【The Australia】China should focus on quality of growth, not the pace

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China should focus on quality of growth, not the pace
http://www.theaustralian.news.com.au/business/story/0,28124,25748412-5018066,00.html

Ben Simpfendorfer | July 08, 2009

CHINA'S economy has recovered faster than many expected. The government targeted 8 per cent growth early in the crisis, and will likely meet its target later this year.

It is an impressive result given that many of the region's other economies are contracting. Yet, chasing a growth target has only exaggerated economic imbalances, and cracks in the economy are now starting to emerge.

The problem is that government is too heavily focused on the pace of growth, rather than the quality of growth.

First, fiscal deficit spending has left the economy worryingly dependent on public investment spending, even as private spending is likely contracting. Of course, China releases no detailed data on the latter. However, exports are 30 per cent below their peak, and domestic competition is intensifying as a result of a build-up of manufacturing slack, so it is unlikely that private firms are building new factories or buying new equipment.

Second, and more worryingly, the government appears to be pumping up the property sector again in a bid to meet the growth target. After tightening policy towards the property sector last year, officials have since made a policy u-turn. The property market has responded. Housing starts are growing again after only a brief dip last year. Home prices are also rising in a number of cities. Local media worry openly about a property bubble.

Credit growth is another concern. The central bank relaxed monetary policy aggressively in the wake of the crisis, as did central banks across the world. But credit growth in China has surged by seven trillion yuan ($1.283 trillion) in the past six months, or more than the country's banks lent out in the previous two years. There are only limited details on how the credit was used. But estimates suggest that only half of the value is being spent on bridges, factories, or railways.

And the remainder? A State Council-associated economist recently estimated that it was being used to buy equities and property. I would add commodities to the list. For instance, there are stories of property developers having cashed in and purchasing copper inventories in anticipation that the fiscal stimulus is going to push commodity prices higher. It is no surprise that local media also worry about the risks of another credit bubble.

The irony is that small and medium-sized enterprises are starved of capital. Take the example of Wong Yongding, manager of an electrical goods company in Shenzhen. He says that, in spite of a 10-year operating record, evidence of tax and customs payments, and a good credit record, he is unable to take out a loan without first pledging property as a security. Many SMEs are unable to pledge assets of sufficient value to take out the size of loan needed.

The SMEs sector is often overlooked because of lack of data. But it accounts for up to 60 per cent of the economy and an even greater share of employment owing to its tendency to focus on labour-intensive production. The government is offering subsidies for the consumption of manufactured goods, but Chinese consumers cannot yet replace deleveraging foreign consumers.

The SMEs will have to restructure dramatically if they are to survive.

Indeed, the lessons of the late-1990s are clear. It was during this period that growth last slowed sharply. However, it was economic reform, not fiscal spending, which produced the double-digit growth rates of the subsequent years. The scale of the reforms in the late-1990s was astonishing and, to name a few, included liberalisation of the property sector, entry to the World Trade Organisation, and the restructuring of state-owned enterprises.

China needs the same "big-bang" reforms today. What might these reforms look like?

It is popularly argued that the economy needs to reorient away from external demand towards domestic demand. But it also needs to restructure away from manufacturing towards services. Manufacturing accounts for almost half of
China's economy. This is high even when measured against Asia's other major manufacturers -- manufacturing accounts for a quarter of Korea's economy, and an even smaller share in Taiwan.

The services sector is arguably China's last great untapped growth driver. But it suffers from heavy regulation and government monopolies just like the manufacturing sector did two decades ago. The government must liberalise the services sector and encourage the private sector to run schools, establish hospitals, or operate travel agencies. If so,
China will not be alone, as services account for a growing share of activity in all of Asia's big manufacturers.

The service sector will not save the economy from today's crisis. But it will lay the foundations for more balanced growth over the next decade.

The world's belief that China will meet its growth target has buoyed confidence, and Australia has benefited in particular through higher commodity prices. Yet, our confidence may be misplaced if the result is more overcapacity and another asset price bubble. And the risks to Australia are especially acute if commodity prices take a tumble as final demand slows.

It is time for the growth target to be lowered, or better yet, eliminated altogether, and for both the central and provincial governments to focus on the quality of growth, not the pace.

Ben Simpfendorfer is chief China economist for the Royal Bank of Scotland and author of The New Silk Road

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