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Robert Lawrence Kuhn: Understanding China’s Economy

Editor: Qian Ding 丨CCTV.com

12-12-2016 10:32 BJT

 

  

By Robert Lawrence Kuhn, a public intellectual, political/economics commentator, and international corporate strategist, also the host of Closer To China with R.L. Kuhn on CCTV News produced by Adam Zhu

How best to understand what is going on with China’s economy? Most people think China’s GDP growth rates. I think GDP growth rates can be misleading.

When the Chinese economy expanded at an annual rate of 6.7 percent in the third quarter of 2016, maintaining the same growth rate as in the first two quarters of the year and thus in line to hit or slightly exceed the government’s full-year target, world markets were pleased. In fact, China is now so important to the global economy, that every time China reports its GDP, world markets holds their collective breath, and if the numbers are in line with expectations, one can almost hear world markets collectively exhale with great relief.

These GDP growth rates are needed to achieve China’s high-profile goal of a “moderately prosperous society” by 2020 (with GDP per capita of about USD 9,000, double the GDP per capita of 2010, which was about USD 4,500. In 2015, GDP per capita was USD 6,416).

But there are concerns. The fear, especially among foreign economists, is that China’s mounting debt, especially corporate debt, is reaching unmanageable levels. Though most Chinese economists are optimistic that the country’s debt is manageable, the fact that the rate of growth of debt well exceeds the rate of growth of GDP means that the current growth model is, over time, not sustainable. Some analysts believe 2016’s better-than-expected growth has been the byproduct of a precipitous expansion in credit, outstripping nominal GDP growth, employed primarily to finance real estate construction and national infrastructure projects. If left unchecked, the increasing debt will increasingly strain the financial system.

In 2016, the IMF released a working paper on China’s debt. It estimated that China's non-financial debts in 2015 stood at 168 trillion yuan (about USD 25 trillion), accounting for 225 percent of GDP. Of that total debt, government debt represents about 40 percent of GDP, while households account for just over 40 percent. Neither is especially high by international standards. Household debt is well below developed and developing Asia standards, but it has been increasing in 2016 with net new mortgage lending this year projected to be more than double that of 2014.

Corporate debt is a different matter: about 145 percent of GDP, which is very high. However, the IMF stated that while China’s risks appear high, they are manageable.

In recent years, as China’s economy has slowed, more defaults have been occurring. Few are buying the official non-performing loan ratio of less than two percent. Because 65% of China's corporate debt is incurred from industries with over-capacities, paying back loans is much more difficult.

Debt is only one of the reasons why GDP growth rates, by themselves, are not sufficient to portray a true picture of China’s economy. To get closer to truth, one must embed other factors, especially China’s long-term economic policies as well as the nature of GDP growth rates themselves.

Regarding the quarterly GDP reports, both the initial anxiety and the subsequent relief are overweighted. Neither is entirely justified. At best, GDP growth rates tell only part of China’s economic story.

Consider the widespread displeasure over China’s slowing growth. How terrible is this? Ten years ago, in 2006, when China’s growth rate was a robust 12.7%, everyone was happy – count on China to drive world economic growth! Now everyone is on edge about China. But consider this: the GDP base is far bigger. In 2005, China’s GDP was $2.3 trillion, and 12.7% growth meant an increase of under $300 billion in 2006. Fast-forward ten years. In 2015, China’s GDP was $11 trillion, and 6.5% growth would mean an increase of over $700 billion in 2016 – more than twice the absolute amount the economy grew in 2006 when the growth rate was that happiness-engendering 12.7%. And since China’s population in 2016 is only marginally more than it was in 2006, the absolute amount of GDP growth per capita will be well more this year than it was a decade ago.

That’s the good news. But there’s complexity, pulling in the opposite direction. What are the components of the growth rate? What sectors are driving it? Investment looms large, so we must ask: how productive are those assets being formed? Massive industrial overcapacity is China’s most serious economic impediment. Debt-fueled investments in fixed assets – particularly via government stimulus programs (needed for economic stability) – have rendered some investments unproductive or even counterproductive (they cost money to maintain).

  

While we cannot know in real time how much unproductive assets are embedded in each year’s GDP growth rate, we do know for sure that some of the growth of past years now sit as overcapacities – coal, iron, steel, cement, glass, heavy equipment, chemicals, housing, etc.

So, on the one hand, the GDP growth rate on a much larger base continues to impress, but on the other hand, some of that growth is unproductive. Yet, there is real growth in consumer products, e-commerce and service industries.

So while short-term prospects are uncertain, long-term prosperity is founded on economic transformation.

Obviously, we need GDP growth rates for standardization and benchmarking, but we should not deify them. It’s no surprise that they dominate discourse. GDP growth rate is a simple, single number, seemingly easy enough to understand. That’s its power. That’s also its problem.

How else to assess the economy? I track China’s national policies, seeking indicators to discern status and progress.

“Supply side structural reform” is critical for reducing overcapacity and corporate debt. Progress in the former could be assessed by, say, an increasing number of corporate bankruptcies – closing down “zombie” enterprises would be a good thing, not a bad thing. It’s no state secret that some state-owned enterprises (SOE) are moribund, and so a leading indicator that the government is willing to make hard choices and endure short-term pain to achieve long-term gain would be an uptick in the number of SOE bankruptcies. Similarly, progress in reducing corporate debt would be an increase in debt-for-equity swaps.

Another indicator is the percentage of non-performing loans (NPL) issued by banks, largely to SOEs. No one takes seriously the official NPL rate of about 1.5%, which is based on narrow definitions. Analysts estimate the real NPL rate to be between 10% and 20%. To me, a positive indicator of economic progress would be an increase in officially reported NPLs, because it would mean that the government is ready to clean up the financial system, which is necessary for sustainable growth.

There is a larger vision. To see future trends, one must look beyond current numbers. China's economy is in historic transition. Opportunities and challenges abound. China’s problems are daunting: slower growth, social imbalances, industrial overcapacity, excessive debt, massive pollution — the list goes on.

How to address such diverse, complex issues? China has an overarching, guiding strategy for economic and social transformation, the highest-level drivers of national policy. According to President Xi Jinping, China's developmental model, going forward, will be driven by “innovation, coordination, green, openness and sharing.” It’s called the "Five Major Development Concepts”.

  

Why these five concepts? How does each work? Why are they amalgamated? Why this order? Moreover, since each of the five concepts is already well-known and commonly prescribed, why now this guiding, integrated strategy?

“Innovative development” is the first of the Five Major Development Concepts, Innovation in the top spot because China needs breakthroughs — incremental improvements are no longer sufficient — and because it signals that China’s leaders are enhancing the role of reform. Reform requires change; change requires doing things differently, and doing things differently requires innovation.

This is the first time that innovation comes first in a theoretical framework; moreover, it encompasses diverse kinds of innovation: obviously in science and technology, but also in management and processes. Innovation is technological, industrial, institutional, and cultural.

But innovation-based businesses are more complex, and less predictable, than business based on low-cost manufacturing. Innovation cannot be top-down commanded. It cannot be bought solely with money. What determines market success is often not obvious — and subtle effects, not in one’s control, can make or break new products or services.

The success rate for innovation is by nature low. This means that an innovation-based economy must accept failure. If all of your ideas work, it means that you have too few ideas. Innovation is a disruptor; it does not respect tradition, seniority or authority. China is committed to innovation. Innovation can change China.

Coordinated development is the second of the Five Major Development Concepts, because in order to optimize economic development, both the efficient allocation of resources and the equitable access to resources are essential.

Historically, from the beginning of reform, China’s single-minded focus on economic growth, necessary at the time, generated inevitable problems — especially imbalances across geographies, sectors and classes — disparities between urban and rural and between eastern/coastal and western/inland. Moreover, economic competition among provinces and cities encouraged inefficient allocation of resources and exacerbated industrial overcapacity.

While China now recognizes that the market must play a “decisive” role, still there are issues, such as when provinces and cities compete with each other by developing similar industries. Other issues requiring coordination include how to integrate diverse regions and how to rebalance urban and rural areas.

That’s why the Chinese government has designated “coordinated development” as a prime policy to optimize economic transformation. Coordinated development means addressing and reducing diverse kinds of imbalances and disparities: it means integrating the developmental planning of richer and poorer areas, such as rural regions of poverty on the outskirts of modern cities; and it means more developed regions helping less developed regions such as Shanghai assisting Qinghai Province in healthcare.

Nationally, coordinated development means comprehensive regional initiatives integrating multiple provinces and cities, such as the Yangtze River Economic Belt and the Beijing-Tianjin-Hebei Province urbanized region. Internationally, coordinated development means the Belt and Road initiative, involving more than 60 countries in infrastructure development.

Coordinated development is especially important in China where provincial rivalries have contributed to industrial duplications and overcapacities. Similar risks remain. The challenge is to get provinces and cities to cooperate as well as to compete in order to optimize development.

Pollution is a scourge in China, the debilitating consequences of unbridled industrial growth. The Chinese people are exceedingly displeased to see their air, water and soil so spoiled, but how can China halt and reverse the devastating pollution without undermining economic growth? For China to become a moderately prosperous society, this question must be answered.

And the Chinese government has responded. For the first time in China’s history, “green development” has been elevated to highest national importance as the third of the Five Major Development Concepts.

Why is “open development” the fourth of the Concepts, —when “opening up” has been the core of China’s policy for almost four decades?

I’ve been visiting China since the late 1980s and I bear witness to China’s historic development. In those ancient days, “opening up” meant allowing foreign capital to manufacture low-cost products with cheap labor. Now that China has become the world’s second largest economy, but facing complex structural problems, such as industrial overcapacity and higher labor costs, a new kind of opening up is required.

  

What exemplifies China’s new kind of opening up? Free trade zones; the Belt and Road initiative; and Chinese companies going abroad — building infrastructure, selling high-speed rail, even buying foreign companies and acquiring technology, management, brands, markets and channels of distribution. By connecting with advanced overseas technologies, management and markets, Chinese companies are creating new kinds of multinational competitors in an increasingly globalized world.

China is not further opening up to please foreigners. China is further opening up because it is a domestic necessity. Opening up today means much more than it meant three decades ago. Now it means making it easier, faster and better to do all kinds of business. This includes private companies entering into industries and sectors previously off limits, like energy and healthcare.

Opening up also means that foreign companies should enter more industries in China, and have fewer restrictions, so that intensified market competition will pressure Chinese companies to innovate and improve. The ultimate winners? Chinese consumers!

China cannot become a “moderately prosperous society” until its economic and social imbalances — particularly between rural and urban areas — are reduced and poverty is eliminated. That’s why “shared development,” the fifth Major Development Concept, is vital.

Sharing is a way of thinking. It begins by taking seriously society’s responsibility for its poorest and most vulnerable members, and it operates at all levels. Locally, shared development means urban areas helping rural areas. Nationally, shared development means developed regions helping less developed regions.

China’s government says that it can effect continuous and robust poverty relief, which requires strategic consistency, because the CPC maintains political power long-term. For example, to help eliminate poverty, the government implemented, in 2009, a series of measures aimed at providing affordable, easy-to-access healthcare services.

Shared development is the last of the Five Major Development Concepts not because it is least important, but because it requires the prior success of the previous four development concepts — innovative, coordinated, green, and open. A society needs robust resources to help its poor.

To assess progress on each of the Five Major Development Concepts, various metrics can be tracked. (None are perfect. All are useful.) Following are examples. Innovation: R&D expenditures (as a percentage of GDP), patents, new technology products and companies. Coordination: differentiated economic plans among integrated geographic regions (heretofore competitive). Green: reports from environmental NGOs. Openness: data from China’s free trade zones, such as shrinking negative lists (industries off limits). Shared: reductions in urban-rural imbalances, lower Gini index (test of inequality).

As China's economy settles into its "new normal," with slower growth and multiple challenges, President Xi calls for market and government, working together, to optimize and balance efficiency and fairness. The government, in Xi's philosophy, is "smart," while the market is "decisive." That’s why his Five Major Development Concepts now informs the thinking and guides the behavior of officials at all levels of government.

For China to fulfill its first comprehensive goal of becoming a “moderately prosperous society” by 2020 — and thus realizing the first part of the Chinese Dream — China’s economy must be restructured, society be rebalanced, and poverty eliminated — and to bring about such transformations, the Five Major Development Concepts are crucial.

So, take note of the quarterly GDP, but watch other indicators as well.

 

 

( The opinions expressed here do not necessarily reflect the opinions of Panview or CCTV.com. )

 

  

Panview offers a new window of understanding the world as well as China through the views, opinions, and analysis of experts. We also welcome outside submissions, so feel free to send in your own editorials to "globalopinion@vip.cntv.cn" for consideration.

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