Satyajit Das: For China to start all over, the dinosaurs will have to change
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Version 0 of 1. Central to China’s agenda of driving growth through economic reform is a shift from debt-driven investment to consumption. Since the 1980s, investment has risen from 35 per cent of GDP to 45 to 50 per cent. China’s annual infrastructure spend is far greater than that of the US and Europe but also of other emerging markets. It is double that of India and around four times that of Latin America. The country’s investment levels are also running at 10 to 15 per cent of GDP – higher than in comparable countries such as Japan and South Korea at the equivalent stages of their development. In recent years, Beijing has sought to rebalance the share of GDP contributed by consumption and investment, but the task is difficult. First, as the analyst Michael Pettis has repeatedly stated, the level of consumption growth needed to rebalance China is formidable. That rate has not been static, running at around 8 per cent a year over the past decade. But growth in consumer spending has been slower than that in the overall economy and the increase in gross fixed investment – an average annual growth of more than 13 per cent, which resulted in the share of private consumption in GDP falling to 35 per cent from 45 to 50 per cent. If China grows at 8 per cent a year, consumption needs to expand by around 11 per cent (3 per cent above growth) to increase the share of consumption from 35 per cent to 36 per cent of GDP in a year. Assuming a growth rate of 8 per cent and consumption increases of 11 per cent, it would take about five years to increase consumption to 40 per cent of GDP. If growth slows, the difficulty of the task increases. Second, legacy issues of rapid expansion and excessive investment will need to be managed. Many projects have dubious economics and will not generate sufficient revenues to repay the borrowings used to finance them, resulting in potential losses to lenders. Third, boosting consumption will reduce savings, affecting the deposit base and cost of funding at Chinese banks, which will reduce their flexibility in managing rising losses on bad loans. It will also require a significant boost in household income, and this will affect the profitability of Chinese companies, which already operate on thin margins. Fourth, the rebalancing will result in slower growth, at least during the period of transition. A move away from investment-driven growth also requires reform of China’s state-owned enterprises (SOEs). China has around 150,000 SOEs, which control around 50 per cent of industrial assets and employ around 20 per cent of the workforce. SOEs enjoy several advantages. First, key sectors of the Chinese economy are reserved for them, including construction, infrastructure, finance and banking, insurance, resources, media and telecommunications. Second, they have preferential access to finance from state-controlled institutions. Third, SOEs benefit from a range of subsidies and a preferred procurement position for government contracts. Despite these advantages, their profitability lags that of the 4 or 5 million private-sector firms, which are far more important in terms of employment, tax receipts and output. The prominent role played by often unproductive and unaccountable SOEs distorts capital allocation and causes economic inefficiencies. Often, SOEs do not pursue profits or greater efficiency, choosing instead (with tacit government support) to increase size, diversify, undertake foreign acquisition and acquire new technology. This has contributed to a build-up of overcapacity in many industries. Domestic private sector and foreign businesses find it difficult to compete, resulting in higher prices and limited product choice, which must be borne by Chinese citizens. Successive governments recognised the need to reform SOEs. In 1993, the then premier, Zhu Rongji, led a programme under which the number of SOEs was cut by about half, with thousands of loss-making concerns being restructured, sold or privatised; around 40 million workers lost their jobs. Since then the State has reasserted its control of the economy, with SOEs dominating the key sectors. Unsurprisingly, the SOEs oppose any change. Their economic and political power – and their leaders, many of whom hold ministerial rank – may thwart reform. Confucius is reported to have said: “Only the wisest and stupidest of men never change.” For the moment, the Chinese believe it best to maintain the present strategy. History will judge their wisdom. Satyajit Das is a former banker and the author of ‘Extreme Money’ and ‘Traders, Guns & Money’ |