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China's obsession with growth.

Since Deng Xiaoping's economic reforms in 1978, China has moved cautiously away from a centrally planned economy. The shift toward a market-oriented economy coupled with conditions conducive to growth prior to its reforms entailed immense economic evolution, and the Chinese economy still remains bullish even in the midst of the global recession.

What is the source of its economic potency, and is China's obsession with growth sustainable in the long run?

From Reform to Growth

The "dual-track" strategy constitutes the core of China's reforms. This strategy allows market and planned tracks to coexist in the pricing system, the enterprise ownership structure, and other areas such as urban and housing reform.

Goods and services were allocated at both market and state-controlled prices based on a cost-plus principle, while the state price was adjusted incrementally until its convergence with the market price. The proportion of planned production of output decreased gradually, steadily liberalizing sectors of the economy. Likewise, both state-owned enterprises (SOEs) and non-state sectors, including private, semi-private enterprises, and foreign joint ventures, drove the high-speed Chinese economy forward. Furthermore, special economic zones (SEZs), mostly the coastal regions, were granted institutional autonomy. Such autonomy allowed for rapid growth, while the interior provinces grew sluggishly.

As a whole, Chinese economic reforms have been widely regarded as a success. Four factors have played a particularly critical role in China's progress according to Wing Thye Woo, Professor of Economics at University of California, Davis, and Yuan Zheng Cao, Deputy Director of the Institute for Economic Systems Management.

China's initial economic structure and conditions were well suited for generating growth. The country's surplus agricultural labor force as well as the absence of large macroeconomic imbalances and a severe external debt crisis--unlike Russia and Poland--allowed China to develop its economy by revitalizing the idle agricultural sector through township and village enterprises (TVEs).

Meanwhile, China's smooth integration into the global economy accelerated the movement of labor into highly productive industries, enabled its purchase of cutting-edge technology, and essentially attracted foreign direct investments.

The high savings rate (23 percent of disposable income in China versus 21 percent in Japan, 18 percent in Taiwan, and 8 percent in the United States (World Bank, 1990)) reduced inflation by preserving macroeconomic balance and social stability.

Lastly, the two disastrous leftist campaigns, the Great Leap Forward (1958-62) and the Cultural Revolution (1966-76) politically exhausted the central party and provided Deng Xiaoping with the power to decentralize economic policy-making.

Challenges and Sustainability

Even with more than two decades of double-digit GDP growth (average growth of 10.3 percent from 1987 to 1997 and 9.5 percent from 1997 to 2007), China still faces structural and social challenges.

"In the big picture, a lot of people are very poor," says Kenneth Rogoff, Professor of Economics at Harvard University. "Coastal regions have been served but the interior of China is still very poor. The big challenge in China is to help spread the middle class across China. Having a more domestic-oriented economy would be very helpful."

Joseph Stiglitz, Professor at Columbia University and Nobel Laureate in Economics, agrees that disparate development and regional income inequality ought to be fixed. He further addressed China's need to find the right opportunities for investment: "The answer [to Chinese economic recovery] is not more consumption ... it's more investment on climate change and for poverty reduction." Growth fueled by the consumption-oriented market loses its momentum quickly; its contribution to the fall of the US economy should send a message to the rest of the world that support for long-term benefits needs encouragement. "If China aspires to the kind of consumption that the US has, the world planet is doomed," Stiglitz added.

Assar Lindbeck, Professor of International Economics at Stockholm University, points at China's export-oriented economy. "It is unlikely that the current 35 percent share of the GDP claimed by exports and the heavy reliance on foreign technology are sustainable in the long run." Especially in times of an economic crisis, a strong domestic market can function as a shield against the impact of a recession, while exports may serve to import the crisis. And Stiglitz added, "This crisis should be the impetus to ... move away from the export-led model." If the export-oriented trend continues, it will create a similar domino effect in the next economic crisis.

Lindbeck also addressed China's three specific and deeply-rooted features that hinder its long-term sustainability: the tension between private ownership of firms and public ownership of assets, corruption, and extensive or resource-consuming growth.

The tension between private entrepreneurship and public sector ownership particularly aggravates the agricultural sector, as "public ownership of land harms the investment incentives for family farms and reduces their chance of consolidating land holdings in order to exploit economies of scale," Lindbeck argued. State-owned banks also run the risk of distorting the allocation of resources by not lending to private firms, thereby disheartening private businesses and discouraging further innovation.

Corruption has been and is expected to continue wielding its influence in the Chinese economy as long as politicians and bureaucrats have regulatory permits and loans to "offer" or "sell" to private firms and owners. As Lindbeck believes, institutional reforms such as decentralization and the elimination of unnecessary regulations are required in the fight against corruption.

Lindbeck also sees China's resource-dependent development strategy as a future hazard: "China's growth would be more efficient if the proportion [of investment] changed in favor of education, including vocational training, which is very poorly developed." Vast consumption of natural resources not only underpins the excessive generation of pollution, but it also precludes the redistribution of these resources into essential social arrangements, such as income security and social services like health care and education, especially among rural citizens. As Lindebck notes, 43 percent of the GDP is allotted to investment in real capital assets in comparison with 4.3 percent investment in human capital.

Stiglitz agrees: "One of the things that separates developed and developing countries is not just the gap in resources but the gap in knowledge. And you have to spend money to create education and research institutions to close that gap in knowledge."

WHAT LIES AHEAD?

Many analysts view China as the world's next economic superpower. But how long will China be able to sustain this obsession with growth before its economy crumbles?

China's efforts and progress over the last quarter decade in reducing extreme poverty is truly remarkable: the World Bank's figures reveal that the population living on less than a dollar-a-day has fallen from 65 to 10 percent, and more than half a billion people have been lifted out of poverty. But the number of poor still remains high by international standards. Whether income disparity is a necessary prerequisite to stable growth or a separate problem in itself is up for debate, but merely assuming that the poor has not felt the trickle-down effect is a dangerous gamble China cannot afford; failure to spread out China's middle class may lead to China's much dreaded nightmare: social unrest and instability.

As China drifts away from its export-dependent model, it is vital to invest in infrastructure, the environment, and education to buttress the domestic market and to foster human capital. It must be emphasized that the consumption-led strategy or resource-consuming growth is not sustainable, and resources must be redistributed for macroeconomic stability and social benefits.

As far as China's domestic market is concerned, "reducing tension over ownership of firms and assets is imperative, because the entry and expansion of small private companies will be increasingly important when China's domestic innovation needs to play a greater role. Thus, for China to gain maximum advantage from private entrepreneurship, it is important to continue shifting the share of financial assets and land holdings out of the public sector," Lindbeck asserts.

Lastly, "If corruption becomes a permanent element of China's economic system, it is likely to both reduce the efficiency of the allocation of resources and damage the legitimacy of private entrepreneurship."

With its eyes fixed at the throne of economic superpower, China now stands as the world's third largest economy after the US and Japan, but what lies ahead is a mystery.

"Everyone's predicting a steep downturn in the growth rate for next year--in the neighborhood of 5 and 7 percent rather than the traditional 9 to 10 percent. There are even forecasters that are predicting zero percent growth in China for next year," Elizabeth C. Economy, C.V. Starr Senior Fellow and Director of Asia Studies, commented.

If anything can be certain, China must not grow for the sake of growing; unless its deep-seated barriers to the evolving economic system are removed, China is unlikely to maintain its momentum of growth in the long term.

Suggested Reading

International Monetary Fund, eds. Transition Economies: How Much Progress? International Monetary Fund, 2001.

Kazmer, Daniel and Michele Konrad. Economic Lessons from the Transition. M.E. Sharpe, Inc, 2004.

Lavigne, Marie. The Economics of Transition. St. Martin's Press, 1999.

Snowdon, Brian. Globalisation, Development and Transition: Conversations With Eminent Economists. Edward Elgar, 2007.

Kevin Eom studies Finance and Information Systems at New York University's Stern School of Business.
COPYRIGHT 2009 Martin Jan Stransky
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Title Annotation:ECONOMICS
Author:Eom, Kevin
Publication:The New Presence: The Prague Journal of Central European Affairs
Geographic Code:9CHIN
Date:Sep 22, 2009
Words:1515
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