A translation of a talk He Qinglian delivered in Vancouver on May 3, 2015.
My talk today, “The New Norm: Chinese economy faces six bottlenecks”, is to give an overview of the state of the Chinese economy. What lies ahead for China depends on whether or not the Chinese government can find ways to work around the six bottlenecks.
Before I start, I would like to share a piece of good news: In 2014, China’s gross GDP volume reached 10 trillion dollars. The only other country which gross GDP is of this volume is the US. However, the Chinese government doesn’t seem too pleased with this. Since the year China’s gross GDP surpassed that of Japan, the Chinese government had been trying to dissuade others from calling China the second largest economy, it even said that certain international forces exaggerated China’s GDP out of ulterior motives. In fact, the World Bank and the IMF did their math based on the data from China National Bureau of Statistics and Purchasing Power Parity. That’s to say, if you inflated your data in the first place, you can’t blame others for exaggeration.
Right, so now I get into the topic.
The first bottleneck: China—no longer the factory of the world
After a golden decade of being the world’s factory between 2001 and 2010, China has now inevitably started its decline. According to latest news reports, Dongguan, a major pillar of the world’s factory, has seen the second wave of enterprise closures. It was said that within a year, no less than 4,000 companies shut their doors.
The world’s factory began its decline in 2008. Based on disclosed data, 72,000 businesses closed down between 2008 and 2012 in Dongguan. Now, as labor-intensive enterprises shut down in larger numbers, the Chinese economic growth model that was fueled by exploitation of labor and environment has reached its limit.
In the past, investment, foreign trade, and domestic demand used to be the three engines that propel China’s economic growth. Now, all three engines lost their steam.
In the first quarter this year, foreign trade growth fell by 15% year-on-year—a sign that foreign trade cannot propel China’s economic growth anymore. Another way has to be found.
In the last two decades, real property had always been the prime industry that drove Chinese economic growth. Yet, starting from two years ago, the highly bubblized real property came to standstill. While the Chinese government and enterprises fought to shore up the housing market, a dozen or so industries related to real property fell victim to full scale overcapacity. For example, industries most closely linked to real property like steelmaking and cement manufacturing have seen an overcapacity as high as 30%; industries producing flooring, furniture and textile too have experienced severe overcapacity.
This type of overcapacity crisis is referred to as “the nuclear threat of the Chinese economy”. In other words, such a crisis is like a nuclear bomb that could trigger an economic crisis at any time. It is because of this that China seeks to export excess capacity by pushing forward the “One Belt One Road” project and establishes the AIIB. The one thing I would say about this project today is that its chance of success is quite low because most of the countries included in the project do not have good sovereign credit. Except for countries like Pakistan, with which China intends to achieve a different objective through economic cooperation, Chinese investment made in those countries might bear no fruit.
The issues above show that there is no hope for Chinese economic restructuring. Economic restructuring is not something that can be done whichever way the government wants it to. Back in 2005, Guangdong province had already called for an industry upgrade as it tried to replace labor-intensive industry with hi-tech industry. The result was: labor-intensive industry relocated elsewhere while hi-tech industry didn’t move in, and now the Pearl River Delta is witnessing industrial “hollowing out”.
The second bottleneck: astronomical number of unemployed people
China is the most populous country of the world, and the unemployment issue has always been a sword hanging above the heads of the Chinese people. During the Cultural Revolution, when I was a teenager, China had already had a serious unemployment issue. At that time, young people in the urban area were forced to take part in the Down to the Countryside Movement, those who managed to get a job or join the army were considered to have found a good way out.
After the implementation of Reform and Opening Up, China, despite being in a prosperous era serving as the world’s factory, still had huge number of people without a job. For instance, labor surplus in the rural area was as high as 100 million. Now as the world’s factory is in decline, the unemployment issue became even more serious.
For a long time, the jobless rate in urban area disclosed by Chinese government stayed below 4.5%. Such a figure does not show the actual state of unemployment in China because, firstly, this figure counts only those urban residents who registered with government as jobless and leaves out all those who didn’t do so; secondly, this urban unemployment figure does not take in the number of unemployed in rural region, where huge labor surplus exists. An unemployment figure that leaves out two massive chunks of data is itself grossly incomprehensive.
Currently, the unemployed in China consists of four components: first, the labor surplus in rural region, a problem that gets worse as plants are shutting down; second, white-collar workers who lost their well-paid job as foreign investment withdraws from China; third, college graduates who are jobless—given that colleges require students to present proof of employment before conferring them their graduate certificates, students are forced to fake the documents needed to get their certificate, the employment figures provided by colleges are thus meaningless; fourth, junior and senior high school leavers who stay unemployed at home over an extended period, Chinese media outlets refer to these people as NEETs.
How many people exactly are out of work in China? There are two sets of data for reference. First, former Premier Wen Jiabao stated at the China Development Forum in March 2010 that “200 million people are unemployed in China”; second, Justin Yifu Lin, former Senior Vice President of the World Bank, said during the World Economic Forum Annual Winter Meeting 2015 in Davos that, due to the rise in wages, 124 million manufacturing jobs would relocate to other developing countries.
Currently, the working-age population in China is 940 million. When the number of people out of work reaches 300 million, the actual unemployment figure would stand at about 32%.
With so many people out of work, it indicates that the “bread contract” between the ruling clique and the populace no longer works. As we all knew, China is a totalitarian country where the “bread contract” means that the rulers make the general public "transfer" their political rights such as suffrage, the freedom of the press, the freedom of speech, the freedom of assembly and the freedom of association in exchange for the freedom from want.
Now that there are so many jobless people, it means the general public has neither political rights nor the freedom from want. Any country facing such a high ratio of unemployed people would have a serious headache.
The third bottleneck: severe resource crisis
The pollution problem in China is three-dimensional. This means the country’s water, soil, and air are all badly polluted. Information on this is abundant, and due to time constraint, I would not go into the details and would only focus on resource crisis. China faces serious resource constraints for economic development and becomes heavily dependent for resources from all kinds of minerals that are used as means of production to food that is used as means of subsistence.
China now gets 60% of the lifeblood of economy—petrol it needs from import; it is also highly dependent on foreign metal minerals like iron, copper and zinc. I’m not going to list out each of the figure; I only intend to point out that China’s economy safety has become seriously dependent on external factors.For the Chinese people, there is nothing more important than food and so let’s use that an example. Sixty percent of the Chinese population grows crops, yet in 2014, the country’s food self-sufficient rate dipped below 87% and it gets its three staple diets—soybeans, corns and wheat from import. So what does this figure tell us? It indicates that, aside from food contamination resulted from soil pollution, nearly 200 million people in China source their food from other parts of the world. This causes food price in China to fluctuate alongside international food price. When disaster or humanitarian crisis strike—for instance, grain-producing countries reduce their output because of war—food price in China would hike.
Twenty years ago American environmental analyst Lester Brown wrote a book called Who Will Feed China? to remind China to pay attention to its food safety. However, China saw this work of research as a “conspiracy of the anti-China forces to smear China” and threw criticism at it for years. In recent years, however, China came to realize that food safety really is a problem, so it changed its attitude toward Brown and invited him to give a talk in China. Yet many of Brown’s viewpoints were deemed hard to stomach and the Chinese government sort of retracted its welcome extended to Brown.
The attitude changes of the Chinese government toward Brown shows just how difficult it is to say the truth in China.
Canada is a country with lots of resources, and its water resource is particularly abundant. I would like to suggest business people to plan ahead and invest in these industries. There will come a day when China needs to import these resources.
The fourth bottleneck: local government caught in the quagmire of debts
The prospect that a local debt crisis could trigger a local financial crisis gives the Chinese central government a big headache.
According to estimates made by foreign investment banks two years back, the scale of the total debt volume in China was 168% of its gross GDP (when I wrote this, McKinsey Global Institute published its latest report stating that China's total debt has reached 282% of its GDP), only a tiny part of this is individual debt, while most of the rest is government and corporate debt. And local government debt tops the list at about 20 trillion RMB.
Speaking of this, I would like to share a story.
Previously, the amount of total local debt reported was 18 trillion. That was a figure smaller than the actual sum. And the reason local officials made partial report of the debt incurred was that they didn't want to look bad. NDRC official Li Tie said that the 18 trillion debt reported was less than half of the actual local debt incurred. During a survey of a dozen of cities, NDRC officials found that some reported only 10% of thier debt, and some reported 20 to 30%, hardly anyone reported more than 50% of their debt. Thus it was estimated that the 18 trillion debt reported was only 30 to 50% of the actual local debt incurred.
Unsettled by this, the central government issued in September 2014 the “document no. 43” ordering local governments to truthfully report all of their debt before January 5, 2015 and hinting that the central government would help to repay part of the local debt.
Upon seeing the “document no. 43”, local officials who tried their best to cover up their debt to avoid being sacked now found a new hope, and so they made a truthful report of their debt as instructed. Hainan province even disclosed its debt to the public. As a result, the amount of local debt ballooned in a short time. The Ministry of Finance received the local debt reports and figured the sum was greater than they expected. So, the Ministry issued another document in late January ordering local government to “correct mistakes” in their reports and submit them again.
Now the central government plans to handle the 20 trillion local debt by helping to repay some of it, marketizing some of it and holding the local and provincial governments responsible for the rest. By holding the local and provincial governments responsible, it means that, if the local governments default on their debt and trigger mass incidents, the provincial governments would have to make a gesture shouldering some of the debt to placify the public.
Knowing that local governments have no other source of revenue other than selling of land, the central government is deeply troubled by the massive quagmire of debt.
The fifth bottleneck: financial crisis
Aside from a debt crisis, the rising rate of bad debt and the massive liquidity excess resulted from over-issuance of currency are also factors that would lead to a financial crisis.
Let’s first look at bad debt in banks. The bad debt in banks at the moment is the third debt crisis triggered by bad debt in the real property industry since Reform and Opening up. The first crisis emerged back when Zhu Rongji was the Premier. Beginning in 1998, the Chinese government spent more than 6 years to handle the 170 billion bad debts that were peeled off in the initial stage. Yet the way the Chinese government tackled them was to borrow new debt to repay for the old ones. And so, more bad debts incurred, which in term seriously hindered the efforts to get the Bank of China publicly listed overseas.
To solve this problem, the Chinese government came up with an ingenious idea. It established four state-owned asset management companies and transferred to them the bad debts incurred in banks. And then, part of those non-performing assets was repackaged and sold to foreign investment companies. Why did foreign investment buy non-performing assets? Because at that time, Chinese financial system was a mystery for them and they wanted to understand how the Chinese financial system worked.
The second crisis appeared during the Wen Jiabao era. At that time, the accumulated bad debts in banks stood at more than 800 billion US dollars. In order to ensure the banks that were going to be publicly listed in the US could fulfill the requirements of the Sarbanes-Oxley Act, the Chinese government hired accounting agencies such as Ernst & Young, PricewaterhouseCoopers to help with the audit.
Back then, the chairman of the SEC was seasoned politician Christopher Cox, who was very strict in listing application reviews. The auditors hired by the Chinese government found that the state of the Chinese banking system was too messy and figured that the banks could hardly satisfy the requirements. So they suggested those banks to get listed in Hong Kong instead of Wall Street.
The Chinese government then invited a dozen of foreign banks including UBS, Citibank, Bank of America and Temasek to become “strategic partners” of Chinese banks and allowed them to exit when the contracts expired.
Afterward, the four state-owned banks got listed in Hong Kong and the A-Share market of China and became stocks of high demand. At one point, the market value of these banking giants accounted for more than 50% of the total market value of the A-share market. Those strategic partners pocketed hefty profits and exited in 2007.
Foreign governments found the ways the Chinese government resolved bad debts in banks impressive.
After the outbreak of US financial crisis in 2008, governments in the West struggled to cope with the aftermath. And the United States had to let the Lehman Brothers went bankrupt.
Seeing a scene like that, a contributor of the Chinese version of the Wall Street Journal Report jokingly wrote that the Communist Party should be invited to help deal with the financial crisis in Wall Street.
Let’s then talk about the problem of over-issuance of currency in China. One of the major means that spurred the Chinese economic growth in the last three decades was over-issuance of currency.
In recent years, China became the world’s largest money printing machine.
In the ten years between 2003 and 2013, China’s monetary base increased by 88 trillion RMB, and its foreign exchange assets grew by 3.4 trillion US dollar.
During the years of investment boom, the effects of over-issuance of currency were not as noticeable. Now, however, as investment slowed, domestic saving and idle fund increased and added to the problem of excess liquidity.
In view of the limited options to sterilize the currency, PBOC governor Zhou Xiaochuan came up with a new way to do that.
During the Caixin Summit in November 2011, he raised the “Pool theory”, the key concepts of which were that in order to tackle the influx of short-term, speculative fund or hot money, the levees have to be reinforced; and as for the hot money that had already been inside China, a pool should be devised to retain them.
What would Zhou use as pools? To put simply, one of those included the real property. To keep the liquidity in, the housing market was used as a pool. That was why housing price in China skyrocketed and became the most expensive in the world. Someone wrote that if the real property in the city of Beijing was sold, the money obtained would be enough to buy up the entire United States.
Now that the real property faltered, Zhou used instead the stock market as a pool to keep liquidity in control. Once the stocks stumble and their market value vaporize, the amount of liquidity would be markedly reduced.
The predominant reason the inflation rate in China appears to remain low despite issuing so much currency is that, unlike in the US, the CPI in China does not include the property price. If the property price is included, CPI in China would be quite high.
Given the wild fluctuation of stock prices, the use of stocks as a pool could help temporarily dissolve the financial crisis.
Such a method to get around a crisis is cleverer than the Gold Yuan certificate currency reform initiated by the KMT. The currency reform of the KMT was tantamount to arbitrarily robbing the people of their assets. That resulted in the KMT suffering from political and military defeat, a financial meltdown and losing the remaining trust the people had in it. (A side note, a few years back, the Oriental Outlook, a weekly periodical in China ran a piece about a Red economist named Ji Chaoding. The article said that Ji, the person who suggested then Financial Minister T. V. Soong to unveil currency reform, was actually a Communist spy working for Zhou Enlai. His suggestion at that critical moment sped up the downfall of the KMT.)
As for the use of stock market to push off the crisis today, it is the stock buyers themselves that get inside the trap out of their own free will. If the stock market stumbles, they have no one else to blame.
Viewed with the Western financial perspective, Zhou Xiaochuan is a terrible banker. He should not dissolve a crisis by passing it on to others. Yet in the eyes of the Chinese government, Zhou is an irreplaceable banker who managed to steer away from financial torrents and perils during his three terms of the chief of the PBOC, doing his best to postpone the arrival of crises while anticipating them.
Now, what would happen in the future depends on his luck.
The sixth bottleneck: unfair distribution and hyper wealth inequality
Over the last two decades, the appropriation of public and private assets by crony capitalism in China could be seen as reckless. And it resulted in phenomena of severe wealth disparity and the concentration of wealth in a handful of people. I’m sure that everyone here knew about this and to back what I just said, I will quote a set of data taken from the “Chinese People’s Livelihood Report 2014” published by the China Social Science Research Center of the Peking University:
In 2012, the Gini coefficient for net wealth of families in China was 0.73; the top 1% of families have control over a third of wealth of the whole country while the bottom 25% of families have control over only about 1% of the country’s total wealth.
Such a high degree of concentration of wealth, such a staggering figure of Gini coefficient could hardly be seen in anywhere else, not even in Zimbabwe, the worst country in Africa.
Therefore, in China, the low-income social stratum, or the poor, account for nearly 60% of the country’s population. A society with too many poor people, one which upward mobility channels are non-existent is one that is teeming with instability factors.
If a democratic country encounters three of the six bottlenecks listed above, its government would collapse and its cabinet would have to resign. But this is China, where the CPC still maintains an unchallenged rule through autocratic measures and forceful control.
Even so, these problems have to be resolved sooner or later; they cannot be put on the back burner indefinitely.
Since modern times, the humanity came up with three ways to deal with social crisis. First, the Marxist approach, this is, stage a violent revolution and start everything all over again.
Before in 1949, this kind of approach was used in China. There were farmer revolts, farmer uprisings and the Communist Revolution.
The second way is the imperialist approach: to try to resolve domestic crisis during difficult times by staging war and seeking expansion abroad.
And the third way is the Keynesian approach: to address the overproduction crisis through state interventions such as raising taxes, expanding deficit budget, resorting to stimulus, employment boost and elevate the purchasing power of the public.
The approach being used in China today is basically a combination of government regulation under a planned economy and the Keynesian measures. As we are all aware, the result of this approach is not quite good.
Which approach would China use to solve the crisis in the future? This is a question I would like everyone here to contemplate. Compared with the second and the third approaches, the first approach is the one that fits most perfectly in with the official ideology, the values of the people in China today.
Marxism would give a simple explanation to conditions such as those in China today: the root of all crises is that the vast majority of the public is exploited, their income too low; while the minority lay claim to most of the wealth in society through exploitation and privileges.
However, it is possible that we come together to find ways for China to get out of its predicament based upon the system path, cultural soil, government ideology and the thinking habit of the people in the country.
Thank you everyone.