China now faces a difficult but essential phase in its development and the reforms it must continue to pursue will not be easy. Up to now, rapid growth has been achieved by shifting excess labor from agriculture and state-owned enterprises to market-based manufacturing. Today, as the most obvious sources of inefficiency are disappearing, growth will depend on raising productivity which, in my judgment, will require markets to allocate capital as opposed to administrative decisions. The Chinese have an astonishingly high savings rate – 50% of GDP – because Chinese households face so many uncertainties.
China needs a more harmonious, more balanced pattern of growth that gives Chinese households more income and the confidence to spend it.
These challenges are made even more difficult by the fact that within China, as in the US, there are loud voices espousing anti-reform, protectionist sentiment. In China this resistance stems from a number of factors including that the benefits of this economic expansion have been spread unevenly among its citizens and that some influential people have never fully embraced the need to open up the Chinese economy to competition.
This protectionist sentiment is evidenced by increasing levels of public discontent, demonstrations, and anti-reform articles written by prominent academics.
Yet, it is impossible to overstate the importance of China moving forward with liberalization. First and most importantly, only reform can guarantee the future growth that the Chinese people expect and deserve. Second, liberalization sends a clear signal of China’s willingness to assume its role as a global economic leader. And third, reform will do much to ease rising anti-Chinese sentiment?
While we can work together on these issues and others, China must confront its long-term structural challenges as it makes the transition to a market-driven economy.
Without question, the nation must modernize its financial sector, open up its capital account, and move to a more consumption-based model of growth. A competitive, well-regulated financial system and the free flow of capital will help reduce the extraordinarily high levels of precautionary savings and allocate capital to its most efficient use, which will help raise productivity and living standards. China must also pursue fiscal and regulatory polices that address the investment/savings imbalance.
These changes will help create the millions of jobs that China needs to generate annually, and will help create markets for U.S. exports of goods and services to China.
From “The Turning Point in Economic Development” in Citigroup Macro China by Yiping Huang and Minggao Shen, September 8, 2006:
Experiences of the past couple of years suggest that China’s economic development has reached an important turning point – the ending of the so-called unlimited labor supply – even though the impact of rising labor costs on inflation and profitability are limited in extent. Such changes in the labor market can be expected to accelerate significantly in coming years.
A closer look at the supply and demand for relatively unskilled labor suggests that there is likely to be considerable tightening in the market in the period ahead – larger and earlier than has been featured in general discussions about China’s economic prospects, within China or abroad. The balance between supply and demand for and the cost of skilled and managerial labor will not be subject to as much tension, where supplies are being expanded rapidly by formal education, on-the-job training and experience, and the demonstration effects are evident through the presence of foreign enterprises.
Growth of China’s total labor force has already slowed markedly, from 3% per annum in the 1980s to 1% in the period of 2000-05, as the effects of the one-child policy of the reform period have moved through into the working-age population. Until recently, migration of workers to meet the requirements of strong urban employment growth slowed the growth of rural employment only moderately. Between 2000 and 2005, however, the rural labor force declined by 0.9%. This raises the productivity of rural labor at home and can be expected to put strong upward pressure on rural labor costs, which raises the supply price of migrant labor to urban areas.
From Deutsche Bank Asia Economics Daily by Jun Ma, September 11, 2006:
China’s merchandise trade surplus rose to an all-time high in August, to US$18.8 billion from US$14.6 billion in July. This was well above our and market forecasts of about US$14 billion. This widening of the trade surplus reflects a further divergence between export and import growth rates. In August, export growth accelerated to 32.8% year-on-year from 22.6% in July, while import growth rose less, to 24.6% year-on-year from 19.7%, in July.
This record trade surplus, together with the forthcoming G7 meeting on Sept 16 and Hank Paulson’s visit to China afterwards, will continue to support expectations of accelerated RMB appreciation, and could benefit market sentiment on airlines, real estate, consumer, telecoms, oil, and infrastructure. On a medium-term basis, however, we believe that the pace of RMB appreciation will remain in the range of 3-4% annually and may disappoint many speculators. In addition to RMB appreciation, China will use other structural measures – including VAT rebate cuts and unification of corporate income tax rates – to help narrow the trade surplus.