China's reserve ratio rises again - interest rates next?

China appears to be set on controlling a potentially overheating economy by restricting the ability of China's commercial banks to lend money. This will have the affect of absorbing liquidity and lowering bank lending (especially for smaller banks).

However, such liquidity tightening methods are rarely used by Western governments as banks have endless methods of getting around such restrictions.

Moreover, such a small increase (even if it is the seventh in a row could be seen as minor tinkering given China's rapid growth (over 11%) and inflation creeping up to 3.3%.

Interest rates will have to rise and the currency appreciate. As we have said before on this blog however, is that domestic consumption needs to increase and savings need to fall - for this to happen requires huge structural and cultural changes with precautionary savings only falling as the social security net widens (which all costs money and requires investment).

The China Daily article gives a decent if badly written overview. Some quotes are included in this post.

China hikes bank reserve ratio to cool investment

The deposit reserve ratio for depository financial institutions will be raised by 0.5 percentage point to 11 percent starting on May 15, the People's Bank of China said in a statement on its website.

That marked the seventh hike in less than a year in addition to three interest rate increases as regulators try to prevent the economy from overheating.

China's economy surged 11.1 percent in the first quarter of this year after growing 10.7 percent in 2006, as shown in official statistics.

Meanwhile, fixed-asset investment countrywide grew a robust 23.7 percent during March, while the consumer price index (CPI), a key indicator of inflation, rose 3.3 percent last month, above the government's three percent target.

In the first quarter, China's commercial banks posted a 16.25 percent growth in loans, up 1.52 percent from the same period last year.

Meanwhile, Zhu noted the reserve ratio hike is a mild control mechanism, compared with an interest rate increase, especially during the current sensitive period leading to the May Day holiday. There has been speculation in the market that the central bank may raise the interest rate before, during or soon after the holiday.

This final quote is telling - expect a rate rise AFTER the May day holiday but not before.

The asset bubbles in China are growing....

Environmental Summary: Trouble ahead

Chinadialogue have an excellent summary article by Orville Schell. The article should be read in its entirety but here are a few quotes:

Cleaning the air with China

This year, China broke a 161-year-old temperature record. The environmental consequences of the country’s breakneck growth are evident, says Orville Schell, and coal is at the heart of the crisis.

In 2000, the U.N. Development Program reported that air pollution was already causing about 400,000 premature deaths a year. It is hardly surprising, as China is home to 16 of the 30 cities with the worst air pollution in the world.

China's State Environmental Protection Administration (SEPA) estimates that sulphur-dioxide (SO2) emissions alone are causing China's GNP an annual loss of 12%, which is about equal to its impressive growth rate.

Last November, China did commit itself to deriving 15% of its energy from renewable sources by 2020 and to cutting the energy consumed per unit of GDP by 20% over five years. But during the first half of last year, Beijing not only failed to meet these targets but had an increase of 8% in energy consumption per unit of GDP. Initial reports from China's massive hydropower facility at the Three Gorges are also underwhelming; it appears that the Yangtze River isn't yet flowing fast enough to keep the turbines turning.

Joseph Stiglitz on China's "new economic model"

An interesting article from Stiglitz on China's new economic model.

Professor Stiglitz is someone who should be listened to and has written excellent books on globalisation.

Globalization and Its Discontents
and
Making Globalization Work: The Next Steps to Global Justice

In this article Stiglitz covers export driven growth, rural-urban migration, social services, environmental problems and US-China relations. This is a well balanced article that makes some interesting points and provides clues as to some likely future scenarios.

China’s New Economic Model

China’s success since it began its transition to a market economy has been based on adaptable strategies and policies: as each set of problems are solved, new problems arise, for which new policies and strategies must be devised. This process includes social innovation . China recognized that it could not simply transfer economic institutions that had worked in other countries; at the least, what succeeded elsewhere had to be adapted to the unique problems confronting China.

Today, China is discussing a “new economic model.” Of course, the old economic model has been a resounding success, producing almost 10% annual growth for 30 years and lifting hundreds of millions of Chinese out of poverty. The changes are apparent not only in the statistics, but even more so in the faces of the people that one sees around the country.

I recently visited a remote Dong village in the mountains of Quizho, one of China’s poorest provinces, miles away from the nearest paved road; yet it had electricity, and with electricity had come not just television, but the internet. While some rising incomes came from remittances from family members who had migrated to coastal cities, the farmers, too, were better off, with new crops and better seeds: the government was selling, on credit, high-grade seeds with a guaranteed rate of germination.

China knows that it must change if it is to have sustainable growth. At every level, there is a consciousness of environmental limits and the realization that the resource-intensive consumption patterns now accepted in the United States would be a disaster for China – and for the world. As an increasing share of China’s population moves to cities, those cities will have to be made livable, which will require careful planning, including public transportation systems and parks.

Equally interesting, China is attempting to move away from the export-led growth strategy that it and other East Asian countries have pursued. That strategy supported technology transfer, helping to close the knowledge gap and rapidly improving the quality of manufactured goods. Export-led growth meant that China could produce without worrying about developing the domestic market.

But a global backlash has already developed. Even countries seemingly committed to competitive markets don’t like being beaten at their own game, and often trump up charges of “unfair competition.” More importantly, even if markets are not fully saturated in many areas, it will be hard to maintain double-digit growth rates for exports.

So something has to change. China has been engaged in what might be called “vendor finance,” providing the money that helps finance the huge US fiscal and trade deficits, allowing Americans to buy more goods than they sell. But this is a peculiar arrangement: a relatively poor country is helping to finance America’s War on Iraq, as well as a massive tax cut for the richest people in the world’s richest country, while huge needs at home imply ample room for expansion of both consumption and investment.

In fact, to meet the challenge of restructuring China’s economy away from exports and resource-intensive goods, China must stimulate consumption. While the rest of the world struggles to raise savings, China, with a savings rate in excess of 40%, struggles to get its people to consume more.

Providing better social services (public health care, education, and nation-wide retirement programs) would reduce the need for “precautionary” savings. More access to finance for small and medium sized businesses would help, too. And “green taxes” – such as on carbon emissions – would shift consumption patterns while discouraging energy-intensive exports.

As China moves away from export-led growth, it will have to look for new sources of dynamism in its growing entrepreneurial ranks, which requires a commitment to creating an independent innovation system. China has long invested heavily in higher education and technology; now it is striving to create world-class institutions.

But if China wants a dynamic innovation system, it should resist pressure by Western governments to adopt the kind of unbalanced intellectual property laws that are being demanded. Instead, it should pursue a “balanced” intellectual property regime: because knowledge itself is the most important input in the production of knowledge, a badly designed intellectual property regime can stifle innovation – as has been the case in America in some areas.

Western technological innovation has focused too little on reducing the adverse environmental impact of growth, and too much on saving labor – something that China has in abundance. So it makes sense for China to focus its scientific prowess on new technologies that use fewer resources. But it is important to have an innovation system (including an intellectual property regime) that ensures that advances in knowledge are widely used. That may require innovative approaches, quite different from intellectual property regimes based on privatization and monopolization of knowledge, with the high prices and restricted benefits that follow.

Too many people think of economics as a zero-sum game, and that China’s success is coming at the expense of the rest of the world. Yes, China’s rapid growth poses challenges to the West. Competition will force some to work harder, to become more efficient, or to accept lower profits.

But economics is really a positive-sum game. An increasingly prosperous China has not only expanded imports from other countries, but is also providing goods that have kept prices lower in the West, despite sharply higher oil prices in recent years. This downward pressure on prices has allowed Western central banks to follow expansionary monetary policies, underpinning higher employment and growth.

We should all hope that China’s new economic model succeeds. If it does, all of us will have much to gain.

Chinese Partners, Western Firms and the "Hotel California" effect.

In a series of posts charting the extent of corruption in China and how this affects Western companies comes an excellent summary article from the always consistent China Law Blog.

In recent economic papers by myself and others it has been shown that corruption has a negative affect on FDI (at the country and regional level) as well as damaging reputation effects (and why of course China likes to keep all publicity about corruption levels to a minimum). This is not, of course, much of a surprise although there is the "speed money" theory where high corruption levels act to attract FDI if the investor believes that well placed bribes can speed up certain processes (and may then even result in increases in economic growth).

It is interesting therefore to get a new perspective - that of the advice given by foreign partners to Western investors/partners.

What is particularly interesting is that the "advice" from the local Chinese firms gives us an excellent glimpse into what is really happening on the ground and the pereived levels of corruption from locals.

This is in no way is meant to encourage Western firms to break the law but what is does show is that Western firms who DO stick closely to their perception of what the law is, are at a competitive disadvantage compared to local Chinese firms who may be taking so-called "short-cuts". Local firms are therefore exploiting local knowledge for economic gain and thus making business harder in China that it would be in a corruption free economy.

The other interesting aspect is what could be called the "Hotel California" effect. This is where foreign investment is allowed in with few restrictions, but once there it is made very difficult to leave.

"'Relax,' said the night man,
'We are programmed to receive.
You can check-out any time you like,
But you can never leave!'"

The encouraging bit of this post is that it is clear that lawyers such as those at China Law Blog take Chinese law very seriously AND give the impression that things have been tightened up considerably. This bodes well for China being able to throw off its reputation as a "wild west (or should that be wild east) town"

I have posted this article in full so as not to disrupt the flow of the argument.

Foreign Partners In China Crime Do The Time

Yet another great post by Andrew Hupert over at the Chinese Negotiation/Negotiating in China Blog, entitled, Negotiating in China: Partners in Crime. Post is on how foreign companies must avoid engaging in illegal acts just because asked to do so by their Chinese partner.

Now I know many of you are saying/thinking, "Well, Duh," (which is what I always get from my daughters whenever I say something they deem particularly obvious), but I can assure you foreign business constantly engage in illegal activities in China on the advice of their Chinese partners.

Hupert's post starts out by noting how if an American company with were to ask you to issue a fake receipt, forge a contract or commit fraud, you would almost certainly say "no" and terminate your relationship. But when "many newly arrived westerners are asked to do the same type of things in China . . . a surprisingly large number actually do it."

The post correctly notes how China now has a functioning legal system, at least when it comes to foreigners against whom it does not hesitate to use it:

The days of back-room deals, special favors for connections and outright bribery are largely over for run-of-the-mill transactions. (Ok, there may still be a lot of corruption and back-channel deals at higher levels, but if you are reading this for business entry information then you shouldn’t be dealing with that sort of thing yet.) China has a new legal system that it is very proud of. So proud, in fact, that they are excited about showing it off to their new foreign friends. Trust me, you don’t want to see it close up.

Your Chinese parter will entice you to engage in illegalities by telling you "everyone breaks the rules," "the government expects you to cut corners," "no one does the paperwork," and, "you'll never be caught." Hupert's response to this is eminently sensible:

Well, they don’t, it doesn’t, they do, and you will.

Plenty of Americans evade taxes and break laws in the US, but that doesn’t make it a good idea. You certainly wouldn’t recommend that a newcomer to your town start his new venture by committing fraud and forgery. Well, don’t be that guy in China.

The post then points out THE relevant difference between you and your Chinese partner: he or she is Chinese and you are NOT:

Yes, your local lawyer, accountant and partners have had a ripping success evading the authorities and living by their wits. But that doesn’t mean it will work for you. The Chinese government is very sensitive about foreigners it perceives to be exploiting China or taking advantage of Chinese people – and breaking business laws will put you in that category.

Nearly every month, one of my firm's clients comes to us planning to do something blatantly illegal in China, solely on the instructions of and with assurances from one of its Chinese partners. This happens so often that I have a stock response, which is, "what makes you think Mr. so and so is an expert in Chinese law as it applies to foreigners?" I then ask whether it would make sense for their assistant plant manager here in the United States to be the one giving legal advice to foreign companies doing business in the United States.

The post then goes on to point out that making the money in China and keeping the money you made are two very different things:

Another issue in China is the exit strategy. You may be able to buy the property, you may be able to sell the product – but collecting the money, selling the business and getting the money out are all much different things. You will see the same bureaucrats on the way out that you saw on the way in – so you’d better have all your paperwork.

I found this part of the post particularly interesting because just last week I spoke with a U.S. company owner who kept insisting his million dollar China investment had to have been "completely legal" because the local government knew about it and had done nothing to stop it. My explanation that the governments in China (particularly the local ones) tend to be very liberal in allowing money to come into China but very strict (particularly Beijing) when it comes time for that money to leave China seemed to stun him. This had simply never occurred to him.

I have said it before and I will say it again. In practice, there are essentially two legal systems in China, one for foreign companies and one for domestic companies.

In many ways, figuring out what is legal and what is illegal is easier for foreign companies because those companies need to know only one thing: they must follow the law as it is written. Do this no matter what anyone may say.

China and Production Networks

I am particularly interested in my academic work on the relationship between China and its near neighbours - Malaysia, Thailand, Indonesia, Singapore, Vietnam etc.

From an adjustment perspective, the rise of China provides both an opportunity and a threat. China's growing consumer lead society will demand more products but the intense competition from Chinese firms may lead to import as well as increased competition in their home markets.

This World Bank working paper looks at a related topic - that of production networks across East Asia and the integration of China. The issue above is touched on in the abstract - although Chinese growth has been beneficial it has resulted in some vulnerabilities.

This is not a technically demanding paper and has lots of pictures and simple to understand tables.

Trade Integration in East Asia: The Role of China and Production Networks

MONA HADDAD
World Bank - EASPR March 1, 2007

World Bank Policy Research Working Paper No. 4160

Abstract:
Production networks have been at the heart of the recent growth in trade among East Asian countries. Fragmentation trade, reflected mainly in the trade in parts and components, is expanding more rapidly than the conventional trade in final goods. This is mainly due to the relatively more favorable policy setting for international production, agglomeration benefits arising from the early entry into this new form of specialization, considerable intercountry wage differentials in the region, lower trade and transport costs, and specialization in products exhibiting increasing returns to scale. The economic integration of China has deepened production fragmentation in East Asia, countering fears of crowding out other countries for international specialization. International production fragmentation in East Asia has intensified intraregional trade but has depended heavily on extraregional trade in final goods. While production networks centered on China have contributed significantly to growth in East Asia, they also breed vulnerabilities. They have not automatically led to technology spillovers and have led to an extreme interdependence across East Asian countries.


Keywords: Economic Theory & Research, Free Trade, Trade Policy, Trade Law, Technology Industry

Research Paper: Projections of Chinese Energy Demand in 2020

The news that China is about to takeover the US in terms of its total CO2 emissions (although a mile away from any per capita comparison) it a staple of many a newspaper article.

In the following paper Adams and Shachmurove use an econometric model to predict Chinese energy demand in 2020. The reason for posting this article is that I tend to agree with its conclusions. For all the talk of "increased energy efficiency" this will be drowned by the sheer size of the increase in demand for energy particularly from the increased demand for transport (car ownership).

In economics we tend to talk about scale, composition and technique effects when talking about the environmental impact of growth. Whilst new technology will affect the "technique" so that all cars are cleaner, the size of the scale effect means the sheer number of extra cars will outweigh the technique effect by a considerable margin.

"Projections of Chinese Energy Demands in 2020" PIER Working Paper No. 07-012


Author: F. GERARD ADAMS
Northeastern University - College of Business
Administration
Email: f.adams@neu.edu
Auth-Page: http://ssrn.com/author=144628

Contact: YOCHANAN SHACHMUROVE
City University of New York - Department of
Economics, University of Pennsylvania - Department
of Economics
Email: yshachmurove@ccny.cuny.edu
Auth-Page: http://ssrn.com/author=25958

Full Text: http://ssrn.com/abstract=965431

ABSTRACT: As current trends of Chinese economic growth and motorization continue, its demand for higher efficiency fuels (oil, gas, and electric power) will increase. This, coupled with China's limited domestic production, can translate into a massive demand for energy imports. To predict China's energy demand into 2020, an econometric model of the Chinese energy economy is constructed based on its energy balance. This paper suggests that China's increase demand for energy imports will be most sensitive to increases in motorization rather than economic growth. It can be partially offset by increasing domestic energy production or energy efficiency.

Environmental Roundup: Farm Land Polluted, Water Shortages and Global Warming

Today PlantArk ran 3 stories on China - all with worrying implications for the Chinese economy.

China has not been growing sustainably and today sees the first official response that clearly states that future economic growth is threatened by the affects of global warming.

China Says Ten Percent of Farming Land Contaminated

Over 10 percent of China's farm land is contaminated, threatening the ability of the world's most populous nation to feed itself, the official Xinhua news agency said on Sunday.

Excessive fertilizer use, dirty water and solid waste were among the main pollutants, with heavy metals alone poisoning around 12 million tonnes of grain a year, the report said, quoting the Ministry of Land and Resources.

That pollution caused 20 billion yuan (US$2.59 billion) of annual losses.

In total, around 12.3 million hectares have been damaged, and the country is also losing large amounts of arable land to development as its cities expand, posing a "severe threat" to national food security, Xinhua quoted an unnamed ministry official saying.

China had already announced that agricultural land had shrunk by 306,800 hectares in the first 10 months of last year alone, to a total 121.8 million hectares.

Beijing is trying to halt the outward sprawl of its cities, with a series of restrictions on luxury developments and the use of farmland for housing or industrial zones.

China's Hebei Province Hit by Drinking Water Shortage

Some 500,000 people in China's northern province of Hebei are suffering from a shortage of drinking water following a drought that began late last year, the official Xinhua news agency said on Saturday.

Quoting local water conservation authorities, the agency said more than 200 small reservoirs had dried up in Hebei.

Sources at the provincial bureau of agriculture said the water shortage was affecting farmland in Hebei, one of China's major wheat and corn growing provinces.

It was also affecting hydro-power generation, the news agency said.

Last month it was reported that a drought in southwestern China could continue well into April, affecting nearly 10 million people and 9 million livestock.

China Says Global Warming Threatens Development

Global warming could devastate China's development, the nation's first official survey of climate change warns, while insisting economic growth must come before greenhouse gas cuts.

Hotter average global temperatures fueled by greenhouse gases mean that different regions of China are likely to suffer spreading deserts, worsening droughts and floods, shrinking glaciers and rising seas, the National Climate Change Assessment states.

This environmental upheaval could derail the ruling Communist Party's plans for sustainable development, a copy of the report obtained by Reuters says.

"Climatic warming may have serious consequences for our environment of survival as China's economic sectors, such as agriculture and coastal regions, suffer grave negative effects," the report states.

There is a lot more in this last article. Talking about the report:

The 400-page report was written over several years by experts and officials from dozens of ministries and agencies, representing China's first official response to global warming.

With its mixture of dire warnings and caveats, it bears the markings of bureaucratic bargaining.

On the potential disasters ahead for China:

By the end of the century, glaciers on the Qinghai-Tibet highlands that feed the Yangtze river could shrink by two thirds. Further downstream, increasingly intense rainfall could "spark mud and landslides and other geological disasters" around the massive Three Gorges Dam.

Coastal cities will need to build or strengthen barriers to ward off rising sea levels.

Unless steps are taken, water scarcity and increasingly extreme weather could reduce nationwide crop production by up to 10 percent by 2030. Wheat, rice and corn growing capacity could fall by up to 37 percent in the second half of the century.

"If we do not take any actions, climate change will seriously damage China's long-term grain security," the report states.

So what of the future? It is clear that the Chinese government is increasingly prepared to face up to the impact of China's rapid growth on the environment and is now showing some willingness to act now to prevent far worse (and more costly) disasters in the future.

They key to China's environmental future is for China and the Party to have a clear understanding of the economics - that is to say, the costs of doing nothing now may be severe costs in the future. However, it must be remembered that the cause of global warming today was not China but the West's rapid industrialisation. So whilst China is certainly contributing to future problems, they also have to adapt to the man-made global warming from the developed world.