Economists are divided over the prospects for post-stimulus China. Stephen Roach, Asia chairman at Morgan Stanley, is generally regarded as one of the bears. He spoke to CHINA ECONOMIC REVIEW about how the recent revival isn’t necessarily conducive to long-term reform.
Q: What is your view on how China has got out of the downturn?
A: China did what it had to do. It experienced a huge demand shock – largely external demand – that resulted in a major increase in unemployed migrant workers in Guangdong province. The government opted for a very quick fix, which was bank-funded infrastructure spending. But this is not a sustainable recipe for dealing with shocks and there may be adverse consequences to these initiatives, especially if they are repeated again next year. The story begins and ends with social instability. This is a government that doesn’t want to let the growth rate slow enough to create a new round of unemployment and heightened risk of social instability.
Q: You focus on the troubles in the export sector, while some other economists also pin the downturn in China specifically on overaggressive tightening in the property market…
A: Here is a sector – exports – that went from 20% to 30% of GDP between 2001 and 2007. Then along comes this external demand shock and it goes from 26% year-on-year as recently as July 2008 to minus 27% by February 2009. There were other factors at work – property market policy is a fair point – but reports of massive unemployment in export-led Guangdong province fit the script of a powerful external demand shock.
Q: What do you expect in terms of the easing of the stimulus effect?
A: The bulk of the stimulus will have run its course by the middle of 2010. But the support from external demand, which typically lifts the export recovery, will be disappointing. I wouldn’t be surprised to see another slowdown in China in the second half of 2010 and I think then the government would resort to the same formula to deal with a weak economy.
Q: How many times could it actually do that?
A: With a state-directed system you can do it for a long time but you have to deal with the consequences of that – mounting imbalances, the risk of higher non-performing loans in the banking system, and excess liquidity flooding your asset market.
Q: So it can’t go on forever.
A: This crisis is all about unsustainable macro imbalances and China doesn’t get special dispensation for that. Perhaps their savings cushion and state-directed mechanism of capital allocation creates more time to face up to these imbalances, but they have to face them. The government knows that the external demand underpinnings of the Chinese economy are not going to be as nearly robust as before. I think in the 12th Five-Year Plan, to be enacted in 2011, you will see some very broad and explicit proposals introduced that to change the model and stimulate internal private consumption.
Q: What kind of proposals?
A: There are three major initiatives: first, the social safety net – social security, private pensions, medical insurance and unemployment insurance aimed at reducing the excesses of increased fear-driven precautionary saving; second, supporting rural incomes through tax policy, land reform and IT-enabled connectivity in central and western China; and third, offering a blueprint for the development of large-scale consumer products and services industries. China’ s service sector is about 40% of GDP – the smallest of any major economy in the world. If the Chinese promote these initiatives, they will really push towards a more consumer-led society. If they don’t, the risk of continuing imbalances grows and ultimately with painful consequences.
Q: The key elements of a five-year plan are usually telegraphed in advance. Have you seen signs that you will get what you are looking for?
A: Based on discussions I’ve had with Chinese officials, I’m hopeful that plans are underway in several areas. As to whether or not we get the full package, it’s too soon to tell. I don’t think we’ll know until the fall of 2010.
Q: These reforms are so large that, even if implemented tomorrow, you wouldn’t see much of an effect in the short term. How do you balance that with current needs?
A: They will do what it takes to maintain social stability, but they need to move on this structural agenda, forcefully and effectively. The benefits will come much more quickly than people think. I don’t buy the idea that Chinese people save because of DNA. The savings excesses are rational given the lack of a safety net and the insecurity of the workforce. You address those issues and you could turn savings behavior around fairly quickly.
Q: How quickly is fairly quickly?
A: You would make major progress over the five-year plan period.