International Herald Tribune
Bowring: China can't help
Tuesday, November 25, 2008

HONG KONG: Do not expect that China can - at least in the short term - do much to offset the recession spreading through the global economy. This is not to suggest that China will deliberately shirk its responsibilities as a global player, nor is it intended to be gloomy about the country's longer-term prospects. But inflated expectations of China's potential to create demand for the rest of the world are liable to bring disappointment, and thus add to friction over trade imbalances, notably in its surpluses with the United States and Europe.

The World Bank on Tuesday downgraded China's GDP forecast for 2009 from 9.2 percent to 7.5 percent, and even that looks like officially driven over-optimism. Unofficial estimates go as low as 2 percent growth in GDP.

The unpleasant reality is that, even without the current global problems, China itself was overdue for a major cyclical downturn. Global events are now merely exacerbating the structural flaws in China's growth over the past decade. Stimulus packages like those announced recently by Beijing will help offset a sudden collapse in export growth and inward investment, but the structural issues will take time to address.

The main one is the direction of investment. China has had extraordinarily high rates of savings and investment, which for several years enabled very rapid economic growth to be combined with massive accumulation of foreign assets. But both the rate of savings and the direction of investment have been closely linked to an increasing income divide within China, which is reflected in weak consumer demand. Private consumption languishes at less than 40 percent of GDP and is proving hard to stimulate. Investment that does not produce returns - economic or social - is wasteful, as China's experience illustrates.

The country's other structural problems include:

Excessive spending on extravagant public buildings, sometimes financed with borrowing from state banks.

Excessive investment in upscale housing, producing a glut in the market for upper- and middle-income buyers, with developers and banks now unwilling to see prices fall to market-clearing levels. Meanwhile there is inadequate investment in housing for the lower-income majority.

Excessive corporate reliance on speculation to generate profits.

Excessive investment in capital- and energy-intensive industries brought on by low interest rates and a focus on size rather than return on capital.

Excessive investment in manufacturing production aimed at higher-income households. The auto industry is one of several examples. Although car ownership is still low - 2 per 100 people - demand is falling far behind potential output because household income growth is insufficient.

Widening income gaps have contributed to weak domestic demand. People in the higher brackets have a greater propensity to save - for education, health care and home ownership. Lower income people with a high propensity to consume have done less well. Further adding to the consumption problem has been an apparent (though probably temporary) sharp rise in corporate profits' share of national income.

Of course, China is also directly effected by what is happening on the global scene. Just as its own boom was a direct consequence of loose monetary policies in the West, so the contraction elsewhere is impinging on the Chinese financial sector. Chinese banks, now mostly listed on foreign as well as local stock markets - and thus subject to more scrutiny than in the past - have become more cautious. But this is not a prime cause of difficulties for China, which, unlike most developing countries, still has foreign exchange controls and state ownership of most banks.

The government is trying to address these issues - with social spending to reduce the incentive to save, with higher wages and increased spending on low income housing, rural infrastructure, improved farm price supports, and attempts to regain influence over major investment decisions by state companies and local governments. But results are necessarily slow. Fear that a new round of bank bailouts will be needed will limit Beijing's willingness to see big budget deficits.

China's difficulties may be short-lived compared with those of deeply indebted Western countries. But China's current problems illustrate why Beijing is focusing on domestic issues and why the rest of the world should not expect too much of a country experiencing its first big cyclical downturn since it joined the global market economy.