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Rocky road to reform

Fixating on 7.5pc GDP growth will only distract China's leaders from tackling restructuring needed to deal with a raft of problems

PUBLISHED : Wednesday, 19 September, 2012, 12:00am
UPDATED : Wednesday, 19 September, 2012, 3:35am

China has many distractions - the mysterious disappearance of its leader-in-waiting Xi Jinping, demonstrations against Japan over the disputed Diaoyu/Senkaku islands, and, greatest of all, the foggy speculation over who will get what in the imminent political changing of the guard - preventing it from giving full attention to its main task of promoting vital economic change.

But through the haze of gung-ho talk about China imminently overtaking the US as the world's biggest economic power, there is a growing realisation that China needs radical reforms.

Michael Feller, an investment strategist at Macro Investor, amusingly compared China's economic plight to the 1994 film Speed where Keanu Reeves has to drive a commuter bus through the streets of Los Angeles without letting its speed drop below 50 miles an hour or it will detonate a bomb and kill all the passengers.

"With 1.3 billion passengers on board, the stakes are high for the Chinese Communist Party as it navigates the winding laneways of slowing exports, an uncertain property market, rising capital outflows and a Europe - the country's biggest trade partner - mired in recession," writes Feller. He points out that China's helmsmen have been adept at the wheel in keeping growth above the 7.5 per cent target.

But, hey presto, that's one of the problems - that 7.5 per cent magical target, above which China will be saved and below which it will be eternally damned. Western commentators regularly speak of 8 per cent as the target needed to provide enough new jobs.

Fixation with 7.5 or even 8 per cent growth this year and every year is dangerous, not merely because it is not achievable, but the only way of getting close to it would take China away from the essential reforms.

Last week Morgan Stanley presented an economic report on China headlined "From mudding through to a bumpy macro ride". Nevertheless, it still predicted growth of 7.5 per cent this year and 7.9 per cent in 2013, down from its previous forecasts of 8 per cent and 8.6 per cent.

Some investment bank economists are tracking the economy so carefully that they lose sight of the wood for all the trees. Cynical economists, of course, citing premier-in-waiting Li Keqiang's references to statistics being "man-made" and "for reference only", believe that China's actual growth may be 5-6 per cent.

At the allegedly pessimistic extreme is Michael Pettis, who sees growth of 3-4 per cent for the next decade. Pettis is credible because he has a good grasp of both micro- and macroeconomic factors and implications, of theoretical and practical economics and is in touch with a variety of Chinese opinion from his post as professor of finance at Peking University.

Pettis pointedly describes himself as a sceptic, not a China bear. He makes the good point that the rise of the US as the world's economic superpower took decades and had many bumps and roadblocks.

The US was the leading power by the 1870s but, writes Pettis: "It took a horrible decade of steep economic decline in the 1930s and a devastating war that pretty much wiped out its competitors to create the US century."

The last thing China needs is a war with Japan - in spite of the pressures of hot-headed nationalists who would like to nuke Japan to oblivion. The same applies to Japan. Unfortunately, politicians are tempted to stir up nationalism as a smokescreen to cover other difficult issues they don't want discussed.

China cannot expect that its own journey to economic greatness will be a continuously smooth ride, particularly when its current model is unsustainable and needs a major overhaul, as most economists apart from blind China bulls admit.

Pettis adds that it is "hyperventilated nonsense" to suggest that economic readjustment means that China will collapse: "It just means that an adjustment is needed, debt levels must one way or another be addressed, and the longer it takes to begin the adjustment, the more painful it will ultimately be."

Rebalancing, and raising household consumption to 50-55 per cent of GDP, would also be good for the global economy by boosting Chinese demand.

Critics such as Minxin Pei and Andy Xie have long complained that Chinese economic policy is digging a dangerous deep hole. Pei asks whether Chinese banks are hiding "the mother of all debt bombs".

Xie says that the only way forward is to raise the productivity of Chinese workers, which would lift wages and consumption, but it also means challenging and changing the central allocation of resources.


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