China’s economy faces an uncertain future

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The Chinese economic model may be unsustainable. It relies on global trade and investment (much of it export-related), which together contribute a high proportion of China's GDP. This trade entails importing foreign components that are then reassembled and exported. Domestic consumption has been kept low.

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Hey there, time traveller!
This article was published 31/12/2009 (4651 days ago), so information in it may no longer be current.

The Chinese economic model may be unsustainable. It relies on global trade and investment (much of it export-related), which together contribute a high proportion of China’s GDP. This trade entails importing foreign components that are then reassembled and exported. Domestic consumption has been kept low.

Chinese Premier Wen Jiabao warned that Chinese growth was becoming increasingly “unstable, unbalanced, unco-ordinated and ultimately unsustainable.” That was two years ago. Currently, China may be aggravating the problems by massive liquidity-driven stimulus to perpetuate a failed strategy. Speaking at the meeting of the World Economic Forum in Dalian, China, on Sept. 10, Wen repeated his message from two years ago without signalling any change in direction: “China’s economic rebound is unstable, unbalanced and not yet solid. We cannot and will not change the direction of our policies when the conditions aren’t appropriate.”

China’s problems, to a degree, mirror earlier problems of Japan, its neighbour and competitor for global influence.

Japan’s export-driven model successfully generated strong growth of 10 per cent, on average, in the 1960s, five per cent in the 1970s and four per cent in the 1980s. This growth was driven by a number of factors, including an artificially low exchange yen rate.

On Sept. 22, 1985, Japan, the United States, the U.K., Germany and France signed the Plaza Accord, agreeing to depreciate the dollar in relation to the yen and German mark by intervention in currency markets. The accord had limited success in reducing the U.S. trade deficit or helping the American economy out of recession.

The Plaza Accord signalled Japan’s emergence as an important participant in the international monetary system and global economy. The effects on the Japanese economy were disastrous.

The stronger yen triggered a recession in Japan’s export-dependent economy. In an effort to restart the economy, Japan pursued expansionary monetary policies that led to the Japanese asset-price bubble that collapsed in 1989. Economic growth fell sharply and Japan entered an extended period of lower growth and recession, generally referred to as “The Lost Decade.”

In the 1990s, Japan ran massive budget deficits to finance large public works programs in a largely unsuccessful attempt to stimulate growth to end the economy’s stagnation. Only structural reforms in the late 1990s and early 2000s restored modest rates of growth. Japan’s public debt is now approaching 200 per cent of Japan’s GDP.

Significant shifts in economic strategy are necessary. Chinese President Hu Jintao recently noted: “From a long-term perspective, it is necessary to change those models of economic growth that are not sustainable and to address the underlying problems in member economies.”

China can try to continue its existing economic strategy, which looks increasingly difficult. Changing its economic model is also difficult if it means a slower rate of growth. China’s challenge will be to learn from and avoid the problems and fate of Japan.

History and cultural issues compound China’s dilemma. The 1842 Treaty of Nanking entered into at the end of the first Opium War awarded Britain war reparations, eliminated the Chinese Hong monopoly, set Chinese exports and imports at a low rate, provided British access to several Chinese ports and transferred Hong Kong to the English. The humiliation of the treaty is deeply etched into China’s dealing with the West.

China should have heeded the warning of Kang His, emperor of China, on the British presence at Canton in 1717: “There is cause for apprehension lest in centuries or millennia to come China may be endangered by collision with the nations of the West.”

The tradeoff between economic and political liberalization may also be problematic. As Fang Li, a renowned astrophysicist who’s often called China’s Andrei Sakharov, remarks in dissident author Ma Jian’s novel about China Beijing Coma: “Without a democratic political system in place, (China’s) economy will eventually flounder. The people’s wealth will be eaten up by the corrupt institutions of this one-party state.”

There is an apocryphal story about a visiting world leader drawing back the curtain of his hotel room to be stunned by the futuristic skyline of Shanghai’s Pudong Financial District. “How long has this being going on?” He asked. Today, the question might be: “How long can this go on?”

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall) and a consultant to Jory Capital.

TUESDAY: Secrets of China’s success

WEDNESDAY: China has stepped on dollar’s bounding mine

TODAY: China’s economy faces an uncertain future

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