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S P E C I A L R E P O R T
CH I NA ’ S ECONOMY
May 26th 2012
Pedalling prosperity
S PECIALREPORT
C HINA’S ECONOMY
Pedalling prosperity
China’seconomyisnotasprecariousasitlooks,saysSimonCox.
Butitstillneedstochange
C ONTENTS
3 Exports
The retreat of the monster
surplus
5 Investment
Prudence without a purpose
6 Localgovernment
The ballad of Mr Guo
8 Finance
Bending not breaking
8 Crossborderows
Homeric wisdom
10 Shadowbanking
Shades of grey
11 Consumers
Dipping into the kitty
13 Thenextchapter
Beyond growth
IN1886THOMASSTEVENS,aBritishadventurer(picturedabove),seto
onanunusualbicycletrip.HepedalledfromtheowerboatsofGuang
zhouinChina’ssouthtothepagodasofJiujiangabout1,000km(620
miles)tothenorth.Hewasdisarmedbythescenery(thecountrysideout
sideGuangzhouwasamarvellouseldgarden)anddisgustedbythe
squalor(theinhabitantsofonetownwerescrofulous,soreeyed,and
mangy).Hispassagearousedequallystrongreactionsfromthelocals:
fascination,fearandoccasionalfury.Inonespotasoulharrowing
mobpeltedhimwithstones,bruisinghisbodyandbreakingacoupleof
hisbicycle’sspokes.
A centurylaterthebikewasnolongeralientoChina;ithadbecome
symbolicofit.Thebicyclekingdomhadmoretwowheelersthanany
othercountryonEarth.Manyofthosebikeshavesincebeenreplacedby
carsoneobvioussignofChina’srapiddevelopment.Buteventodaythe
bicycleloomslargeinthebattleforChina’ssoul.
ForChina’sfastdiminishingpopulationofpoorpeople,bikesre
mainanimportantbeastofburden,piledhighwithrecycledjunk.For
China’sfastexpandingpopulationofcityslickers,thebicyclerepresents
everythingtheywanttoleavebehind.I’drathercryinthebackofyour
BMW thanlaughonthebackofyourbicycle,asChina’smaterialgirls
say.Somedreamersingovernmentseeareturntothebikeasananswer
toChina’sgrowingproblemsofprosperitypollution,tracandab.
Thecountry’sNationalDevelopmentandReformCommissionwants
governmentocialstocycletoworkonedayaweek,thoughonlyifthe
distanceislessthan3km.
EvenifitisafadingsymbolofChinesesociety,thebicycleremainsa
temptingmetaphorforitseconomy.Bikesespeciallywhenheavilylad
A CKNOWLEDGMENTS
In addition to those quoted in the
text, the author would like to thank
the following for their help in
preparing this special report: Vivek
Arora, Kent Calder, Stephen Green,
Han Gaofeng, Louis Kuijs, Edwin Lim,
Koji Nomura, Jack Rodman, Andrew
Sheng, Michael Spence, Murtaza
Syed, Mark Williams, Xiao Geng and
Wenlang Zhang
A list of sources is at
Economist.com/specialreports
An audio interview with
the author is at
Economist.com/audiovideo/
specialreports
1
TheEconomist
May 26th 2012
1
S PECIALREPORT
C HINA’S ECONOMY
1
The alchemy of China’s growth
China’s GDP growth
% increase on year ago
Contributions to growth, percentage points:
% of GDP:
China
South Korea
Japan
Consumption
Investment
Net exports
Private consumption
Investment
18
90
50
15
80
40
70
12
30
60
9
50
6
20
40
3
10
+
30
0
–
0
3
0
5
10
15
20
25
30
35
40
0
5
10
15
20
25
30
35
40
Years since take-off
Years since take-off
1980
85
90
95
2000
05
11
Source: CEIC
enarestableonlyaslongastheykeepmoving.Thesameis
sometimessaidaboutChina’seconomy.Ifitlosesmomentum,it
willcrash.Andsincegrowthistheonlysourceoflegitimacyfor
therulingparty,theeconomywouldnotbetheonlythingto
wobble.From1990to2008China’sworkforceswelledbyabout
145mpeople,manyofthemmakingthelongjourneyfromitsru
ralbackwaterstoitscoastalworkshops.Overthesameperiod
theproductivityoftheworkforceincreasedbyover9%ayear,ac
cordingtotheAsianProductivityOrganisation(APO).Output
thatusedtotake100peoplein1990requiredfewerthan20in
2008.Allthismeantthatgrowthof810%ayearwasnotaluxury
butanecessity.
Butthepressureiseasing.Lastyeartheranksofworking
ageChinesefellasapercentageofthepopulation.Soontheir
numberwillbegintoshrink.TheminoritywhoremaininChi
na’svillagesareolderandlessmobile.Becauseofthislossofde
mographicmomentum,Chinanolongerneedstogrowquiteso
quicklytokeepup.Eventhegovernmentnolongersees8%an
nualgrowthasanimperative.InMarchitsetatargetof7.5%for
thisyear,consistentwithanaverageof7%overthecourseofthe
veyearplanthatendsin2015.Chinahasbeeninthe
habitofsurpassingthesetargets,whichrepresenta
oornotaceilingtoitsaspirations.Nonetheless
thelowergurewasasignthatthecentrallead
ershipnowseesheedlessdoubledigitgrowth
asathreattostability,notaguaranteeofit.
mandtoChina’sgrowthhasalwaysbeenexaggerated,anditis
nowshrinking.
Itisinvestment,notexports,thatleadsChina’seconomy.
Spendingonplant,machinery,buildingsandinfrastructureac
countedforabout48%ofChina’sGDP in2011.Householdcon
sumption,supposedlythesoleendandpurposeofeconomicac
tivity,accountsforonlyaboutathirdofGDP (seechart1).Itislike
thesmallfarthingwheelbringinguptherear.
A disproportionateshareofChina’sinvestmentismadeby
stateownedenterprisesand,inrecentyears,byinfrastructure
venturesunderthecontrolofprovincialormunicipalauthori
tiesbutnotontheirbalancesheets.Thisinvestmenthasoften
beenclumsy.Inthe1880s,accordingtoStevens,Chinashoweda
scrupulousrespectforindividualrightsandtheeconomyofthe
soil.Theroadhepedalledtookmanywearisometwistsand
turnstoavoidimpingingonanyprivatepropertyorfertileplot.
ThesedaysChina’sroadsrunstraight.Between2006and2010
localauthoritiesopenedup22,000
sqkmofruralland,anareathesize
ofNewJersey,tonewdevelopment.
China’scitieshavegrownfast
erinareathaninpopula
2
HEILONGJIANG
J I L I N
X
I
N
J
I
A
N
G
LIAONING
Thepennyfarthingtheory
Stevens’s1886journeyacrosssouth
eastChinawasremarkablenotonlyforthe
routehetookbutalsoforthebikeherode:a
highwheelerorpennyfarthing,with
anoversizedwheelatthefrontandadimin
utiveoneattherear.Thecontraptionisnot
widelyknowninChina.Thatisapity,be
causeitprovidesthemostaptmetaphorfor
China’shighwheelingeconomy.
Thelargecircumferenceofthepennyfarthing’s
frontwheelcarrieditfartherandfasterthananythingthatpre
cededit,muchasChina’seconomyhasgrownfasterforlonger
thanitspredecessors.Askedtonamethebigwheelthatkeeps
China’seconomymoving,manyforeigncommentatorswould
sayexports.OutsideChina,peopleseeonlytheChinesegoods
thatappearontheirshelvesandthefactoryjobsthatdisappear
fromtheirshores;theydonotseethecitiesChinabuildsorthe
shoppingaislesitllsathome.Butthecontributionofforeignde
Dongsheng
BEIJING
TIANJIN
N
Ordos
(Kangbashi)
Beijing
HEBEI
NINGXIA
SHANXI
SHANDONG
Q I N G H A I
GANSU
JIANGSU
HENAN
SHAANXI
Shanghai
Gushi
T
I
B
E
T
SHANGHAI
Yingxiu
H U B E I
ZHEJIANG
Jiujiang
S I CH UA N
CHONGQING
Wenzhou
Yingtan
HUNAN
FUJIAN
GUIZHOU
Y U N N A N
GUANGDONG
GUANGXI
Guangzhou
Shenzhen
Pearl River
Delta
Hong Kong
Macau
HAINAN
1
Sanya (Phoenix Island)
2
TheEconomist
May 26th 2012
 S PECIALREPORT
C HINA’S ECONOMY
weibo.com/pdfmags
Exports
The retreat of the
monster surplus
China’scurrentaccountsurplusisonthevergeof
extinction
THREEDINOSAURSLURKinaformerfactorydistrictof
Beijing.Brightred,withMadeinChinaembossedon
theirbellies,theylooklikethecheapplastictoysChinaexports
totherestoftheworld.Butthesemodeldinosaursarelifesized,
toweringoverpassersby.Andtheylookhungry.
Thethreebeastsareoneoftheimposinginstallationsatthe
798ArtDistrictinBeijing.SculptedbySuiJianguo,aformerfac
toryworker,theyareimprisonedinthreecages,stackedontop
ofeachother,likethe20footcontainersthatcarrythecountry’s
manufacturestotheworld.Inresin,bronzeandsteel,thesculp
tureembodiesthewidespreadfearthatChina’sexporterswill
gobbleupforeignmarketsandmanufacturers.Whenitwas
madein1999,thecountry’sexportswerelessthanathirdof
America’s.TenyearslaterChinawastheworld’slargestexport
er.OfthetoysshippedtoAmericaandtheEuropeanUnion,
8590%weremadeinChina.
Thecountry’sroaringexportscontributedtoagrowingcur
rentaccountsurplus,whichexceeded10%ofitsGDP in2007(see
chart3,nextpage).China’ssurplusesitsfailuretoimportas
muchasitexported,spendasmuchasitearned,orinvestas
muchasitsavedbecameaneconomic
cause célèbre
,generating
anequallyimpressivesurplusofcommentaryandexplanation.
BenBernanke,nowchairmanofAmerica’sFederalRe
serve,arguedthatChina’ssurpluswasaddingtoaglobalsav
ingsglut.Itwasthesubjectofmuchdebateanddiplomacyat
G20 summits,andtheobjectofmuchblameandmanybillsin
America’sCongress.Thelatestofthose,whichpassedtheSen
ateinOctober,callsforretaliationagainstanycountrythatengi
neersanoversizedsurpluswithanundervaluedcurrency.Mitt
Romney,thepresumptiveRepublicannomineeforpresident,
hasthreatenedtobrandChinaasacurrencymanipulatoronhis
rstdayintheWhiteHouse.
China’stradesurpluswithAmericaremainslargeandcon
troversial,butitscurrentaccountsurpluswiththerestofthe
worldisdyingout.Lastyearitnarrowedto$201 billion,lessthan
Keepthosewheelsturning
tion.Thisrapidurbanisationisabigpartofthecountry’seco
nomicsuccess.Butithascomeataheavypriceindepletednatu
ralresources,adamagedenvironmentandscrupulously
disrespectedpropertyrights.
Theimbalancebetweeninvestmentandconsumption
makesChina’seconomylookprecarious.Acartoonfromthe
1880sunearthedbyAmirMoghaddassEsfehani,aSinologist,
showsaChineseriderlosingcontrolofapennyfarthingand
fallingatonhisface.Avocalminorityofcommentatorsbelieve
thatChina’seconomyisheadingforacrash.InAprilindustrial
outputgrewatitsslowestpacesince2009.Homebuildingwas
only4%uponayearearlier.Thingsarelookingwobbly.
ButChina’seconomywillnotcrash.Likethehighwheeled
pennyfarthing,whichrolledserenelyoverbumpsintheroad,it
isgoodatabsorbingthejoltsinthepathofanydevelopingcoun
try.Thestate’sinuenceovertheallocationofcapitalisthe
sourceofmuchwaste,butithelpskeepinvestmentupwhen
privatecondenceisdown.AndalthoughChina’srepressed
bankingsystemisinecient,itisalsoresilientbecausemostof
itsvastpoolofdepositorshavenowhereelsetogo.
2
Notsofast
Thepennyfarthingeventuallybecameobsolete,super
sededbythemorefamiliarkindofbicycle.Theleapwasmade
possiblebytheinventionofthechaindrive,whichgenerated
moreoomphforeverypedalpush.China’shighwheeling
growthmodelwillalsobecomeobsoleteinduecourse.Asthe
country’sworkforceshrinksandcapitalaccumulates,itssaving
ratewillfallandnewinvestmentopportunitieswillbecome
moreelusive.Chinawillhavetogetmoreoomphoutofitsin
puts,raisingtheproductivityofcapitalinparticular.Thatwillre
quireamoresophisticatednancialsystem,basedonamore
complexsetoflinksbetweensaversandinvestors.
Otherinnovationswillalsobeneeded.China’sstate
ownedenterprisesemergedstrongertoostrongfromthe
downsizingofthe1990s,butthecountry’ssocialsafetynetnever
recovered.Thusevenasthestateinvestslessinindustrialcapaci
ty,itwillneedtospendmoreonsocialsecurity,includinghealth
care,pensions,housingandpovertyrelief.Thatwillhelpboost
consumerspendingbyoeringrainydayprotection.
Thechaindrivewasnottheonlyinventionrequiredto
movebeyondthepennyfarthing.Thenewsmallerwheelsalso
neededpneumatictyrestogivecyclistsasmootherride.Inthe
absenceofstronginvestmenttokeepemploymentupandsocial
unrestdown,China’sstatewillalsoneedanewwaytoprotectits
citizensfrombumpsintheroadahead.
7
1
Safelycaged
TheEconomist
May 26th 2012
3
S PECIALREPORT
C HINA’S ECONOMY
DomesticdemandinChina’sbigtradingpartnershasbeen
slowtorecoverfromthecrisis.China’sownspending,onthe
otherhand,hassurpassedallexpectations.Investmentasa
shareofGDP rosebyoversixpointsbetween2007and2010as
bankslentliberallytohelpstimulatetheeconomy.TheIMF reck
onsthatthisriseininvestmentinitselfaccountedforbetweena
quarterandathirdofthenarrowingofChina’ssurplus.Butit
mayalsohavebeenacontributorycauseofsomeoftheother
factors,suchastheriseincommoditypricesandtheincreasein
Chinesewagesandprices.
2
Less cheap
China’s exchange rate, March 2005=100
140
Internal real exchange rate
130
120
110
Real effective exchange rate
Willitreturn?
Thesurpluscouldwidenagain,foroneoftworeasons.
First,China’shighinvestmentcouldsetthestageforarenewed
exportboom.Second,China’sinvestmentratecouldfalterwith
outconsumptionrisingtomakeupforit,forcingChinatorelyon
foreigndemandtokeeptheeconomymoving.
Toimaginetherstscenario,youonlyhavetoexaminethe
recentpast.PieterBottelieroftheConferenceBoard,athink
tank,arguesthatChina’sbigsurplusesbefore2008owedsome
thingtoaninvestmentboomaroundthetimeChinajoinedthe
WorldTradeOrganisationin2001.Thisinvestmentcreatedex
cesscapacityinindustriessuchascars,constructionmaterials
andespeciallysteel.Atrstthesenewfactoriesdisplacedim
ports;then,whenthedomesticmarketprovedtoosmall,they
oggedtheirsurpluswaresonforeignmarketsinstead.China
wentfrombeinganetimporterofsteelin2004tobeingthe
world’slargestnetexporter,noteBrettBergerandRobertMartin
oftheFederalReserve.
Butarepeatisunlikely.Itwouldre
quireChina’slowconsumptionrateto
movestilllowertomakeroomforso
muchinvestingandexporting.Itwould
alsorequireChinatomakefurtherrapid
gainsinglobalmarketshare.
Thepostcrisisinvestmentboomwasalsodierentfrom
thepostWTO one.Itwasweightedtowardsinlandprovinces,
farfromtheseaportsthatshipChina’sgoodstotherestofthe
world.InlandChina’sshareofxedassetinvestmentmatched
thatofthecoastalprovincesforthersttimein2009,thenex
ceededitin2010.Theinvestmentboomin200910wasalsocon
centratedininfrastructureandproperty.Neithercanbetraded
acrossborders.
Butsomeeconomistsbelievethatthelatestinvestment
boomwillproveunsustainable.Ifconstructioncollapses,some
oftheindustriesthatfedChina’sbuildingrushwillturntheirat
tentionsoverseas,astheydidin2006.
ThefutureofChina’sex
portmonsterthusdependson
whetherChina’shighinvest
mentrateissustainable.Many
thinkitisnot.Economistslike
PaulKrugman,aprofessorat
PrincetonUniversityanda
commentatorforthe
New York
Times
,havegonefrombashing
Chinaforitsunderpricedcur
rencytofrettingaboutitsover
pricedproperty.Itsspectacular
buildingboomhasdiverted
China’senergiesinwards,suck
inginimportsanddisplacing
exports.Ithasthuseasedthe
world’sfearofChina.Butithas
raisedfearsforChina.
7
100
90
2005
06
07
08
09
10
11
12
Sources: Hong Kong Institute for Monetary Research Working Paper; BIS
2
2.8%ofthecountry’sGDP,thesmallestpercentagesince2002.In
moneytermsitwassmallerthanGermany’s.
Isthatsmallenough?TheSenatebillreliesonIMF methods
tocalculateacurrentaccountnormforacountrylikeChina.
Suchcalculationsaremoreartthanscience:oneexercisebythe
EuropeanCentralBankestimatedChina’snorm16,384dierent
ways.ButanunocialstudyusingtheIMF’smethodscalculated
a benchmarkofabout2.9%ofGDP overthemediumterm,
whichsuggestsChina’ssurplusisaboutwhereitshouldbe.
Whetheritremainstheredependspartlyonwhyitnarrowedin
therstplace.Initslatest
World Economic Outlook
,theIMF iden
ThefutureofChina’sexportmonsterdependson
whetherChina’shighinvestmentrateissustainable.
Manythinkitisnot
tiesfourreasons:China’sexchangerate,itstermsoftrade,glo
balspendingandChina’sowninvestmentexpenditure.
China’sexchangeratehasrisen,ifnotasfarorasfastas
manyAmericanshadhoped.Thisappreciationcanbemeasured
invariousways.Themeasuremosteconomistswatchisthereal
eectiveexchangerate(REER)adjustedforconsumerpriceina
tionandweightedbytrade.Thishasgoneupby27%sinceJuly
2005.Analternativegaugeistheinternalrealexchangerate
(IRER),whichmeasuresthepriceofChinesegoodsthatcannot
betradedacrossbordersrelativetothepriceofthingsthatcan.
AccordingtoastudybytheHongKongInstituteforMonetaryRe
search,China’sinternalrealexchangeraterosebyover35%be
tweenJuly2005andDecember2011 (seechart2).Thisapprecia
tionencouragestheChinesetomakemorenontradablegoods
andtobuymoretradableones.Bothhelpnarrowitssurplus.
ThesizeofChina’ssurplusalsodependsonsomevolatile
prices,suchasthecostofcrudeoilandothercommoditiesthat
Chinaimports.ThepriceofChina’simportshasrisenrelativeto
thepriceofitsexportsinrecentyears.AccordingtotheIMF,this
deteriorationinChina’stermsoftradecouldexplainuptohalf
thedropinitssurplusbetween2007and2011.Thosetermsare
unlikelytoimprove.AslongasChinaremainsthedominant
forceinthemarketforitsmainimportsandexports,itwillcon
tinuetoinuencethepriceofboth.
Thispincermovementshowsupinsurprisingways.One
BritishscholararguesthatcheapChineseexportshavedeterred
burglariesinhiscountrybecausea£19.99DVD playerishardly
worthstealing.ButotherssaythatChina’simportsofcopper
havecontributedtoariseinmetaltheftbecauseChina’sappetite
forsuchcommoditieshasmadethemamoretemptingtarget.
3
Back where it belongs
China’s current-account surplus
As % of GDP
10
8
6
4
2
0
2001 03
02
04
05
06
07
08
09
10
11
Source: CEIC
4
TheEconomist
May 26th 2012
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