China faces the challenge of improving the quality of economic growth. An annual rate of 8 percent GDP growth in a global recession may grab the headlines, yet it is the quality, not the raw quantity of growth that is relevant. High quality growth is sustainable and finances social investments like education, health and welfare that will ensure an equitable, prosperous future. Low quality growth is unbalanced, unequal and inflicts terrible costs to the environment.
In order to maintain confidence in their ability to govern, the Chinese Communist Party needs to deliver prosperity and employment to countryside and country, not just the fast-developing coastal cities. Much of the current GDP growth was built on a policy of promoting exports and financing it with foreign direct investment. The result has been an impressive transfer of knowledge, technology and skills to a new generation of workers. It has enabled manufacturers to quickly scale up the quality and innovation ladder and leverage the enormous potential of production automation and information technology. This has provided rich rewards to the owners of capital, including many multinationals that earn a majority share of the export profits.
The recession in the developed world is dampening demand for many of China’s consumer exports. Much of the Government’s stimulus investment in infrastructure and directed banking lending has gone into fueling substantial overcapacity in heavy industry. There is a strong argument for boosting the road and rail network in order to support future industrial growth. However, China’s banks are not geared up towards the effective allocation of capital to industry. Too often the credit ends up as a capacity overhang in heavy industry, in the real estate market or other assets like commodities. This is driving up asset prices and adding to imbalances in the economy that makes it even harder to implement structural change without impacting growth.
What is missing from all of this is Chinese private industry. When China took on the mammoth task of restructuring the large State-Owned Enterprise, officials cherry-picked industry sectors believed to be “strategic” to the national interest. Large capital-intensive industries like banking and finance, metals, minerals, energy and chemicals were kept for state-owned giants to champion global growth from a position of domestic market dominance. Other industries were left to private Chinese and foreign enterprise. A few hybrid exceptions exist, most notably automotive which remains partially regulated with a wide playing field of state-owned producers with foreign JVs like SAIC and FAW and private Chinese firms such as Cherry and Geely. Since restructuring the SOEs, there has been relatively little privatisation. And many private companies are now being re-nationalised under a phenomenon known as Guo Jin, Min Tui or “The state advances and private retreats.” The Government denies this is an overt policy, yet there have been many instances of state-owned companies acquiring private companies including Rizhao Steel, Mengniu dairies and large sections of the Shanxi coal mining industry.
Some of this may be spurred by previous lax health and safety regulation of private enterprise, with recent problems specifically in milk production and mining. However, the regulation of industry through nationalization does not have a strong track record in the history of economic development. It is unlikely that this approach will generate the best combination of safety, innovation and growth.
Meanwhile, state-owned banks are accumulating loans that will be backed by under-performing or speculative assets. Private industry is starved of capital and faces fierce competition from international companies in the Chinese domestic market. Many foreign firms have been operating in China for long enough to have a cost base that is highly competitive in their market segment. The domestic consumer economy is largely open and as Chinese consumers demand higher quality products, they will more often reach for foreign brands.
If private Chinese companies are to innovate and develop their own brands, they will need access to the huge potential source of capital in savings accounts. This can be done through three main channels: banking lending, capital markets or profits from consumer spending. It is clear that China’s banks are not yet equipped to do this without the push of policy. The capital markets lack transparency, governance and trade only a fraction of the equity. There is a lot of expectancy for the consumer to open their wallets and release this savings glut into the economy. Much of this spending relies on confidence in the government to reform welfare and healthcare so that people do not feel they need to hoard for an uncertain future.
