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Understanding China’s economy requires looking beneath the surface (Part I)
Wu Fan, The Epoch Times
9/12/2005

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People may differ as to whether China’s economic situation is good or bad, but I am of the opinion that an analysis based on the facts of China’s current economic situation would be more convincing.

International views and analyses of China’s economy can be categorized into two camps (Camp A and Camp B). Because the basic viewpoints differ significantly, the results of these analyses are completely different.

Some in the international community as well as others in Taiwan (Camp A) believe that China’s economic development is quite good, because its annual GDP growth rates range from 8 percent to 9 percent annually. Most of the people in this camp are those who have business connections or investments in China, or experts and scholars who benefit from promoting the viewpoint of Camp A. The article “Does the Future Belong to China?” was carried in Newsweek’s May 9 issue, while “A New China Rises” was published in Time’s June 27 issue. Apparently, these two articles are looking at China from the standpoint of Camp A. Readers may wonder whether these reports are based on observations of surface phenomena or a deep analysis of China’s inner conflicts and social structure (Camp B)? Undoubtedly these two approaches can lead to different conclusions.

Camp A is of the view that China’s economic development is very good, as China has attained three major economic achievements in recent years: The GDP growth rate was over 8 percent for over 20 years. China has become the world’s factory, and in terms of attracting foreign investment in recent years, China was second only to the U.S.

However, Camp B believes that the aforementioned three major achievements have serious flaws in that they put emphasis on a single statistic, the GDP, without taking into account the costs to GDP, let alone other factors. Camp B analyzes China’s economic state from an overall perspective to determine the weaknesses in its economy [1].

Although China’s economy continues to grow, Camp B thinks that its economic development model and financial system’s fundamentals have gradually exposed its inner structural conflicts. In this context, people in this camp are not optimistic about the outlook for China’s economic future. In particular, some economists and officials in China have repeatedly warned that a financial crisis is likely to take place in the not-too-distant future.

To analyze the on-going economic situation, the following critical indicators need to be taken into account: GDP statistics, huge influx of foreign capital, being a world’s factory, debt ratios, stock market, real estate, scarcity of energy, inflation, etc. By doing so, we may be able to see the overall picture of China’s economic situation.

I. China’s Current Economic Situation

1. China uses GDP as the only indicator to measure economic strength

According to the main focus of the article “Does the Future Belong to China?” the author predicts that China’s GDP is projected to overtake that of other major nations in the next 10 to 35 years. On page 3, the article highlighted that China’s current GDP is US$ 1.6 trillion, which may triple in the next 15 years, and it may surpass Japan and the United States in terms of total GDP by 2015 and 2039, respectively. According to a rough estimate based on the existing statistics, the global GDP may reach some US$ 40 trillion in 2005, including China’s US$ 1.6 trillion, which accounts for about 4 percent of the global GDP, Japan weighs in at US$ 4.5 trillion, which accounts for about 11 percent, and the United States at US$ 11.7 trillion, accounts for about 29.4 percent. These figures roughly show that Japan’s GDP is almost three times larger than that of China, while the United States is about 7.5 times China’s GDP.

If each country is regarded as an economic body, it is obvious that measuring economic strength simply by the GDP is unreasonable. In reality, GDP can only partially represent the facts in the process of economic development. It can by no means reflect the overall picture. The Chinese regime prefers to use GDP as the index of its economic development, and even regards it as the only index.

There are many flaws in using GDP as an economic development indicator. First, the GDP does not measure social costs. Simply speaking, the GDP is the total market value of all final goods and services produced by a nation in a given year, of which the measurement is based on the value system of the economy in a particular country. For a country with a sound market mechanism, this measurement can accurately reflect the total market value of the economic activity as a whole. For a country evolving from a planned market economy to a free market like China, the GDP is unrealistic for measuring the total market value of all economic activities. For instance, China’s GDP does not reflect factors pertaining to environmental pollution, workers' compensation insurance, child employment, medical insurance, social welfare, health problems, etc. It is for this reason that some have come up with the concept of a “Green GDP.”

For instance, to have a GDP growth of 10 billion Renminbi (RMB), the environmental protection or remediation cost needed for the ecological damage incurred may be as high as 3 billion RMB. Thereby, ostensibly the GDP generated is 13 billion RMB (10+3=13); however, the effective GDP is only 7 billion RMB (10-3=7). In other words, the Chinese government simply wants to pursue nominal GDP growth at the expense of environmental protection and its people’s health, regardless of the safety of its employees and their offspring. As a result, the resource base for the Chinese society’s sustainable development has been significantly damaged. [2]

The GDP’s second flaw is that it does not measure quality. Quality isn't taken into account for purposes of GDP, as GDP is calculated at the present market value of social activities. The wealth of a society is accumulated by quality rather than quantity. It's of no use to accumulate greater quantity. This involves issues at two levels. One is that only quality accumulates social wealth or the rate of depreciation for social wealth will be faster than that of production. The other is that only products of good quality have external exchange value. One of the most evident examples is that state enterprises in China are eager to get loans from banks in order to manufacture the identical goods with high demand in the marketplace. They even engage in manufacturing counterfeit articles. This soon results in over-production and surplus, and the market is rife with a commodity that has different grades of quality. Eventually, their products cannot be sold in the market, and the enterprises go bankrupt one after another. During the process of manufacturing the products, the value of this over-production and surplus is all included in the GDP, but the GDP doesn’t take into account how many products are sold in the market. This is a glaring flaw of GDP statistics.

The third flaw is that GDP does not measure the effectiveness of resource allocation. From an economic perspective, expenditure itself is not a social cost. When evaluating the social cost of investment A, we consider how investment A causes investment B to become obsolete. For example, if the government makes a military expenditure, such expenditures themselves are not social costs as they promote the development of the military industry. However, if the investment in the military industry causes a shortage in the education budget or a failure to fulfill social needs, this is then a social cost of military development that needs to be taken into account.

In addition, the GDP does not measure waste. There is no difference between wasting money and building a school in calculating GDP. How much has China wasted each year? On one hand, it makes huge investments in building the largest fiber optic telecommunication network in the world; and on the other hand, it places restrictions on Internet usage, with strict controls over Internet cafes and websites. Such waste isn’t reflected in the GDP.

The GDP’s fifth flaw is that it does not measure negative impacts. The objective of all economic development is to have a positive effect. But the Beijing government has long made policies according to the “will of leaders.” As a result, they push ahead with many projects to expand the nominal GDP. These are so-called “leaders’ projects,” “image projects” and “accomplishment projects,” but in reality their economic effect is negative. The Sanmen Gorge Dam Project in Henan province is a typical example. Instead of enhancing water conservancy, it became a facility that lead to flooding, which posed a tremendous threat to areas in the lower reaches of the dam. Therefore, the government had no choice but to remove the dam. Lastly, the GDP statistics publicized by the Chinese government is by no means reliable. Since the Chinese government uses GDP as the indicator of economic development, government officials at all levels resort to inflating GDP figures in order to keep their positions and get a promotion. The GDP growth rates reported by all the provincial governments are over 10 percent, and some are even as high as 20 percent. However, the figure publicized by the Beijing government was only 8 to 9 percent, hence nobody really knows which one is correct.

Since the Chinese government uses GDP as an indicator, even the sole indicator of economic development, the irrationality is evident. Newsweek magazine still used the GDP concept to compare the economic strengths of China, the United States and Japan. It is obvious that the forecasts in the article “Does the Future Belong to China?” are not very meaningful. For instance, recently the European Union asked China’s Minister of Commerce Bao Xilai to voluntarily reduce the volume of textile exports to the E.U. (textile product dumping) in order to reduce the impact on E.U. markets. In reply to a question raised by a journalist regarding this, Bao said: “China’s selling one hundred million pieces of textiles to the E.U. can only be exchanged for one Airbus airplane.” This indicates that China’s on-going economic development practice is to manufacture mass low value-added products in exchange for importation of some high value-added products. And this trading practice cannot be reflected in the GDP statistics.

Presently, China is counting on massive investments of capital, labor and other resources to increase its GDP figures. It is a low-level production approach, which has low efficiency and high energy consumption. Though ostensibly China’s annual GDP growth rate is as high as 8 to 9 percent, its net profit is not high, and its social wealth accumulation is very low as well. As a result, I have different views on the claim that China’s GDP will overtake Japan’s in the next ten years. Take energy consumption as an example, China’s energy efficiency is quite low. The energy consumed to produce US$ 100 million worth of products is ten times that of Japan’s. As Japan’s current GDP is about 2.8 times that of China’s, if China’s energy infrastructure is not changed and its energy efficiency is not improved, China must consume three times more energy in order to surpass Japan’s GDP.

What’s the possibility of this? As a matter of fact, it is a daunting question, isn’t it? Presently, China consumes 30 percent of the world’s energy, but it produces only 4 percent of the global GDP. According to the prediction made by Newsweek magazine, China’s GDP may triple in the next ten years. That being the case, the energy to be consumed by China will have to increase three fold. In other words, 100% of the current level of global energy production will be consumed by China, which is absolutely impossible. So obviously China’s economic efficiency is very low, and China’s economic development should no longer rely on a low level manufacturing approach. As a matter of fact, China should develop itself into a “green China” to conserve its ecology, as opposed to making it a “black China” with high energy-consumption and low efficiency.

The side effect of the so-called “Twenty consecutive years of high GDP growth” is the great damage done to the foundation of Chinese society’s sustainable development.

II. The Consequence of Bringing in Large Foreign Capital

1) The need for bringing in foreign capital is the fact that state-owned enterprises have degenerated and this has resulted in an overall deterioration of the key national industry sectors.

The pros and cons of bringing in huge foreign capital are gradually becoming apparent. The initial reason for bringing in foreign capital was to boost the state-owned enterprises. The hope was that the injection of foreign capital in the form of joint investment would save the large-scale state-owned enterprises.

Because China's state-owned enterprises cannot compete with multinational corporations with regards to funding, technology, name brands, business management and marketing, they are now under great pressure after the introduction of foreign capital in the form of joint ventures. A large number of state-owned enterprises went bankrupt. Especially, the dramatic increase in capital and technology-intensive projects invested in by the multinational corporations, has severely affected China's state-owned heavy industries, like petrochemistry, machinery, electronics, steel, etc. The full-scale degeneration of the Chinese commercial aviation industry is a typical example. In the last stage of the Great Cultural Revolution, China tried to produce two large aircraft (the "Yun 10"), and one prototype successfully flew from Shanghai to the Tibetan Plateau. After the reform and opening up policy, as well as with the new focus on attracting foreign capital, the "Yun 10" was completely neglected. China formed a joint venture with the U.S. Douglas under which it was decided that the Chinese commercial aviation industry would manufacture the Boeing airplane’s wings and gates. This had a large negative impact on the overall technical level of the Chinese aviation industry. Several years after this joint venture, the cooperation between China and the U.S. aviation industry was announced as having failed.

In contrast to this, let us consider the rise of Airbus in Europe. Airbus is presently one of the largest airplane manufacturers in the world, jointly set up by in 1970 by Germany and France, who were later joined by the United Kingdom and Spain. After years of hard work, the Airbus has unceasingly grown stronger, and has eventually broken Boeing’s monopoly in the world airplane manufacturers. Airbus has now taken over half of the global airplane market. When China successful test-flew its "Yun 10", its technology was only 10-15 years behind Airbus’. China originally had the opportunity to become one of the world’s large-scale civil aircraft manufacturing centers, but the short-sightedness and desire for personal gain of Chinese Communist Party policy-makers has led to abandoning the effort to develop domestic industry. Instead, they are now turning their eyes on foreign capital. The Chinese civil aviation industry has now been left behind for over more than half a century.

Moreover, along with the import of more and more foreign technology and products, the Chinese state-owned enterprises have found themselves trapped in operational difficulties. Large numbers of workers have become unemployed and the absence of employment security has lead to a drop in income and a sharp decrease in social buying power. [3]

Trying to save the state-owned enterprises in a different way, the Chinese government started employing a positive financial policy in 1996, which included instructing banks to provide loans to state-owned enterprises, and simultaneously promoting National Bonds. Large sums of money were invested into state-owned enterprises, but this still could not save these state-owned enterprises due to their low-technology level, lack of market competitiveness, and no bank load repayment ability. As a result, the government nowadays carries two heavy burdens: nearly 3.5 trillion Yuan (approximately US$432 billion) bad debts in banks and 2 trillion Yuan national debts (approximately US$247 billion). The introduction of foreign capital did stimulate the export of low value-added products, but under the WTO’s stipulation, China would not be acknowledged as a market economy before 2016 by the US, European Union and Japan. China’s export is restricted by so-called “anti-dumping” sanctions. The income from export is, therefore, limited and not enough for China to offset its debt.

Because of the above disadvantageous factors, the Chinese government spares no efforts to attract foreign investment so as to maintain its economic growth. Due to the decrease in the number of the projects that are attractive enough for foreign investors to put money in, and due to the fact that less people want to invest in National Bonds, how to attract foreign investments has become ever more important. Many local governments have strengthened their efforts to attract foreign investment, allocating quotas to their lower level governments. They have even used bonus mechanisms to encourage companies and individuals to do well in attracting foreign investments. In recent years, Chinese domestic stability has been dependent on economic growth, but this growth in turn heavily relies on the massive inflow of foreign capital. So as long as the inflow of foreign capital drops, the Chinese economy will have serious difficulties.

Huge foreign investment could benefit short-term economy development, but in the long run, China’s industry, finance, business and export products will be controlled by foreign investment companies. This is definitely no good to China. Especially when foreign investment companies lose their interest in China and retreat on a large scale, it will hit China big—actually, foreign investment companies have already retreated from China’s oil and energy resource sectors.

III. The World’s Factory

The Beijing government often claims that China has become the world’s factory. Such a statement is actually exaggerated. In 2003, China’s gross domestic product (GDP) was about 10 trillion Yuan (approximately US$1.2 trillion) which is merely 3.89% of the global GDP. Such a small portion of the global GDP should not be called “the world’s factory.” However, there are indeed some popular lower value industrial products manufactured by the 200 million farmers in China’s coastal area that sell well in the global market. Such an economic model has greatly restricted China’s economic and social development. It is not a good thing to celebrate that all the high energy-consuming, highly polluting, low technology, labor- and resources-intensive and low efficiency industries moved to China from all over the world. Most Chinese workers have not been able to improve their technical skills and wage levels, and will be forced to retire without any social security as early as 45 to 50 years old. In the meantime, China’s industrial technology has remained at a low level for a long time now.

200 million farmers have left their lands and have become cheap laborers. If these laborers lose their jobs and income, China’s society will be in chaos. China has become a low-cost world manufacturer at the cost of cheap laborers and the destruction of its ecological environment.

Today’s Chinese economy heavily relies on export. In 2004, China’s total export and import reached US$1 trillion, which is 62.5% of China’s total GDP. Worldwide, this is extremely high. Such an economic model, relying on export trade and low margins from processing products for other countries is hard to continue and is easily affected by the global environment. It is a dangerous path for development.

IV. Bank Debts

The current debts Chinese banks carry for central and local governments have exceeded the global warning limit.

1) Central government debts

China’s current national debt is about 2 trillion Yuan (approximately US$242 billion), which is about 20% of its 11 trillion Yuan (US$ 1.36 trillion) GDP for 2004 (This number is from [9] and is different from that reported in “Does the Future Belong to China?”). However, China also owes US$170 billion (US$ 21 billion) in overseas borrowing, which converts to more than 1 trillion Yuan (US$ 123 billion). The total of the two debts is about 3.4 trillion Yuan (US$ 419 billion).

In addition, China’s government has a deficit of about 300 billion Yuan (US$ 37 billion), construction payables of 300 billion Yuan (US$ 37 billion) and owes 240 billion Yuan (US$30 billion) in export tax refunds. These and the 3.4 trillion Yuan (US$ 419 billion) in debts add to 4.24 trillion Yuan (US$ 523 billion), which is 38.8% of its GDP (This calculation is based on a GDP of 11 trillion Yuan).

China’s Premier Wen Jiabao once said that China’s state-owned banks’ bad debt rate is about 20%, an amount of around 3.4 trillion Yuan (US$ 419 billion). Even if one-third of these bad debts could be collected, the loss is about 2 trillion Yuan (US$ 247 billion). This totals China’s central government total debt close to 6 trillion Yuan (US$ 741 billion), or more than 50% of its GDP. Taking into account that all these numbers are from official resources (which are most likely understated), the estimated actual debt could be as high as 70% of China’s GDP, which is far above the global warning limit [9].

2) Local governments’ debts

There are different sources of local government debts: a) borrowing domestically or internationally through local banking systems, and the local governments’ guarantee for borrowing by local state-owned enterprises, b) unpaid salaries of government employees and state-owned enterprise employees, c) unpaid social security benefits, and d) all kinds of construction payables. In China, more than 70% of the county governments and more than 90% of the township governments have high-level debts; the total debt of township and village level governments is more than 600 billion Yuan (US$ 74 billion).

600 billion Yuan (US$ 74 billion) is only an average for different estimates of the total debt of township and village governments; the high-end estimate is as high as more than 1 trillion Yuan (US$ 123 billion). This means the village governments’ debt is close of 10% of China’s GDP, and 30% to 50% of its total national fiscal income, which exceeds the long-term construction national debt. [10]

To be continued

Wu Fan, editor-in-chief of China Affairs, Chairman of the Board of the Alliance for a Democratic China.

References (all in Chinese)

1. He Qinglian. 2005. “The Truth Hidden Under China’s Prosperity.” China Affairs, Feb 23.

2. Anonymous. 2002. “Behind China’s Fast Growing GDP.” China Affairs, Dec 21.

3. Yue Jianyong, and Chen Man. 2003. “Why China Goes All Out to Bring in Foreign Capital?” Modern China StudiesThe Pitfall of China’s Modernization, Chapter 5. Sunnyvale, CA: Broad Press Inc.

5. Secret China (staff). 2005. “China’s Media Report Half of Foreign Companies Withdraw from China.” Secret China website (kanzhongguo.com), Jan 3.

6. He Qinglian, 2005. “The Truth Hidden Under China’s Prosperity.’ China Affairs, Feb 23.

7. Zhang Bangsong. 2003. “In the Name of Foreign Investment, Enormous Amount of Dirty Money from Corruption Laundered Overseas and Flows Back to China.” China Affairs, June 17.

8. Zhou Yang. 2005. “Scary Intention: Foreign Investment Quietly Plot to Control China’s Commodity Price.” China AffairsThe Epoch Times, January 10.

10. Han Shan. 2005. “Chinese Local Governments’ Debts—Signs of Danger Appearing Everywhere.” China Affairs, July 9.

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