China's pro-market reforms must not be on paper only
Andy Xie says the Chinese government's fine words about retooling the economy will ring hollow unless it begins to, for a start, roll back the state's influence in the market and cut taxes
The government's Central Economic Work Conference last weekend emphasised quality over quantity for China's future development. It is a laudable objective. But, unless the government is revamped, it will be hard to accomplish.
The government has talked about rebalancing the economy and shifting to consumption for a decade now. Yet, the consumption level today is lower than ever. Unless credible and drastic changes are implemented soon, the talk about quality may end up being just talk, like that about rebalancing.
China has reaped dividends from its membership of the World Trade Organisation and its favourable demographic trends. These twin dividends have led to a surge in the country's share of global trade, which in turn raises income and savings. The government has used part of its riches well, building good infrastructure to support manufacturing growth and urbanisation.
Unfortunately, image projects, grey income and asset bubbles have also risen to claim a share of the pie. The massive and wasteful stimulus in 2008 amplified the anomalies in China's economy. At the same time, the twin dividends are running out. The debt crises in the West signalled the end to the WTO dividend, and the shortage of blue-collar labour, as reflected in wages increasing faster than exports, points to the end of the demographic dividend. The economy has tumbled since the second half of 2011.
The recent recovery is probably just perception, fuelled by misleading statistics. While industrial contraction probably ended in September due to a pick-up in exports, no strong growth in industry is discernible at the micro level. Most statistics can mislead, including figures on electricity, industrial production and retail sales. China's economy has not grown much this year, certainly not close to the level the official statistics suggest.
China's economic model is investment-led - that is, build first and wait for the demand. In this model, the return on capital is low, as the capacity is wasted during the waiting time. When this model is extended, the real return on investment becomes negative. It needs a source of money to keep it going.
China's property bubble has played that role. The WTO and demographic dividends first became export income that turned into bank deposits. Through land sales and taxes on property transactions, they became fiscal revenue. And, the fiscal revenue became subsidies for manufacturing activities through cheap land and tax concessions. Many manufacturing companies have themselves depended on property development for profits.
While China's nominal gross domestic product has risen fourfold in the past decade, grey income may have risen 10 times as fast, due to the rapid rise in fiscal revenue, state-owned enterprise investment and asset bubbles. The people paid for it by not gaining much from the rapid development. For example, the stock market has fallen. The negative returns are transfers from the household sector to others, as subsidies for loss-making investment and grey income. High property prices are another form of transfer. Over half the proceeds from property sales end up in the government's pocket.
The property bubble has begun to deflate. But the statistics and market stories won't convince you of that. The smokescreen is really to confuse speculators with multiple empty apartments and potential buyers who have been waiting. The confusion is designed, first, to stop the speculators from liquidating, by giving them hope, and, second, to suck in more credulous bottom feeders.
China's property market is likely to deflate for five years. At the bottom, the average price will be down by half. The property bubble is deflating because exports are not rising like before, which makes rapid monetary growth impossible. Like all other East Asian economic booms before, China's asset bubbles deflate when the export boom ends.
As the twin dividends end, China must decrease waste and subsidies for the economy to grow. Without concrete action on both fronts, the economy won't recover. Massaging statistics, cooking up stories or signalling a stimulus for a psychological impact may rally stock market sentiment for a short time, but it won't change the reality on the ground. Words cannot replace action.
First, China should cap government expenditure and investment by state-owned enterprises. If there is a cash surplus in either, it should go to tax cuts or dividends. The key to China's economic efficiency is in limiting the size of the public sector. Whatever the government's policies, if they don't achieve this goal, the economy won't improve.
Second, China must limit government intervention in the market. Often, such interventions are designed to increase the grey income. Their damage to the economy is far greater than any income redistribution. Despite China's economic growth, few globally competitive companies have emerged. The system is to blame. Bad companies don't die, because they get government support. As resources are locked in to underperforming companies, good companies have little chance to flourish. The government's role is causing bad money to drive out good.
Instead of words, the government must starting taking meaningful action. First, it could cut taxes. Overcapacity afflicts almost all industries. The solution is to cut investment and increase consumption, and the best tool for that is to cut taxes. Yet, the government prefers to subsidise the loss-making businesses. This, of course, creates a bigger government. Unless this mentality changes, China's economy will struggle for years.
Even without the twin dividends, China has plenty of room for growth because productivity is low. Its per capita income is US$6,000, compared to over US$20,000 in South Korea and Taiwan, and US$40,000-US$50,000 for developed economies. Productivity-led growth requires a bigger role for the market. To achieve it, China needs to revamp its political economy that seems to be driven by grey income. Pro-market reforms can bring back China's economic boom. Propaganda won't.
Andy Xie is an independent economist