CHINA’S ECONOMY: Vision quest

Perhaps the key phrase guiding China’s startling economic rise has been former paramount leader Deng Xiaoping’s advice to cross rivers by “feeling the stones”. Deng’s pragmatic counsel urged his countrymen to learn from what exists, not from what might be.

Yet in recent weeks tentative signs of a slightly more visionary China have emerged, a country that might seek to create its own destiny, rather than simply learning from the mistakes of others – and then hoping for the best.

In economic terms this means rebalancing an economy too dependent on exports and inefficient investment in heavy industry, towards an economy geared toward private enterprise, service, consumption and the creation of brain jobs.

The die was cast in March by Wen Jiabao, China’s outgoing premier. At his annual press briefing, Wen pledged to “accelerate” and “deepen” economic and market reforms while highlighting the importance of political change.

A month later, he criticized the country’s banks, accusing them of reaping profits too easily. “A small number of major banks occupy a monopoly position,” he said. “That’s why we are dealing with the issue of getting private capital into the finance sector.”

Wen’s comments come at a key moment in the country’s emergence as a global superpower. China’s economy is slowing, with inflation rising, imports down, and export growth looking tepid. The government, which got used to growth rates north of 10% in the years before the financial crisis, expects growth to ease to 7.5% this year, and to 5% by 2020.

DIFFERENCE OF OPINION

Experts are divided on the state of the economy. Some believe all is fine – that storms elsewhere won’t lead to heavier rain on China’s shores. The IMF believes GDP will hit 8.2% in 2012; economists at JPMorgan Chase and Bank of America Merrill Lynch tip economic growth of 8.4% and 8.5% respectively.

Others have more apocalyptic forecasts. Under the IMF’s nightmare scenario, which envisages another systemic crisis in Europe, China’s growth rate falls as low as 4.5%. Some economists believe that, absent inefficient investments in real estate and industrial goods (creating stockpiling of everything from property to cars to golf courses, merely to boost job figures), the rate of growth is already close to that level.

For months, strategists and forecasters have lined up to ask whether China will experience a hard or a soft landing as it transitions to a more pedestrian long-term rate of growth, as befitting a more mature economy.

Andy Rothman, chief China micro strategist at CLSA, says that by posting GDP of 8.1% in the first three months of 2012 – historically the slowest quarter of growth – China has shrugged off any concerns of a hard landing. He also cast doubt on any prospects of dramatic policy easing, notably cuts in banks’ required reserve ratio, noting that “big easing will remain an investor’s dream”.

Others offer a far gloomier prognosis. JPMorgan Chase’s chief Asia and emerging-market strategist Adrian Mowat believes China’s economy has already hit the wall, noting: “China is in a hard landing. Car sales are down, cement production is down, steel production is down, construction stocks are down. It’s not a debate any more, it’s a fact.”

The disparity of these views points to two further, related issues. First, interest in China’s economy, seen as the single, working major growth engine in a broadly moribund global economy, is greater than ever. And second, it highlights the difficulty of getting hold of reliable statistics in the People’s Republic, a country run by a party that still enjoys operating under a shroud of secrecy.

Most experts agree that GDP was labouring along at way below 8%, the official government growth figure, for most of the 1990s. The tables after the millennium, when the party started underplaying growth, claimed a rate of around 10% when any economist worth their salt was estimating GDP at anything up to 15%. The reason for this duplicity was simple: low growth raised recession fears, which in turn weakened party legitimacy; soaring growth ratcheted up public expectations while raising fears of an unsustainable economic bubble.

China’s economy probably hasn’t touched down yet. “I don’t think we’ve landed yet – to me, there’s a lot of wishful thinking out there,” says David Wolf, founder of independent Beijing consultancy Wolf Group. “I can see a lot more room to descend, to see whether we land as a feather or as a brick.”

OVERHANGS

Wolf points to several massive overhangs in the economy, notably: a stockpile of completed-but-unsold high-end residential and commercial property; and huge and still-growing investment in export-focused light and heavy industry.

Both of these overhangs create corollaries: areas of the economy where investment is much needed yet scarce, even non-existent. If capital is still flooding into heavy industry, supporting export-focused state firms, it is by default being diverted away from nimble young privately owned firms. Likewise, a glut of high-end property translates into a paucity of affordable housing for lower-earning households – a genuine concern for a party that professes to wed its past and its future to the fortunes of the common man.

Then there are the concerns of Wen Jiabao. China’s premier wasn’t always a reformer: his stint as premier, which formally comes to an end in March 2013, when he is replaced by likely successor Li Keqiang, has been notable for its conservatism.

Wen’s decade in power coincided with the consolidation of power in the hands of a few state organizations, notably a handful of regulators and a few leading state enterprises, led by the manufacturers and the ‘Big Four’ banks.

That it is this nexus of power at which Wen has taken aim in his fading years is interesting. Some say it merely makes him look and sound like an old man in a hurry. Others identify a whisper of Dwight D Eisenhower’s farewell presidential address in 1961, in which he warned of the untamed power of America’s military-industrial complex. In much the same way, Wen is now excoriating China’s banks – and, through them, an entire state of vested interests – handily overlooking the fact that it was his administration that handed them unheard-of power, profits and privilege.

Wen knows he cannot change anything overnight. Political reform may take decades and still never be complete. Economic reforms are, in many ways, just as tough to push through. Most of China’s top leaders, along with those who have profited from its rise, support the ‘Beijing Consensus’, an ill-defined term connoting the gradualist, authoritarian Chinese model of state capitalism.

Fracturing this cosy consensus won’t be easy. Wen’s recent speeches, suggests Wolf, are carefully pitched “to beat the bushes and see if anyone who agrees with this policy is inclined to step out” and reveal themselves. Only then will Wen (and with him the country’s reformist thinkers) be able to shift the argument away from an inherent belief in the Beijing Consensus towards a time when China can begin the process of recasting its economy.

ON SIDE?

Wen has potential backers, notably China’s smaller lenders and a small batch of increasingly powerful, privately run mainland corporates – firms such as telecoms equipment manufacturer Huawei and auto maker Geely. Then there’s the relatively liberal enclave of the PBoC (People’s Bank of China) – it’s worth noting that the China 2030 report, a huge tome issued in March 2012, which slammed Beijing for failing to support private enterprise, was co-authored by World Bank president Robert Zoellick and a small group of PBoC officials.

An influential paper published last year by Yasheng Huang, a professor at the MIT Sloan School of Management, noted that China performed best “when it pursued liberalizing, market-oriented reforms” that moved “away from statist policies”.

Wen remains outgunned: several hugely powerful lobbies want the Beijing Consensus to endure for as long as it can. China’s leading banks profit from the status quo, as do leading export-focused SOEs (State-owned Enterprises) and much of the remaining edifice of power.

“The big division in policy circles is that on one hand you have a group that says that the current situation is unsustainable, and believes the economy must shift from production to more consumption,” says Michael Pettis, a finance professor at Peking University’s Guanghua School of Management. “Then on the other side of that argument are people who don’t see a problem with the current model – people who believe that the state sector has done fine, and will continue to do fine.”

China’s outgoing premier clearly doesn’t believe that to be true. Despite spending the past decade fighting against much needed reforms, Wen is doing one, final thing: laying the groundwork for the new generation of leaders, who take office in early 2013.

The new group of top mandarins is set to be led by two more technocrats, a new premier (Li) and president (Xi Jinping) who got where they are by knowing when to champion an issue. Wen is doing the groundwork for them now, creating foundations upon which a case in favour of economic and financial recalibration can be built, as and when the time is right.

Few outside China doubt that the country’s economic model needs a serious rethink. The economy is slowing, and will continue to slow further, precisely because it is so skewed. “China can’t rely on exports to power its economy forever, particularly at a time when the European economy is heading into recession,” says Liu Li-Gang, chief Greater China economist at ANZ in Hong Kong. “It has to cut its reliance on exports and boost domestic consumption.”

Doing this will require Beijing to liberalize its fiscal policy further, allowing capital to move into and out of the country with greater ease, and move toward a less statist economic model powered by private companies and a broader range of credit institutions. Maybe in time China’s politicians will come to see private enterprise as Churchill saw it: not a “predatory tiger”, or a cow to be milked, but a “healthy horse pulling a sturdy wagon”.

These choices aren’t easy. The nation’s long-term growth prospects will only become clear once inefficiencies in industry, real estate and banking are ironed out.

As Peking University’s Pettis notes: “If you do change the system, you’ll see a slowdown in growth. But if you don’t, you’ll end up with bigger and bigger imbalances, as well as a slowdown in growth.” Yet just maybe, thanks to an old premier in a hurry, China has finally shown the ability to dream, if only a little.