Double-digit Growth Dangerous for China

To help CEIBS Alumni assess their business strategy for this year, the school’s alumni magazine TheLINK interviews a top economist.

TheLINK: What do you expect for China’s economic development in the short term?
Professor Wang Jianmao: One of the points I have been emphasizing recently is that even without the global financial crisis, China’s growth rate would have had to come down in 2008, 2009 and the near future. For the 31 years of 1979 to 2009, China’s compound annual GDP growth rate was 9.9%. The growth rate of 2007 was recently revised to 14.4%. These levels are simply too high and had to come down.

What will happen in 2010? If we look at exports, of course they dropped in 2009, by -16%. This year, they will rebound, but only by single digits according to my prediction. In China, exports still accounted for 24.5% of GDP in 2009, which was much lower than the peak of 35.7% in 2006 but still too high compared with other large economies. In the U.S., exports are around 10% of GDP. I expect China’s ratio to return to its pre-WTO level of about 20%, which will be healthier.

Ideally, China will have moderate GDP growth of 7-8% for the next three years. We need three years for adjustment and reform. That will lead to a soft landing of the economy and a U-shaped recovery. If the economy grows by double digits this year, no one will want to adjust or reform anything – why change? Double-digit growth for a few more years will trigger a really painful W-shaped adjustment process. If the government becomes reckless and allows the economy to overheat again, there would be another bigger crisis. Don’t forget: Success can be the mother of failure.

TheLINK: How can China shift from exports to domestic consumption?
Prof Wang Jianmao: To make up for the loss in exports, China has to shift toward the domestic market. If you look at the country’s heavy industries, you can see why China must rely on the domestic market. In 2009, for nearly all major heavy industry sectors except aluminium, the growth rate already came back to double digits (see chart). And automobiles rose by 48% in unit sales last year. My point is that the scale of production in China is already too huge for the external market to absorb. Look at steel production. Not only is China the #1 steelmaker in the world, it is bigger than the combined total of the U.S., the EU and Japan. Not may people realize that. That’s why we must rely on the domestic market – the Chinese economy is already too big to rely on exports. We are much bigger than Japan!

 

How can we boost domestic consumption? The solution is actually simple. A very important inhibitor of domestic consumption is China’s birth control policy. If the government can relax the birth control policy, people will immediately spend more money. In fact, you should only have a one-child policy for one generation. If it continues for two generations, you will face big trouble. We would have the so-called “4-2-1 situation” in which every young man would be supporting two parents and four grandparents. China’s workforce will reach a peak very soon, then will gradually decline. So, now is the right time to relax the policy – relax the policy but not end it. For example, the government could allow every couple to have two children, and if both the husband and the wife are single children themselves or members of ethnic minority, they could have up to three children.

TheLINK: Besides domestic consumption, what other factors will drive China’s economic development?
Professor Wang Jianmao: If real estate speculation remains so profitable, why should people try innovation? Why bother? No wonder we have seen the decline of the Silicon Valley in the U.S. and the slow progress of Chinese firms in R&D investment. We must change the economic growth model to focus on technological progress. Of course the protection of IP rights is also necessary. We must encourage wealth-creating activities and discourage wealth-grabbing activities. That means containing activities like rent seeking, speculation, and corruption. Otherwise, all of China’s money and talent will be wasted on these non-productive activities. Instead, we should focus on the most important wealth-creating activity: the creation of knowledge.

The LINK: What are the key threats to China’s economic growth?
Professor Wang Jianmao: The #1 threat to China’s economic growth is real estate speculation. Boosting growth by tolerating real estate speculation is like the saying “quenching thirst by drinking poison.” In China, because the government tolerated speculation, the downturn in real estate prices after the start of the global financial crisis was very short (see chart 2). In fact, during 2009, in monetary terms, China’s nationwide real estate sales rose by 75.5%, and by 42.1% in square metres sold, which imply a nationwide average rise of 23.5% in real estate price. These growth figures are the highest since 1993. But in 1993, the market size was about 5% the current size. So you see the problem.

 

The real estate bubble is blocking the rise of consumption. Chinese families which are overly indebted with mortgage loans won’t spend money elsewhere. And the bubble will slow urbanization. When housing prices in cities are so high, rural people cannot move to cities. The bubble is also triggering increased bad loans. The Chinese government’s effort to switch the model of economic development while allowing real estate speculation has been like “seeking fish from trees.” It was a misguided effort – so it has never succeeded.

The solution to real estate speculation is a capital gains tax, which I proposed two years ago. This is a controversial issue but it was raised 100 years ago by someone who is very highly esteemed and respected: Dr Sun Yat-sen. Dr Sun was termed a bourgeoisie revolutionary by some people, but now it seems that he was more revolutionary than the so-called proletariat revolutionaries.

Actually, my proposal of capital gains tax is not only for China but also for Western countries. The current global crisis was also caused by the real estate bubble. If developed countries had had a high capital gains tax, they would not have had this crisis.

[Reprinted with permission from The China Europe International Business School.]