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Thursday, June 20, 2019

The Century of the Dragon

by Fabio Scacciavillani

© Shutterstock
The Bank of China building in Chongqing, China.

As the world ponders a possible hard landing of the Chinese economy, we examine how it has avoided the global financial crisis and ask what is likely to happen in the future

As the world ponders a possible hard landing of the Chinese economy, we examine how it has avoided the global financial crisis and ask what is likely to happen in the future

The engine of the world economy runs on four cylinders: the US, Europe, Japan and China. Since the inception of the global crisis only one cylinder has been firing reliably – China. The worldwide repercussions of the crisis have been cushioned in no small part thanks to a massive stimulus plan enacted in 2008 by the Chinese authorities, even before the full extent of the crisis became apparent. And emerging markets, but even advanced economies such as Germany, Korea and Australia, which are plugged into the supply chain of the Asian giant were pulled out of the Great Contraction quite fast.

It is therefore not surprising that policymakers and asset managers around the world are fretting over a hard landing of the Chinese economy. These fears – latent due to the bubble in real estate and the opacity of the banking sector – are intensifying after five consecutive months of weak survey data from the manufacturing sector and weak export performance. In March for example, the Purchasing Manager Index compiled by HSBC remained in recessionary territory. New industrial orders are close to the minimum over months and hiring is at a two-year low.

The fact that the Chinese leadership has announced a small drop in the forecast growth rate over the next few years from 8 per cent to 7.5 per cent has not reassured the world. This was well below the double digit figures to which we have become accustomed in past decades. This slowdown was largely expected by most economists, nevertheless it came at a delicate juncture and adds to the uncertainty which unnerves an already edgy investors’ community.

The slower pace of the Chinese locomotive has quantitative and qualitative implications which reflect two macro trends: the ebbing of the demographic wave and the shift to a mature and more inclusive society. In the long term, it is the latter aspect that will yield more profound, and mostly positive, effects.

Despite its breathless progress, China remains a country where the vibrant coastal regions and large cities stand in stark contrast with entrenched poverty in the interior and the rural areas. China in essence is still in the midst of a transition from a predominantly subsistence economy to a high income one. The current leadership has recognised that the exportled model which is based on cheap labour has exhausted its course and the economy needs to be driven by high-value added service sectors.

This is exactly the goal set by the current leadership for the next one, which will be appointed in October by the 18th Congress of the Communist Party. Premier Wen emphasising the ‘quality’ of growth, not just the quantity, stressed the rotation from investment and exports to consumerled growth which would lead to a much needed normalisation of the current account imbalances between China and the US. The new Central Committee will ‘elect’ a Politburo of about 25 members where for the first time in 20 years, President Hu Jintao and Prime Minister, Wen Jiabao, will not sit as members. Then, in 2013 they will both retire from active politics, completing the most radical change of leadership in a decade.

Behind the curtain, the fight to decide the course of Chinese politics is intense and in March unusually it erupted publicly with the ousting of conservative leader Bo Xilai, Party Secretary of Chongqing. His supporters included party traditionalists, workers from state-owned factories, bureaucrats, and intellectuals loyal to communist ideals. This episode paves the way for a victory of the ‘reformist’ camp and means that China could make progress on three fronts: the introduction of a universal pension system, as well as public health care and financial liberalisation.

In a decidedly momentous break with tradition, which has tended to shun foreign influence, the roadmap for the leap forward was enshrined in a report by the World Bank laconically entitled ‘China 2030’ co-authored with the Development Research Centre (DRC) of the State Council, an influential think tank which advises the government, and foremost the Ministry of Finance.

Under headings as explicit as ‘Structural Reforms for a Market-Based Economy’, ‘Increasing the Pace of Innovation’, ‘The Opportunity of Green Development’, ‘Equal Opportunity and Basic Security for All’ the report asserts that to become a high income society by 2030, China must change its policy and institutional framework, rethinking the role of the state and the private sector to encourage increased competition in the economy.

As if these words were not bold enough, the report advocates promoting equality and social protection for all, strengthening the fiscal system and ensuring that China continues to be integrated into the global markets.

It is likely that the most immediate progress will be seen in the area of financial liberalisation, spearheaded by the People’s Bank of China – the Central Bank, long considered a stronghold of the reformists – which is accelerating the demise of capital controls with the aim of making the Yuan a global reserve currency. Furthermore repressive laws are already being relaxed by new provisions coming into effect almost every month, in fixed income, exchange rate dealing and foreign investors' activities. Essentially, the authorities recognise the pressing need to remove barriers to international capital flow and to foster a vibrant domestic financial market.

By 2015 it is expected that China will give rise to a more balanced growth outlook and as a consequence the current account surplus is expected to turn into a deficit, and the country will become a net capital importer.

If the new leadership under the next President Xi Jinping has the political strength and determination to pursue the agenda set by ‘China 2030’, in 20 years time the long march towards a market economy will be completed and China will likely have become the largest economy on the planet, although its per capita income would still be a fraction of the average in advanced economies.

This gap in income means that there will still be room for further expansion, provided that environmental and food security issues do not become insurmountable bottlenecks. The stage is set for what the history books might one day dub the ‘Century of the Dragon’.

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