Sunday, October 28, 2012

Fundamental Problems in the Chinese Economy (II)

By Tianlun Jian

Can exports and investment continue to support high GDP growth in China?

China’s International Competitiveness Is Weaker

Since the outburst of global financial crisis, global economic demand has drastically weakened. Demand for China's exports has since grown at much a slower pace.  China’s export growth rates declined from around twenty percent per year between 2000 and 2007 to 8.8 in 2011. It further slowed to merely 1.0 percent and 2.7 percent year-over-year rate in July and August, respectively. (Graph 3)
In addition to a lower global demand, more and more products of low cost Asian emerging economies are coming into the market, substituting China's export goods.

China's exports are no longer cheap

In the past two decades, the rmb undervaluation caused price distortions in the international trade. China's exports have been sold at low prices to push up China's exports. However, under international pressure, during the past few years, rmb has appreciated. Thus Chinese exports are losing the price advantage due to the currency undervaluation, which they had relied on for decades.

Changes within China have reduced its international competitiveness. Domestic wages have gone up at a double digit rate each year in the past several years.  Demographic dividend due to single child policy in the past 3 decades seems to have come to an end. Labor abundance is no longer China's characteristics.  Between 2000 and 2010, China's working population decreased about 3 million each year.  Labor shortage and rising wages have largely pushed up costs of exports, weakening China's competitiveness.

High Investment Induced Huge Overcapacity

China’s investment grew at high rates during the past decades, spurred by near zero real interest rates and high GDP pursuit.  As a result, China’s capital formation share in GDP went up from 35.1 percent in 2000 to 48.4 percent in 2011. In contrast, global capital formation declined during the same period. In South Korea, Hong Kong, Singapore, Japan, Malaysia, United States and Germany, capital formation shares declined to a range between 15 to 29 percent.

With such high capital formation rates for over a decade, over capacity is a sheer fact in most of China’s industrial sectors.  According to statistics released by Ministry of Industry and Information Technology, many industrial sectors seriously suffer from overcapacity. 

For example, China has a production capacity for cruel steel of 900 million ton, up about 300 million ton from 2008. According to the Committee of Development and Reform, the steel sector has an overcapacity of 160 million ton.

For the first seven months of 2012, 33.8 percent of the steel sector is losing money. If excluding investment income from sources other than the steel sector, then, the entire sector is losing money.

Even though steel companies know that they cannot sell their steel products, they are still producing at almost at full capacity (95%). Why?  Because steel output accounts for about 8 percent of China’s GDP, reduction in steel production will directly affect GDP growth rates – an indication of failure of the administration.  So no governments want to see reduction in steel production. 

China’s solar sector perhaps has the worst overcapacity. According to a report China And Global Economic Crisis of Overcapacity by Andrew McKillop, “massive subsidies and state intervention have driven China's overcapacity in solar power panels and systems to more than 20 times total Chinese national market demand for these panels, and close to two times the total of world demand.”  Not surprisingly, shares of China’s solar companies, such as Trina Solar and Suntech Power, have dropped over 80 percent in the past five years.

Overcapacity is a serious issue in China’s manufacturing, mining, aluminum, iron ore, cement, etc. Continuing investment will only create more problems and waste resources and do nothing good for balancing the economy. So more likely investment will only grow at lower rates than before.  It cannot lead to GDP growth either.

Housing Bubbles Are Ready to Pop

Investment in the real estate sector has also grown at soaring high rates in the past years. Investment in real estate accounted for 13 percent of China’s GDP in 2011, pushing up associated sectors as well.  So during the housing bubble years, housing has also made a significant contribution towards China’s high GDP statistics, with some side products of ghost towns such as Erdos.

However, the coexistence of high soaring housing prices and high vacancy rates indicates that China’s housing bubble is ready to prop.  With price-to-income ratio at 30-to-1, the mass Chinese cannot afford purchasing houses.  On the other hand, with vacancy about 30 percent, there is a huge mismatch between supply and demand. Such a twist is related to the extremely wide income gap among Chinese people and the long-lasting low real interest rates.

As demand for housing dwindles, many land developers are already leaving the sector.  This will not only show up in the reduction in investment, create unemployment, it will also reduce demand for steel, aluminum and other related sectors.

Local governments will also be affected. During the past decade, easy and vast amount of revenue from land sales has supported larger and larger local governments.  Now shrinking in real estate directly affects local governments’ cash flow. Some may even get insolvent. Recently more and more local governments find financial difficulties.

Throughout the past decades rmb undervaluation has made China’s exports sold at cheaper prices. While this has helped push up export volumes, yet China’s natural resources have been priced too cheap and used up too much, creating environmental problems. Low interest rates have misallocated capital resources, wrongly and freely transferred money from depositors to corporations and governments, depriving resources from Chinese ordinary people.  These macro policies created unbalanced economic development and widened China’s income inequality, driving down the consumption share in GDP.

Ending Remarks

In sum, the undervaluation of rmb currency, distorted interest rate policy, policies to support financial monopoly, a deformity of industrial policy, and the predatory land policy ...... these macroeconomic policies form the model of China’s imbalanced economic development, worsening China's income inequality, and driving down consumer share in GDP, year after year.

“Some people” indeed have “got rich first." How?  Here is the secret: The root cause of the widening gap between rich and poor has nothing to do with ability or effort, it is related purely with powers (and policy).

The most heartbreaking is the over-exploitation of natural resources, which has caused serious environmental pollution, destructed the nature resources and living environment on which future generations rely to survive. The result is that the masses of Chinese people have to pay for the consequences for the Chinese government, and forebear the disasters that the economic reforms have brought about on this land.