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Hidden risks in China's economy

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Many foreign companies feel that they cannot afford to overlook the opportunity to invest in China’s 1.3 billion-person-market. Many believe the rosy statistics for this economic “superpower”, its purported 8% GDP growth for 2002, and 9% for the first quarter of 2003 (BBC). Indeed, China is the top recipient of foreign direct investment, surpassing the U.S. with USD52.7 billion in 2002 (BBC).

Yet those with extensive experience dealing with China’s officials share concerns regarding hidden economic, financial and social risks.

Gordon Chang, lawyer, economist, and author of The Coming Collapse of China pointed out, “There are two things to know about the banking system in China. First, the major state banks, the so-called Big Four, are insolvent. Second, the effort to bail them out is not working… The most important is this: The crisis in the Chinese banking system is perhaps the most serious in the world today. ”

The September 16, 2002 issue of Hong Kong’s Contends magazine published the key dangers in the current economy: “It has already been verified that the proportion of banks' bad accounts and bad properties has topped 38%, a problem in which the Central leadership has unavoidable responsibility. Basically, the four largest state-owned commercial banks cannot reach the 8% Capital Adequacy Ratio stipulated by the Barsel Accord… Mainland China now ranks 4th after Venezuela, Mexico, and Argentina in capital loss from large numbers of high-ranking officials and their families fleeing with the country’s financial resources… In 2000, China suffered capital flight of US$48 billion, but overseas investment was only US$40.7 billion.”

According to He Qinglian, a leading China economist and author of the highly acclaimed China’s Pitfall, the enormous wealth gap is a potential source of turmoil, as 15% of the people own 85% of the wealth and the unemployment rate is as high as 20.2%. “Severe corruption by government officials and the demoralization in China has surpassed all developing countries in the world... To protect the image of the Party and the government, it fabricates news. The likes cannot be found anywhere in the world.”

Two major factors drive China’s economic growth: foreign investment and massive state spending of people’s life savings. China has the highest average savings rate in the world, with 40% of people’s income in state banks.

So, are foreign companies making money in China? "If any of these foreign companies were making money in China, they would be talking about it constantly,” says Joe Studwell, editor of the China Economic Quarterly. Yet most companies hold on to the “China dream” and continue to invest.

What happens to a joint venture? A western company sets up a joint-venture factory to manufacture its product for the domestic market. A local partner steals its technology and sets up an identical factory. The venture’s bank account has been cleaned out, and local workers turn against it. Legal recourse is impossible because the Chinese partner is a best friend of the mayor, police chief, and district court judge. “Bigger companies seek help from their embassy; smaller ones usually walk away from their losses…” according to the August 22, 2003 Wall Street Journal’s “Soda and Suckers.”

On May 18, 2003 Bloomberg commented “AOL Time Warner foresaw boundless opportunity in China in June 2001, when then-chief executive Gerald Levin signed a US$200 million agreement to sell online services in the world's most populous nation… Almost two years later, AOL hasn't signed up a single paying subscriber in a nation of 59 million Web users. Links on the AOL-Legend Chinese-language Web site to services such as e-mail, instant messaging, and Internet access lead nowhere: Users get a message saying the system is still being tested.”

Contends magazine reported on the five causes of hidden economic dangers addressed then-Premier Zhu Rongji:

#1.The present political system has revealed its incompatibility with economic reforms, or has even negatively hindered the economy. This is a fact, but there are still many comrades who do not wish to acknowledge it as the key reason.
#2.The political and professional qualities of the official ranks are very low.
#3.Rule of law along with laws and regulations cannot play a restraining role in the economy. They amount to nothing but an empty shell in a majority of areas and departments, and are overruled by officials abusing power.
#4.Serious deviation has occurred in the implementation of the reform and development policy, which has created incisive conflicts and doubt in, and even repugnance and resistance to, the economic reform policy among the mass of employees and farmers. The solid foundation of support has been lost.
#5.The habit of reporting only the good news and not the bad, practicing fraud, and deceiving the superiors while deluding the subordinates, and so on, have already become the persistent ailment of many bureaucrats in party organizations and government departments.”

References for further reading:
New Republic: Is China's Economic Boom a Myth?
Economist: A Dragon Out Of Puff
Financial Times: Asia-Pacific: Pyramid Of Power Behind Numbers Game: Cases Of Official Fabrication Highlight The Shortcomings Of An Unreformed Communist System, Writes James Kynge
CNN: China Wages 'Big-Bucks Diplomacy'
The Straits Times: Lack Of Trust Dogs China Businesses
The Seattle Times: Court Rules Corporations Can Be Held Liable For Human Rights Abuses
WSJ: Soda And Suckers
San Francisco, The Examiner: Enron Bust Awaits China's Businesses
Far Eastern Economic Review: People's Republic Of Cheats
Baltimore Sun: Deal with the Devil Proves Deadly

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