at the Australian National University (ANU). The update examined China’s prospects in what is currently a very challenging international economic environment.

Professor Ross Garnaut, Professor of Economics at ANU’s Asia Pacific School of Economics and Government, put things in perspective when he described the past year as being one in which the ‘dogs didn’t bark’. He was referring to the major challenges facing China which turned out not to upset growth: the structural adjustment necessary as a result of China’s entry into the World Trade Organisation (WTO) on 11 December 2002 proved to be not such a big hurdle; China’s leadership transition was made without much fuss; the SARS virus was contained and its damage to China’s economy curtailed through fiscal and monetary stimuli; the security environment has had fewer risks in the climate of Sino-US cooperation since September 11, 2001.

The verdict on China’s massive Keynesian fiscal expansion based on a fixed exchange rate policy was that it has worked despite the Asian financial crisis of 1997/98 and recent US recession. Indeed, China has taken over from the USA as the world’s largest destination of foreign direct investment (FDI) with annual levels exceeding US$50 billion. It is now (in 2002) the world’s 5th largest trading nation after the USA, Germany, Japan, Germany and France (and closely followed by the UK). Since 1996 China has contributed one quarter of the global growth in output and international trade; in the more difficult times since late 2000 it has contributed the whole of growth world-wide.

According to Yiping Huong, Chief Economist for Greater China with the Citigroup in Hong Kong, China may emerge as the global centre for production and trade, though there are some structural problems. China seems set to continue to sustain the GDP growth rate of 7-8 per cent, which it has achieved for the last six years, though this is down from the heady heights of the early 1990s when GDP growth peaked at 14.2 per cent (in 1992). However, this has been generated by continued public sector expenditure (with a fixed asset investment-to-GDP ratio of 42 per cent in 2002 compared with 20-30 per cent in other Asian countries). This has resulted in a dependency on the mobilisation of resources rather than on productivity improvement; rising public debt and contingent liabilities (including a significant level of non-performing loans) in the public banking system, all of which are unsustainable in the longer term. Its external payment surplus may also be more fragile than it looks with expenditure on imports up by 43 per cent in the first seven months of 2003, exceeding export growth of 33 per cent. The attractions of China’s 1.3bn person consumer market may also be more illusory than actual. Because of low profit margins and weak consumer demand, it is not so easy to make money in China. Local concerns over the need for retirement savings because of the lack of a state-guaranteed cradle-to-grave social security system has meant that people are putting money into the bank and not spending. (The savings rate was almost 20 per cent of GDP in 1981, 30 per cent in 1988 and almost 40 per cent in 2001.) Further, mechanisms to convert domestic savings into investments in non-State-Owned Enterprises are weak. A home-grown growth engine, according to Yiping Huong, must be built along with an improvement in investment efficiency and a pick-up in household consumption.

Wing Thye Woo, Professor in Economics from the University of California, suggested investment in infrastructure as a short-term solution to soaking up excess savings, whilst in the longer term the financial sector will need attention. Unemployment remains a problem exasperated by SOE reforms which since 1998 have seen around 27 million workers laid off; surplus rural labour and a relaxation of residency permit rules and their enforcement have resulted in massive rural-urban migration; urban poverty has forced government to make improvements to the social security system; and, less educated and skilled workers in their 40s and 50s are finding it most difficult to find jobs. China’s rapidly aging population is seen in the rising ratio of retired to working people. Distributional issues are also a factor with Eastern China doing better in terms of FDI than Western China, which has in turn done better than Central China. Rural-urban income gaps have widened markedly. Communist Party Members have done better than others in the population in terms of wealth accumulation.

Thus, whilst the continuing outlook for China is strong, there are still some ‘dogs with potential to bark’ that must be attended to if China is to become a sustainable engine for world growth.

WATCHPOINT: Because of China’s current accounts surplus (in particular its bilateral trade surplus with the US), China’s fixed exchange rate policy has recently come under challenge with calls for the yuan to be allowed to appreciate against the US dollar – pressure which China has resisted but which is likely to continue in the lead-up to elections in the US.

 

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