CHINA: PAST, PRESENT & FUTURE by Jeremy Sullivan
The rapid progression of the Chinese economy over the last 30 years has turned the nation into a world superpower, with a population of 1.39bn (2013) and GDP of 8.2tn USD (2012) which is still growing at a rate of 7.7% p.a. (2014). The future of China will have ramifications for not only wider Asia; but the world economy as a whole. In this essay I will firstly look at the rise of China, uncovering the political, economic and social reforms which have shaped this nation. I will then look towards the issues the nation is currently facing. Finally I will address the issues the country will likely face in the future. Adam Smith dispelled the benefits of export led growth through Mercantilism in the 18th century; however the export policies and resulting large and unsustainable current account surplus of China, combined with cheap credit and off balance sheet lending has given rise to under-consumption, asset inflation, financial instability as well as social and resource misallocation. These factors increase the prospect of civil unrest and economic stagnation or worse disintegration, replicating the fate of Japan in the 1980’s (Marroquin 2007). The Chinese Government and corporates must increase domestic investment in education (currently 4% of GPD, below the average of developing countries. Tao Yang 2012) and allow liberal labour flows between urban ‘hukou’ (a household registration system) and agricultural ‘hukou’ in order to increase the standard of living, productivity, family incomes and therefore domestic consumption.
The rise of China
The two fundamental elucidations that led to the rise of China are Globalization and Internal Reforms, financial and social (Huang 2012). In 1978 China was one the poorest countries in the World, with real GDP per capita being only one fourteenth of the U.S. (Zhu 2012). 1978 was a pivotal year in the narrative of the rise of China as it was when the general policy of Gaige Kaifang or “reform and opening up” after the Cultural Revolution ended; post the death of Chairman Mao Zedong in 1976 (Zhu 2012). Market pricing for agricultural production above quotas and decentralisation of local economies, introducing “township and village enterprises” (TVEs) were two of the early reforms. Grain being sold above quotas at market prices increased the agricultural efficiency and aligned incentives, as noted by (Zhu 2012) this reform increased productivity by 47%. The amplified productivity destined these agricultural workers to other sectors. From 1978 to 1984, 49 million or 19% of the work force reallocated from the agricultural sector. As part of the decentralisation programme the majority of the reallocated workers did not move to urban centres but rather set up or went to work in the TVEs. By 2007 employment in the agricultural sector had fallen from 69% in 1978 to 26%. As work in the TVEs and urban centres generated labour productivity that was six times that of the agricultural sector (Zhu 2012) the productivity gains were argued by Zhu to be the most imperative reason for Chinas growth in the first two decades of reform.
Globalisation started when Deng Xiaoping opened up China for foreign investment and created explicit exporting nucleuses which were, by and large; funded with foreign investment. In 2001 China joined the World Trade Organisation (WTO), (Yang 2012). The export driven policies of an artificially low exchange rate and incentives for exporters in the form of preferential loans and tax rebates aligned to make China the powerhouse exporting economy we see today. The large current account surpluses were initially met with similar increases in investment. However, since the mid 2000’s investment has lagged leading to enormous foreign reserves (Yang 2012).
The Issues China currently faces
Li, Li, Wu and Xiong (2012) argue the one of the main challenges for China moving forward is the inevitable end to cheap Chinese labour. Since the 1990’s wages have increased faster than productivity gains, this is shifting Chinas comparative advantage and moving labour intensive industries to lower wage economies such as Vietnam and India. China will have to move to value added production in order to justify the wage increases or risk being priced out of the market. In order for China to compete on the world stage, investment will need to be focussed towards R&D and education (Tao Yang 2012)
As with most countries, China is heavily reliant on its trading partners. However, as China has low domestic consumption (evidence by their consumption to GDP ratio) there is insufficient internal demand to absorb domestic production, leaving China vulnerable to external shocks. The large current account surplus has resulted in the largest accumulation of foreign reserves in the world leaving China susceptible to large losses should rates move against them. The major countries in which China is accumulating reserves from are or have been easing monetary policy, economic theory states if you increase the money supply inflation will result. This inflation will increase nominal rates; all things equal. China, in 2011, held 3.2trillion USD in foreign reserves (Tao Yang 2012) with US inflation currently 2% and the 30 year T-Bill offering a yield 3.16% (22.8.2014). A small increase in inflation or currency appreciation will eliminate any real return for China. I theorise the U.S is inflating their way out of debt.
Labour market migration and inequality between rural and urban ‘hukou’ is one of the mounting pressures within China (Meng 2012). Meng predicts the number of migrants over the next few decades from rural to urban areas could reach 300m, they will need to be housed, clothed, their children educated and work opportunities abundant otherwise China will face civil unrest and increased inequality. Migration within China is still regulated with rural workers being allowed ‘quest’ status in the urban areas. The rural migrants often take the jobs the urban settlers do not wish to do (Meng 2012). This structural segregation threatens to create a social underclass and create labour market distortions and exploitation. Meng notes:
“89 percent of migrant workers are employed as unskilled workers in sales and service or production jobs, while only 40% of urban hukou workers are in this category”.
Migrant children are often denied education at local schools and their parents have little access to unemployment services, healthcare and retirement plans.
The issues China will face in the future
Rebalancing the Chinese economy from export driven growth to consumer led growth is going to provide numerous challenges for China moving forward. The imbalances, rapid credit growth, and social policies most pressing to China in the future have been highlighted herewith.
Inflation and the ‘Shadow Banking Crisis’
Decades of investment into the urban centres has led to the accumulation of billions in off balance sheet financing for companies and infrastructure projects. Some estimate the amount of off balance sheet lending is of a similar size to the regulated on balance sheet lending. Jamil Anderlini wrote in the Financial Times in April 2014
“After the 2008 collapse of Lehman Brothers and the ensuing global crisis, the Peoples Bank of China PBOC ordered the banks to lend indiscriminately in massive amounts to prop up slowing Chinese growth”
The relaxed and unregulated lending has the potential to lead to a liquidity and refinancing crisis, the magnitude of which China has not seen before. 50% of capital flows in China are now unregulated (Anderlini 2014). Current policies of increasing domestic consumption combined with a financial crisis could see interest rates spike as witnesses earlier this year.
“People familiar with the matter said relations between the two bodies (regulators & PBOC) turned especially nasty in June, when the central bank allowed liquidity to dry up in the interbank market. That sent short-term interest rates soaring and confronted investors with the prospect of a Chinese financial crisis for the first time in a decade. China's banks are feeding unwanted assets into the country's "shadow banking system" on an unprecedented scale, reinforcing suspicions that bank balance sheets reflect only a fraction of the actual credit risk lurking in the financial system”(Anderlini 2014).
Resistance to reforms
Some in China view the increasing inequality as a result of reform, increasing the likelihood of resistance to future reforms. The current legislation regarding labour force flows, discriminate against a large part of the population, people in power or currently benefiting from the legislation e.g. urban ‘hukou’ or corrupt government officials will have motivation to resist change. (Zengke 2000)
Increasing wage pressures
Wages in China have been increasing faster than productivity gains since the 1990’s. I predict this will continue in the future, diminishing the comparative advantage of the Chinese labour force. As China transitions to a middle wage economy, pressure will be put on policy makers for an increased standard of living, namely through reduced pollution and increased provisions for education and healthcare.
Many international markets wish for the Renminbi to appreciate, the advantage a low exchange has on an exporting economy is clear, with the ‘Bigmac’ index implying the Chinese currency is undervalued by 44% (2014). Currency speculation and freer capital flows, could appreciate the nominal exchange rate lowering Chinese competitiveness.
Liberal policies have led to reduced poverty in China. In 1990 60% of the population lived below the poverty line, by 2008 that number had fallen to 13% (World Bank 2012).Rising wages have not been dispersed equally, with the rural workers being discriminated against and left behind in the economic progression of China. Without careful management the disparity between rich and poor could lead to civil unrest and political upheaval.
Chinas rampant population explosion during the 1950’s after the Cultural Revolution led to the implementation of the one child policy in 1979. This policy achieved its goal of slowing the population growth but has led to unintended consequences as male children were favoured. The ageing population will put constraints on domestic consumption and healthcare.
In conclusion China is in a transitional phase; much like that of Japan and Korea two decades prior. The augmentation of China has been a leading illustration of neoliberal economic policy and the affects it has on progression. The growing pains apparent pose jeopardies for China and the world going forward. The next chapter of China’s evolution will be one scrutinised closely by the international community. The development of social policies such as healthcare, subsidised education, pensions and welfare that are mutually inclusive to both urban and rural ‘hukou’ will assist the people of China to rebalance the economy. The increasing divide between urban and rural ‘hukou’ has the potential to destabilise the current regime and distinct consideration needs to be given in order to avoid a social underclass and minimise labour market distortions. The suspicions of a ‘Shadow Banking Crisis’ are well justified, as are the apprehensions around inequality and discrimination. Social policy reform and financial reform are required to assist China through this transitional phase, the execution of which will prove delicate and challenging.
This article has been written by Jeremy Sullivan, Authorised Financial Adviser at Hamilton Hindin Greene ltd www.hhg.co.nz
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