Economic Reform ‘Made In China’ – Analysis

By Emre Tunc Sakaoglu

In the aftermath of an era of economic rediscovery and opening, China today stands forth as the fastest growing economy of the world. Questions raised by analysts focus around the blurry conceptions regarding what really constitutes the Chinese model as a unique recipe for rapid development, or what will future bring for China and the rest of the world in the case of continuing Chinese elevation into the ranks of global economic leadership. Whereas alternative scenarios are also decrypted foreseeing China’s development pace reaching a setback or at least getting closer to a halt, thereby underlining the possible repercussions of such latter scenarios for the international system. In any case, China’s current status as a rapidly developing country with a gigantic economy, and its emergence as a more assertive political actor on the international political arena as a result of the economic dynamism generated by a process of reform that is still ongoing in a unique political and economic context, is definitely worth elaborating on.

The Chinese Dilemma

As the 18th Congress of the Communist Party of China (CPC) is approaching, China is at the eve of a new breaking point in the progress of updating its economy in line with the changing global circumstances.[1] When the influential Chinese leader Deng Xiaoping initiated the reform phase behind the scenes and began separating out reformist-minded party officials for higher echelons of central and local bureaucracy between 1978 and his death in 1997 (until when he continued to be an active and influential figure on the decision-making mechanisms); Chinese “market” was overcrowded with heavy-industrial output while consumer goods were still “extinct” for the majority of Chinese populace.[2] These two elements of China’s communist heritage in economic realm are still valid to some extent as China is, although partially, still a producers’ economy rather than a consumers’.

It is true that economic reforms were realized with special emphasis on global markets, foreign demand and international competence with the strong support of Chinese state taken behind; but China’s internal market was largely turned a blind eyed to as a classical example of export-oriented growing model that was also the case in other East Asian economic “miracles”.[3] Household consumption in China, although growing at an unmatched rate of 10 percent since 2009, is still lower than the levels in many developing countries and most OECD countries. While the rates of household consumption correspond to 71 percent and an overall 60 percent of the GDP in the US and high income economies respectively, household consumption in China just passed the level of 40 percent by the end of 2011.[4] And heavy industrial complex in China is over capacitated in various sectors which are favored in loans and credits by the central government, and which are dominated by state owned enterprises (SOEs).[5] Therefore the urgent task of the new government to take the office with the 18th Congress will be to capitalize on either privatizing the current SOEs serving in heavy industrial sector and making tremendous losses, which is an unlikely option as these sectors are rightfully considered “strategically in expendable” by the CCP, or to revitalize the banking system by increasing the interest rates and let some state owned enterprises go bankrupt while letting the “survivors” dominate an oligopolistic market. This will also enable the consumers to receive higher returns and encourage them to spend more.[6]

Another aspect of Chinese economy which is in dire need for reform is the over-reliance on cheap labor and the low rates of multi-factor productivity.[7] Although still nearly half of Chinese population lives in rural parts and many peasants are still flowing to urban centers creating a sufficient supply of unqualified labor force for the new industries to be established, Chinese population is rapidly aging and wages for laborers are increasing as a result of the diminishing supply of labor when compared with the numbers of ten years past.[8] Chinese decision makers are aware of the fact that sustainability of an economy based on continuing investment (by both foreign and national capital owners) owes much to the ability of an economy to circumvent the trap of sticking with cheap labor and low value added products.[9] East Asian tigers of the previous decades also realized that by spreading the benefits of industrialization to the masses through higher education and better wages for all will lead to the emergence of a qualified labor force able to upgrade the productivity rates of the economy and pave the way to high-tech industrialization which is less labor-intensive. And today, as the 12th five year plan foresees, Chinese authorities are next to a threshold of upgrading the quality of the production capabilities of their economy just like Japan, Taiwan and Korea did decades before.[10]

Indeed, China’s multi-factor productivity rates have been on the rise especially since 1990, yielding an overall rate of growth over 4 percent annually until now.[11] This is one of the highest rates of increase witnessed in MFN in recent history and the rate is over all OECD countries’. Nevertheless, there is still a long way to go for China in creating a qualified, well-educated and sufficiently paid labor class if China wishes to avoid an economic downturn resulted by a massive concentration of qualified workers at the coasts with low life standards and an inland peasant class which is becoming less productive (as their share in GDP relatively decreases) and more desperate day by day.[12] Medium to high tech production facilities need to be established in the inner parts of the Chinese landmass if life standards in the coastal urban centers for qualified laborers are to be raised and the inland peasant is to be lifted to the status of workers who do not need to immigrate to coastal regions leaving behind public benefits in his/her home town.[13] Hence while the services sector in coastal cities is going to expand for the limited but steady inflow of laborers from rural areas, inland centers of attraction will create a rear brake in stabilizing and managing the rapid industrialization and upgrading progress of a gigantic country with decreased income gaps and increased opportunities for every citizen. Such a progress will also trigger domestic consumption as the markets in inner regions and the ones in coastal regions will compete on a relatively equal footing while life standards, hence consumption capabilities of workers all around the country will be enhanced.

What should we expect?

It is usual for many analysts to suggest that Chinese economy relies also on exports and that makes Chinese economy fragile as waves in global demand can mark an end to export-based growth, or a banking bubble can put an end to such a path.[14] However, China’s economy differs from the East Asian tigers’ in the sense that its growth is not over-reliant on exports in fact. This is because while calculating the ratio of the income gathered through exports to the GDP, the net revenue from exports is divided to a value added calculation of the overall GDP.[15] But when a value added number that actually corresponds to the real export income of the Chinese economy is divided by a value added GDP, this will yield a ratio of around 10 percent.[16] This means much of the export-oriented work done in China in the name of creating industrial output is no more than assembly work with imported products assembled to be re-exported.

Insofar as such a progress is concerned, we can deduce two things: Chinese economy needs to move up the value chain of exports for bringing China a regular income in the future and those investments of infrastructure and industry are the main source of Chinese growth and not the exports unlike in Japan, Taiwan and Korea. On the other hand, neither a mortgage bubble nor a banking bubble is valid scenarios regarding a future breakdown in Chinese growth. While the loans provided by Chinese banks are risky as they are not market oriented but rather politically guided by the central government such as in the case of Japan and Korea before the Asian Financial Crisis in 1997, most of these credits are provided towards state owned enterprises (SOEs) in energy, heavy industry, metals and rare earth material, and infrastructure.[17] Furthermore, the increasing rate of urban construction and house sales will not create a bubble as at the end, as a Chinese consumer class is newly emerging and most of the rural population is expected in the future to mobilize towards urban centers.[18] At the end of the day, we have a unique model in China that resembles the post-WWII Asian model but that also differs from it in various aspects thereby leaving elbow room for further elaborations and making it harder to predict the future path of its developmental progress.

A double-footed scheme regarding the current challenges and facts facing Chinese economic growth today was outlined above in an endeavor to simplify the basics of Chinese economic reform from its initial phase which was constructed upon a philosophy of “crossing the river while feeling the stones”, in Deng Xiaoping’s words.[19] The idea beneath this vague statement was more of a pragmatic consequence of the very fabric of Chinese economy rather than an all encompassing directive. Regions were destined to move up the value chain through a progress of trial and error as the central authority’s iron fist upheld the strings of the whole economy thanks to the centralized manner in which the system was organized as a wholesale organism.[20] Pilot regions – usually ones with lower risks or that were “expandable” to some extent such as underdeveloped ones – were identified for economic reform and the result of the “experiment” was then reasoned out by decision makers looking at the bigger picture.[20]

Through strict vertical hierarchy and with the help of economic diversity in every region owing much to the distribution of industry throughout regions, China was able to undergo reforms so swiftly until now. And today, China is moving away from such a homogeneous concentration of economic activity throughout the country which once enabled China to replicate exemplary applications in an applied manner. Domestic consumption figures demonstrate the widening discrepancy between each region in terms of income as well.[21] Therefore China will be overwhelmed by over-investment,[22] in unproductive sectors to a lower extent, via an unequal distribution on a region by region basis; if the relevant concern and program of the 12th Five Year Plan are not followed strictly by a conservative government to replace the current one at the end of 2012.

References

1. Eurasia Group Report, China’s Great Rebalancing Act, August 2011.
2. Tisdell, C., “Economic reform and openness in china: china’s development policies in the last 30 years”, Economic Analysis and Policy, Vol. 39, No. 2., September 2009
3. Boltho, A., Weber, M, “Did china follow the east asian development model?”, The European Journal of Comparative Economics, Vol.6, No.2.
4. Bottelier, P., “China’s economy slowly becoming more normal”, International Economic Bulletin (Carnegie Endowment), July 2012, available at http://carnegieendowment.org/2012/07/26/china-s-economy-is-slowly-becoming-more-normal/d0hd
5. Li, W., Fumin, S. & Lei, Z., China’s Economy (Published and delivered by Foreign Ministry of PRC), January 2010.
6. Eurasia Group Report, China’s Great Rebalancing Act, August 2011.
7. OECD Report, China in the 2010s: Rebalancing Growth and Strengthening Social Safety Nets, March 2010.
8. Zhao, C., “What are china’s long-term economic challenges?”, FP Investing Pro, June 2011, available at http://business.financialpost.com/2011/06/30/what-are-chinas-long-term-economic-challenges/
9. Eurasia Group Report, China’s Great Rebalancing Act, August 2011.
10. Boltho, A., Weber, M, “Did china follow the east asian development model?”, The European Journal of Comparative Economics, Vol.6, No.2.
11. OECD Report, China in the 2010s: Rebalancing Growth and Strengthening Social Safety Nets, March 2010.
12. Freeman, C.W. & Yuan, W.J., “China’s new leftists and the china model debate after the financial crisis”. Report of the CSIS Freeman Chair in China Studies, July 2011.
13. Pei, M., “The end of the chinese miracle”, Newsweek, July 2012.
14. Beeson, M., “Developmental states in east asia: a comparison of the japanese and chinese experiences”, Asian Perspective, Vol.33, No.2., 2009.
15. Atli, A., “China and the global financial crisis”, In Bal, I., Demirtepe, T. (ed.), USAK Yearbook of Politics and International Relations. Vol.5, July 2012.
16. Ibid.
17. Ibid.
18. Morrison, W.M., “China’s economic conditions”, Congressional Research Service, June 2012.
19. Jha, P.S., Crouching Dragon, Hidden Tiger: Can China and India Dominate the West (Berkeley, CA: Group West), 2010.
20. Cai, H., Treisman, D., “Did government decentralization cause China’s economic miracle?”, World Politics, January 2007.
21. Ibid.
22. Kroeber, A.R., “Bear in a china shop”, Brookings Institute Webpage, May 2012, available at http://www.brookings.edu/research/opinions/2012/05/22-china-economy-kroeber