Can China Grow Itself Out of Trouble?

Wing Thye Woo
Wing Thye Woo Former Brookings Expert

February 26, 2009

Editor’s Note: In an interview in the Straits Times, Wing Thye Woo discusses China’s growth prospects during the global financial crisis, including the potential for sustainable development, and issues related to China’s currency valuation and current account surpluses.

Andy Ho: Even before the global crisis hit, China’s 2008 growth was lower than the two previous years’. Why?

Wing Thye Woo: From October to December last year, a collapse in exports exacerbated the slowdown in China’s growth already in place from January to September. The latter was actually induced by domestic policies per se. Here’s how.

To help President Hu Jintao consolidate his leadership at the October 2007 Congress of the Chinese Communist Party, credit quotas that every bank was subject to were continually adjusted upwards by the People’s Bank of China, the country’s central bank. So the 2007 growth was 13 per cent.

But after the congress, fighting inflation became paramount. Credit quotas were strictly enforced and growth dropped from 10.8 per cent in the fourth quarter of 2007 to 6.2 per cent in the third quarter of last year.

Note that exports in the first nine months remained good, so growth slowed in the period because of domestic policies. With the global crisis, exports plunged in the last quarter of 2008, so exports grew only 9.4 per cent for the whole year compared to the decade’s average of 20 per cent. Export growth last month was minus 17.5 per cent, industrial production has dropped, and unemployment is rising.

Ho: Last month, the International Monetary Fund projected China’s 2009 growth at 6.7 per cent. At Davos, Premier Wen Jiabao predicted 8 per cent. Who is correct?

Woo: I think Mr Wen – because China’s 4 trillion yuan (S$890 billion) stimulus should work. Here’s why. As they won’t be held accountable for any non-performing loans, state-owned banks will now lend freely. Last month, they extended 1.62 trillion yuan in new loans compared to 772 billion yuan in December. And state-owned enterprises will now borrow heavily since future losses will be socialised, while some gains, if any, may be ‘privatised’ with creative accounting.

Ho: The undervalued renminbi keeps China’s trade surpluses large. Would it be forced to appreciate – to reduce United States trade deficits?

Woo: Bilateral US-China trade imbalances may be thereby reduced but not US global trade deficits because the US would continue to import from other countries. When yen-dollar rates fell from 239 in 1985 to 128 in 1988, the US current account deficit only fell from 2.1 per cent to 1.7 per cent of GDP. Why? Japanese firms started investing abroad to export to the US from there. Starting a trade war now would mean a disgruntled China and a no happier US.

Ho: Where do China’s current account surpluses come from?

Woo: When you sell more than you buy abroad, you are putting your savings into foreign assets. China should not do this as domestic investments garner higher rates of return. But it has to because the financial system can’t translate savings into investments. China’s private savings rates are up to 12.2 per cent higher than that of the US because, first, its financial institutions don’t transform savings into education, housing and investment loans. So people just save. Second, it has no financial instruments to pool social risks through medical insurance, pension insurance and unemployment insurance. So people save up for a rainy day.

Ho: Should China rebalance its economy for less investment-led and more consumption-led growth?

Woo: That is an oxymoron because growth needs productive capacity to increase, which requires investments. Consuming more may use up savings but the state could also expend more of savings in import-intensive investments, like buying planes or scholarship programmes to send students abroad. If the state provides health insurance, a pension system, and so on, that would also be consuming more without lowering investments.

Ho: What may cause the Chinese economy to sputter?

Woo: Any speeding car may suffer hardware, software or fuel supply failures. A hardware failure, like a blown tyre, is an economic mechanism breaking down – like, say, a banking crisis that leads to a credit crunch which dislocates production.

A software failure, like people altercating inside a moving car, is something like social upheaval. High growth along with corruption and regulatory failures like the melamine-tainted milk crisis have seen the trickle down dry up, inequality grow and social dislocations rise. China is the most unequal country in Asia. In 2004, the combined income of its top 20 per cent was 11.4 times that of the bottom 20 per cent. Public-disorder incidents rose from 8,700 cases in 1993 to 74,000 in 2004. The average number of persons involved in a mass incident rose from eight in 1993 to 50 in 2004.

Ho: One ‘fuel supply failure’ would be protectionism reducing demand for China’s goods. Another is bumping up against nature. Is China’s development sustainable?

Woo: China’s dirty air is legendary. Less well-known is that 400 of China’s 660 cities face water shortages. Lower than normal rainfall in the past 15 years means extended semi-drought in northern China. Combined with population growth, more water has to be pumped from aquifers. So the water table is dropping 3m to 6m a year and deserts are expanding. There are increasingly major sandstorms interrupting aviation, crippling high-tech manufacturing and causing health problems in northern China.

To bring water from the south to the north, China began building in 2002 an eastern coastal canal from Jiangsu to Shandong and Tianjin. In 2003, it began a central canal from Hubei to Beijing and Tianjin. Next year, it will start a western one from Tibet to the north-west.

The canals, each over 1,000km long, are fraught with environmental risks. The central one has to tunnel through the foot of the huge dyke holding up the elevated Yellow River. The western one will move water through freezing regions.Water temperatures might drop, which may see fish stocks decline.

Future urbanisation may have to be located mainly in the south.

Ho: So China can’t grow its way out of trouble by doing more of the same?

Woo: Its earlier reforms led to providing more jobs, which reduced poverty significantly. But now, the trickle down isn’t working so well. What the poor need most now is help with building their human capital through education and health interventions.