China: A True Story and the pending danger Since opening up to foreign trade and investment and implementing free-market reforms in 1979, China has been among the world’s fastest-growing economies, with real annual GDP growth averaging up to 9.5% through 2018, a pace described by the World Bank as “the fastest sustained expansion by a major economy in history”
As China’s economy has matured, its real GDP growth has slowed significantly, from 14.2% in 2007 to 6.6% in 2018, and that growth is projected by the IMF to fall to 5.5% by 2024
Now that much has been written, discussed and read about the flourishing Chinese economy, let’s take a close look at the challenges China has on its hand which are seldom reported by the media.
Policies that were employed in the past to essentially produce rapid economic growth at any cost were very successful. However, such policies have entailed a number of costs (such as heavy pollution, widening income inequality, overcapacity in many industries, an inefficient financial system, rising corporate debt, and numerous imbalances in the economy) and therefore the old growth model is viewed by many economists as no longer sustainable.
This appears to indicate that the government accepts and allows the use of free market forces in a number of areas to help grow the economy, but the government still plays a major role in the country’s economic development.
Industrial Policies and State Owned Enterprises (SOE)
China has become one of the world’s most active users of industrial policies and administrations. China’s State Council has said that they currently continue to dominate a number of sectors (such as petroleum and mining, telecommunications, utilities, transportation, and various industrial sectors); and are shielded from competition; and are the main sectors encouraged to invest overseas and dominate the listings at the Chinese Stock Markets.
There are more than 150000 State Owned Enterprises (SOE) at the central and local government level employing about 57 Million people.
China’s SOEs may account for up to 50% of non-agriculture GDP.
One study found that SOE constitutes 50% of the 500 largest manufacturing companies and 61% of the top 500 service sector enterprises.
Not only are SOEs the dominant players in China’s economy, many are quite large by global standards.
Fortune’s 2019 list of the world’s 500 largest companies includes 119 Chinese firms (compared to 29 listed firms in 2007). Of the 119 Chinese firms listed, Fortune identified 80 % of these are SOE. Together, these 80% firms in 2019 generated $8.2 trillion in revenues.
State-Dominated Banking Sector, Excess Credit, and Growing Debt
China’s banking system is largely dominated by state-owned or state-controlled banks. The managers of China’s state banks are drawn from the ranks of the Chinese Communist Party cadre system, which enables the party and government leaderships to exert influence over bank lending. In 2019, the top five largest banks in China in terms of assets were state-owned entities. banks (including the five large state-owned banks), the three government policy banks, joint-stock commercial banks (where government entities are a major stockholder), together accounted for 68.5% of total bank assets in China. Foreign participation in China’s banking system is relatively small accounting for 1.25 % of the total bank assets.
SOE’s are believed to receive preferential credit treatment by Government banks, or private firms must pay higher interest rates or obtain credit elsewhere. The Chinese banking sector is the largest in the world with a total assets of US40.1 Trillion. SOE’s are having a lion's share of the bank advances. It is often estimated that SOE do not repay their loans, which may have saddled the banks with ever increasing non performing loans. Many analysts contend that one of the biggest weaknesses of the banking system is that it lacks the ability to ration and allocate credit according to market principles, such as risk assessment.
China Chengxin International Credit Rating reckons the magnitude of hidden local government debt was roughly $6.5 trillion in 2019, up from about $6 trillion in 2018. This year, analysts at Chengxin International figure it could rise toward $7.2 trillion
The Chinese central government uses the banking system to boost credit in order to help meet its GDP growth objectives. However, China’s debt levels (in both dollars and as a percentage of GDP) have risen sharply within a relatively short time, which some have speculated could spark an economic crisis in China in the future. From 2006 year-end to mid-2016, China’s total non financial sector debt as a percentage of GDP increased from 143% to 254% (up 111 percentage points). In dollars, China’s corporate debt rose from $3 trillion to $17.8 trillion (up $14.8 trillion) and currently greatly exceeds U.S. corporate debt levels. Several observers have warned that China’s credit growth may be too extensive and could undermine future growth by sharply boosting debt levels, causing overcapacity in many industrials (especially extending credit to firms that are unprofitable to keep them operating), contributing to bubbles (such as in real estate), and reducing productivity by providing preferential treatment to SOEs and other government-supported entities.
Local government debt is viewed as a big problem in China, largely because of the potential impact it could have on the Chinese banking system. During the beginning of the global financial slowdown, many Chinese subnational government entities borrowed extensively to help stimulate local economies, especially by supporting infrastructure projects. The Chinese Government has a reported
debt of $5.48 trillion as of 2020. Efforts have been made over the past few years by the central government to restructure local government debt and restrict local government borrowing, with mixed success, according to some press reports, because of pressures on local Government to maintain rapid economic growth
Many economists blame China’s closed capital account for much of China’s debt problems. The Chinese government has maintained restrictions on capital inflows and outflows for many years, in part to control the exchange of its currency, the renminbi (RMB), against the dollar and other currencies in order to boost exports. Many argue the Chinese government’s restrictions on capital flows have greatly distorted financial markets in China, preventing the most efficient use of capital, such as overinvestment in some sectors (such as real estate) and underinvestment in others ( such as services)
Environmental Challenges
China’s economic growth model has emphasized the growth of heavy industry in China, much of which is energy-intensive and high polluting. The level of pollution in China continues to worsen, posing serious health risks to the population. The Chinese government often disregards its own environmental laws in order to promote rapid economic growth. China’s environmental challenges are illustrated by the following incidents and reports.
2018 report by ExxonMobil estimated that China contributed about 60% of the growth in global CO2 emissions from 2000 to 2016, and that its emissions would surpass the combined CO2 levels of USA and EU by 2025
More than 80% of underground water in China is heavily polluted. According to statistics reported by the Chinese media, more than 80% of the underground water in large river basins of mainland China is unfit for drinking or bathing because of contamination from industry and farming.
Air pollution is estimated to contribute to more than 1 million premature deaths in China each year.
The Chinese government has indicated that it is taking steps to reduce energy consumption, boost enforcement of environmental laws and regulations, reduce coal usage by expanding the use of cleaner fuels (such as natural gas) to general power, and relocate high-polluting factories away from large urban areas, although such efforts have had mixed results on the overall level pollution in China . In addition China has become a major global producer of clean and renewable technology In January 2017, the Chinese government said it would spend $361 Billion in renewable energy power generation by 2020.
Corruption and the Relative Lack of the Rule of Law
The relative lack of the rule of law in China has led to widespread government corruption,
financial speculation, and misallocation of investment funds. In many cases, government
“connections,” not market forces, are the main determinant of successful firms in China. Many
U.S. firms find it difficult to do business in China because rules and regulations are generally not
consistent or transparent, contracts are not easily enforced, and intellectual property rights are not
protected (due to the lack of an independent judicial system). The relative lack of the rule of law and widespread government corruption in China limit competition and undermine the efficient allocation of goods and services in the economy. A New York Times article reported that (former) Chinese Premier Wen Jiabao’s family controlled assets worth at least $2.7 billion. One study estimates that between 2001 and 2010 , China was the world's largest source of illicit capital outflows of USD 3.8 Trillion. A 2012 survey by the Pew Research Centre’s Global Attitudes project reported that 50% of respondents said that corrupt officials are a very big problem ( up from 39% in 2008)
Chinese officials often identify government corruption as the greatest threat to the Chinese communist party and the state.
The Chinese government anti corruption watchdog reported that 106,000 officials were found guilty of corruption in 2009. Since assuming office in 2012, Chinese Xi Jinping has carried out an extensive anti corruption drive. China has reportedly sought cooperation with the United States to obtain extradition of 150 alleged corrupt who have fled to the USA. However many analysts contend that the anticorruption campaigns are mainly used to settle political scores with out-of-favor officials. Some analysts contend that President Xi's anti-corruption drive is more about consolidating his own political rather than instituting reforms .
In addition, there are some indicators that the current anti corruption campaign may be having a negative impact on the Chinese economy, due to hesitancy by some local officials to pursue projects they feel will lead to scrutiny from the central government.
Many observers argue that meaningful progress against government corruption cannot occur without greater government transparency, a system of checks and balances, a free press, Internet freedom, and an independent judiciary. In October 2014, China held its fourth Plenum of the 18th Party Conference. The meeting focused on the need to enhance the rule of law in China, but emphasized the leading role of the Communist Party in the legal system.
China maintains a weak and relatively decentralized government structure to regulate economic activity in China. Laws and regulations often go unenforced or are ignored by local government officials. As a result, many firms cut corners in order to maximize profits. This has led to a proliferation of unsafe food and consumer products are being sold in China or exported abroad. Transparency International’s Corruption Perception Index for 2019 ranked China 80th out of 176 countries and territories up from 72nd in 2007.
Demographic Challenges
Many economists contend that China’s demographic policies, particularly its one-child policy (first implemented in 1979), are beginning to have a significant impact on the Chinese economy. For example, according to a McKinsey Global Institute study, China’s fertility rate fell from about 5.8 births per woman in 1964 to 1.6 in 2012. This is now affecting the size of the Chinese workforce.
The existence of a large and underemployed labor force was a significant factor in China’s rapid economic growth when economic reforms were first introduced. Such a large labor force meant that firms in China had access to a nearly endless supply of low-cost labor, which helped enable many firms to become more profitable, which in turn led them to boost investment and production. Some economists contend that China is beginning to lose this labor advantage. According to the Chinese government, the size of its working age population (ages 16 to 59) peaked at 925 million in 2011, but then fell for seven consecutive years to 897 million in 2018. The Chinese government projects that its working age population will drop to 830 million by 2030 and to 700 million by 2050. If these projections prove accurate, the Chinese working age population could drop by 225 million individuals (2011-2050).
The one-child policy has also resulted in a rapidly aging society in China. According to the Brookings Institute, China already has 180 million people aged over 60, and this could reach 20 % by 2020 and 27% by 2030.
With a declining working population and a rising elderly population, the Chinese government will face challenges trying to boost worker productivity (such as enhancing innovation and high-end technology development) and expanding spending on health care and elderly services.
Credits: Wayne M Morrison, Bank for International Settlement , Economist Intelligence Unit , OECD, China National Statistics office , Bloomberg,
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