Does China know what it is doing?

By Raz Koroh

There is a lot of confusion surrounding the Chinese economy lately, especially among those watching in the United States and Europe.  At most times, this includes scepticisms about whether the Chinese are “already in the same league” despite China having nominally overtaken Japan as the second biggest economy, and (not so well-known) at purchasing power parity or PPP level overtaken the U.S. economy as the world number one.  These scepticisms are well-founded as in the last several months, China had taken steps that are simply unthinkable in the advanced economies of the U.S., Europe and Japan.

The ‘unthinkable’ actions China had taken include the deliberate interventions of its government using the country’s trillions of dollars-worth of foreign currency reserves to either devalue (twice within six months!) or support the yuan, even trading threats with professional currency speculators like George Soros that the likes of him have no idea who they are dealing with!  This is the kind of brinkmanship that China’s economic managers like to engage in, and it is not a surprise that their critics and friends in Japan and the West are shaking their heads.  Then there is the similar invisible hand intervention in the Shanghai and Shenzen stock markets by using so-called circuit breakers to prevent ‘unacceptable’ volatility in stock price movements.

So does China know what it is doing?  In fact this question is not as important (for China, even though not for the sceptics) as to whether China is taking the right path that can make or break its economic future.  One thing for sure is that events in the past several months indicate that China is now at its own economic crossroad, similar to ones long-trodden before by the U.S., Japan and Europe.

There are several important factors to consider.

ECONOMIC GROWTH.  China’s 2015 growth of 6.9 per cent can be considered the absolute minimum for a country with a population of its size, as anything less will mean unemployment rate will rise.  So China is right to worry when the growth trend is downward every year.  However, it needs to realize that as its developing economy is still global trade-dependent unlike the U.S. or Europe, a slowdown in the advanced consumer-led economies of the U.S. and Europe will naturally mean that there is less trade to be expected with any country, not just China.  Furthermore, as the less advanced countries rely on commodities exports to China, a slowdown in industrial activity in China will mean that those countries will not be importing much from China either.  There is nothing China can do about this and it has to just go along with the economic downturn as everyone else and wait out the bad times.  The last thing that it should do is to devalue its own currency in order to make its exports more attractive compared to others, for such action reveals immaturity and impatience.  Worse of all, such action affects everyone else as countries like Brazil, Mexico and Malaysia will engage in fruitless, competitive devaluations to compete with China!

CONSUMPTION ECONOMY.  In response to its low GDP growth, China suddenly thinks that its present economy is “not sustainable” and that it needs serious tweaking especially by replacing its investment and trade growth strategy with a U.S. style consumption-led economy.  This is a lofty goal and again reveals a complete misunderstanding of the nature of economic growth.  China had a similar lofty goal to overtake the century–old British steel industry from zero within a matter of ten years during the ill-fated Great Leap Forward decade under Mao Zedong.  Now, from the time it joined the World Trade Organization in 2001, Chinese officials expect to transform their economy to not only become the biggest or second biggest in the world, but to also become as advanced as the U.S., Europe and Japan.  And all this within a matter of twenty years (?!), that took the others since the beginning of the industrial revolution in the eighteenth century!  A simple look at current economic data is suffice to reveal this immaturity and impatience – China’s per capita income of US$7,000 will need to grow consistently at 6% per year for the next 13 years in order to reach the US$15,000 minimum level recognized as an advanced economy by the World Bank.  Even then it will only be a third of the current US$45,000 level of the U.S., Japan and Europe.  If China hopes to replace its present investment and trade-led economy with a consumption-led one, it will need a middle class the size of those of the U.S., Japan and Europe combined, and it won’t have this for at least another 30 years even at an annual net GDP growth rate of 6 per cent!  In short, Chinese officials should realize that presently China’s sizeable but comparatively small middle class by itself can only support an annual GDP growth of at most 1 per cent, if it is lucky.  China is still a developing country and it will take many, many decades to become an advanced economy, if it ever gets there.

INVESTMENT PATTERN.  Thus the most important factor for China is where it is heading.  Events of the past several years indicate very clearly that China is experiencing a hallowing out of its core manufacturing industry, and this is due to the facts that coastal China is running out of affordable industrial land and Deng Xiao Ping’s one child policy had resulted in a decreasing working age population over time.  U.S., European and Japanese multinational corporations are already planning to relocate to greener pastures in ASEAN economies, and yet China is still going ahead with its long-term plan to open up the interior and essentially create more of the same manufacturing hubs like in coastal China in the past.  Such short-sightedness reveals a lack of vision and an inability to appreciate that it is no longer a preferred global manufacturing hub besides the ever-growing social unrest caused by ill-treatment of its rural-urban migrant workers in the cities.  In short, China needs to learn from the U.S., Japan and Europe who have experienced similar crossroads in the mid-1980s, and adopt their solutions where possible.

 

A lot of good things can be said about the Chinese economy but a lot more bad things can be said about it at the same time.  Regardless, this is one last chance that China has and if it gets it wrong, it will become an impossible dream – its economy is already matured yet it is still a developing country.  This one looks like a repeat of the Great Leap era all over again.