Wednesday, 23 May 2007

China Untamed - can China control its overheating economy?

The stockmarket "bubble" is merely part of a much larger crisis in China at the moment (although few of those getting very rich, very quickly would call it a crisis including UK pension funds).

The FT yesterday published an excellent article with the by-line "China's Leaders struggle to restrain a surging but unbalanced economy".

There are some real economic and social problems on the horizon for China if the current growth rate continues (and even if it doesn't).

I have not yet posted on the Blackstone deal as $3bn is a mere drop in the forex ocean and is simply being used by China to placate the US in their current negotiations and the upswing in China bashing going on in the US press (substitute China 2007 for Japan in the late 1980s).

In this post I highlight a few of the more pressing issues:


For more than three years, Beijing has shouted from the rooftops that its economy is out of balance: too reliant on exports and investment for growth, with a dangerously high share of output from energy-intensive, polluting heavy industries.

This will not change any time soon - so apart from the environmental issues which are important (see the China category of Globalisation and the Environmentblog), things will not change that quickly.

The immediate problem is the mountain of cash that is rapidly accumulating. You might wonder however, what is the problem with having lots of money? Surely this is a good thing?
In the short term, the problem of managing excess liquidity will only get worse. The latest estimates put the current account surplus for this year as high as $400bn (£203bn, €296bn), or about 12 per cent of gross domestic product. This would be unprecedented for a big country such as China. Surpluses of this magnitude have usually been recorded only by smaller nations emerging from a crisis or by significant oil exporters.

So what is the problem? More on that later - so what has China attempted to do so far?
Given the size of China's challenges, it is no surprise that the measures announced on Friday, the latest in a series of small interest rate and bank reserve ratio requirement increases over the last 12 months, had little impact. Their most immediate target, the stock market, which has more than tripled in the past 18 months despite repeated efforts to talk it down by senior officials, rose by 1 per cent yesterday.

This is similar to the supertanker argument - changing China's direction of travel will take a long time and some seriously strong policies otherwise the trade surplus will continue to grow.

In an interesting paragraph the FT also highlight that China is slipping in some trade protection - this will help create jobs but is a dangerous strategy.
China has been happy to facilitate this trend through protectionism. In a little noticed decision, China in March ended tariff exemptions for nearly 200 kinds of industrial equipment, such as smelting and mining machinery and packing materials, imported for use by local companies. The finance ministry said the 30 per cent tariff had been restored to "create a fair environment for domestic equipment makers to compete with foreign rivals through innovation".

Exports of the output of China's rapidly expanding heavy industries, such as steel, aluminium and chemicals, are also picking up. Overseas sales of finished steel rose by 159 per cent in April year-on-year, according to Macquarie Research. In this case, the surge is partly attributable to manufacturers front-running the government's well-signalled decision, announced yesterday, to tax steel exports, the kind of product that can bring trade tensions to a head.

But if the trade surplus is the problem, neither appreciation of the renminbi nor random administrative measures to restrain exports, such as the ones applied to steel, will be a panacea. China's increased labour productivity alone over the past two years has been enough to wipe out any cost increases - and therefore any decrease in export competitiveness - from the roughly7 per cent appreciation in the renminbi against the dollar since mid-2005. Even if China's currency rose rapidly, the bilateral trade surplus would remain high in any case.

China will witness a significant labour productivity increases in the next few years - this will be China an even more fearsome competitor in international markets.
However, problems remain -
China's spectacular growth rates for the moment are camouflaging the fact that the country and its citizens are getting a lousy return on the billions the country invests and the raw materials they use.

This is crucial - all the foreign reserves have to be parked somewhere. We have posted before on moves to allow investment in riskier assets and not just US paper. However, it still holds that China is getting a poor return for all the capital and resources it is using up. Problems of job creation and inequality will get worse.

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