International | Dec 05 2006
By Greg Peel
Morgan Stanley’s chief economist Stephen Roach has recently visited Beijing to see what’s happening in China first hand. Government policy measures will prove important ahead of strategic consultations with US Treasury Secretary Hank Paulson and a high-level delegation on December 14-15.
Roach notes that the Chinese economic revolution to date has been all about quantity. China’s GDP per capita has more than quadrupled in the past fifteen years, taking it from the tenth largest global economy to the fourth. An annual growth rate of over 10% has been a necessary evil of the transition from state-run to private ownership. Some 60 million workers were displaced since 1997 from state-owned enterprises. Social stability was maintained by allowing runaway private growth.
The worst of this transition is now over. For China, this is timely, as the negative by-products of a quantity-based economy have become formidable. Long dominated by exceptionally rapid gains in export-led industrial activity, the Chinese growth model, notes Roach, has been characterised by open-ended investment spending, undisciplined bank funding, environmental degradation, nearly insatiable demand for oil and other materials, and mounting trade frictions, particularly with the US.
But now China wants to put the brake on quantity, and go for quality. In doing so, it would like economic growth to slow to “just” 7.5%. Paulson has set the stage for bilateral trade talks that cover more than just China’s 25% of the US trade deficit and renminbi valuation.
One area of reform is intellectual property. China needs to clamp down hard on piracy, and it is doing so. This is one measure needed in order to avoid growing protectionist feelings in the US. At the same time, China can turn its attentions to technological developments of its own.
The quality of manufacturing technology is an area that sorely needs addressing. China now boasts seven of the ten most polluted cities in the world, and its water is three times more polluted than the second worst offender – the US. China currently consumes twice as much oil per unit of GDP growth than the rest of the world average, and is rapidly consuming vast amounts of raw materials.
China plans to reduce its oil consumption by 20% by 2010 by various means, and to move away from a “commodity-heavy” growth model by focusing on private consumption. Roach sensed a “heightened sense of awareness” in Beijing. (Investment consultants GaveKal are not convinced. See “Reality Check: China’s Increasing Energy Intensity”, 30.11/06).
Roach was also encouraged by the banking industry. If the economy slows, there will only be a new rash of non-performing loans. In order to alleviate this problem China has to increase the quality of its capital allocation process. This means curtailing investment and loan approval in overheated sectors. Privatisation of the banking industry will lead to greater commercialisation of the business. But China has to move fast in a slowing economy, and Roach found a new sense of urgency.
All of these reforms will increase the quality, but stifle the quantity, of China’s economy. But when growth is running at over 10%, it’s a luxury the government can afford. The five-year plan to reduce growth to 7.5% still leaves a robust economy, but one that is less likely to implode.
Roach worries that increasing protectionism in the US could yet derail China’s plans. However, in Beijing Roach found a greater willingness to pay the price of slower growth. While that may not be great news for various markets – particularly commodities – says Roach: “That’s outstanding news for China and the world as a whole”. A soft landing in China would head off a disastrous one.
Now we just have to see whether China can really do it.
