The Chinese Economy: Challenges and Opportunities Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.) Vice-Chancellor, The Chinese University of Hong Kong and Kwoh-Ting Li Professor of Economic Development, Stanford University A Presentation at a Meeting of Carl Zeiss Vision Hong Kong, 15 November 2005 Phone: (852) 2609-8600; Fax: (852) 2603-5230 Email:LAWRENCELAU@CUHK.EDU.HK;WebPages:HTTP://WWW.CUHK.EDU.HK/VC/
A Preview Introduction The Chinese Economy Today Challenges Ahead Prospects for Economic Growth Concluding Remarks Lawrence J. Lau, The Chinese University of Hong Kong 2
Introduction The emergence of the Chinese economy on the global scene is one of the most significant developments in the world economy during the past quarter of a century. The opening of China to the world through international trade and direct investment has had and will continue to have major impacts on itself as well as on the world economy. The implementation of the Chinese commitments under the World Trade Organization (WTO) accession agreements has proceeded quite well. In the draft Eleventh Five-Year (2006-2010) Plan for Economic and Social Development of China, the policy of an open-door to trade and investment is not only affirmed Lawrence J. Lau, The Chinese University of Hong Kong 3 but also will be further enhanced.
Introduction China will continue to open its markets further to imports and to foreign direct investment (FDI). More and more Chinese enterprises will be making foreign direct investments overseas, much as their Japanese counterparts did in the 1970s and 1980s. The Chinese objective is to maintain an overall balance of payments equilibrium (of zero) going forward. With its official foreign exchange reserves standing at almost US$800 billion as of today, China does not need a higher level of official foreign exchange reserves. Lawrence J. Lau, The Chinese University of Hong Kong 4
The Chinese Economy Today (1) China is Still a Developing Economy East Asia is the fastest-growing region in the world over the past quarter of a century, notwithstanding the East Asian currency crisis of 1997-98. China is the fastest growing country in East Asia approximately 9.4% p.a. since beginning of economic reform in 1978. Between 1978 and 2004, Chinese real GDP grew from $160 billion to $1.65 trillion (2004 prices) (6 th largest GDP in the world) and real GDP per capita grew from $168 to $1,275. By contrast, the U.S. GDP (approximately $11.7 trillion) and GDP per capita (approximately $39,000) are respectively more than 7 and 30 times the comparable Chinese figures in 2004. Despite its rapid growth, China is still a developing economy in terms of its real GDP per capita. Lawrence J. Lau, The Chinese University of Hong Kong 5
The Chinese Economy Today (2) 1978 2004 US$ (2004 prices) Real GDP 160 bill. 1.65 trill. Real GDP per capita 168 1,275 Lawrence J. Lau, The Chinese University of Hong Kong 6
The Chinese Economy Today (3) U.S. China US$ (current prices) 2004 GDP 11.7 trill. 1.65 trill. 2004 GDP per capita 39,000 1,275 Lawrence J. Lau, The Chinese University of Hong Kong 7
The Chinese Economy Today (4) China is one of the very few socialist countries that have made a successful transition from a centrally planned to a market economy. The 11th Five-Year (2006-2010) Plan is only indicative and not mandatory; the rate of interest (the price of money) and the exchange rate are the only prices that are still administratively determined on the margin. China is a model for the transition from a centrally planned to a market economy. The private (non-state) sector accounts for more than 70% of GDP and an even greater percentage of employment in 2004 compared Lawrence to essentially J. Lau, The Chinese 0% University in of 1978. Hong Kong 8
The Chinese Economy Today (5) The distribution of GDP by the originating sector has become Primary, 15%; Secondary, 53% and Tertiary, 32%. China is no longer a shortage economy--insufficient aggregate demand is a real possibility. China has become the World s Factory, the major supplier of inexpensive light manufactured goods such as textiles, apparel, shoes, electrical and electronic appliances, furniture, etc., on the basis of its low real wage rate (surplus labor). Lawrence J. Lau, The Chinese University of Hong Kong 9
The Chinese Economy Today (6) It is also rapidly becoming the World s Market because of its increased demands for goods and services around the world: It is the World s major user and importer of oil, minerals, and other natural resources and primary raw materials. It has also become the World s fastest-growing market for consumer goods, such as automobiles, cell phones, and tourism services, and producer goods such as aircrafts, computers, and steel. It has been an engine of growth for the Asia-Pacific region (Northeast Asia, Southeast Asia, Australia and New Zealand) since 2000 China runs a trade deficit vis-à-vis almost all countries in East Asia. It has become the most important trading partner for Hong Kong, South Korea and Taiwan. Lawrence J. Lau, The Chinese University of Hong Kong 10
The Sectoral Contributions of Chinese GDP Billion Yuan 14,000 The Contributions of Sectoral Value-Addeds to China's GDP (2004 prices) 12,000 10,000 Tertiary Industry Secondary Industry Primary Industry 8,000 6,000 4,000 2,000 0 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Lawrence J. Lau, The Chinese University of Hong Kong 11 Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
International Trade and Investment Chinese international trade has been growing at doubledigit rates in recent years, more than twice the rate of growth of world trade as a whole and is expected to continue to do so in the future. Total Chinese exports and imports of goods and services amounted to US$1.29 trillion in 2004 (US$1.15 trillion for goods alone), making China the third largest trading nation in the world, after United States and Germany. In 2004, exports of goods alone grew 35.4% to $593.4 billion while imports grew 24% to $561.4 billion; resulting in a trade surplus in goods of $32 billion, or less than 3% of total trade in Lawrence goods. J. Lau, The Chinese University of Hong Kong 12
International Trade and Investment Taking goods and services together, China had a trade surplus of $22.4 billion in 2004, or less than 2% of total trade in goods and services. Chinese exports is still characterized by a relatively low domestic value-added content estimated to be 30% for all exports and 20% for exports to the U.S. (Thus a 10% revaluation of the Renminbi will result in only a 2% increase in the cost of Chinese exports to the U.S. in U. S. $ terms, and a very limited impact on the volume of trade.) Lawrence J. Lau, The Chinese University of Hong Kong 13
Chinese Exports and Imports of Goods and Services $700 Chinese Exports and Imports of Goods and Services, billion US$ $600 $500 $400 Exports of goods and services (current US$ billions) Imports of goods and services (current US$ billions) Trade Balance of goods and services (current US$ billions) Billion US$ $300 $200 $100 $0 -$100 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 Lawrence J. Lau, The Chinese University of Hong Kong 14 Year 1992 1994 1996 1998 2000 2002 2004
Chinese International Trade More than 50% of Chinese international trade is foreigndirect-investment (FDI)-led, i.e., conducted by foreigninvested enterprises. More than 50% of Chinese international trade consists of intra-company trade. A large percentage of Chinese international trade consists of trade in raw materials, intermediate inputs, semifinished goods and services rather than finished products. China is often the last link of the global supply chain thus, it has trade deficits with almost every economy in East Asia but large trade surpluses vis-à-vis the U.S. (and to a lesser extent the other developed economies). Lawrence J. Lau, The Chinese University of Hong Kong 15
Chinese Official Foreign Exchange Reserves and External Debt 700 Official Foreign Reserves and External Debt (US$ billions) 600 500 Total reserves minus gold Long-term debt Short-term debt Billions US$ 400 300 200 100 0 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 Lawrence J. Lau, The Chinese University of Hong Kong 16 Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Rates of Growth of Total World Exports & Total Chinese Exports (Current Prices) 60 Annual Rates of Growth of Total World Exports and Total Chinese Exports (Current Prices) 50 World China 40 Percent 30 20 10 0 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003-10 Lawrence J. Lau, The Chinese University of Hong Kong 17 Year
China s Shares of Total World Trade China's Shares of Total World Trade 6 5 4 3 2 1 0 Lawrence J. Lau, The Chinese University of Hong Kong 18 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Exports Imports Year Percent
The Macroeconomic Situation The Chinese economy showed signs of over-heating in selected sectors and regions in 2004. The rate of growth of real GDP for 2004 was a high 9.5%. The rate of inflation, as measured by the consumer price index (CPI) may be estimated to be 3.9% for the same period, the highest rate since the mid-1990s. Efforts to engineer a soft landing has met with some success the rate of increase of prices of certain manufactured products such as cement and steel, the rate of growth of fixed investment (2004Q1, 43%; 2004Q2, 15.7%; 2004Q3, 25.9%; 2004Q4, 20.2%; 2005H1, 25%), and the prices of Lawrence real J. Lau, estate, The Chinese have University all of begun Hong Kong to come down. 19
Quarterly Rates of Growth of Real GDP Year-over-Year Quarterly Rates of Growth of Real GDP (YoY) 25% 20% GDPQ1 GDPQ2 GDPQ3 GDPQ4 15% 10% 5% 0% 1983q1 1984q1 1985q1 1986q1 1987q1 1988q1 1989q1 1990q1 1991q1 1992q1 1993q1 1994q1 1995q1 1996q1 1997q1 1998q1 1999q1 2000q1 2001q1 2002q1 2003q1 2004q1 2005q1-5% Lawrence J. Lau, The Chinese University of Hong Kong 20 Quarter Percent per annum
Quarterly Rates of Growth of Real Gross Domestic Fixed Investment, Y-o-Y YoY Quarterly Rates of Growth of Real Gross Domestic Fixed Investment 55 50 Quarter 1 45 40 35 30 25 20 Quarter 2 Quarter 3 Quarter 4 15 10 5 0 1996q1 1996q2 1996q3 1996q4 1997q1 1997q2 1997q3 1997q4 1998q1 1998q2 1998q3 1998q4 1999q1 1999q2 1999q3 1999q4 2000q1 2000q2 2000q3 2000q4 2001q1 2001q2 2001q3 2001q4 2002q1 2002q2 2002q3 2002q4 2003q1 2003q2 2003q3 2003q4 2004q1 2004q2 2004q3 2004q4 2005q1 2005q2 2005q3 2005q4 percent per annum Lawrence J. Lau, The Chinese University of Hong Kong 21 Quarter
The Macroeconomic Situation The core rate of inflation, defined as the change in the general price level net of the changes in the prices of energy and agricultural products, was always non-negative even during the period from mid- 1997 to 2002. Even with the latest surge in the prices of selected commodities and products, the core rate of inflation remains low at approximately 1%. Within the past 12 months, prices of key commodities such as steel and cement have begun to fall, providing yet another sign of the economic slowdown. The rate of inflation was negative for 2005Q2. However, the increase in the price of oil and the resulting adjustments will have an impact. For 2005M1-8, the consumer price index rose 2.1% YoY. In the long run, there is no upward pressure on the real wage rate of unskilled labor because of the abundant population in the rural areas. This lack of wage pressure coupled with growth in labor productivity should imply a relatively stable price level and hence relatively low rates of inflation. Inflation is likely Lawrence to be manifested J. Lau, The Chinese not University in the of Hong prices Kong of goods and 22 services, but in the prices of assets, in particular, real estate.
35 30 25 20 15 10 5 0-5 -10 The Consumer and Retail Price Indices % Monthly Rates of Change of Price Indices Since 1994 (Y-o-Y) RPI Retail Price Index for Agricultural Production Material CPI CPI for 36 Big Cities Jan-94 Apr-94 Jul-94 Oct-94 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Lawrence J. Lau, The Chinese University of Hong Kong 23 Month
Investment in China by Foreign Direct Investors China is now the second most popular destination country for foreign direct investment (FDI) after the United States, with a total of US$60 billion in 2004, compared to US$96 billion for the U.S. However, FDI into China is less than 10% of the total FDI worldwide. However, the nature of (FDI in China has been undergoing a transformation It has changed gradually from export-oriented to domestically oriented, taking advantage of the large Chinese domestic market; from light industry to heavy and high-technology industries; and from small projects to large projects. It has changed from China as the World s Factory to China as the World s Market --foreign direct investors increasingly view China not only as an export base but also as a market for their finished products in its own right-- e.g., BASF, General Motors, Honda, Motorola, Toyota, and Volkswagen all plan to market at least a significant proportion of the products they produce in China, if not all, in China itself. Lawrence J. Lau, The Chinese University of Hong Kong 24
Foreign Direct Investment (FDI) FDI was US$60 billion in 2004 (US$53.5 billion in 2003, should have been higher if it were not for SARS). At US$60 billion, it amounts to less than 10% of the annual Chinese aggregate gross domestic investment of approximately US$680 billion. Moreover, a significant proportion of it is what is known as recycled or round-tripped investment, ultimately originated by Chinese entities and individuals. Quantitatively, FDI is not critical to the Chinese economy. The stock of cumulative FDI at year end 2004 amounted to some US$560 billion. Qualitatively, FDI is probably more important because it brings in technology, know-how, business methods, management techniques and markets that will otherwise be unavailable in China. FDI has been responsible for most of the growth of exports (and imports). Lawrence J. Lau, The Chinese University of Hong Kong 25
The Shares of FDI in Chinese Gross Domestic and Gross Domestic Fixed Investment Percent 16 The Share of Foreign Direct Investment in China (percent) 14 12 Foreign Direct Investment / Gross Domestic Investment Foreign Fixed Investment / Gross Domestic Fixed Investment 10 8 6 4 2 0 Lawrence J. Lau, The Chinese University of Hong Kong 26 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Year
The Relative Stability of the Rate of Growth of Real GDP Gross domestic investment is mostly financed through domestic savings rather than foreign investment or loans. Foreign direct investment (FDI) accounts for less than 10% of gross domestic investment in China, a relatively small proportion. Despite fluctuations in exports and imports, the rate of growth of real GDP has remained remarkably stable at 7-8%. This is due to the combination of two factors: the relatively low share of exports in GDP, and the relatively low domestic value-add content of Chinese exports. Lawrence J. Lau, The Chinese University of Hong Kong 27
The Relative Stability of the Rate of Growth of Real GDP Exports are approximately 35% of GDP, but the valueadded content of exports is only approximately 30%, resulting in an export-generated value-added to GDP ratio of 10.5%. Chinese exports to the U.S. is approximately 10% of Chinese GDP (according to adjusted U.S. data), with a value-added content of 20%, resulting in a valueadded to GDP ratio of 2.0%. The contributions of net exports of goods and services to economic growth were negative for 2003 and 2004. The volatility of the Chinese annual rates of growth of real GDP has also declined over time, indicating an improved capacity for macroeconomic Lawrence J. Lau, The Chinese management. University of Hong Kong 28
Quarterly Rates of Growth of Exports: Selected East Asian Economies 50 40 Figure 3.2: Year-over-Year Quarterly Rates of Growth of Exports in U.S.$ (Percent) China,P.R.:Hong Kong India Indonesia Korea, Rep. of Malaysia Philippines Singapore Thailand China,P.R.: Mainland Japan Tai wan 30 1997Q1 1997Q2 1997Q3 1997Q4 1998Q1 1998Q2 1998Q3 1998Q4 1999Q1 1999Q2 1999Q3 1999Q4 2000Q1 2000Q2 2000Q3 2000Q4 2001Q1 2001Q2 2001Q3 2001Q4 2002Q1 2002Q2 2002Q3 2002Q4 2003Q1 2003Q2 2003Q3 2003Q4 20 10 0-10 Annualized Percent per annum -20-30 -40 Lawrence J. Lau, The Chinese University of Hong Kong 29 Quarter
Quarterly Rates of Growth of Imports : Selected East Asian Economies 80 Figure 3.3: Year-over-Year Quarterly Rates of Growth of Imports in U.S.$ (Percent) 60 40 1997Q1 1997Q2 1997Q3 1997Q4 1998Q1 1998Q2 1998Q3 1998Q4 1999Q1 1999Q2 1999Q3 1999Q4 2000Q1 2000Q2 2000Q3 2000Q4 2001Q1 2001Q2 2001Q3 2001Q4 2002Q1 2002Q2 2002Q3 2002Q4 2003Q1 2003Q2 2003Q3 2003Q4 20 0-20 Annualized Percent per annum -40-60 China,P.R.:Hong Kong India Indonesia Korea, Rep. of Malaysia Philippines Singapore Thailand China,P.R.: Mainland Japan Taiwan Lawrence J. Lau, The Chinese University of Hong Kong 30 Quarter
Quarterly Rates of Growth of Real GDP: Selected East Asian Economies 15 Figure 3.1: Quarterly Rates of Growth of Real GDP, Year-over-Year, Selected East Asian Economies 10 5 0 1994Q1 1994Q2 1994Q3 1994Q4 1995Q1 1995Q2 1995Q3 1995Q4 1996Q1 1996Q2 1996Q3 1996Q4 1997Q1 1997Q2 1997Q3 1997Q4 1998Q1 1998Q2 1998Q3 1998Q4 1999Q1 1999Q2 1999Q3 1999Q4 2000Q1 2000Q2 2000Q3 2000Q4 2001Q1 2001Q2 2001Q3 2001Q4 2002Q1 2002Q2 2002Q3 2002Q4 2003Q1 2003Q2 2003Q3-5 Annualized Rates in Percent 2003Q4-10 -15 Lawrence J. Lau, The Chinese University of Hong Kong 31 Quarter China Hong Kong Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Japan India
Exports as a Percent of GDP: East Asian Economies and U.S. 250 % Exports as a Percentage of GDP Hong Kong, China India Indonesia Korea, Rep. of Malaysia Philippines Singapore Thailand China Japan Taiwan Untied States 200 150 100 50 0 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 Lawrence J. Lau, The Chinese University of Hong Kong 32 1992 1994 1996 1998 2000 2002 Year
Imports as a Percent of GDP: East Asian Economies and U.S. 250 % Imports as a Percentage of GDP Hong Kong, China India Indonesia Korea, Rep. of Malaysia Philippines Singapore Thailand China Japan Taiwan Unites States 200 150 100 50 0 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 Lawrence J. Lau, The Chinese University of Hong Kong 33 1992 1994 1996 1998 2000 2002 Year
Challenges for the Hu-Wen Administration Chinese economic reform has been most successful. Everyone is better off by a large margin compared to 1978. No one wishes to roll back the economic reform. However, many problems have remained and new problems have emerged: the low level of household consumption (and the resultant high savings rate) the prevalence of duplicative and wasteful investment the inadequate provision of social services the rising income inequality (between urban and rural, between regions, and between individuals) Corruption environmental degradation the potential for macroeconomic instability posed by the financial sector Local protectionism Lack of protection of property rights, including intellectual property the stability of the exchange rate Lawrence J. Lau, The Chinese University of Hong Kong 34
Household Disposable Income per Capita (2004 Prices) US$ $1,200 Household Disposable Income Per Capita (2004 prices) $1,000 $800 $600 $400 $200 $0 1978 1980 1985 1989 Lawrence J. Lau, The Chinese University of Hong Kong 35 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Year
Household Consumption (2004 Prices) Household Final Consumption Expenditure (2004 Prices) 750 700 650 600 550 500 450 400 350 300 250 200 150 100 50 0 Lawrence J. Lau, The Chinese University of Hong Kong 36 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Year US$ billions
Household Consumption per Capita (2004 Prices) Household Final Consumption Expenditure per Capita (2004 Prices) 550 500 450 400 350 300 250 200 150 100 50 0 Lawrence J. Lau, The Chinese University of Hong Kong 37 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Year US$ Billions
Real Rates of Growth of Total and per Capita Household Consumption 15 Growth Rates of Real Household Consumption Expenditure 10 5 0 annual rate (%) 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004-5 -10 Household Final Consumption Expenditure Household Final Consumption Expenditure per capita -15 Lawrence J. Lau, The Chinese University of Hong Kong 38 Year
Monthly Rate of Growth of Retail Sales, (Current Prices) Year-over-Year 35 Monthly Growth Rates of Retail Sales (YoY) 30 25 20 15 10 5 0 Jan-94 Apr-94 Jul-94 Oct-94 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 % Lawrence J. Lau, The Chinese University of Hong Kong 39
The Hu-Wen Strategy of Economic Development Mr. HU Jintao, President and General Secretary of the Chinese Communist Party, has assumed complete control with the retirement of former President JIANG Zemin from the Central Military Commission. Mr. WEN Jiabao, the Prime Minister, works very well with Mr. HU as a team. The Hu-Wen administration has shifted the emphasis of economic development from simply maximizing the rate of growth of real output (GDP) to taking into account other social welfare indicators such as employment, the quality of life, and the environment. Lawrence J. Lau, The Chinese University of Hong Kong 40
The Three Valued Qualities of the Hu- Wen Strategy of Economic Development In particular, the Hu-Wen administration strives to achieve three valued qualities in its strategy of economic development: Thrift (Non-Wastefulness), Harmony and Sustainability Thrift implies making do with less, including conservation, which in turn implies a more efficient utilization of scarce resources such as oil or water. Harmony implies a greater focus on actual and perceived fairness, less inequality of income, more redistribution, prevention of the occurrence of losers, assuring insofar as possible that every reform is Pareto-improving, i.e. is win-win for all, and the creation of hope. Sustainability implies the frugal and efficient use of exhaustible resources and preservation of the environment in the long term and the moderation of economic bubbles and boom and bust cycles in the short term. Lawrence J. Lau, The Chinese University of Hong Kong 41
The Eleventh Five-Year Plan for Economic and Social Development Doubling per capita GDP between 2000 and 2010 implying a rate of growth of 7-8% for the rest of the decade (and doubling again between 2010 and 2020). Rapid economic growth is not the only objective. Encouraging thrift, conservation and efficiency Promoting social harmony Ensuring long-term sustainability Lawrence J. Lau, The Chinese University of Hong Kong 42
Encouraging Thrift, Conservation and Efficiency Encouraging conservation through the market (prices, nonlinear pricing, taxes) energy consumption/gdp ratio to be reduced by 20% in the next 5 years. Infrastructural investments, planning and regulation to take into account externalities (e.g., urban planning, promotion of mass transit systems) Reducing excessive investment. Preventing or regulating monopolies and oligopolies and facilitating competition. Lawrence J. Lau, The Chinese University of Hong Kong 43
Reducing Excessive Investment Chronic excess demand for investment, especially during an economic boom is a constant feature of the Chinese economy. It results from moral hazard on the part of investors and enterprises that do not have to bear the financial consequences of the failures of their investment projects. The excessive investment during the economic boom inevitably leads to over capacity and large losses and results in a bust in the particular industry/sector. Thus there are cycles of large amplitudes. In this process, the marginal efficiency of capital suffers. Lawrence J. Lau, The Chinese University of Hong Kong 44
Macroeconomic Stability-Enhancing Microeconomic Reforms The over-heating of the economy is largely due to excessive investment in certain sectors cement, steel, automobiles, aluminum, and real estate. The over-investment is made possible not through public funding of investment (central government funded fixed investment now accounts for less than 5% of the total fixed investment in China), and only partially through improperly approved bank loans, but with the bulk of it through possibly properly approved but improperly diverted bank loans and funds. The objective of the microeconomic reform is to distinguish between the good projects from the bad so as to allow the good ones to proceed and the bad ones to be stopped, thus reducing excessive investment. Reform of the microeconomic process of loan approval and disbursement can help enormously in this regard. Moreover, success in differentiating between the good and bad projects will help prevent the renewed rise in the non-performing loans (NPLs) in the Chinese commercial banking system. Lawrence J. Lau, The Chinese University of Hong Kong 45
Reforms in the Loan Approval and Disbursement Process Equity requirement--in order to reduce the moral hazard of borrowers and potential borrowers, there must be a significant equity requirement up front. On investment projects, the equity requirement should be no less than 30 percent. The equity requirement must be fully paid in and retained by the commercial bank financing the project before the project can be initiated. Lawrence J. Lau, The Chinese University of Hong Kong 46
Reforms in the Loan Approval and Disbursement Process Progress method of loan disbursement in order to prevent diversion of funds to other, non-project-related purposes, funds should be disbursed first from the initial equity deposit, and only then from the loan proceeds, and in any case only in accordance with actual progress made on the project and only to third-party contractors and sub-contractors upon independent verification of progress (e.g., payments for turbines for electricity generation should be made directly to the supplier and not to the borrower and only upon properly verified installation and acceptance). In addition to preventing diversion of loan proceeds, this also provides additional protection for the lender. In the event of a failure of the project, at least all the loan funds were spent on the project itself. Lawrence J. Lau, The Chinese University of Hong Kong 47
Reforms in the Loan Approval and Disbursement Process Since the equity requirement is expressed as a percent of the value of the entire project, reliable appraisals prior to the approval of the loans are absolutely necessary. This is especially the case if the equity consists in whole or in part of the value of the land or long-term lease contributed to the project. Trained professional appraisers are urgently needed in China. All of the above practices are actually common international lending practices. Lawrence J. Lau, The Chinese University of Hong Kong 48
Preventing or Regulating Monopolies and Facilitating Competition The easiest way for a Chinese enterprise to make a profit is to create a local monopoly or to commit fraud. Reduction of information asymmetry--quality assurance, standardization, certification, protection of brand names. Enforcement of contracts, regulations, laws and taxes the impracticability of self-regulation and self-enforcement in general (due to conflict of interest, mobility and the non-repetitive nature of many transactions) Insufficient enforcement penalizes the law-abiding enterprises and individuals Prevention and prosecution of fraud and public education (e.g., pyramid sale schemes). Integration of the national market to prevent the emergence of local monopolies. Lawrence J. Lau, The Chinese University of Hong Kong 49
Preventing or Regulating Monopolies and Facilitating Competition Regulation of monopolies Technological economies of scale (electricity transmission, petrochemical plants, telecommunication services) Market economies of scale (network effects, e.g., operating systems) Government-sanctioned monopolies (e.g., tobacco) Enactment of anti-trust laws (collusion, price-fixing, cartelization, predatory pricing, tied sales). Externalities pollution of air and water, global warming, congestion (e.g., automobile license fees, oil price and gasoline tax). In the absence of government regulation, monopoly (especially local) and cartelization are the most likely outcomes. Lawrence J. Lau, The Chinese University of Hong Kong 50
Coordination, Enforcement, Regulation and Supervision Enforcement of contracts is absolutely essential in a market economy, just as enforcement of the rights and obligations under the plan is absolutely essential in a centrally planned economy. Credibility of the state, and expectations thereof, affect enterprise (and household) behavior, and hence compliance with the laws and regulations (post reform). Full and impartial enforcement of the laws and regulations is just as important creating a level playing field. Multiple equilibria (outcomes) are possible, depending on the credibility of state enforcement. Explicit or implicit self-regulation, and regulatory capture, should be avoided (conflict of interest). Regulation and supervision should be based on simple, straightforward rules, the non-compliance of which can be readily observable and verified. Lawrence J. Lau, The Chinese University of Hong Kong 51
Integration of National Markets Abolition of explicit and implicit provincial and local barriers to the flow of goods and services. Reform of the procurement practices of the provincial and local governments. Promotion of government-supported and supervised standardization and certification of products and services. Protection of capital against unauthorized taxes and fees and other forms of local predation. Establishment of a single national commercial and tax court system with the power of enforcement to deal exclusively with commercial and tax cases, including intellectual property rights cases, with its decisions binding over the entire country. Enhancement of the mobility of labor. Reform of the residence permit hukou system. Portability and vesting of pension and retirement accounts. Lawrence J. Lau, The Chinese University of Hong Kong 52
The World Trade Organization and Openness Encouragement and facilitation of imports of goods and services both to spur competition and innovation (and to reduce the balance of payments surplus). Extension of national treatment--the WTO accession agreement provides for national treatment for all foreign enterprises. By extension, national treatment will also apply to all non-state domestic enterprises. This should facilitate mobility of capital across provinces and enhance competition and raise efficiency. Lawrence J. Lau, The Chinese University of Hong Kong 53
The Role of Openness China has had high domestic savings and investment rates. However, simply having high savings and investment rates, and hence a high rate of growth of the tangible capital input, is not enough to guarantee good economic performance. The Chinese economy prior to the beginning of its economic reform in 1978 and the former Soviet Union are two examples that a high rate of tangible capital accumulation does not guarantee a high rate of economic growth. This is where openness of the economy becomes important. One can distinguish between external openness and internal openness. On external openness, one can further distinguish between trade and capital flows, and on the latter, between long-term and short-term. In the Chinese case, external openness is limited to trade and long-term capital flows (including foreign direct investment). Lawrence J. Lau, The Chinese University of Hong Kong 54
The Role of Openness Openness, external or internal, has three implications. First, it allows the free flow of resources both goods and factors (free entry and exit). Second, it promotes competition, and in some cases can substitute for regulation (e.g., a petrochemical monopoly has to compete with imports). And third, it facilitates the transfer of technology (defined broadly to include business models and methods and simply ideas). It is the competition and the free entry and exit that assure minimal economic efficiency of the investment. In the long run, only the efficient enterprises will be able to survive in an open Lawrence and J. Lau, competitive The Chinese University of environment. Hong Kong 55
The Role of Openness The long-term economic significance of Chinese accession to the World Trade Organization (WTO) is the Chinese commitment to an external open economy guaranteeing access to imports and potential imports and foreign direct investment which in turn implies a minimal degree of competition and potential competition in the Chinese markets, putting pressure on domestic enterprises to be efficient and preventing the emergence of domestic monopolies or oligopolies. Lawrence J. Lau, The Chinese University of Hong Kong 56
Promoting Social Harmony Guaranteeing the satisfaction of the most basic needs Avoiding and minimizing the creation of losers Protection of the poor, the weak and the downtrodden in society using transfer payments wherever appropriate and necessary Providing a social safety net Ensuring the adequacy of basic social services such as education and health care Assuring the actual and perceived equity and fairness of the distribution of income Equitable sharing of the burden of provision of public goods Fair and impartial administration of justice and equal treatment before the law Lawrence J. Lau, The Chinese University of Hong Kong 57 Enabling economic and social mobility and creating hope
Promoting Social Harmony A society must strike a balance between efficiency and equity. Redistribution, in particular, lumpsum redistribution, is actually not incompatible with efficiency. Efficiency only requires that economic agents face identical prices on the margin. Different inframarginal prices (and taxes) do not affect efficiency. Perceived equity and fairness and potential social mobility are fundamental to long-term social harmony and stability. Lawrence J. Lau, The Chinese University of Hong Kong 58
Promoting Social Harmony Short-term redistribution can be implemented through direct transfer payments. Intermediate-term redistribution depends on the establishment of a credible social safety net, the institution of a progressive comprehensive individual income tax, and the full implementation of the rule of law in the economic sphere protection of labor and land rights as well as other tangible and intellectual property rights. Long-term redistribution can be done through the investment in education and human capital especially in the poor areas of the country. It is the proven most effective means for alleviating poverty and reducing income inequality permanently. Universal secondary education as a goal Central government back-stop of educational expenditures for provinces/municipalities/regions with low per capita GDP Ensuring equal opportunities of access for all Lawrence J. Lau, The Chinese University of Hong Kong 59
Promoting Social Harmony Investment in education enables citizens to support themselves eventually by greatly improving their employability and re-trainability in the long run. It thus helps to narrow the inequality in the income distribution and reduces long-term social costs, enhances social harmony and strengthens long-term sustainability of economic growth. Investment in infrastructure is also a form of redistribution, e.g., mass transit system financed from taxes on gasoline; schools, parks, hospitals and other public facilities built with general revenue. Universal basic social insurance can also be financed through general tax revenue. Bringing capital and jobs to labour rather than labour to capital and jobs industrialization and urbanization in situ. Lawrence J. Lau, The Chinese University of Hong Kong 60
Promoting Social Harmony Specific Measures in the Eleventh Plan Implementation of universal compulsory basic education of 9 years. Additional investments in basic education in the rural areas of 1-2% of GDP. Strengthening of the social safety net (unemployment, retirement, health care) both to protect the poor and the weak in society and to encourage greater consumption. Already some provincial governments such as Guangdong have been requiring employers to contribute to provincial retirement schemes and to offer health care benefits. This should help to stimulate increased consumption by the households. Lawrence J. Lau, The Chinese University of Hong Kong 61
Enhancing Individual Security and Reducing Risk Completing the markets for contingent commodities reduces the risks faced by individual households and enterprises and lowers the precautionary savings that must be maintained. This is the key to increasing domestic consumption and reducing the savings rate. Social security reform Pension Unemployment Health care financing Insurance and futures markets Lawrence J. Lau, The Chinese University of Hong Kong 62
Using the Market to Combat Corruption Discretion is the source of all corruption by relying on the open market as much as possible, the possibility of corruption is minimized. For example, business franchises (e.g., taxi licenses) can be granted through open public auctions. Corruption, when found, must be prosecuted to the fullest to provide an example so that future cases may be deterred. Lawrence J. Lau, The Chinese University of Hong Kong 63
Reducing Regional Inequality: The Development of the Great West Even though all regions benefited from the economic reform since 1978, the coastal regions benefited much more than the inland regions there is an estimated 6 to 1 or even 8 to 1 ratio between the per capita GDP of the richest and poorest province/region. Interregional income inequality has risen, resulting in: Dissatisfaction and restiveness Deterioration of social services, especially education and health care Massive illegal migration from the inland regions to the coastal regions, creating huge pressure on social and physical infrastructure Lawrence J. Lau, The Chinese University of Hong Kong 64
Reducing Regional Inequality The Development of the Great West Relaxation of rural-urban migration (mostly controlled by the local authorities) Transfer payments from the central government Raising agricultural incomes (reduction of agricultural taxes already accomplished; standardization and quality assurance so as to facilitate direct trade between producers and users; introduction of competition among middlemen) Lawrence J. Lau, The Chinese University of Hong Kong 65
The Development of the Great West: Reducing Regional Inequalities Urbanization in situ through the creation of new towns and cities, not the growth of existing towns and cities--moving investment and jobs to where people are, not people to where jobs are Investment tax incentives for poor provinces/municipalities/regions based on per capita GDP Maintaining long-term competitiveness: WTO accession can help by putting pressure on enterprises to move inland to lower their costs and maintain competitiveness Opening a new Silk Road a direct land bridge to Europe and the relocation of the capital from Beijing to a city in the Western region of China can significantly accelerate the development of the Great West Lawrence J. Lau, The Chinese University of Hong Kong 66
Reducing Regional Inequalities: Rejuvenation of the Northeast The Northeast is China s Rust Belt. Its conditions are much better than the West it has a strong industrial base and a very productive agriculture. What is needed is greater promotion of the private (nonstate) sector more local initiatives, less reliance on government and less regulation. Lawrence J. Lau, The Chinese University of Hong Kong 67
Trade Fiction The problem lies in the domestic internal distribution of the gains within each country; whether part of the gains from trade are used to compensate the actual losers. The challenge for all governments is to find, insofar as possible, win-win strategies that allow the respective countries to benefit from the increased trade and at the same time provide compensation for the displaced workers in the contracting industries. These considerations apply not only to the entry of China but also to the entries of India and Russia into the world economy. Lawrence J. Lau, The Chinese University of Hong Kong 68
Maintaining Stable International Economic Relationships Social harmony is promoted by preserving low-wage jobs and protecting farm income. An appreciation of the Renminbi (the Chinese currency) hurts both. Neither a wildly fluctuating exchange rate nor a continually appreciating exchange rate contribute to longterm sustainability of economic growth. The exchange rate should be managed so as to assure longterm equilibrium of the balance of payments independently of the hot money inflows and outflows. As long as there is only a small current account surplus or deficit, there is no need to change the exchange rate. Lawrence J. Lau, The Chinese University of Hong Kong 69
Maintaining Stable International Economic Relationships Increasing imports (building strategic reserves of oil and other minerals and natural resources; import financing and facilitation; encouraging flags of convenience). Reducing exports (as an alternative to an exchange rate revaluation) by imposing an export tax or by reducing or even eliminating rebates of VAT or import duties paid on the inputs used for the production of exports. The latter is to ensure that there is a level playing field between domestically produced inputs and imported inputs. If there is reduced or zero rebate of value added taxes paid on the use of domestically produced inputs, there should also be zero rebate of similar taxes paid on imported inputs. Facilitating orderly outflow of capital; strengthening inbound capital controls. Lawrence J. Lau, The Chinese University of Hong Kong 70
Ensuring Long-Term Sustainability The efficient use of exhaustible resources (oil, water) The control of environmental pollution Maintenance of macroeconomic stability Maintenance of price stability and overall balance of payments equilibrium (i.e. at zero) Ensuring stability of the exchange rate to facilitate international division of labor Investment in R&D; enhancement of the capacity for innovation and brand-building. The ultimate goal of the Hu-Wen administration is not only to achieve rapid economic growth but also to assure efficiency, harmony Lawrence J. and Lau, The sustainability. Chinese University of Hong Kong 71
The Sources of Economic Growth-- China Chinese economic growth over the past quarter of a century has been mostly driven by the growth of inputs, principally tangible capital (structures, equipment, and physical infrastructure) and not by technical progress or growth in total factor productivity. The growth of tangible capital accounts for the bulk (90 percent) of the measured economic growth in China. The tangible capital stock has been growing at approximately 15 percent per year. Moreover, the differences in the levels of real GDP per capita between China and the other economies can be largely explained by the differences in the tangible capital and human capital per unit labor. Lawrence J. Lau, The Chinese University of Hong Kong 72
The Fundamental Importance of Domestic Savings The bulk of the gross domestic investment in China is financed by domestic savings. Foreign direct investment accounts for approximately 10% of gross domestic investment in China. While helpful, foreign direct investment and foreign loans alone cannot sustain the rapid economic growth of China. This underscores the fundamental importance of domestic savings in Chinese economic growth--without the domestic savings financing the investment, the growth of the tangible capital input would not have been possible; and without the growth of the tangible capital input, the growth of real output would Lawrence J. Lau, not The have Chinese University been possible. of Hong Kong 73
The Savings Rate as a Percent of GDP: Selected Countries and Regions The Savings Rate as a Percent of GDP 70 60 Hong Kong, China India Indonesia Korea, Rep. Malaysia Philippines Singapore Thailand China Japan Taiwan Mexico 50 40 30 20 10 0 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Annualized Percent per annum -10 Lawrence J. Lau, The Chinese University of Hong Kong 74 Quarter
The Savings Rate and Real GDP per Capita: East Asian Economies 60 50 40 China Hong Kong Indonesia Japan Korea, Republic of Malaysia Philippines National Savings Rate and Real GDP per Capita Percent 30 Singapore Thailand Taiwan 20 10 0 Lawrence J. Lau, The Chinese University of Hong Kong 75 10 100 1,000 10,000 100,000 Real GDP per Capita, 2000 US$
The Advantages of a High Domestic Savings Rate A country with a high savings rate does not need to rely on foreign savings does not need to borrow abroad and bear the potential risks of non-renewal of a large, and often callable, foreign-currency denominated debt. With new resources being made available each year from new savings, enabling new investments to be made, the necessity of restructuring and redeploying existing investment is greatly diminished (thus making it more possible to avoid creating losers). Moreover, with a high domestic savings rate, the non-state sector (which is generally more efficient) can grow without significant, possibly socially disruptive, large-scale privatization. Lawrence J. Lau, The Chinese University of Hong Kong 76
China s Gross Domestic Investment as a Percent of GDP China's Gross Domestic Investment as a Percentage of GDP 50 40 30 20 10 0 Lawrence J. Lau, The Chinese University of Hong Kong 77 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Percent Year
Additional Advantages of the Chinese Economy: A Large Domestic Market A large internal market permits the realization of economies of scale. The minimum efficient scale can be readily achieved in any industry on the basis of domestic demand alone. A large internal market also allows a significant influence on the development and setting of quality, service and technical standards for the world markets, e.g., mobile telephone standards, operating systems for personal computers. Standardization in turn enables the realization of economies of scale. Control of standards also confess huge advantages in competing for market share and profits. Lawrence J. Lau, The Chinese University of Hong Kong 78
China and Its Large Domestic Market A large internal market provides a base for the establishment of brand names in the world markets, generating market economies of scale (the higher the market share, the higher the profit margin). A large internal market also enhances the returns to R&D and other forms of intangible capital, by leveraging intangible capital (R&D capital, knowledge capital, intellectual property broadly defined)-- economies of scale in the creation and utilization of intangible capital imply that the rate of return increases more than proportionally with the size of the market. No global player or aspiring global player can leave the Chinese market alone to its competitors or potential competitors because it may provide an opening for them to establish themselves on the basis of their success in the Chinese market. Lawrence J. Lau, The Chinese University of Hong Kong 79
Additional Advantages of the Chinese Economy An almost unlimited supply of surplus labour there will not be any pressure on the real wage rate of unskilled labour for decades to come. The advantages of backwardness the ability to learn from the successes and failures of other economies; the ability to leap-frog stages of development; the possibility of creation without destruction Lawrence J. Lau, The Chinese University of Hong Kong 80
Long-Term Economic Growth: Three Paradigms of Chinese Economic Growth Domestic demand-driven growth--the domestic market paradigm a la the United States in the 19th century. China is a large continental economy--international trade will never be as important as other, smaller countries and China must rely on internal demand for further economic growth. Valueadded from exports constitutes only a little more than 10 percent of Chinese GDP. The "wild-geese-flying pattern" metaphor of East Asian industrial migration over time can apply to Chinese provinces and regions Privatizing the economy without privatization--shrinking the state sector through the growth of the non-state sector in the absence of explicit privatization--the experience of Taiwan and South Korea Lawrence J. Lau, The Chinese University of Hong Kong 81
Long-Term Economic Growth: Three Paradigms of Chinese Economic Growth What does it take? Availability of infrastructure (transportation and communication, including the internet) Continued marketization of the economy Maintenance of a domestically open economy (the equivalent of the interstate commerce clause of the U.S. constitution) Affirmation of tangible and intangible property rights and the rule of law (a national commercial and tax court?) Maintenance of an internationally open economy--the role of the "open door (WTO) Lawrence J. Lau, The Chinese University of Hong Kong 82
Long-Term Economic Trends Aggregate GDP The Chinese economy is likely to continue to grow, more or less independently of what happens in the rest of the world, over the next several decades at an average annual rate of approximately 7-8%. The source of this growth will come primarily from tangible capital accumulation, supported by a national savings rate of 40%, human capital accumulation, and economies of scale, and to a lesser extent on the growth of intangible capital (for example, R&D capital) and improvements in efficiency. By 2020, aggregate Chinese GDP is projected to exceed the aggregate GDP of Japan (and not quite one half of aggregate U.S. GDP). Some time around 2040, aggregate Chinese GDP may reach the same level as aggregate U.S. GDP. Lawrence J. Lau, The Chinese University of Hong Kong 83
Long-Term Economic Trends Per capita GDP However, even then, Chinese GDP per capita will only be able to reach US$10,000, or not quite 20% of U.S. GDP per capita, during the decade of the 2030s. Chinese GDP per capita will approach the level of U.S. GDP per capita only beyond 2075. Population By 2035, India will have overtaken China as the most populous nation in the world. The currency The Renminbi will in time become one of the strongest currencies in East Asia and a quasi-reserve currency like the Euro. However, this will imply that China will eventually have a much higher rate of consumption and run if not trade deficits at least balance of payments deficits with the rest of the world. The balance of payments China will probably run an overall balance of payments deficit if not a current account deficit vis-à-vis the rest of the world but definitely a capital account deficit (i.e., a net outflow of capital). The World Tourism Organization predicts that China will become the world s fourth largest source Lawrence of J. overseas Lau, The Chinese tourists University by 2020. of Hong Kong 84
Long-Term Projections Real GDP 2004 2010 2020 US$ (2004 prices) 1.65 trilll. 2.5 trill. 5.0 trillion Real GDP per capita 1,275 1,800 3,500 Lawrence J. Lau, The Chinese University of Hong Kong 85
The Structure of the Economy: GDP 2004 15% 32% 53% Primary Secondary Tertiary Lawrence J. Lau, The Chinese University of Hong Kong 86
The Structure of the Economy: Employment 2004 31% 46% 23% Primary Secondary Tertiary Lawrence J. Lau, The Chinese University of Hong Kong 87