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Thursday, March 8, 2012

EDITORIAL

The real 'China threat'

Considerable attention has been devoted to the threat seemingly posed by the growth of China's power and influence. It seems like every week the country is marking some new "first" in its military modernization program, all of which are said to be underwritten by a desire to become the pre-eminent power in Asia.

In fact, if China threatens international stability, it is more likely an economic rather than a military challenge. And the problem is not China's strength that should be the focus of policymakers, but its weaknesses. The unraveling of the Chinese economy would deal a body blow to the global economy and ripple through the region and the world.

The China story in modern memory has been its outstanding growth. The country has registered 10 percent growth on average for three decades, overtaking Japan to become the world's second largest economy and the world's largest exporter of goods.

Hundreds of millions of people have been lifted out of poverty and its middle class is now equal to or exceeds in size the entire population of most countries. Its dynamism powered the global economy. Despite the downturn triggered in 2008, China's economic resilience, while the rest of the world flirted with a new depression, imbued the country with a status and image that exceeds its actual wealth.

In recent months, however, economists are troubled by the prospect of a "hard landing" as the Chinese economy slows. The country's manufacturing sector has shrunk for four consecutive months, as global demand slows. With a glut of housing — it is estimated that there are 10 million to 65 million unoccupied units nationwide — the average prices for homes have fallen in 100 cities for five consecutive months.

Meanwhile, consumer goods prices are creeping up, with inflation hitting 4.5 percent in January; food prices, which make up a third of the consumer index, ballooned 10.5 percent in January.

Real estate problems are especially worrisome. The real estate sector is said to account for about 20 percent of the Chinese economy. It is the primary asset of many households; a widespread drop in value could stir unrest.

But the spillover effects are most troubling. Local governments rely on land sales to raise revenues; in 2011, land sale revenues dropped 13 percent year on year.

Banks have considerable exposure to the real estate market. Banks were also the primary vehicle for the massive stimulus program that Beijing implemented after the 2007-08 financial crisis to stave off a downturn. There is little faith that those funds were invested well and there are concerns about a banking crisis when those loans come due.

Most economists anticipate a gradual slowing of the Chinese economy, a drop from double-digit growth to a more reasonable level. After expanding 9.2 percent in 2011, the World Bank estimated in November that China will register growth in excess of 8 percent in 2012, although some fear that 8 percent could be a ceiling. It is a core belief in China that 8 percent growth is the minimum necessary to absorb new labor market entrants and workers displaced by privatization.

Anything less risks social unrest and potential political instability. It is not at all clear how the Beijing government — or the people — will handle a downturn like that which has gripped the advanced economies during the last few years. Will it unleash nationalism? Will China look overseas for scapegoats to distract the public?

And how will a downturn impact those economies, like Japan's, that have grown on the back of China's own expansion?

Most observers believe that the stakes as too high — especially during a time of political transition — for the economic situation in China to get out of hand. In other words, the Chinese government will do whatever is necessary to keep the economy expanding and maintain popular support.

A new report from the World Bank argues that the task is getting tougher. According to World Bank President Robert Zoellick, the Chinese economic model is "unsustainable" and could fall into a "middle income trap" if the country does not embrace significant reform that, among other things, promotes a rise in productivity as well as the accumulation of human capital.

The report called "China 2030," done in conjunction with the Development Research Center, a think tank associated with China's State Council, and released on Feb. 27, calls for change in several key areas: tax reform, green growth, improvements in rights for rural residents and financial liberalization.

The most pressing and most problematic reforms concern competition in China, which means breaking the grip of the state-owned enterprises.

While there has been privatization of the economy, about 120 central government-owned companies dominate key sectors of the economy. When combined with an additional 150,000 smaller firms in other sectors, the public sector accounts for about 30 percent of the total economy.

These enterprises are less efficient, but because of their state involvement, they have first claim on badly needed capital and other limited resources. Worse, because they are attached to the government, these businesses are intimately connected to political battles and often breed corruption.

World Bank officials concede that there were differences in opinion between their organization and their Chinese partner. But the report recommendations echo those of an International Monetary Fund report released in November.

The World Bank has concluded that failing to reform "risks the possibility of an economic crisis in the future," which could in turn lead to social unrest. The stakes are too high for China and the world to do nothing.



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