Challenges ahead for China as it looks to get growth back on track

Political reform, energy needs and bridging the wealth gap are among the pressing issues for Beijing
Larry Elliott, economics editor
guardian.co.uk, Sunday 17 May 2009 22.17 BST

During the winter, the closed factories in the Pearl river delta and the drift back from the towns to the countryside told their own story. China, the country that has based its development strategy on becoming the low-cost workshop for the world, was feeling the impact of an implosion in global trade caused by the financial crisis.
Across Asia, empty container ships lay idly at anchor as consumer demand collapsed and stocks of manufactured products were run down. China had always expected – indeed, had planned – a slowdown in its economy once the 2008 Beijing Olympics finished, but it was not ready for the global collapse that followed the bankruptcy of Lehman Brothers last September.
Suggestions that China might be able to decouple itself from the problems that originated in the US housing market proved fanciful. Having caught the flood tide of globalisation for a decade and a half, the world's most populous country was inevitably affected as the tide went out.
Yet everything is relative. Beijing expects China's economy to expand by 8% this year – down on the explosive double-digit pace since the turn of the millennium, but a growth rate to die for if you are Gordon Brown, Barack Obama or Angela Merkel.
Already there are signs that the government's fiscal boost – worth 16% of gross domestic product over two years – is having an impact. A country that for three decades has been a curious mix of Karl Marx and Adam Smith has now turned to John Maynard Keynes to speed its way out of the global downturn.
"Because of China's structure, the government has direct levers to spend money quickly," said Prof Peter Williamson, of the Judge Institute of Management in Cambridge. "Whereas in Britain it can take years to get an infrastructure project going, in China things can happen immediately."
Much of the stimulus package is planned investment that has been fast-tracked rather than new money, but Gerard Lyons, the chief economist at Standard Chartered Bank, says it will make a difference. "The reality is that Beijing has announced a lot of new measures and they have started to push these measures through. They have pulled out all the stops."
Political structure
The real issue for China, however, is not whether the state can push the growth rate back above 10% next year; the consensus among economists is that it certainly can. Periods of rapid growth are by no means exceptional in Asia: Taiwan grew at 9.4% a year for more than a quarter of a century after 1962; Singapore expanded at much the same pace between 1967 and 1993; Japan's purple patch was the period between 1960 and 1973, when its average growth rate was 10%-plus. But China faces three sets of challenges that will shape the way it – and the global economy – evolves over the next half century.
At the root of everything lies the question of whether the country's political structure is conducive to sustained growth. In the west, the classic pattern of development has been for economic change to stimulate demands for political reform and greater democracy. Despite the arrival of designer labels to the glitzy shopping malls of Shanghai, China remains a one-party state and there is little evidence that the ruling Communist party has any intention of loosening its grip.
Anxiety that rapidly rising unemployment, particularly among disaffected graduates, might put millions on the streets this summer demanding change, helps explain both the scale and the speed of China's economic stimulus. Memories of Tiananmen Square are still vivid for the policy elite in Beijing.
But some economists believe the fear of political change will hold China back. Prof Andrew Tylecote, of Sheffield University, believes the top-down fiscal package exacerbated the fundamental weakness of the economy – its lack of a thriving private sector. "You tell state-owned banks to lend more money and they will do so. You tell state-owned enterprises to take on more staff and borrow more money and they will do so. If you throw money at anything remotely shovel-ready in terms of infrastructure, you will have an impact.
"But what they are not doing is beefing up the private sector. The dynamism ought to be coming from the private sector, which has been hammered by the crisis yet is not being looked after by the stimulus or by the boosting of credit. The stimulus is going to produce a more top heavy, muscle-bound economy full of rather expensive, poorly-utilised equipment."
China, though, is the country that pioneered paper, the compass, steel, the wheelbarrow, gunpowder, canals and a host of other innovations while western Europe was still struggling to emerge from the Dark Ages.
New challenges
In more recent years, Chinese expats have taken their entrepreneurial skills around the world, and in the domestic market Chinese companies are about to overhaul western multinationals in patent filing for the first time.
"There is a lot of innovation," says Williamson. "The really interesting companies are hybrids, which are 30% state owned and which get the best of both worlds – autonomy but support from the state. The idea that there is a Soviet Russia-style state sector is completely incorrect."
Every bit of that innovation will be needed as China grapples with its next set of challenges, all of which – according to Lyons – relate to significant imbalances.
These are the gap between living standards in the cities and in the countryside; the comparison between the wealth of the coastal strip and the poverty of the inland regions; the mismatch between the country's projected growth rate and its energy needs; the rudimentary social safety net which encourages the population to save rather than spend; and the way that lack of domestic consumption exacerbates tensions in the global economy between those countries that export too much and those that export too little.
None of these challenges will be solved quickly or easily. China's energy needs are enormous, and it has started to channel part of its export earnings into sovereign wealth funds, which are now taking advantage of the global recession to buy up assets at knockdown prices.
"Cash-rich Chinese concerns are taking advantage of depressed asset prices and debt deleveraging in the resources sector to lock in future energy and resources needed for continued growth", said Jan Randolph, of IHS Global Insight. Recent coups have been "loan-for-oil" deals with Russia, Brazil and Kazakhstan; in Africa, China has helped build roads, railways and ports to secure access to the raw materials it needs to sustain its high growth rate.
These needs are – and will remain – substantial. China is undergoing the most rapid urbanisation the world has ever seen and has 221 cities with a population of more than 1 million. To put that in perspective, Europe has 35. The gap in living standards between those living in the cities and the rural population is large and growing: China's development has been accompanied by a widening of income inequality.
Welfare state costs
Yet because it is unusual in experiencing the problems of both a developing and developed country – high growth and an ageing population – the government is worried about the cost of a western European-style welfare state. Rudimentary healthcare and the cost of a decent education means that families save far more heavily than in the west, leaving them with less money left over at the end of the month to spend in the shops. Unless that changes, the imbalances in the global economy that were at the root of the crisis will remain a threat.
In the longer term, Beijing has to decide how to use China's growing economic clout on the global stage. China has allowed Americans to live beyond their means for years by using its export earnings to buy US Treasury bonds; the fear in Washington is that Beijing will pull the plug once it is ready to challenge US hegemony.
According to Tylecote, China's geopolitical objectives are far more limited. "Taiwan is clearly a massive issue and China does not want to be told it cannot reclaim the motherland because an American fleet is sitting in the Taiwan Strait. It wants to challenge US hegemony in its own sea lanes. But I don't think policy makers have a 30-40 year time horizon; they are much more focused on short-term issues."
One of these issues – which runs through decision making in the short, medium and long term – is how to make China's growth environmentally sustainable. Jeffrey Sachs, the US economist, believes that by 2050 China and America will have economies of a similar size, yet if China operated at the same level of resource use and energy intensity as the US it would require four planets to support its 1.5 billion people.
"Pollution is a really serious issue," said Williamson. "But it is only partially being addressed. The government is looking at nuclear power, solar power, and renewables in an attempt to improve efficiency but in some cities there is a dash for growth and the environment is low on the priority list."
China's stance at December's climate change summit in Copenhagen is seen as crucial in piecing together a successor to the 1997 Kyoto agreement. Western diplomats say they detect a softening in Beijing's approach, but China will not be pushed around. Its growth rate means it will get the one thing its policymakers want more than anything else: respect.