Is China Ready for 2012?

Damien Ma, 12/29/11

It is appropriate that the year began with the Tiger Mom and closed with an official indictment of the management of the Chinese high-speed rail program. The book ends of this year's China narrative capture the zeitgeist in 2011: the ever fiercer duels between the China bulls and bears. Yes, Amy Chua is American, but her story became instantly linked to the general competitive fears that Americans had about what appeared to be an unstoppable juggernaut -- perhaps one of the most overused nouns in describing China. From raising future Ivy Leaguers to clocking the fastest bullet trains, the Chinese can do it all and with exacting efficiency. It was a year in which many latched onto the China story, many more traveled to China for days or weeks and commented on it, and many used the country as a reflection of America's own debilitating dysfunctions. A "juggernaut" it may be, but China's size is also its curse. The country is no longer under the proprietary province of China specialists -- it is now subject to Saturday Night Live parodies and Gary Shteyngart's literary satire. For better or worse, 2011 saw the democratization of the China narrative.

This debate is due in large part a consequence of this democratization, leading to a proliferation of "takes" on China that make it difficult to separate the good from the bad. Each camp can marshal enough evidence to support their respective cases. To be sure, the China bulls had plenty of ammunition entering into 2011. China was the indisputable growth engine in the wake of the financial crisis, just as the Eurozone was lurching from fiscal to political crises and the U.S. faced abysmal employment figures. Formally assuming the #2 spot in the global economy, China took on some swagger. President Hu Jintao's January state visit in Washington was popularly viewed as a debt-collection exercise (call that the "SNL effect"). I recall watching Hu's motorcade, regaled in Chinese flags, descending Connecticut Avenue as a random passerby quipped, "you know what that means, he's gonna want his money back."

Of course, Hu wasn't asking for his money back and in fact continued to pile China's foreign exchange reserves into U.S. Treasuries as the export sector boomed amid a global downturn. Yet support for an export-led strategy had already waned and was clearly de-prioritized as Beijing finally unveiled its long-awaited 12th Five-Year Plan in March, as I have previously discussed. (Also see here, here, and here.) The rebalancing agenda incorporates a major effort to restructure China's energy landscape, including a commitment to nuclear energy. And so, despite initial concerns over the prospects of China's nuclear program in the immediate aftermath of the tragic Fukushima disaster, China never intended to ditch its ambitious program. The Chinese position lent some cheers for those hoping for a nuclear renaissance.

Things appeared rather swell, even as the perception on China began to shift. For the next several months, China was walloped by investor bears, who overwhelmed the bulls. Few were as colorful as investor guru Jim Chanos in describing China as running on a "treadmill to hell". But the compounded effect of stubbornly high inflation, a clampdown on the property sector, cleaning up the stimulus hangover, a deadly bullet train crash, and embarrassing discoveries of fraudulent Chinese IPOs all made China appear much more wobbly than many had thought. And all of this took place as the Arab Spring reached a crescendo, prompting the arrest of activist Ai Weiwei -- the Liu Xiaobo of 2011 -- and as the mood over Eurozone prospects grew darker than ever. "Pork prices," "ghost cities," "hard landing," "political repression," and "debt-laden local governments" became the watch words for the rest of the year.

So did the Beijing mandarins over-tighten as it was heading into a double dip because of Europe? In other words, was China repeating the mistakes of the 2007-08 period? For markets, China was the remaining leg in the tripod of global growth -- the other two being the U.S. and EU -- and any sputtering of its economic engine could prove disastrous. Beijing responded by signaling a looser fiscal and monetary policy to put a floor on growth, even as it is determined to keep the screws tight on the housing market to prevent another bout of irrational exuberance. Why? Because despite the preference for full-throttle growth by some, the Chinese public still ranked inflation and housing prices as top issues in 2011, according to a recent survey by an influential state think tank (h/t China Smack):

Indeed, nearly 60 percent of respondents believe that inflation was the #1 issue, while housing costs ranked #6. Healthcare and education costs, employment, social security, wealth gap, and corruption all made the top ten. These are largely bread-and-butter issues that have little to do with demanding Western-style political liberalization, though corruption and the income gap would require political solutions. What transpired in "Occupy Wukan" over the last month or so was not an urgent demand for democracy, but is emblematic of the worsening rural-urban divide and local government malfeasance. Wukan alone won't bring down the Chinese government, but the two structural maladies, if left untreated, could, not least because they have before.

That is precisely what the rebalancing agenda seeks to solve. It is meant to rescue the party-state from defeating itself by allowing these problems to fester. I think what I wrote in last year's wrap-up remains valid as we head into 2012:

...But the outstanding question remains whether China's leaders will pursue the right policies with the kind of urgency necessary. Major economic adjustments are usually never pleasant, and most leaders would prefer to minimize the pain on the largest swath of the population possible during that process. The Chinese are no different in this regard, but how much heavy-lifting can they tolerate?

Yu and a similarly reform-minded lot are advocating temerity over timidity, likely in a bid to influence the direction of debate as there are forces inevitably arrayed against them. Plenty of interests in China eschew these changes that will involve taking away some of their wealth, likely prompting a vigorous defense of the status quo...

To me, one of the biggest questions next year is whether China can create the necessary political conditions, amid one of the most important transitions in a decade, to forge ahead with its restructuring. With the anticipated slow down in growth and a shrinking export surplus, there appears to be an opportunity to steer the ship of state in a different direction. Yet with a political leadership still unsettled, I find it hard to be optimistic over the extent of progress next year. But I am fully open to being surprised.

http://www.theatlantic.com/international/archive/2011/12/is-china-ready-for-2012/250162/

Will China Stumble? Don’t Bet on It

STEVEN RATTNER, 12/02/11

HARDLY a day goes by without news of yet another economic problem facing China. A frothy real estate market. Quickly rising wages. A weakening manufacturing sector. Tightening lending standards. The list can seem endless and frightening.

But after a recent visit to China, I remain staunchly optimistic that it will continue to be the world’s greatest machine for economic expansion. While developed countries bump along with little growth, China’s gross domestic product is expected to increase by 9.2 percent in 2011 and an equally astonishing 8.5 percent next year.

The country pulses with energy and success, a caldron of economic ambition larded with understandable self-confidence. Visit the General Motors plant on the outskirts of Shanghai and watch Buicks churned out by steadily moving assembly lines almost indistinguishable from those in plants in Michigan.

That shouldn’t surprise, as G.M. strives for uniformity across its Chinese facilities. Perhaps more startling is that G.M. achieves American levels of productivity, quality and worker safety — with pay that is a small fraction of levels in the United States.

This illustrates China’s great strength: its ability to relentlessly grind down costs by combining high labor efficiency with wages that remain extraordinarily low. At Foxconn’s largest plant, in Shenzhen, 420,000 Chinese earning about $188 per month assemble electronic components for megacustomers like Apple, Hewlett-Packard and Dell.

Often criticized for just being a nation of “assemblers,” China has been increasing the value it adds to exports as more components are produced there. G.M., for example, uses 350 local suppliers.

China’s economic success is colored by its opaque political system, repressive and riddled with corruption. But the unusual mix of authoritarianism and free enterprise should continue to work because of its ability to deliver rising incomes, satisfying a populace that appears more interested in economic advancement than in democracy.

China has a plethora of tasks on its economic to do list, but none are impossibly daunting. Just as in the United States a century ago, jobs are needed for vast numbers of rural migrants moving into cities. Inefficient state-owned companies must be restructured (as they were in recent decades in many European countries). The other evident stresses, like the indisputable property bubble, are manageable and far short of what brought down the American economy.

Meanwhile, an opportunity lurks in China’s seeming inability to create innovative products with international identities. In an era of global corporations, a country that reveres brands, especially luxury ones like BMW and Louis Vuitton but also Starbucks and Häagen Dazs, has yet to give birth to its first.

Lenovo, one of the best-known Chinese companies, has achieved limited success with its 2005 acquisition of IBM’s personal computer business. Astonishingly, Chinese auto companies have the lowest share of their home market of any major country. So China has emphasized building products like ships, where brands don’t matter.

Not unlike the United States in the 19th century, China’s early stage of industrialization has brought with it an unsavory wild West flavor, from cronyism to fraudulent accounting, that justifiably worries investors. But behind those distractions is a country that is investing substantially in its future — about 46 percent of its gross domestic product, compared with 12 percent in the United States.

And while total government debt in China is high — by some estimates, higher than in the United States — much of the Chinese debt was incurred for investment rather than consumption, far better for longer-term growth. Notwithstanding accounts of “roads to nowhere,” China has vastly improved its core infrastructure. Its government arguably does better than ours at allocating capital.

The antipathy of Chinese households toward personal debt (a quarter of homes are bought with cash) has resulted in a savings rate of nearly 40 percent of income, compared with less than 5 percent for Americans.

Underpinned by a reverence for entrepreneurship, China has made starting new businesses easier, paving the way for the accumulation of vast fortunes; there are more billionaires in China than in any country except the United States. (China’s income inequality also rivals that of the United States.)

A gradual move toward reform appears evident. Controls over interest rates, foreign exchange, cooking oil and gasoline, to name a few, are being liberalized. There is even attention to the environment, with tax subsidies for fuel-efficient autos and limits on new-car purchases in the largest cities.

The frustrating mercantilist approach taken by China — it manipulates its currency and trade rules with abandon — has served it well. It has accumulated vast foreign currency reserves ($3.2 trillion and rising) while blocking access to its market and gaining competitive advantages internationally in everything from solar panels to toys. Congressional saber rattling notwithstanding, China is likely to continue to get away with reforming only slowly.

While China hardly lacks challenges, I am betting on its continued success.

Steven Rattner, a contributing writer for Op-Ed, was a counselor to the Treasury secretary and lead auto adviser. He is a longtime Wall Street executive.

http://www.nytimes.com/2011/12/03/opinion/will-china-stumble-dont-bet-on-it.html?_r=1

China's Hard Landing

The state-led growth model is leading the country into trouble.

WSJ Editorial, 12/03/11

The People's Bank of China's surprise announcement Wednesday of a half percentage point cut in banks' required reserve ratio is an admission that the economy is facing stiff headwinds. Consumer price inflation remains relatively high at 5.5%, and the true level of inflation as reflected in the GDP deflator is probably closer to 10%.

Most analysts expected monetary easing to start next year when inflation had subsided further. But then most China analysts were predicting a "soft landing" for the economy. The data in recent days suggest the stagflation trend will continue and the landing may be bumpy.

Property prices have fallen for three consecutive months and the trend is accelerating. HSBC's and the government's own purchasers managers' indices of corporate sentiment took a big tumble in November, falling into negative territory for the first time since early 2009. This time China can't export its way out of its domestic problems, since external demand is shrinking.

China is a poster child for the Austrian school of economics' theory of the business cycle. After undertaking the biggest stimulus program the world has ever seen in response to the global financial crisis, the country is drowning in unproductive investments financed with credit.

The government spent 15% of GDP largely on public works projects in inland regions, financed with loans from the state-owned banks. Investment as a share of GDP soared to 48.5% in 2010, and the M2 measure of money supply ballooned to 140% that of the U.S.

Now comes the hangover. The public works projects are winding down, unleashing a wave of unemployment and an uptick in social unrest. The banks' nonperforming loans are rising, and local governments are insolvent. The country is littered with luxurious county government offices, ghost cities of empty apartment blocks, unsafe high-speed rail lines and crumbling highways to nowhere.

One effect of negative real interest rates was a nationwide bubble in private housing, with the average price of an urban apartment reaching eight times the average annual income. Real estate is the most popular investment for the wealthy, according to a central bank survey in September. Millions of luxury apartments are vacant, even as there is a shortage of affordable housing for the poor.

Property construction became "the most important sector in the universe," in the words of UBS economist Jonathan Anderson. It directly accounts for about 13% of the economy, 20% if one includes related industries like concrete and steel. It also provided 40% of local government revenues through land sales.

Worsening inflation forced the government to put on the brakes this year. As with most property busts, transactions dried up, followed by a free fall in prices. Land prices were down 60% year on year in September. Property developers are slashing prices of new homes to stave off bankruptcy.

Beijing recognizes the dangers of a property bubble and deliberately popped this one by telling banks to cut back loans to developers. The government seems to be determined to force some of the smaller developers to the wall, both to force consolidation in the industry and convince the remaining developers to get on board with the state-run program of building low-income housing.

Earlier this year banking regulators conducted stress tests that supposedly showed the financial system can withstand a 40% fall in property prices. Loans to developers and mortgages account for about 20% of the banks' loan books. But since the health of the wider economy is tied to property, China could face a scenario close to that of the U.S. in recent years. Because the private market for housing was tiny 10 years ago when the current boom began, the country has never experienced a broad-based decline in property prices.

The government and the more sanguine analysts say low-income housing construction will pick up the economic slack, as activity at the top end of the market contracts. The problem is that even if the government meets its goals, the program is still too small to save the economy. Barclays estimates that it will contribute one percentage point to growth in 2011, and 0.5 percentage points in 2012.

There is no easy way to avoid the bust that is coming. The silver lining is that China's increasingly state-led growth model will be discredited, and a debate will begin on restarting the reforms that stalled in the mid-2000s. A financial sector that allocates credit based on politics rather than price signals led China into this mess. Popular pressure to dismantle crony capitalism is building, and the Communist Party would be wise to get in front of it while it can.

http://online.wsj.com/article/SB10001424052970203833104577071901186892744.html

China's Superior Economic Model

The free-market fundamentalist economic model is being thrown onto the trash heap of history.

ANDY STERN, 12/01/11

Andy Grove, the founder and chairman of Intel, provocatively wrote in Businessweek last year that, "Our fundamental economic beliefs, which we have elevated from a conviction based on observation to an unquestioned truism, is that the free market is the best of all economic systems—the freer the better. Our generation has seen the decisive victory of free-market principles over planned economies. So we stick with this belief largely oblivious to emerging evidence that while free markets beat planned economies, there may be room for a modification that is even better."

The past few weeks have proven Mr. Grove's point, as our relations with China, and that country's impact on America's future, came to the forefront of American politics. Our inert Senate, while preparing for the super committee to fail, crossed the normally insurmountable political divide to pass legislation to address China's currency manipulation. Secretary of State Hillary Clinton, former Gov. Mitt Romney and President Barack Obama all weighed in with their views—ranging from warnings that China must "end unfair discrimination" (Mrs. Clinton) to complaints that the U.S. has "been played like a fiddle" (Mr. Romney) and that China needs to stop "gaming" the international system (Mr. Obama).

As this was happening, I was part of a U.S.-China dialogue—a trip organized by the China-United States Exchange Foundation and the Center for American Progress—with high-ranking Chinese government officials, both past and present. For me, the tension resulting from the chorus of American criticism paled in significance compared to reading the emerging outline of China's 12th five-year plan. The aims: a 7% annual economic growth rate; a $640 billion investment in renewable energy; construction of six million homes; and expanding next-generation IT, clean-energy vehicles, biotechnology, high-end manufacturing and environmental protection—all while promoting social equity and rural development.

Some Americans are drawing lessons from this. Last month, the China Daily quoted Orville Schell, who directs the Center on U.S.-China Relations at the Asia Society, as saying: "I think we have come to realize the ability to plan is exactly what is missing in America." The article also noted that Robert Engle, who won a Nobel Prize in 2003 for economics, has said that while China is making five-year plans for the next generation, Americans are planning only for the next election.

The world has been made "flat" by the technological miracles of Andy Grove, Steve Jobs and Bill Gates. This has forced all institutions to confront what is clearly the third economic revolution in world history. The Agricultural Revolution was a roughly 3,000-year transition, the Industrial Revolution lasted 300 years, and this technology-led Global Revolution will take only 30-odd years. No single generation has witnessed so much change in a single lifetime.

The current debates about China's currency, the trade imbalance, our debt and China's excessive use of pirated American intellectual property are evidence that the Global Revolution—coupled with Deng Xiaoping's government-led, growth-oriented reforms—has created the planet's second-largest economy. It's on a clear trajectory to knock America off its perch by 2025.

As Andy Grove so presciently articulated in the July 1, 2010, issue of Businessweek, the economies of China, Singapore, Germany, Brazil and India have demonstrated "that a plan for job creation must be the number-one objective of state economic policy; and that the government must play a strategic role in setting the priorities and arraying the forces of organization necessary to achieve this goal."

The conservative-preferred, free-market fundamentalist, shareholder-only model—so successful in the 20th century—is being thrown onto the trash heap of history in the 21st century. In an era when countries need to become economic teams, Team USA's results—a jobless decade, 30 years of flat median wages, a trade deficit, a shrinking middle class and phenomenal gains in wealth but only for the top 1%—are pathetic.

This should motivate leaders to rethink, rather than double down on an empirically failing free-market extremism. As painful and humbling as it may be, America needs to do what a once-dominant business or sports team would do when the tide turns: study the ingredients of its competitors' success.

While we debate, Team China rolls on. Our delegation witnessed China's people-oriented development in Chongqing, a city of 32 million in Western China, which is led by an aggressive and popular Communist Party leader—Bo Xilai. A skyline of cranes are building roughly 1.5 million square feet of usable floor space daily—including, our delegation was told, 700,000 units of public housing annually.

Meanwhile, the Chinese government can boast that it has established in Western China an economic zone for cloud computing and automotive and aerospace production resulting in 12.5% annual growth and 49% growth in annual tax revenue, with wages rising more than 10% a year.

For those of us who love this country and believe America has every asset it needs to remain the No. 1 economic engine of the world, it is troubling that we have no plan—and substitute a demonization of government and worship of the free market at a historical moment that requires a rethinking of both those beliefs.

America needs to embrace a plan for growth and innovation, with a streamlined government as a partner with the private sector. Economic revolutions require institutions to change and maybe make history, because if they stick to the status quo they soon become history. Our great country, which sparked and wants to lead this global revolution, needs a forward looking, long-term economic plan.

The imperative for change is simple. As Andy Grove pointed out: "If we want to remain a leading economy, we change on our own, or change will continue to be forced upon us."

Mr. Stern was president of the Service Employees International Union (SEIU) and is now a senior fellow at Columbia University's Richman Center.

http://online.wsj.com/article/SB10001424052970204630904577056490023451980.html

China, Inc. Goes Global

Karl P. Sauvant, 11/30/11

NEW YORK – China’s economy is now taking its next great leap forward: parts of its manufacturing sector are now moving up the value-added chain and out of the country. The China challenge is now a global one.

The reasons are not difficult to fathom. Production costs (wages, office rents, land, capital, etc.) in China’s coastal provinces – where most of the country’s manufacturing and service production, as well as foreign direct investment, are located – have been rising fast. Since last year alone, minimum wages in nine of twelve coastal provinces (including Beijing) rose by an average of more than 21%.

At the same time, the renminbi is appreciating, making domestic production of export-oriented goods and services even more expensive. This matters, especially for labor-intensive activities (ranging from toy manufacturing to data-entry services), whether by affiliates of foreign multinational enterprises (which account for more than half of China’s exports) or by local firms, which are losing competitiveness in international markets.

To maintain its export-oriented production base, output must move up the value-added chain, toward more sophisticated products. Multinational enterprises can do that within their integrated global production networks, which allow them to organize an international intra-firm division of labor. Any part of these production chains can be located wherever it suits the firms’ international competitiveness best. And such firms have the experience to scout the globe for the right investment locations.

Domestic Chinese firms, too, need to respond to these pressures. They are helped in this effort by the rapid deepening of China’s skills and technology base. This partly reflects training in foreign affiliates, but the main reason has been the Chinese government’s sustained effort to foster education and training, encourage technology transfers from foreign to domestic firms, and, in particular, to build up research and development capabilities.

In short, producers of more sophisticated goods and services in developed and emerging-market countries need to be prepared for growing competition from China.

At the same time, China’s labor-intensive production will increasingly move to countries with lower labor costs – including Bangladesh, India, Indonesia, and neighboring Vietnam (where Chinese firms have already established about 1,000 affiliates), as well as various African countries. This process has already begun, and has been supported since the beginning of the last decade by the government’s “Going Global” policy, through which it encourages outward FDI from China.

The data bear this out: FDI outflows more than doubled in 2008, to $52 billion, from $23 billion in 2007, and rose even further in 2009 (when world FDI flows collapsed by about 50%, owing to the Western financial and economic crisis), before reaching $68 billion in 2010. Not counting Hong Kong, this made China the world’s fifth largest outward investor that year.

This development creates new opportunities for other developing countries to reap the trade benefits of inserting themselves into the international division of labor. These countries’ investment-promotion agencies – indeed, those of all countries, including developed ones – should increasingly target firms in China to lure them to their shores. In so doing, they should aim not only for big state-owned companies, but also for the rising number of vibrant, private small and medium-size enterprises in China that can be found in all sectors of the economy.

But an important caveat is in order: China has a vast interior that is far less developed than the coastal provinces. The government is making special efforts to develop these areas in the framework of its “Great Western Development Strategy,” including by building modern infrastructure, promoting high-quality education, supporting science and technology (all key determinants of the location of production), and encouraging investment there. As a result, firms based in the coastal provinces that have to move their production (and see no need to diversify away from China) can choose to relocate to China’s interior, rather than going abroad.

The pattern is clear: this sort of transition away from labor-intensive manufacturing happened before in today’s developed countries, when firms headquartered in Europe, Japan, and the United States moved production to developing countries. In Asia, Hong Kong, South Korea, Singapore, and Taiwan were (and have been) among the beneficiaries.

When costs for labor-intensive goods and services became too high in these countries, production was shifted elsewhere. This relocation of manufacturing has since been accompanied by the off-shoring of services whose information-intensive components have become tradable.

China itself has benefited from today’s open international trade and investment regime, which allows firms to locate production where it is most beneficial for their international competitiveness – and is now beginning to shed labor-intensive industries itself.

Governments need policies to adapt to this global shift in production. They should help their countries’ firms to adapt to the departure of some producers by establishing training programs, stimulating innovation, and maintaining or creating a competitive environment that encourages “creative destruction” while providing for a social safety net.

Likewise, governments that attract the production that was shed elsewhere need to have policies in place that enable them to benefit as much as possible from this global shift, thereby furthering their own economic development.

Karl P. Sauvant is Executive Director of the Vale Columbia Center on Sustainable International Investment at Columbia University.

Copyright: Project Syndicate, 2011, www.project-syndicate.org

http://www.project-syndicate.org/commentary/sauvant5/English