Brian Fallow on the economy

Brian Fallow is the Herald's Economics Editor

Brian Fallow: Dazzled? Slip on Sino-sceptic sunglasses

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China seems to have pulled off a soft landing.

Or so governor Alan Bollard told MPs last week.

Let's hope he is right, because a healthy Chinese economy is essential to New Zealand's ability to rebalance its economy from consumption-led to export-led growth.

It is our second largest export market and the largest source of imports and these days is expected to deliver about a third of global growth.

China's annual inflation rate, which was looking menacing, dropped to 3.2 per cent last month, from 4.5 per cent in January.

And the risk of a property bubble going messily pop all over everybody seems to be receding.

The International Monetary Fund, in a report last month, concluded that Beijing's efforts to cool the property market had been effective, with price growth slowing and transaction volumes down.

This seems to have been achieved without too high a cost in terms of economic growth.

The Chinese Government did cause some perturbation in financial markets last week when it announced it had lowered its "target" growth rate for 2012 to 7.5 per cent.

But the semantics may be confusing.

"We don't see this as a forecast," said AMP chief economist Bevan Graham. "We view it more as a lower bound, or the rate which the authorities would not want growth to fall below."

The previous target was 8 per cent which was in place over a period when actual GDP growth averaged more than 10 per cent, Graham said.

The IMF forecasts Chinese GDP to grow around 8.25 per cent this year, down from 9.2 per cent last year, before picking up to around 8.75 per cent next year.

It is easy to be dazzled by the string of such numbers, now decades long, and by the progress China has made in terms of raising living standards and education levels.

But slip on the Sino-sceptic sunglasses and a different picture emerges, one of a country that is seismically unstable, metaphorically speaking.

Beneath the impressive surface are fault lines where enormous strains and pressures are grinding away.

And as with literal earthquakes, no one can predict where or when a catastrophic adjustment will occur.

When 1.3 billion people are on the march, they are not going to all move at the same pace. Disparities will increase.

According to the OECD by one standard measure of inequality, the Gini coefficient, China is significantly more unequal than we or other Western countries are, in terms of household incomes.

Part of the reason is a paradox at the heart of its growth miracle.

It has seen a huge migration of more than 200 million people from the countryside to burgeoning industrial cities.

It keeps the marginal cost of labour low on factory floors and building sites.

But that mobility is at odds with the longstanding hukou system, which registers households and ties them, officially if not in practice, to a particular location.

The result is a two-tier labour market in the cities with rural migrants, who lack a local residency permit, significantly disadvantaged compared with the tangata whenua of the cities they live in. Like having to pay hefty fees to send their children to public schools.

Most rural migrants work in the private sector, without labour contracts, the OECD says. Minimum wage legislation is often not respected and contributions to the social security system not paid at all.

The OECD estimates there are 74 million rural migrants without a local hukou, representing 80 per cent of the workforce in construction and more than two-thirds of those in manufacturing.

Reform of the hukou system is under way but is seen as slow and patchy. Widespread resentment is inevitable.

It is hard to square this with the Government's famously high level of concern about social unrest or with its policy of rebalancing the Chinese economy, so that growth is less top-heavy in investment spending and exports and driven more by domestic consumption.

But it is a dilemma. If higher incomes would be a boon to some Chinese firms, they could be lethal to those whose only competitive advantage is low labour costs.

Another driver of China's growth is its low cost of capital

Artificially low, the IMF calls it.

The banking system is skewed in the interest of borrowers, policy-favoured ones anyway, and reliant on a high need for precautionary savings by households to keep the money rolling in.

Meagre or negative real returns for depositors, combined with low interest rates for borrowers, are liable to encourage speculative investment in real estate or equities.

"A more durable remedy to China's propensity for property bubbles has to be firmly rooted in policies that raise the cost of capital, provide a broader range of alternative investment vehicles for savers, and institute a broad-based property tax," the IMF says.

It acknowledges, all the same, the "encouraging steps" China has taken to reduce its vulnerability to the vagaries of demand in its export markets.

Like allowing the renminbi to appreciate (a bit), improving the social safety net, expanding pension and health care coverage, raising the minimum wage and beginning to raise the cost of inputs to production, particularly energy.

But more effort is needed to lift incomes, the IMF says, and shift the composition of growth from investment and exports towards consumption.

Between 2005 and 2010, an astonishing 56 per cent of China's growth was investment spending and only 40 per cent consumption.

The risk is wasted resources - like that city built to accommodate a million people but so far almost uninhabited - and a lot of bad loans.

But as we, who need to rebalance in the opposite direction, are finding out the process is neither quick nor easy.

Another fault line is the ageing population - not a problem unique to China, of course, but especially acute because of its one-child policy.

A drop in the birth rate reduces a country's dependency ratio (the young plus the old, divided by the working population) and boosts the productivity of the population as a whole. But not indefinitely. Eventually more people are reaching the end of their working lives than beginning them and the dependency ratio deteriorates.

And if too many of the sibling-less young, in whom all the hopes of their parents and grandparents are invested, cannot find the jobs, or afford the apartments, they expect, in the age of the internet and social media are there enough censors in the world to contain that frustration?

Then there is the issue of the future of Chinese agriculture.

The green revolution was all about maximising yields per hectare, and treating the inputs of labour and water as unconstrained. But when the water table is dropping in areas which rely on aquifers for irrigation and the young people are departing for the cities, what then?

Clearly, then, China's rulers have a formidably challenging agenda.

We all have a stake in their succeeding.

- NZ Herald

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