Leaders

China’s coming recession

Far from thriving amid the turmoil, China has already caught a dose of Asian flu

|

IT IS surreal, but a winner is deemed to have emerged from Asia's financial chaos. Three cheers for China! While beggar-thy-neighbour devaluations tore through the region late last year, China's communist leaders stoutly ensured that their currency, the yuan, remained rock-solid. Since then, though other Asian leaders seemed to lose their heads and blame it on each other or else outsiders, China's statesmen have unveiled a seemingly breathtaking array of reforms to the country's socialist banks and enterprises, which have been given three years to shape up. An axe is to be taken to the unwieldy, but hitherto untrimmable, government bureaucracy. Government and business are to be separated, and 4m civil-service jobs lost. All this, and China's leaders have tossed out a further promise: growth of 8% this year. “China”, one evangelist lauds, “pulls away from the pack.”

The euphoria is dangerously misplaced. Far from having escaped the Asian flu, China has already been smitten by a virulent strain. In order to counter looming deflation, China's political leaders are now planning to stimulate demand on a massive scale. It is far from obvious that such a stimulus can successfully stave off a short-term slump. Even if it does, it poses a threat to the new commitment to reform.

Before the Asian crisis had a chance to infect the country, deflationary forces in China's own economy were already apparent. These stemmed partly from four years of austerity imposed after the boom of the early 1990s. Annual economic growth fell from a peak of 14% in 1992 to 8% (by official, optimistic reckoning) last year. By the end of 1997 prices in China's cities were falling.

The Asian shock has added to these deflationary pressures at home. True, exports are still increasing, at over 12% in the first quarter of this year. But such year-on-year growth has fallen by half since last June. Two-fifths of China's exports are to other parts of Asia, so the export figure might soon actually begin to shrink. Moreover, the growth in foreign investment in China—well over three-fifths of which comes from within the region—looks certain to stall this year.

Stagnant domestic demand and a grim situation abroad are beginnning to take their toll. Last week it was announced that year-on-year profits at state companies fell by over 80% in January and February. First-quarter GDP growth slumped to 7.2%, the lowest quarterly figure in at least six years. At a time when state enterprises are furiously sacking workers in an attempt to reform, every percentage-point fall in growth creates 2m-4m more unemployed. Last week the head of the World Bank in China gave warning that growth below 5% would have serious consequences for social stability.

Any normal country would deal with falling demand by loosening monetary policy. China is denied that option, because its quasi-socialist central bank still lacks the monetary levers that western central banks use to influence short-term interest rates. The government's only choice, then, is to increase spending. Li Lanqing, a deputy prime minister for the economy, talks of a $750 billion infrastructure programme. In all likelihood, that figure is meaningless. But the government is probably looking for $60 billion-70 billion of extra public-works spending, equivalent to over 6% of GDP. The budget deficit this year, however, is due to shrink by nearly a fifth, to roughly $6 billion. Unless this is breached, fresh money for spending must therefore come from one of two sources: raising the arbitrary taxes and fees that fall under the banner of “extra-budgetary” revenues; or, alternatively, further directing the lending of state banks.

With ordinary Chinese fearing for their jobs, such a stimulus could well fail. Meanwhile, the recent promise to let the market allocate capital looks in danger of being compromised. And not just temporarily. The prime minister, Zhu Rongji, who is disliked in China's provinces for his bluntness, relies upon sheer momentum to push his reforms forward. Recommitting the state to capital-allocation now will make it that much harder to carry through reforms later.

Compete or crash

A stimulus would also hide the deeper fact that China's “gradualist” approach—of which the new reforms proposed under Mr Zhu are merely an accelerated kind—has probably run its course. Fully 20 years since China began to loosen central controls on the economy, two-thirds of the country's investment spending remains state-directed. The big four state banks that hog the country's savings are technically insolvent. They are being exhorted to become more efficient. Yet they face no serious competition, the most important tool for knocking them into shape (see article). There is no question of their being privatised. Ruled out, too, is any suggestion that China's 500-odd biggest companies be sold or allowed to fail. “Privatisation” is still a dirty word in China.

Meanwhile, the development of capital markets is thwarted by the state banks' control of resources. Proper capital markets—and in particular corporate bond markets—would allow China's most deserving companies to get their hands on the country's savings. Markets are essential if China is to solve a growing pension crisis as the population ages. Most of all, it is upon market-allocated capital that China's growth and job-creation will depend. Until China learns this lesson, it does not look a winner under anybody's rules.

This article appeared in the Leaders section of the print edition under the headline "China’s coming recession"

Europe takes flight

From the May 2nd 1998 edition

Discover stories from this section and more in the list of contents

Explore the edition

Discover more

Russia is gearing up for a big new push along a long front line

Ukraine must prepare

Antarctica needs a lot more attention

Melting ice sheets do more than raise sea levels


Some advice to the corporate world’s know-it-alls

With growth slowing, consulting firms like McKinsey need some counsel of their own