It is heart-warming to hear of economic miracles. For investment bankers and portfolio analysts, it is good cocktail party chat. Such stories were common in Japan in the early 1980s and much of Southeast Asia in the early 1990s. Now, it is China's turn, with sustained annual growth of 8 to 9 per cent. Or rather, that is how things were before Sars. The disease has exposed a structural dependence which was previously obscured by the thrill of high growth rates. Now, the fallout from Sars could shatter second- and third-quarter growth for this year. There are still more questions than answers as China enters uncharted economic territory. The impact of Sars is already dwarfing the fallout from Tiananmen in 1989 and the Asian financial crisis of 1997-98. Critically, China's economy is no longer insolated but, rather, is integrated with international communities - in short, it is dependant on foreign investors who are now unnerved by Sars. In the first quarter of this year, China witnessed a phenomenal growth rate of 9.9 per cent, attributable to the cumulative effects of policies implemented over five years. These include: First, massive state capital investments in the construction of transport, telecommunications and water conservation facilities, and the trickle-down effect from such Keynesian policies. Second, the commercialisation of housing, financing for car and house purchases, and the promotion of mobile telecommunications last year, contributed to rising consumption at the beginning of this year. Third, and most significant, the momentum from entry into the World Trade Organisation resulted in a first-quarter surge of 42.4 per cent in foreign trade and 56.7 per cent in foreign capital utilisation. But this miraculous growth, attributed to state fixed-capital and foreign investment, is in contrast to the poor performance of domestic enterprises. To date, none of China's publicised brands has been able to gain a significant competitive foothold in international markets. The inadequacy of state-dominated corporations, perpetuated by irrational staffing structures, signals a need for further private-sector growth - already running at 25 per cent. More is needed, however, for China's economy to adapt to full market parameters, and private growth will require adequate capital sources. So far, the function of China's capital markets has been to cushion the inadequacy of state-owned enterprises, limiting channels for non-state-sector growth. The role of capital markets as a source of growth for both the private sector and China's economy in general requires adjustment. But this would probably result in serious insolvency within the banking system - one reason why any such adjustment will not be immediately forthcoming. In short, China's economic miracle is dependent on foreign investment, and this will be increasingly so in the future. The attraction of cheap labour costs is balanced by the high logistical and management fees. Appointing Chinese to management roles is extremely difficult, unless they have obtained a degree abroad and have at least 10 years' international experience, which effectively puts them on a par with expatriates, at least in terms of how much they cost to hire. This explains why, when faced with an international crisis or confrontation, China's foreign policy appears weak, at best vague, and often confuses western diplomats who expect a resurgence in nationalism on the back of economic strength. The truth boils down to economics. China's government cannot afford to offend any western government, as its political survival depends on economic stability, which can be achieved through prolonged foreign investment. Since 1990, China has absorbed US$230 billion in foreign investment, accounting for 45 per cent of the entire Asia region. In turn, foreign-invested enterprises account for half of China's exports, and it is the export economy that will drive China's growth in the medium to long term after state capital investment inevitably slows. The Sars crisis has caused foreign investors to cancel visits and negotiations, and put deals on hold, revealing the Achilles' heel of China's economic structure. For the first time, China has become acutely aware of how exposed its economic miracle is to international opinion, moreover the volatility of foreign investment. Laurence Brahm is a political economist and lawyer based in Beijing
