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A Hallucinated China: Is It Time To Sober Up!!

Posted in Finance Articles, Total Reads: 1967 , Published on July 13, 2012

In the recent past this sentiment had affected the attitudes of politicians, businessmen and investors round the world. We have seen a huge surge in the private capital flow into developing countries from an annual pace of $200 billion in 2000 to nearly a trillion dollars a year in 2010.

It seemed like every man wanted a share of the emerging market pie, but history suggests that economic development is similar to the game of snake and ladders. There is no ladder that directly leads to victory and remember the game board has lesser ladders than snakes, which means it’s much easier to fall than to climb. A nation can climb the ladder for a couple of decades, eventually to hit a snake and fall back to the bottom and start over again.


The Emerging Tide Unleashed:

This was a unique golden age, unlikely to happen again yet widely accepted as the new standard by which poorer nations should measure growth. It all began with China, which for two decades starting from 1978 grew rapidly but inconsistently, anywhere from 4 to 12 percent a year. Then came 1998 where China began an unbroken run of 8 percent growth each year, it was as if the lucky number 8 had become an iron rule of the Chinese economy.

This phenomenon didn’t restrict itself to China, it spread, the rising tide lifted nation after nation in the emerging world from 3.6 percent GDP growth to 7.2 percent. To cite an example, Russia saw the average national income soar effortlessly from $1500 to $13000 in the course of the decade. The number of nations that had inflation under control and containing the annual rate of price increase to lower than 5 percent rose from 16 in 1980’s to 103 in 2006. This was similar to high growth and low inflation economy that America enjoyed in the 1990’s and expanded to a planetary scale including much of the west. All nations singing the stories of high-speed growth and watching with undiscriminating optimism.

Not All Touch The Sky:

China and other big emerging markets follow an export driven growth model similar to that of Japan, South Korea etc. these tiger economies saw a high growth of 9-10 percent during their boom times, however as the per capita income reached the middle-income levels i.e more than or equals to $4000 (as per world bank) they hit the wall with a moderate growth rate of 4 to 5 percent.

In other words richer the country gets, harder it is to grow national wealth at a rapid pace. Hence it is only a matter of time that this law of economy will pull China, Russia and other emerging markets back to earth. As most of the emerging economies are export driven, the expected growth rate of rich country’s GDP is intended to fall from 2.5 to 2 percent in the case of USA and 1.5 to 1 in the case of Europe and Japan. Hence, the richer countries will buy less from the export driven countries which is evident as the trade has fallen by 1 percent since 2008, so the emerging countries would need to find other way to grow at a strong pace.

A Crack In The Great Wall:

In the early 1980’s China went on to launch “big bang” reforms in every four to five years, each new opening - first to private farming, then the private businesses, then foreign businesses set off a new spurt of growth. But the cycle has run its course. Back in 2008 Premier Wen Jiabao described Chinese growth as “unbalanced, uncoordinated and unsustainable” and the situation has grown more precarious since.

The total debt as a share of GDP is raising fast and the advantage of cheap labor is soon fading away which was a key to China’s boom, as the labor shortage increases the labor’s power to negotiate wages have increased over time. China had boomed in the old fashioned way, by building roads that connect factories to ports, by developing telecommunication to connect business and by putting underemployed farmers to better jobs at urban factories.

Now all these factors will soon reach maturity, as the pool of surplus rural labor are drying up, highway network reaching its limit of 49000 miles (second largest network). In terms of China’s demographic drivers, it is closing in on what is known as “The Lewis turning point” which states most of the underemployed farmers have already left the farms for better jobs in the city i.e already 150 million have moved to the cities, 84 million have found non-farm jobs and finally only 15 million people are left in the surplus pool, also another cause of worry is the growing class of pensioners who will soon have their decaying effect on growth.

China has narrowed the income gap with rich nations with relative ease, by borrowing or copying the technology and management tools from the developed countries, at a certain point it would have to start innovating and inventing on their own which is a difficult task and they may fail in this challenge.

The Fountain Of Youth Runs Dry:

For the first time in decades, China is seeing a wage-driven inflation, with the surplus labor soon becoming a myth, difficult times lie ahead, as on 2011 the average rise in wages was about 15 percent p.a and prices were rising at a 5 percent increase, a sudden rise in wages is a bad sign for the economy. Additionally, the wages have been growing faster for the unskilled labor when compared to educated and skilled workforce, which means Chinese employers will be paying more and more for less and less.

The Property Concerns:

The worst case of consumer price inflation is in the property market, to maintain growth as the global financial crises struck in 2008 the government ordered the banks to open the tap on loans so wide that in the following three years the country issued new credit up to $4 trillion which lead to almost zero money circulation, most of this money found its way into the real estate.

This triggered an upward spiral i.e developers are building empty ghost cities as people can’t afford them, due to the 1998 reforms in the real estate the private developers buy out property from current residents at a higher price and when they try to buy new apartments, they can’t afford them pushing prices skyward, more over the demand for urban property has gone down as they are lesser migrants from the villages.

“The 2.5 Trillion” Illusion:

China’s indebtedness is also poorly understood, we all know China sits on a 2.5 trillion foreign reserve and no one thinks of it as having debt problems. But it does, though the official government debt is low at about 30 percent of GDP which is just a small part of the story. The debt of companies (mostly government owned) and households combined constitutes to around 130 percent of GDP as debt, which is the highest among the emerging countries, which are the stated numbers by the government, however if we include the so called “shadow banking sector” known as social financing by Chinese central bank the ratio then of debt to GDP raises to 200 percent, off the charts for any developing country’s economy.

The Missing Consumer:

The last hope for the revival of the Chinese golden era lies in a shift from banging on exports to building a consumer society. This would rebalance the economy not only for China but the entire world, providing an opportunity for the slow-growing western economies to sell products to the Chinese consumers. However until now China has deliberately prevented the evolution of a consumer economy by compelling its people to save as to invest in new export factories.

So What Now:

China will be at the verge of natural slowdown in another 2 to 3 years which will change the global balance of power, from finance to politics and also take away the wind from many economies that are sailing along with it. Hence those who bet everything on riding the coattails of China growing at 8 percent or better will face a much nastier surprise!!

This article has been authored by Siddharth Jaiswal from IMT Hyderabad.

Image: FreeDigitalPhotos.net

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