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Between excitement and dreadful crisis Prof. Markus Taube, Mercator University Duisburg/Germany

Different sides in the economy of “red” China – how to overcome the reform dilemma?
Between excitement and dreadful crisis Prof. Markus Taube, Mercator University Duisburg/Germany

Scarcely a national economy seems to be characterized by so much dynamism and growth euphoria as China’s. While Japan, USA and the EU seem to be caught in serious structural crises, China’s economy has now been expanding for two decades with growth rates that have even eclipsed the German “economic miracle“ of the post-World War II era. In the first quarter of 2003, these amounted in real terms to 9.9 % according to official sources – and, according to Goldman Sachs, to as much as 12.5 %. Exports and direct investments are virtually exploding, with growth rates of some 30 % and 50 %, respectively. Can China be the sheet anchor for a crisis-ridden world economy?

China‘s short-term growth seems indeed to possess a strong moment of inertia. With joining the WTO (World Trade Organization) and the accompanying sweeping abolition of protectionist barriers both on the part of China and the trading partners, the previously existing price structure on the world market has been seriously upset. The present upswing of China‘s economy is due to the restructuring of the global division of labor that it initiated, and hence is largely independent of the economic situation.

Mainland’s role in the world economy
China has accomplished a political and structural change, which has led the country out of its quasi-isolation from the international division of labor back into world economic events. Today, after the EU, the USA and Japan, China is the world‘s fourth largest trader with a share of 5.6 % and 4.9 %, resp., in exports and imports. China is the second-most important exporter of clothing (19 %) and textiles (11 %). At the same time, the country absorbs just under 8 % of the cross-border trade in iron and steel products, 6 % of office and telecommunications equipment, and 5 % of chemical products – and has become a major assembler for PCs (motherboards) and electronics consumer goods.
In 2002, China finally overtook the US, and with an inflow of US$ 53bn has risen to the position of being the most important target for foreign direct investments. For just over ten years, China has been absorbing two to three-times as much direct investment of the entire continent of Africa.
Manufacturing location market
China‘s rapid rise in economical significance is based in the first place on its special qualities as a production location. The People‘s Republic has a worldwide unique twofold comparative cost advantage in labor-intensive production and in certain capital and technology-intensive industries. Key to this phenomenon is the obvious regional disparity within China, which leads to the fact that its “economic miracle“ is confined to a narrow strip of the coast, while the majority of the country remains locked in antiquated structures. The economy is extremely segmentalized, so that individual regions in the coastal area (in particular the Pearl River Delta bordering on Hong Kong) are integrated more in the world economy than in trade with the rest of the mainland.
These distinct regional disparities provide one explanation why China is able to maintain its comparative cost advantage in labor-intensive manufacture, while at the same time building up – with massive support from foreign investors – ultramodern industrial plants in technology and capital-intensive industries. The reason: because the labor costs in the booming coastal area have been kept at a low level for some twenty years by an army of immigrant workers fed from a reservoir of approx. 150 m underemployed persons in the mainly agricultural hinterland to the west.
The factors that make China so interesting as a production location also contribute to its attractiveness as a marketplace. But again: the country is not homogeneous. The majority of its population has only very little purchasing power. According to the World Bank, about 200 m people (19 %) live in poverty. Compared to that, however, in industrial agglomeration areas such as Shanghai and the Pearl River Delta are to be found not only the super-rich “transformation profiteers“ so typical of transitional societies, but also considerable population groups living in modest prosperity. Even so, the average disposable income of the population remains at a comparatively low level.
Per capita disposable income in the year 2002
Shenzhen: 2,800 US$
Guangzhou: 1,840 US$
Shanghai: 1,736 US$
Beijing: 1,600 US$
Avg. of 36 major towns: 1,220 US$
China has not yet paid the price for the “economic miracle“ of the past twenty years. Urgently needed structural adjustments in central areas of the national economy have been deferred repeatedly. In the old, centrally planned economic order the banking system and the public enterprise sector represented the pillars of economy. They now stand for the sword of Damocles hanging by a hair over economy and the stability of the whole society. The total lendings of the big commercial banks are burdened with non-performing and non-recoverable loans to the same extent as were the South-East Asian financial players at the time of the breakout of the past crisis. Behind these bad loans stands an army of moribund government-owned enterprises. They are, on one hand, inefficiently run and would not be competitive in a free market, yet on the other hand cannot be closed down or cut off from their financing sources (the commercial banks), because the impact of mass unemployment thereby induced could not be cushioned by an adequate safety net of social benefits.
The Chinese banks and state-owned enterprises are thus fellow sufferers, or companions in misfortune. They have maneuvered into a blind alley from which they can only be led out with the help of radical – painful – measures.
Ailing banks
A reorganization of the banking sector would require expenditure amounting to approx. 30 to 60 % of the GDP (gross domestic product). However, this would only wipe out the existing stock of bad loans from the balance sheets. At the same time, it would have to be ensured that the next bad loans are not immediately accumulated. However, this would mean that loans could not be granted to the majority of the state-owned enterprises, and this would inevitably end up in mass bankruptcy, which would, in addition, lead to a steep increase in undisguised unemployment and to increasing social instability.
The problem of unemployment in China is threefold. First, in the course of privatization of the state-owned into profit-oriented enterprises, there will be a shift from disguised to undisguised unemployment. Second, the abolition of protectionist measures and financial subsidies for enterprises will inevitably bring competitive drawbacks out into the open, which will result in abandoning business models and laying off manpower no longer productively employed. Third, in the next decades a specific demographic structure will become effective on the labor market, and thus China will be forced to create a net eight to nine million new jobs annually, since more workforce will be entering the labor market than there are persons retiring.
Social security and stability system
The volatile nature of the labor market situation is aggravated in its risk potential for social stability by the fact that there is no adequate social insurance system. The changeover, only recently begun, from a company-linked social insurance system to a standard system for society as a whole is still in a very early stage of development. Large sections of the population have not even been statistically recorded yet, and the existing social insurance networks suffer from under-capitalization, and from lack of money due from companies that are unable and unwilling to pay in their prorated social insurance contributions.
Particularly volatile in the medium term will be the situation for old-age pensions, which is facing structural financing problems due to the demographic shift in the age pyramid. According to business consultants McKinsey, the deficit to be borne by the state in the pension insurance fund will reach US$ 15bn in 2005, rising to 110bn in 2010.
Compared to the previous decades, the Chinese government was able to significantly increase its macro-eco-nomic steering capacity at the end of the 1990s. Greater assertiveness vis-à-vis the central, regional and local authorities, the resolving of a far-reaching confrontation between reformers and conservative forces, as well as a distinct improvement in the institutional fundamentals of macro-economic steering have allowed a basic steadying of the economic policy and taken the place of the earlier quick succession of boom and bust periods. This institutional strengthening of the economic-policy steering capacity, however, contrasts with an imbalance between the crisis potential and the resources available for its neutralization.
The most important measure for determining the resources available are the government budget, and, as a scarcity indicator, the national debt. According to official information, China‘s national debt gives no cause for concern. With new borrowings of just under 3 % and a total indebtedness of approx. 23 % of the GDP, China would meet the Maastricht criteria. However, these figures do not give the whole picture. To provide a realistic depiction, the calculation would have to include the liabilities accumulated in the extra-budgetary funds, the depreciation requirements accumulated in the banking sector, the bonds issued for capitalization of the rescue companies assigned to the big commercial banks, the deficit accumulating in the social insurance sector, etc. If this is done, the total indebtedness is clearly in excess of 100 % of the GDP.
The stability dilemma is as follows: banks and state-owned enterprises are caught up in a common destiny and can only be jointly reorganized. The necessary restructuring of these enterprises, however, will aggravate the unemployment problem, and this in turn will put social stability at risk. China‘s entry into the WTO, demographic structures and processes of structural change all contribute to increasing the volatility of the situation at various points. All measures aimed at breaking through this nexus of crises, meaning the rescheduling of bad loans and recapitalization of the banking sector, and building up a social insurance scheme that is able to make massive payouts immediately, will inevitably lead to a significant increase in the national debt and will destabilize society and economy.
Will reform dilemma lead to a crisis?
The reform dilemma is at present being held in check by the uninterrupted expansion of economy. Indeed, it is even conceivable that a crisis could be averted if the country succeeded in growing out of the problems. By stabilizing the problem areas (the total volume of non-performing loans) at the present level, it would be possible, assuming concurrent growth of productive forces and the accumulation of positive assets, to reduce the macro-economic crisis potential, relatively speaking. This would help to gain time until sufficient capacities are available to actively tackle the dilemma.
However, that the crisis will come to a head seems nevertheless more probable than the success of such muddling through. The reason for this lies in a further distortion of the structure data on which China‘s economic growth are based. The enormous dynamism of its export industry and a large part of the inflow of direct investments is based on the fact that China joined the WTO with an undervalued exchange rate (estimated 10 to 40 %), and can, in the medium term, defend this systemic competitive advantage by means of a fixed exchange rate against the US dollar and extensive capital controls. In the longer term, however, such a bad specification of international exchange rates will not be able to be upheld and will force an upward revaluation. This then will inevitably go hand in hand with substantial weakening of the export industry and all export-oriented direct investment involvement. It is at least doubtful whether the domestic economy will be able to make good this loss and prevent a structural crisis caused by depreciation of non-monetary capital.
Flaws and mismanagement
The SARS epidemic has recently exposed further weak points in the success story. The crisis management and, in particular, the highly deficient information policy have made it plain that the demands of many internationally involved enterprises for openness and acceptance of responsibility on the part of the political decision-makers in China are not being met. The government is in decisive measure responsible for the fact that SARS developed into a nightmare, that business operations were massively disturbed and that production targets were missed by a wide margin.
The vision that Credit Suisse had before the outbreak of SARS, that China would in 3 to 5 years account for 70 % of the global electronics production, now seems no longer acceptable. An incident comparable to the SARS epidemic would in such a constellation bring the global supply chain to a complete standstill. Thus, this crisis points quite clearly to the need for a regionally differentiated production structure and negates excessive emphasis on the advantages of agglomeration effects.
(This information was presented first at the sixth PCB technology symposium of the Ruwel AG/Germany.)
EPP EUROPE 409
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11.2023
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