What interested me in the article below were the following paragraphs:
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Although publicly reticent, some Chinese officials are privately questioning whether the country's current development model is sustainable.
"Every year the government invests more and more money to create jobs, but this causes oversupply of almost everything, which causes price wars, which creates deflation, which reduces corporate profitability and increases the number of bad loans in the banks," says one official in a key economic ministry.
"In effect, we are just paying for jobs with tax revenues and bank credit. That is the price we pay to keep our society stable."
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Now it's not so much the "Reform -- Doomsday is Coming" message that interests me (which I have some questions about below). It's more the idea that the champion growth rates in the world -- a 9.7 per cent annual growth fate from 1980 to 2000 -- have been produced through such an enormous deviance from a market model -- an enormous and continuous influx of public funds -- that it might as well be called a public works model of development. It seems like a unique model. But simply in government sector/private sector terms, it sure looks a lot more like the Korean model than the US one. The government might not be as much in control in the directing sense as the Korean one was. But it seems if anything more preponderant in the capital flows sense.
This also speaks to one big question I have about Chinese growth. In each of the last four years, Chinese annual growth has been between 7 and 8 percent. But during all those years, the statistics also show that it's been suffering deflation. Is that possible under any economic laws we know, Marxist or mainstream? To have stellar growth and deflation simulataneously?
If not, there seems only two choices -- either the statistics are so false as to be worthless (i.e., not even the positive or negative trend is correct); or the model is so different from anything we know that normal economic laws literally don't apply.
As for the "Reform -- Doomsday is Coming" message, my question is this. If the vast majority of the non-performing loans are on the books of the four wholely state-owned banks -- which means they have no outside shareholders, and they only loan to businesses -- then what prevents China from simply dissolving the banks at some point at time? Why wouldn't that solve the problem? Isn't this just money the state owes to itself? It seems like NPLs on state banks are essentially a bookkeeping mechanism where the amount of money by which the state has historically subsized the economy through taxes is registered as mounting balances. But whenever they want to stop counting, they're free to, no? If the ultimate bank crisis solution is to nationalize the banks and forgive the loans with public funds, it's already been pre-done. Theoretically, it seems like they could even could start up a new state bank afterwards.
I'm not saying there aren't other problems behind this one that would come out in such a scenario. But I just don't see how the bad loans themselves should lead into a Japan in the 90s scenario. Japan lives in the world where at least some of the normal economic laws apply, and deflation and economic growth represent opposed outcomes
Anything anyone could say or recommend to read to enlighten me on these points would be greatly appreciated.
Michael
Finanial Times; Oct 30, 2002
Creaking economy needs stronger foundations
By James Kynge
Of all the memorable utterances of Zhu Rongji, China's premier, perhaps the most surprising - and revealing - came early this year. He said the national economy would have "collapsed" during the Asian crisis had it not been for the fiscal stimulus package he authorised at the time.
To many, this has appeared an incredible claim. Would the developing world's star performer, a country that averaged a 9.7 per cent annual growth rate from 1980 to 2000, really have been reduced to economic rubble but for a modest bout of pump- priming in 1998?
Nobody will ever know for sure. But the strength of Mr Zhu's assertion spoke volumes about the structural frailties that underpin China's imposing economic architecture. Although publicly reticent, some Chinese officials are privately questioning whether the country's current development model is sustainable.
"Every year the government invests more and more money to create jobs, but this causes oversupply of almost everything, which causes price wars, which creates deflation, which reduces corporate profitability and increases the number of bad loans in the banks," says one official in a key economic ministry.
"In effect, we are just paying for jobs with tax revenues and bank credit. That is the price we pay to keep our society stable."
Statistics amply reinforce the official's conclusion. For each of the past five years, the proportion of manufactured products in oversupply has hovered around 75 per cent, according to an official at the People's Bank of China, the central bank.
But despite the oversupplied market, companies have built more and more capacity. Fired by five straight years of fiscal stimulus, corporate capital spending has posted double-digit growth in every year except 1999 and, in the first nine months of this year, jumped by 21.8 per cent compared with the same period a year ago.
Price wars have plagued most industrial sectors. The price of goods at the factory gate has fallen by several percentage points in each of the last six years, except in 2000. Retail price deflation has occurred in every year since the Asian crisis in late 1997, and still persists despite robust increases in retail sales and money supply.
With their margins hit by deflation, the profits of corporations - especially the state enterprises that still employ around 50 per cent of the urban workforce - remained stubbornly low or negative. In 2001, some 174,000 state-owned enterprises, the bulk of China's industry, experienced a 0.8 per cent decline in overall profits despite the gross domestic product growth rate of 7.3 per cent for that year.
Bankruptcies are scarce, partly because the national legislature has been unable to agree on the passage of a workable bankruptcy law and partly because corporate collapses are regarded as black marks on the personal files of government bureaucrats, who therefore do their utmost to avoid them. The market, therefore, is grossly inefficient at shedding excess capacity.
Li Jiazheng, mayor of Zhangqiu, a city in Shandong province, says the city owned two large insolvent textile factories but neither would be allowed to go bankrupt. "What is the point in having them go bankrupt? We would only have to pay the workers out of our local budget for doing nothing. At least it is better if they are busy," he says.
In the end, the financial burden of supporting such insolvent enterprises is carried mainly by the state banks and the various strata of China's ziggurat-style government. This, in the words of Shawn Xu, head of research at China International Capital Corporation, should indicate a "Japan disease warning".
All of China's problems - the high levels of non-performing loans in the banking system, government debts (plus contingent liabilities such as unfunded social welfare obligations) at over 100 per cent of GDP, industrial overcapacity and deflation - have their corollary in Japan. The main difference is that China's problems are both better hidden and potentially more serious than in its neighbour to the east.
The number of non-performing loans in Japan's banking system is estimated at 8 per cent of GDP but in China the figure is much higher. In a recent report, CLSA, a Hong Kong based brokerage, estimated that total NPLs in the banking system were around $450bn, or 37 per cent of 2001 GDP. Even taking the government's estimate of 23 per cent of bank assets, China has a grave NPL issue.
So far, Beijing's strategy has been to grow out of the problem, hoping that faster growth will generate corporate profits, facilitate the repayment of bank debts, create employment and boost consumer spending. But it is only working up to a point; many economists dispute government claims that the levels of NPLs in the banking system are falling.
"Our view is that they are still adding to the NPL stock at a significant rate," said Andy Rothman, CLSA's China country head.
Nicholas Lardy, senior fellow at Brookings Institution, says that China is in danger of suffering a fiscal crisis sometime around 2006-2008 unless the state banks develop a credit culture and the government is able to continue to increase its tax take as a percentage of GDP. By 2001 government revenues were 17 per cent of GDP, up from a low point of 10.7 per cent low in 1995.
"If new bad loans continue to emerge at the rate of recent years it would still appear that the fiscal situation is unsustainable," said Mr Lardy.
In addition, says Jia Kang, president of the institute of fiscal science under the ministry of finance, large amounts of the government's fiscal stimulus spending has been wasted by local governments over the last five years. The prospects for a commercial return from such spending, which mainly goes on infrastructure and upgrading state enterprises, may also be dim.
If China is to avoid slipping into its own version of Japan's malaise, it must lose no time in pushing through structural reform, several analysts say. The most pressing task is to address a gross misallocation of capital that results in two thirds of the country's credit resources being channeled toward state-owned companies that contribute only around one third of GDP.
China's policy makers understand the urgency of this imperative but are constrained by their fear of social chaos from acting resolutely upon it. No Chinese leader can afford to ignore the latent tensions among 1.3bn people; the famines, political upheavals and civil wars of the 20th century have delved deep into the national psyche.
More narrowly, Beijing faces the world's most onerous responsibility for job creation. An official at the ministry of labour and social security estimates that some 8m jobs are created annually at a GDP growth rate of 7 per cent. But this was insufficient for the 20m urban residents who are expected to seek jobs each year for the next four or five.
Although China has laid off as many as 30m state workers since 1998, it cannot risk the chaos that might spring from halting the drip-feed of state credit that keeps many insolvent state enterprises from collapse. As one central bank official puts it: "The state banks still have an unshirkable responsibility to support the state enterprises." This being the case, it may be unrealistic to expect that a genuine credit culture - in which the criteria for lending are commercial rather than social - will emerge over the next few years. Non-performing loans, therefore, may continue to pile up.
The government's emerging answer to this dilemma - expected to be confirmed at a key Communist party congress starting on November 8 - is to encourage the development of the non-state and foreign-invested sectors of the economy, both of which are more efficient and profitable than the lumbering state companies.
But this strategy may not be adequate. Non-state and foreign-invested companies are competitors to the state-owned enterprises, so the profit of one group tends to cause losses in the other. The rise of a non-state economy is sure to hasten the demise of the state corporations, generating even higher levels of non-performing loans and redundancies.
Under these circumstances, China finds itself peculiarly vulnerable to a sharp slowdown in growth.
Far from sounding overblown, Mr Zhu's warnings over a narrowly averted collapse in 1998 should be treated seriously and serve as a caution to excessive optimism over the future of the world's most populous nation.
Tomorrow: China's rural decline.