Monday, November 24, 2014

China on the Move

BEIJING – The debate is over. After six years of weighing the options, China is now firmly committed to implementing a new growth strategy. At least, that’s the verdict I gleaned from the just-completed annual China Development Forum, long China’s most important dialogue with the outside world.

There were no surprises in the basic thrust of the strategy – a structural shift in China’s investment- and export-led growth model toward a more balanced consumer-based and services-led economy. The transformation reflects both necessity and design.

It is necessary because persistently weak global growth is unlikely to provide the solid external demand for Chinese exports that it once did. But it is also essential, because China’s new leadership seems determined to come to grips with a vast array of internal imbalances that threaten the environment, promote destabilizing income inequality, and exacerbate regional disparities.

The strategic shift is also a deliberate effort by Chinese policymakers to avoid the dreaded “middle-income trap” – a mid-stage slowdown that has ensnared most emerging economies when per capita income nears the $17,000 threshold (in constant international prices). Developing economies that maintain their old growth models for too long fall into it, and China probably will hit the threshold in 3-5 years.

Three insights from this year’s China Development Forum deepened my confidence that a major structural transformation is now at hand that will enable China to avoid the middle-income trap. First, a well-articulated urbanization strategy has emerged as a key pillar of consumer-led rebalancing. This was emphasized by China’s new senior leaders – Executive Vice Premier Zhang Gaoli and Premier Li Keqiang – in the Forum’s opening and closing remarks, and considerable detail was provided in many of the working sessions.

Urbanization is a building block for consumption, because it provides powerful leverage to Chinese households’ purchasing power. Urban workers’ per capita income is more than three times higher than that of their counterparts in the countryside.

The urban share of the Chinese population reached 52.6% in 2012 – up nearly three-fold from 18% in 1980, and is expected to rise toward 70% by 2030. If ongoing urbanization can be coupled with job creation – a distinct possibility in light of China’s emphasis on developing its embryonic labor-intensive services sector – the outlook for household-income growth is quite encouraging.

The pace of urbanization should dispel Western doubts stemming from concerns over so-called ghost cities and chronic over-investment. According to research by McKinsey & Company, with the annual influx of new urban residents totaling 15-20 million, China will need more than 220 large cities (at least one million people) by 2030, up from 125 in 2010. Moreover, because urbanization is a capital-intensive endeavor and China’s capital stock per worker – a key driver of productivity growth – is still only 13% of the levels in the United States and Japan, China has good reason to remain a high-investment economy for years to come.

What is new today is the focus on urbanization’s negative externalities – especially the thorny issues of land confiscation and environmental degradation. A well-developed “eco-city” framework was presented at this year’s Forum to counter both concerns, and features incentives promoting a new urbanization model that stresses compact land usage, mixed modes of local transportation, lighter building materials, and non-carbon energy sources.

The second insight from the 2013 China Development Forum is the new government’s focus on strengthening the social safety net as a pillar of a modern consumer society. In particular, owing to the hukou (China’s antiquated household registration system), access to public services and benefits is not portable. As a result, migrant workers – an underclass numbering roughly 160 million – remain shut out of government-supported health care, education, and social security.

Holes in the social safety net have led to high and rising levels of precautionary saving – driving a wedge between increases in labor income and any impetus to discretionary purchasing power. Significantly, there were strong hints from senior Chinese leaders at the Forum that hukou reform is now under active consideration.

While that would be welcome, such efforts need to be accompanied by an expansion of benefits. China’s retirement system has only about $430 billion of assets under management (national and local government social security and private-sector pensions). I pressed newly appointed Finance Minister Lou Jiwei on this point, suggesting that China deploy some of its excess foreign-exchange reserves to fund such an effort – the same tactic used to provide a $200 billion start-up injection for the China Investment Corporation, the sovereign wealth fund that he ran for the previous five and a half years. Unfortunately, he did not favor this suggestion.

The final – and possibly most important – insight that I took away from the Forum concerned the quality of China’s new leaders. From President Xi Jinping and Premier Li Keqiang on down, China’s new leadership team is quite sophisticated in terms of analytics, risk assessment, scenario modeling, and devising innovative solutions to tough problems. Moreover, under the organizational umbrella of the National Development and Reform Commission (NDRC) – the latter-day version of the old central planning apparatus – China has marshaled considerable resources into the formulation of a comprehensive and well-thought-out economic strategy.

But, in the end, it takes more than strong policy and analytical skills to deal with tough economic challenges. We have seen unfortunate examples of that repeatedly in the West in recent years, and there are no guarantees that China’s newly installed leaders will avoid comparable pitfalls.

Vision and strategy are vital for realizing the “China Dream,” as the country’s new leaders are now calling it. But it will take courage and sheer determination to tackle what is perhaps the biggest obstacle of all – resistance from deeply entrenched local and provincial power blocs. On this critical front, strong words must be accompanied by bold action.

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    1. Portrait of Pingfan Hong

      CommentedPingfan Hong

      Fortunately Lou did not buy your suggestion, as he understood well that foreign reserves were not the assets at the disposal of the Ministry of Finance. If the Chinese government wants to increase fund for its pension fund, it can simply either raise tax or issue debt. Why should the government go circuitousely to set up a foreign currency denominated fund by first issuing RMB bond, then using the proceeds to swap with the central bank for the equivalent amount of foreign reserves, then investing in foreign countries, then earning returns abroad, then repatriating returns back to China by selling the foreign currency denominated returns to the central bank to exchange for RMB, and then finally using it to support the pension?

    2. CommentedJulio Huato

      I wonder why governments in China, Russia, etc. cling to these huge reserves portfolios invested abroad. Clearly, there is no need for such huge insurance policies against BoP risk. So what is it? Like in the case of Russia, what are they insuring against? Another two or three upcoming collapses of the Soviet Union? They are weathering okay the biggest global crisis since the Great Depression. It just seems so disproportionate given the myriad opportunities for domestic development. I'm trying to discount the cynical (?) view that these governments are just corrupt and get a cut from the financial interests that help them manage these funds abroad. Anybody has a sense of why this is going on?

    3. CommentedProcyon Mukherjee

      The structural shift from export led growth to domestic consumption that is so much dependent on urbanization and its success is a pointer that the best solution has been chosen among the alternatives. It is really contrasting to see that India, which has been nurturing ambitions in similar lines have fallen way off the target in terms of urbanization. It is something that democracy could not achieve in India, where land acquisition and managing displacement is concerned; the avoidance of this public debate by the polity marks the critical pitfalls of the process of democracy, whereas a far worse alternative on the contrary has not only made it possible, but is now embarking on an even sharper growth trajectory, making of 95 new cities!

      The answer perhaps lies in the last part of the essay by Stephen S. Roach, it is the quality of leadership that is all that counts.