...and the Chinese economy

The current economic crisis which began in the U.S. housing sector has now spread to many sectors in many countries, China included. Like the U.S. in 1929, China is succumbing to real trouble despite their gigantic cash reserves and their huge trade surplus. They were partly protected from external financial troubles during the Asian financial crisis on the late 1990s, but now they are much more integrated into the global economy, with exports that are at twice the level of India’s, so they are more vulnerable. Export-driven growth was the solution to all their problems – rural poverty, unemployment, the works – and now that is in peril.

Recession in the U.S. means demand for Chinese goods goes down. Chinese firms are loaded with debt; thousands of factories closed in southern China even before the fiscal crisis; half their toymakers went bankrupt; automakers want protection from foreign competition. The government tried to prop up their markets but the Shanghai market dropped seventy percent and a hundred million stock investors were in a state of shock. Also, they will have infrastructure problems – overcoming their long supply chains and transport costs.

They are making little progress on either productivity or innovation: many of their college “graduates” are glorified mechanics, most of their research scientists are working in government labs, they have almost no track record in setting up their own brands or products as the Japanese have done, and the government is still giving privileges to foreign firms which Chinese firms don’t get. Furthermore, China like India has a long history of throwing manpower at a problem rather than innovating. Also, China is heading toward an aging population: innovation comes from young minds.

Even the things the Chinese did well, to get them where they are, are not forever. The forces of recession and competition from other developing countries are reducing their competitive advantage in low-skill industries like clothes and toys.

Employment has gone from bad to worse: as it was, they needed to find millions of new jobs each year, and now the task has gotten even harder. Millions are out of work, particularly among factory workers and college graduates – and the middle class as a whole is in a jam too. Their whole reason for economic success is cheap labor, but it’s unskilled and the government doesn’t spend as much on education as Mao did.

Another inhibitor to growth: much of the recent growth occurred when foreign firms moved production to China, but now most of the firms who want to go that way have done so. Outsourcing has limits as a labor strategy. So their growth rates are even less likely to sustain themselves.

Two poor choices by the government are turning China inside out: the one-child-per-family policy, and the refusal to set up a national pension system. Because government cannot or will not set up a pension system (it would involve a tax increase), Chinese couples need a son to support them in their old age (daughters go off to care for their in-laws). The aging of China will only make it worse. Add the one-child-per-family policy, and parents are aborting, abandoning or murdering their daughters, to retain their chances of having a son. Also, the pension issue means that the Chinese save much more, which means they invest less in the economy: they don’t buy as much in the stores or invest as much in the stock market, depressing the economy further. Also, their level of savings is increased by the fact that they have no system of land registry so they can’t use property as collateral for loans or for long-term investment plans . Also, the one-child policy is setting up more problems down the road, as the surplus of forty million unmarried men jacks up rates of prostitution, rape, forced marriage, and reducing women into commodities.

The National People’s Congress is considering a package of unemployment benefits, pensions and universal health care (health care is declining currently).

We are at a political disadvantage vis-à-vis China because we have borrowed hundreds of billions from them, to finance our deficits. It is hard to press them on political issues while we are also asking them for money. If they were to dump our financial instruments or slow down their purchases of them, it would hurt both countries, but even the threat opens us up to economic and political blackmail. In 2007 some Chinese officials were talking openly about using this sort of blackmail, but in 2008 they were acknowledging that a financial pullout would hurt both countries.

We got a vivid lesson in all this recently, when Britain asked China to donate money to the IMF, in exchange for an increased voting share – and then backed away from its previous recognition of Tibet’s autonomy, and even apologized for not changing their stance earlier, although they still call on China to accept Tibet’s autonomy. This is clumsy because it also affects China-India relations. But China handled it clumsily too, bragging openly that Europe is backing down from a fight due to the current fiscal crisis. How smart are these guys, really?

The problem is that now, thanks in part to us, the Chinese have their own economic problems. There are two ways the Chinese can try to alleviate them.

The first is to encourage more domestic consumption: the world cannot continue to absorb all the Chinese products, but perhaps China itself can. Although they are hustling to create millions of new jobs each year, they haven’t yet turned these people into consumers. The Asian fiscal crisis of a decade ago, and the erosion of the socialist safety net, encouraged the Chinese to save rather than spending. There is really no comparison to the US consumer market: to say nothing of the disparity in wages, in China people aren’t even purchasing homes, let alone $300,000 homes; shifting from a primarily export economy to a primarily consumption economy will simply take time. Perhaps those 250 million internet users will learn the joys of e-commerce. The government may also repeal laws which were passed to encourage exports vis-à-vis consumption. One bright spot: Chinese tourism spending is skyrocketing (or was, before the crisis). The world needs not just China but all the new economies to spend more.

The second way to get things back on track is government spending. The Chinese President, flush with mountains of cash and a budget with much more black ink than ours, will spend more than two trillion dollars on roads, railways, airfields and the power grid; there is plenty of work to do in the transportation sector.

And that takes us back to our original problem: it was bad enough when we had to go to the Chinese to borrow billions to finance our debt. Now they’re telling us – “sorry, we can’t finance our recovery and yours too”. China and the U.S. need to work together to solve international economic problems, but to some extent it’s every man for himself. We are not the only ones holding out a tin cup: the whole world wants China to use its currency reserves to save the world, put money in the IMF and so forth.

Hillary Clinton warned the Chinese that if they pulled out of our financial market, the U.S. market for their goods would collapse, and the Chinese don’t want to pull out drastically because that could be seen as an overt attack; and the Chinese, like other investors, know that the U.S. is still a stable place to invest, with Europe and Japan being relatively unattractive places to put their money. So with luck, the effort to wean the U.S. off of Chinese money will happen slowly, if at all. Nevertheless, China will have less to lend.

We need them to dial back the value of the yuan: the Chinese had allowed the yuan to creep up over the last three years, but after the crisis the People’s Bank of China pegged the dollar/yuan rate very high, to spur Chinese growth. The currency then took a nose dive, closing the Chinese market even more. That might have been their signal to Obama: “don’t get in our faces”. With a weak yuan the Chinese can barely afford food, to say nothing of consumer goods. Obama was among the Senators to support a bill imposing restrictions on imports from countries whose currencies are out of kilter. Fiscal protectionism could ensue, wherein foreign investors could really hurt the Chinese banks by dumping the yuan and pulling out of the investment market.

Trade: again, the Chinese are going to tell us – “sorry, we have our own problems”. For twenty years we have given away our manufacturing jobs and the Chinese, like the rest of Asia , simply hoovered them up. Now they have an incredibly strong trading position. We want China to open its markets, and lower tariffs and other barriers as their WTO accession agreement stipulates; in the 1990s they did cut tariffs but now they have tacked on some short-term export subsidies. We also want them to meet WTO standards on intellectual property rights, and do better on product safety and labor issues.

American businesses have finally joined labor in pushing for protectionism, on the argument that cheap labor is skewing the market; they forget that labor is only a small part of the cost of goods anyway, and that if Chinese goods lower some U.S. salaries, they also lower prices for the goods those workers buy. Meanwhile the Europeans have also warned the Chinese that if China keeps dumping huge volumes of production out into the international market as a safety valve to solve their over-capacity and other problems at home, just when everyone else is trying to get their own products on the street, then a wave of protectionism could indeed begin.

The Chicken Littles of the world should remember a few things. The Chinese government knows that whatever hurts us hurts them: their vice president was yelling at our Treasury Secretary to get our fiscal house in order, because they don’t want us to go down. The Chinese know that we are all in this together, so getting them to work with us on trade, carbon, arms proliferation and everything else should be workable. They know they benefit greatly from their relationship with us, and so do we: among other things a close relationship will help bring about the Chinese transformation everyone seeks. And remember that the Chinese Communist party did in fact reinvent itself thirty years ago under Deng, so hoping for a reprise is not entirely unrealistic. And that was with the old Mao leaders: now a new generation of leaders is bound to rise, people with no memory of the age of Mao.


Environmental issues will be an enormous part of our engagement with China for the next 20 years. Carbon is currently the big issue. China gets 70 percent of its energy from coal and opens new plants every year because coal is cheap. The pollution-related health problems are mounting. At the very least they need to make some positive commitment toward a strategy with the end state of meeting international carbon standards, but when the Kyoto process is reopened in Copenhagen this year, China will continue to be slippery, claiming they are doing all they can, using its economic clout to buy some time. They are in fact working with hydroelectric and trying to build new eco-friendly cities. If they put solar and wind farms out west, would that give the west political power, or would building a connective grid be too much trouble?

A related problem is the pollution closer to home, particularly water. Half the population cannot get clean water, and one third of the Yellow River, the water source for millions, is too polluted to use.