The Future of the Greater China Economy

On February 22 at the Wilbur K. Woo Conference on the Greater Chinese Economy, sponsored by the Asia Institute, prominent economists and analysts explored the future of the greater China economy.

In the opening panel, Justin Yifu Lin, founder and director of the China Center for Economic Research at Peking University, and also Professor of Economics at Hong Kong University of Science and Technology, and also one of the most influential advisors to China's top leaders, painted a rosy picture of the growth in China's economy since the reform era was launched in 1978, and an equally rosy picture of the likely trajectory of the economy over the next three decades. The commentators on the panel shared Professor Lin's view that the Chinese economy will probably continue to grow, but perhaps were not as optimistic that growth will continue at a breakneck pace.

The second panel, on regional perspectives on the Chinese economy, discussed the impact of the China's economic growth on surrounding countries, and the reactions in those countries to the opportunities and challenges presented by the Chinese market.

Is China's Growth Real and Sustainable?

The Record: A Miracle?

From 1978, when the reform era in China was launched, to 2002, according to Professor Lin's figures, China's GDP grew at an average annual rate of 9.4 percent. This is, Professor Lin declared, "a miracle." However, in the last few years, some economists have questioned China's economic growth rate. This is related to a deflationary trend that emerged at the end of 1997 and continued until 2002. "A deflation in an economy," Lin explained, "is generally accompanied by stagnation or slow GDP growth. However, China's GDP growth rate reached 7.8% annually during the deflation period from 1998 to 2002, which was the fastest growth rate in the world." Furthermore, "a high growth rate in general is expected to be a result of increased economic activities, which requires more energy consumption. However, in those three years, energy consumption dropped. This seeming abnormality has prompted some economists to question the reliability of China's statistics." For those economists Professor Lin had an answer: the normal laws of economics may not apply to China. Much of Lin's talk was devoted to developing this notion, and to explaining why China is likely to continue to experience extraordinarily high growth for the next twenty or thirty years.

Deflation & High Growth Rates: Breaking the Mold

How is it that in recent years China has experienced deflation and (contrary to what economic theory would predict) has continued to grow at a very high rate? Lin's answer involves what he termed "an investment rush." Chinese enterprises and individuals are eagerly searching for investment opportunities. "While investment by private enterprises was repressed due to the lack of good investment opportunities [beginning around 1997], investment from the public sector increased." This led to a spike in production capacity. This in turn caused deflation. Or, to put it another way, deflation in China "was caused by a sudden increase in production capacity instead of a sudden drop in consumption due to the bursting of bubbles and the reduction of wealth as in the cases in many [other] countries."

As for the seeming contradiction of energy consumption falling while the economy continues to grow, Lin pointed out that the answer lies in the structure of China's technology. "China was a typical shortage economy before the 1990s. Many township and village enterprises (TVEs) prospered in the 1980s under the shortage condition with very low technology and energy efficiency." However, by the early 1990s "many investments . . . came from firms in the state sector, foreign direct investments, and joint ventures. Such firms possess better technology and are more energy efficient than the TVEs." In short, as the economy grew, the new plants that were built were more energy-efficient than the plants they replaced, and thus the seeming paradox of economic growth combined with a fall in energy consumption. Economists who do not recognize this, and who instead assume China's official statistics are faulty, are, Professor Lin hinted, jumping to conclusions.

Is China's Growth Sustainable?

"Per capita income in China," Professor Lin said, "has just reached one thousand dollars. There is still a large gap to close before China becomes a developed country. Therefore, whether China can maintain dynamic growth in the coming decades is important for the Chinese people."

If Professor Lin is right in his prognostications, the Chinese people have reason to be optimistic. "It is very likely," he declared, "that China will maintain around an 8 percent GDP growth rate for another twenty to thirty years." Lin based this prediction on two factors. First, all the majors indicators are favorable. If one compares Japan in the 1960s, when it's economy was poised for takeoff, and China today, the indicators are remarkably similar.

Second, "technological innovation," Lin argued, "is the most important determinant of economic growth. As a developing country, China's technological level lags far behind that of developed countries. Therefore, China can adapt technological know-how from advanced countries at a lower cost so as to achieve the necessary technological innovation for its economic development. It is because of this reliance on borrowing technology from advanced countries that Japan and the four small East Asian Tigers were able to achieve dynamic growth for about forty years after World War II." In short, China has, in Lin's words, "the advantage of backwardness."

Caveats

Reginald Chua, editor of the Asian Wall Street Journal, commented (in a text read by R. Bin Wong, the moderator, since Chua was unable to attend) that although its growth rate has indeed been remarkable, and is likely to continue (although perhaps at lower rate), China faces some "potential instabilities."

First, the financial system. China's state-owned banks are saddled with an enormous load of bad debts, officially estimated at 13 percent of total banking assets, "a number that is almost certainly understated -- many more bad loans are still being created every day. As we and others report regularly, banks are falling over themselves to offer consumer loans to China's new middle class, with the result that some people are carrying monthly mortgage and other repayments that are bigger than their salaries."

Second, trade dependence. "Another uncertainty," Chua pointed out, "stems from what is genuinely a core strength: China's relative openness and interconnectedness with the rest of the world." China's trade dependency ratio, as Justin Lin mentioned, is 60 or 70 percent, compared to 20 percent in the United States and 15 percent in Japan. Exports play a crucial role in spurring growth in China's economy. Thus China's economy is extraordinarily vulnerable to the vagaries of world markets. China is also vulnerable in that it is "a huge consumer of global resources -- steel, cement, oil, etc. -- making it more dependent on external suppliers."

Third, possible political instability. "It's hard to imagine what could trigger widespread passions again -- clearly corruption is an issue -- but it's never been easy to predict when political problems might flare up. As we saw from the sensitivities when Zhao Ziyang passed away recently, this is something the government is very wary about. At the same time, China is much more actively dealing with two difficult relationships: Hong Kong and Taiwan."

Fourth, imponderables. Chua mentioned China's coming demographic crunch, when as a result of its one-child policy and urbanities' desire for small families, China's age structure will become lopsided, with a huge army of elderly. What will be the implications for pensions, health care, and social safety nets as the demographic bulge works its way through the system and China ages much more rapidly than many other societies, Chua rhetorically asked. "These are the sorts of developments," he concluded, "that have triggered large changes in societies elsewhere when they occurred, and we shouldn't expect China to be an exception to that. The difference is that in China, these developments are happening much faster."

Sebastian Edwards, Henry Ford II Professor of International Economics at UCLA's Anderson School of Management and former chief economist for Latin America at the World Bank, also commented on Lin's presentation, and like Chua expressed optimism about China's future, but also like Chua pointed to areas of concern.

As to the question of whether China's growth is sustainable, Edwards noted that two aspects need to be clarified. First, what is sustainability? If it means simply that the past record will continue into the future, then Edwards is confident that over the next few years -- say, through the 2008 Beijing Olympics -- China's economy will continue to grow. In fact, Edwards projected that the growth rate will be around 5.5 to 6 percent per year for the next twenty or thirty years. Even at this rate, Edwards pointed out, the gap between China and the wealthy, industrialized countries will continue to shrink.

Second, what time horizon does one have in mind? Over the long term, China's growth rate will decline, Edwards argued, because -- based on historical experience -- technological progress, which Justin Lin made the centerpiece of his argument, will not continue at the same high rate. The rate of technological innovation and progress are in the shape of an inverted U. Progress is made very rapidly as an economy climbs up the inverted U, but then the rate falls precipitously.

Professor Edwards went on to list several "potential problems" that could upset the predictions of continuing growth: (1) The health of the banking system is suspect; (2) the infrastructure is challenged (vide rolling blackouts in several Chinese cities), which could affect production; (3) rural-urban inequalities create tremendous pressures for migration, with difficult-to-foresee consequences; (4) the demographic crisis, with a coming explosion in the number of elderly, poses a host of problems; and (5) the international pressure on China to let the renminbi float and appreciate could, if China acts prematurely, slow down exports, which could create shockwaves throughout the Chinese economy.

Regional Perspectives

South Korea, Japan, Southeast Asia, Central Asia, and Russia

In the second session, Arthur Kroeber (Managing Editor of China Economic Quarterly) began by pointing out a couple of areas of concern regarding prognostications on the Chinese economy. First, "data are murky." The data published by the Chinese government as a rule are not reliable. This, Kroeber emphasized, is a fundamental problem. "What appears to be disagreement over theory is often a question of bad or murky data." Second, the "volatility in growth rates has been far greater than the official series [of data] presents." Although overall the annual growth rate since 1978 may indeed hover near 9 percent, the rate year by year has fluctuated, sometimes wildly.

Kroeber went on to discuss how nearby countries and regions have responded to the growth of China's economy. In South Korea, firms have recognized that they cannot complete with Chinese manufacturers in low-end products. They therefore emphasize relatively expensive, high-end products. They also consider China as an extension of the domestic market. Thus Samsung, for example, rolls out in China its newest and best products at the same time they are introduced to the South Korean market. This has been a successful strategy.

Japanese firms, on the other hand, have generally followed a more conservative policy, and not until recently have large Japanese manufacturers began to invest heavily in China. In Southeast Asia, there initially was a fear that local economies would be undermined by Chinese growth. But this, Kroeber said, has not happened. Instead, there has been complementarity. In particular, because of Chinese demand for commodities (petroleum, palm oil, etc.), prices have risen, and this has benefited Southeast Asian economies.

Until recently, Central Asia and Russia did not have extensive economic relations with China. This was partly the result of history, Kroeber explained: for centuries, contracts with China were tenuous. However, the Central Asian countries and Russia now see China as an opportunity. For instance, China is a huge potential market for the oil and gas of Central Asia. As an indication of the growing awareness of China as a market, there is talk of "rebuilding the Silk Road," running from China to Brussels. This is of little or no potential economic value, Kroeber noted, but it is of great symbolic importance.

A Tale of Two Cities

Also in the second session, Xiao Geng (UCLA Ph.D. in economics in 1991, former Head of Research of the Securities and Futures Commission of Hong Kong, and now Associate Professor of Economics and Finance the University of Hong Kong) asked, Will Shanghai overtake Hong Kong? Many observes have assumed that it is only a matter of time before Shanghai surpasses Hong Kong in economic importance -- if it has not happened already. Professor Xiao argued that it is too soon to write off Hong Kong. In fact, Hong Kong enjoys several advantages which, if Chinese policy makers are wise, they will exploit.

A fact of life when it comes to the Chinese economy is its unlimited supply of labor. Xiao pointed out that even with the coming demographic transition in China, the number of working-age men and women will remain huge. To put this in perspective, Xiao mentioned that China's labor force is larger than the number of employed people in all the industrialized countries put together. Thus, China will continue to have a vast pool of low-cost labor. Here, Hong Kong, with it high labor costs, cannot compete. Other factor costs are also much higher in Hong Kong. But, transaction costs (that is, the hidden costs of doing business) in Hong Kong are much lower than they are on the mainland. This is mainly because Hong Kong has excellent institutions (courts, civil service, and the like), while China has weak institutions and remains mired in corruption. "Hong Kong's lower transaction costs," Xiao argued, "have more than offset its higher factor costs."

However, factor costs are declining in the mainland as, under the impact of WTO, China improves the distribution of producer services, law and accounting services, and banking and financial services. In other words, China is becoming more competitive.

The question for the future, in Professor Xiao's words, is Can China leverage Hong Kong's current strengths?

Ties That Don't Bind

The third member of the second panel, Akinari Horii (Director-General of the International Department of the Bank of Japan) mainly addressed China's economic impact on Japan. In the 1990s, Mr. Horii began, Japanese investment in China came mostly from smaller firms. In the past decade, however, large Japanese enterprises have recognized the importance of the China market and have invested accordingly. Often this has involved relocating plants to China. Around the year 2000, Horii continued, the Japanese economy made a transition in which a great many firms that produced products that competed with low-cost Chinese-made products, went bankrupt. This of course reinforced the trend toward moving production to China.

At the same time, Horii noted, there has been a dramatic shift in the pattern of Japan's foreign trade. In the 1980s, Japan's exports to the United States amounted to about 35 percent of all its exports, while exports to Asia totaled only 25 percent. In 2004, however, "Asia captured 47 percent of Japan's total exports, including 13 percent to China, while the U.S. accounted for only 22 percent." In addition, "on the import side, China has become Japan's largest trading partner, capturing 21 percent of its total imports, followed by the U.S. with 14 percent."

Financial links between Japan and China, however, are weak. This is not a problem of personal savings, for the rate in China -- 30 percent -- is very high, compared to Taiwan or Malaysia, at around 20 percent, or South Korea, at 10 percent." In short, Asia not only offers abundant investment opportunities but also savings. Despite these abundant investment and savings opportunities, international [financial] intermediation with the region has failed to develop."

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Panelists

Reginald Chua is the editor of the Asian Wall Street Journal, the largest regional daily and a leading business publication, with a staff of 80 reporters and editors in fifteen Asian bureaus (and a reporter in Washington). It is a sister paper to The Wall Street Journal, The Wall Street Journal Europe and the Online Wall Street Journal, WSJ.com. Mr. Chua joined the paper in 1993 as its Manila reporter and in 1995 he opened the paper's Hanoi bureau. Prior to joining the Asian Wall Street Journal, Chua worked as Manila correspondent for The Straits Times (of Singapore), was a Reuters correspondent in Singapore, and spent two years doing radio and television for the then-Singapore Broadcasting Corp. (now Television Corp. of Singapore). Among other non-journalistic endeavors, he was briefly a computer programmer and served two and a half years in the Singapore Armed Forces. A native of Singapore, Mr. Chua graduated from Columbia Journalism School in 1988 and from the University of Chicago in 1982 with an AB in Mathematics.

Sebastian Edwards is the Henry Ford II Professor of International Business Economics at the UCLA Anderson Graduate School of Management. From 1993 until April 1996, he was the Chief Economist for the Latin America and Caribbean Region of the World Bank. He plays a leading role in a number of organizations and is a research associate of the National Bureau of Economic Research (NBER) and has taught at several distinguished institutions in Latin American and Europe. The author of numerous books and more than 200 scholarly articles, Professor Edwards also shares his views in a Wall Street Journal column and is frequently quoted in American and international newspapers. For ten years he was co-editor of the Journal of Development Economics. He is currently the associate editor of Contemporary Policy Issues and the Journal of International Trade and Economic Development.

Akinari Horii, a graduate of the University of Tokyo and the Wharton School at the University of Pennsylvania, has worked for Japan's central bank, the Bank of Japan, with a few breaks, for three decades. During this time he has held many important posts in several divisions, including supervising the economic research department, heading American operations, and advising the bank's parliament liaison. In 2002, Mr. Horii was named Director-General of the bank's International Department. Mr. Horii's English publications include articles on challenges facing the Japanese financial system and on the process by which monetary policy is made in Japan.

Justin Yifu Lin received the MBA at National Chengchi University and the MA at Beijing University before earning the doctorate at the University of Chicago. Professor Lin taught at UCLA for four years and has also taught at Duke University, the University of Minnesota, and Australian National University. He currently teaches at Beijing University and Hong Kong University of Science and Technology. In 1994, Professor Lin established the China Center for Economic Research at Beijing University. He remains the center's director. The center sponsors research on a wide array of topics. Professor Lin has published over eighty articles and book chapters in English and even more in Chinese. His books include Institution, Technology and Agricultural Development in China (winner of the Sun Yefang Prize, 1992), The China Miracle: Development Strategy and Economic Reform (published in English, Korean, Japanese, Vietnamese, and French in addition to the Chinese), and China's Economic Reform and Development. Professor Lin has received many awards, most of which recognize his research. He has also been named one of Beijing University's "ten best teachers."

Arthur Kroeber is managing editor of the China Economic Quarterly, a research publication, and managing director of Dragonomics Ltd., an economic advisory firm specializing in China. A Harvard graduate, Mr. Kroeber began working as a financial journalist in Asia in 1987, writing on China and India for publications including The Economist, the Far Eastern Economic Review, and Wired. He spent several years as an analyst of the Economist Intelligence Unit, covering Taiwan, China and South Asia. He is a frequent contributor to the opinion page of the Financial Times and frequently advises multinational companies and financial institutions on China market strategies.

Xiao Geng was the first graduate student in the UCLA Economics Department from China. He earned his Ph.D. at UCLA in 1991, with a dissertation on Chinese enterprises and property rights reform. He has published dozens of research papers and policy analyses, along with authoring or co-authoring four books. In addition to his teaching and research at the University of Hong Kong, Professor Xiao has worked for the World Bank and for three years headed research for Hong Kong's Securities and Futures Commission.

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The conference was presented in association with the Pacific Council on International Policy and the Asia Society.

Like its two predecessors, the conference was made possible by a generous gift from Wilbur K. Woo. Mr. Woo, a UCLA alumnus, is a longtime Los Angeles community and business leader and has recently retired from Cathay Bank. To recognize his long service, Cathay General Bancorp in December named him Director Emeritus and Vice Chairman Emeritus.

Click here to read about the second Woo Conference on the Greater China Economy.

Click here to read about the first Woo Conference on the Greater China Economy.