CHINAwatch

"Is China making the consumption transition?"

A Reuters article here by James Saft dated 30 October 2012 shows that during the first nine months this year, for the very first time, China's consumption at 55% of GDP exceeds the share of investment (50%) and net exports (5.5%).

The article contains various caveats, including the perceived unreliability of China's data and the take of Michael Pettis, a professor at Peking University's Guanghua School of Management, that if the exisitng system is unsustainable, then all bets about the future would be off.

Yet, China is a fast changing economy - let's not forget that it was on the verge of collapse during the nadir of the Mao era. And no less than Premier Wen Jiaboa himself has openly warned many times that the country's economy is "unstable, unbalanced, uncoordinated and unsustainable". The momentum of change towards a slower, more balanced and sustainable model has been well enshrined in the latest Five Year Plan (2011-15). Witness the shopping frenzy in many of China's lower-tier cities and the explosion of green energy initiatives across the land. And under a new leadership, China is poised for further change. Click here

According to a presentation by Homi Kharas of Brookings Institution (June XX, 2011), China's middle class is already the world's second largest (after the US) in absolute numbers (157 million consumers). However, this accounts for only 12% of the population. By 2030, this is expected to grow to over 70 % of the population, consuming $10 trillion in goods and services. By 2030, 100% of the population is expected to achieve average income of $10 a day (2005 PPP$). Click here

The extent and shape of China's rising middle-class consumers are also illustrated by the latest McKinsey and other research reports Click here

The reality is that China is witnessing momentous underlying trends towards consumption as a surging middle-class with greater discretionary income grows rapidly in the largest and faster urbanization drive in human history.

According to McKinsey Quarterly report in August 2012, the world stands at the cusp of a holy grail of rising middle-class consumerism in emerging markets.("Winning the $30 trillion decathlon: Going for gold in emerging markets" Click here The report leaves no doubt that amongst them, China is in the lead, at least for now.

Nothing in the world is certain, except as the saying goes, death and taxes. But supported by powerful trends and sheer existential imperatives, it is at least a little facile to dismiss the epochal move towards middle-class consumerism in a rapidly changing China.

Whether the rising tide of middle-class consumer aspirations across the globe is sustainable for the planet is of course a highly critical issue. Let's hope that in an Age of Scarcity, China, along with India and other large emerging economies, are embracing a Low Carbon future where quality becomes more important than quantity, well-being more important than excess, and less becomes more. Click here

Can Xi change China and the world?

On the eve of an epochal leadership transition, The Economist front cover article (27 October 2012)  here shows why Xi Jinping, China’s expected President-in-waiting, must grasp the nettle to overcome a series of dire challenges to the country’s stability, if not its very survival.

“The departing prime minister, Wen Jiabao, has more than once called China’s development (“unstable”,)“unbalanced, uncoordinated and unsustainable”.

This is in spite of China’s impressive gains on a wide front during the past decade under the watch of the out-going Hu-Wen leadership.

The Economist continues,

“In the past ten years under the current leader, Hu Jintao, the economy has quadrupled in size in dollar terms. A new (though rudimentary) social safety net provides 95% of all Chinese with some kind of health coverage, up from just 15% in 2000. Across the world, China is seen as second in status and influence only to America”.

According to successive PEW public attitude surveys, a vast majority of the population remains broadly supportive of where the country is heading, in stark contrast to the surveys’ findings on many Western nations. However, across various strata of society, there is a growing tide of disquiet, mistrust, and civil protest against the Chinese government.

“The poor chafe at inequality, corruption, environmental ruin and land-grabs by officials. The middle class fret about contaminated food and many protect their savings by sending money abroad and signing up for foreign passports. The rich and powerful fight over the economy’s vast wealth. Scholars at a recent government conference summed it up well: China is “unstable at the grass roots, dejected at the middle strata and out of control at the top”, says the Economist article.

The latest protest in Ningbo during 25-28 October 2012 against a petrochemical plant project is a case in point. See a YouTube video here. Like a few recent high-profile cases elsewhere such in Dalian, Liaoning Province and Shifang, Sichuan Province, the governemnt quickly backed down, unlike previous get-tough repressive tactics, even as the projects in questions represented massive investments approved at the highest levels in Beijing. Click here

“Once, the party could bottle up dissent. But ordinary people today protest in public. They write books on previously taboo subjects and comment on everything in real time through China’s vibrant new social media. Complaints that would once have remained local are now debated nationwide. If China’s leaders mishandle the discontent, one senior economist warned in a secret report, it could cause “a chain reaction that results in social turmoil or violent revolution”.

“Having long since lost ideological legitimacy, and with slower growth sapping its economic legitimacy, the party needs a new claim on the loyalty of China’s citizens”, the Economist intones.

There is no doubt that the Party is well aware of its existential challenges. As pointed out by The Economist's Briefing article on the same subject, a rare joint study published in February 2012 of the World Bank and the Development Research Centre of the State Council captures a host of China’s impending challenges with suggested recommendations. These include liberalization of the hukou system which marginalizes China’s “under-class” community of migrant workers, reform of state-owned enterprises to make way for the private sector, liberalization of the financial system, enhancing innovative productivity to escape the “Middle Income Trap”, growing a green economy, and promoting a greater role for civil society. It is reported that Li Keqiang, China’s Premier-in-waiting is the study’s staunch supporter. Click here

Likewise, China’s economy is taking an about-turn in the 12^th Five Year Plan (2011-15), from a high-speed, low-cost, energy-intensive, and export-dependent model to a slower, higher-value-added, consumption –oriented and environmentally sustainable model. This shows how China is responding to the challenges of the “Lewis Turning Point” (a related obstacle of the Middle Income Trap), where the country’s reservoir of cheap labour is running out when the population profile starts to age. Click here

To mitigate the looming aging profile, there is still no sign that China is scrapping the One Child Policy anytime soon. Perhaps this is not going to happen before the middle class exceeds half of the population by 2020 or thereabouts, when without government diktats, quality will count more than quantity in determining the size of families. However, there is urgency in making this policy change as turning around the population profile even a little will take decades rather than years. In any event, under present circumstances, China will grow old because the country gets rich (in per capita terms).

China’s most daunting challenges, however, remain social and political, in particular growing inequalities, lack of checks and balance against corruption and power abuse, absence of an independent judiciary, and want of social justice and freedom of political expression.

It is rumoured that one of Li Keqiang’s favourite reads is Alexis Tocqueville’s opus on the French Revolution. The downfall of the “ancien regime” was characterised by what Daron Acemoglu and James Robinson call “extractive institutions” in their seminal work “Why Nations Fail” (Profile Books, London, 2012). Perhaps the Premier-to-be is mindful of Zhou Enlai’s famous response to Richard Nixon, that the impact of the 1789-99 Revolution was then too early to tell.

Granted, “extractive” elitism is not confined to China alone or developing countries in general. It also happens in America as the lead promoter of democracy. In The American Conservative May 2012 issue, Ron Unz, the journal’s publisher, poses the question "Which superpower is more threatened by its “extractive elites?” His question is the context of a critical comparison between the U.S. and China's body-politic, referring to the 1% versus 99% divide in America. Click here

The United States may also have a kind of “prince-lings” in the form of an unholy alliance between Wall Street and the powerful “military-industrial complex” forewarned by President Einsenhower. However, in the final analysis, notwithstanding any such “extractive elitism”, America possesses, unlike China, the check and balance of the ballot box and a highly independent judiciary defending the spirit of the American Constitution.

As for China, The Economist leader finds signs of further reform in a front-page article dated 16 October 2012 in Qiushi , the Chinese Communist Party’s main theoretical journal, which, according to the magazine, calls on the government to “press ahead with restructuring of the political system”. The Economist proceeds to  lay out, “taking a deep breath”, its vision for progressive political reform, starting from the village level all the way to competitive election for the nation’s top leadership.

“Independent candidates should be encouraged to stand for people’s congresses, the local parliaments that operate at all levels of government, and they should have the freedom to let voters know what they think. A timetable should also be set for directly electing government leaders, starting with townships in the countryside and districts in the cities, perhaps allowing five years for those experiments to settle in, before taking direct elections up to the county level in rural areas, then prefectures and later provinces, leading all the way to competitive elections for national leaders”.

“The Chinese Communist Party has a powerful story to tell. Despite its many faults, it has created wealth and hope that an older generation would have found unimaginable. Bold reform would create a surge of popular goodwill towards the party from ordinary Chinese people”.

“Mr Xi comes at a crucial moment for China, when hardliners still deny the need for political change and insist that the state can put down dissent with force. For everyone else, too, Mr Xi’s choice will weigh heavily. The world has much more to fear from a weak, unstable China than from a strong one”, opines The Economist.

In any case, in the wake of the Bo Xilai saga, the Party has been shocked into reality that strengthening the rule of law and further reforming the Party are pre-requisites for political survival. Click here

However, while the Party is drumming up the need for the rule of law (as distinct from rule by law), there is still no sign of a political decision to establish a more independent judiciary.  Local judges remain appointed by local party secretaries. Despite channels of appeal to higher courts, this system of judiciary has spawned a glaring "feudal" anachronism whereby aggrieved individuals have to make it all the way to Beijing to seek redress against overt or covert resistance of local officials. Short of a complete judiciary overhaul, if at least all judges are appointed by Beijing instead, this would immediately minimize the chances of miscarriage of justice through collusion at local levels.

As for political reform, the magazine’s reading of Qiushi is one-sided at best. The Party article merely reiterates the need for China to find her own path in continuous reform on all fronts in keeping with the changing times. It warns against the inherent contradictions in Western capitalism, which have been increasingly exposed in recent years. The article is an affirmation of the leadership of the Party. Absent is any suggestion of copying the West’s model of competitive multi-party democracy.  

Nevertheless, leaving aside its perhaps over-ambitious recommended timetable, the political reform proposed by The Economist is not totally incompatible with the form of “intra-Party democracy” openly promoted by the Party during the past decade. The success of Singapore’s single-party rule (notwithstanding elections) and the broad support the Communist Party has been enjoying  amongst the vast majority of the Chinese people in recent years may well give the Party added confidence to move in this direction, if only at a measured pace.

To take any view on whether China’s one-party system is sustainable and to envision the likely shape of any political form, however, it is necessary first to understand how China chooses its top leader. The Economist, like most China watchers in the West, is relatively silent on this point. When asked, I have on occasions jokingly alluded to the internal dynamics in the election of a new Pope or the leader of a powerful business association.

After the strongman era ended with Deng Xiaoping, the leadership contest has become a competitive meritocratic process sprinkled with a natural dose of political rivalry and horse-trading for the top job. Gone are the days when ideology alone mattered as the Party has since been firmly wedded into a consensus of continuous reform and opening up. The rallying focal point is to what extent, considering track records and affiliates, an individual can be trusted by the Party polity “across the aisle”, to borrow an American expression, in maintaining a collective, united, and purposeful leadership to carry the Party torch and the nation forward.

Thus, through layers of power structure, from stints as junior local party officials to ministerial appointments, from work in provinces to key municipalities, from socio-economic to political portfolios, some well-tried winners compete over the years to get to the top echelons who are of a right age, proven calibre, and high standing within and outside the Party. This process seem to hark back to China’s ancient meritocratic mandarin system that underpinned the most successful (and long-lasting) dynasties.

The Chinese system of meritocracy resonates with the ancient Confucian wisdom that the state should be well governed by the most meritorious and the most able to serve the public good. 大道之行也, 天下为公, 选贤与能. If in the coming decades, this system of single-party collective leadership based on Confucian competitive meritocracy continues to prove successful in driving China, the world’s largest country, forward on all fronts, it would be a powerful alternative mode of government to the Western model based on rival multi-party democracy.

Read “How are China's top leaders selected and how stable is China's Communist Party?” here

Last but not least, Confucian ideas are being re-interpreted by China in the modern context of government for the people, harmony in the society, harmony between nations  and harmony between man and nature. While Western democracies are revealing various fault-lines, such as the global financial crisis, the European sovereign debt crisis, the “Occupy Wall Street” Movement, and relations with the rise of political Islam, it may be tempting to speculate whether a China Renaissance based on a Confucian model of harmony may offer a viable alternative to the existing West-dominated word order.

However, any such visions of grandeur are unlikely to materialize from China’s economic renaissance so far. First, China’s economy is by no means an unqualified success - more in quantity than in quality. Second, much of the world remains suspicious of the implications of a rising China, seen as an outlier to world-accepted social norms and values. Third, the world’s extant superpower, the United States, feels increasingly threatened by an ideologically-adverse challenger, and is rapidly re-focussing its geopolitical strategy. Fourth, and perhaps most importantly, China’s perceived foibles in human rights, rule of law, corruption, inequalities, social justice, and pollution are having a negative impact on the world’s perception of China.

If China is to rise to the historical opportunity to influence the world order for the better, the nation must first reform its many failings to create a new attractive civilization with a heart and soul that appeal to the spirit of the times.

For Xi, the tasks ahead are historical as they are Herculean. There is no doubt that not only the Chinese people, but the whole world will be watching with abated breath. 

Read “China’s Economic Success and its Ideological Implications for the World Order” here

RMB has eclipsed the dollar as "reference currency" - China's looming economic dominance?

In his new book, "Eclipse: Living in the Shadow of China’s Economic Dominance", Arvind Subramanian, Senior Fellow at the Peterson Institute for International Economics, Washington D.C., presents the following possibilities: "What if, contrary to common belief, China's economic dominance is a present-day reality rather than a faraway possibility? What if the renminbi's takeover of the dollar as the world's reserve currency is not decades, but mere years, away? And what if the United States's economic pre-eminence is not, as many economists and policymakers would like to believe, in its own hands, but China's to determine?", according to the Peterson Institute website.

The Peterson Institute website explains,

"Subramanian's analysis is based on a new index of economic dominance grounded in a historical perspective. His examination makes use of real-world examples, comparing China's rise with the past hegemonies of Great Britain and the United States. His attempt to quantify and project economic and currency dominance leads him to the conclusion that China's dominance is not only more imminent, but also broader in scope, and much larger in magnitude, than is currently imagined. He explores the profound effect this might have on the United States, as well as on the global financial and trade system. Subramanian concludes with a series of policy proposals for other nations to reconcile China's rise with continued openness in the global economic order, and to insure against China becoming a malign hegemon". Click here

Subramanian's prognosis is based on detailed econometric and regression analyses, supported by robustness verifications, which find a rising degree of distinctive currency movement coefficient (CMC) of the RMB as an international reference currency, compared with the dollar and other leading currencies. The Abstract of a Peterson Institute joint working paper (WP 12-19) dated October 2012 by Subramanian and his colleague Martin Kessler states -

"In East Asia, there is already a RMB bloc, because the RMB has become the dominant reference currency, eclipsing the dollar, which is a historical development. In this region, 7 currencies out of 10 co-move more closely with the RMB than with the dollar, with the average value of the CMC relative to the RMB being 40% greater than for the dollar. We find that co-movement with a reference currency, especially for the RMB, are associated with trade integration. We draw some lessons for the prospects of the RMB bloc to move beyond Asia based on a comparison of the RMB situation today and that of the Japanese yen in the early 1990s. If trade were the sole driver, a more global RMB bloc could emerge in the mid-2030s, but complementary reforms of the financial and external sector could considerably expedite the process."

What is tale-telling in these findings is that "the yen at the peak of the Japanese miracle was not a significant reference currency at all even in neighbouring East Asia and the dollar reigned supreme; in contrast, today, the RMB has eclipsed the dollar as the dominant reference currency."

Click here  for "Turning from green to red", an article in The Economist dated 20 October 2012 on the same topic.

Subramanian's claim of China's emerging economic dominance seems to be lent credence by South China Morning Post columnist Tom Holland in his article of 10th September, 2012 - "What 'pivot'? Real US-China war will be over money" Click here

Holland refers to the latest book "Paper Promises" by author and Economist columnist Philip Coggan, who "describes economic history as an endless struggle between borrowers and lenders over the irreconcilable difference in their interests".

"For the last 40 years, ever since the US government severed the link between the US dollar and gold, creditors have had the upper hand". "With the anchor cast loose, the US financial system embarked on a credit creation binge that saw total debt, both public and private, explode from 150 per cent of gross domestic product to almost 400 per cent in 2009". "In Europe, too, debt levels soared, assisted by the continent's monetary union". It couldn't last, says Coggan. "They created more claims on wealth than they created wealth itself."

Holland continues, "The result, believes Coggan, will be a major overhaul of the international financial system, with China, as the biggest creditor, writing the rules to suit itself, just as in 1944 the US wrote the rules for the post-second world war monetary system".

"Naturally this new system will be created in China's image, with exchange rates confined to narrow trading bands, controls on the free flow of capital across international borders, and debtor economies obliged to accept strict limits on the size of their fiscal deficits". "In short, this is a war China will win".

Holland, however, seems to have forgotten about what he wrote in the South China Morning Post on the "Five reasons yuan is no threat to dollar as reserve currency" on 10 February 2012. Click here

There, he invoked important pre-conditions before the yuan could become a major reserve currency as outlined in a new paper by economists Professor Eswar Prasad and Professor Lei Ye of Cornell University in the US. "China's economy must first be big. Second, it must be open, especially to capital flows. Third, it must have a flexible exchange rate. Fourth, it must have broad, deep and liquid financial markets. And finally, China must follow economic policies that inspire confidence in the rest of the world".

Holland deduced that "for the time being, China only fulfils one of the five conditions required of the issuers of major reserve currencies: sheer size".

He went on to conclude that "even if China meets the other four criteria, there is another reason why the yuan will not displace the US dollar as the world's leading reserve currency: sheer arithmetic".

"At the moment, China holds around 30 per cent of all the world's foreign reserves, and China has to hold those reserves in foreign currencies, which for practical purposes means the US dollar and the euro. That means if China were to hold its reserves half in US dollars and half in euros, Europe to hold half US dollars and half yuan, and the US to hold half euros and half yuan, with the rest of the world holding US dollars, euros and yuan equally, then the sheer size of China's reserves would ensure the US dollar remained the dominant currency by a considerable margin, with the euro second and the yuan a distant third".

"So unless China runs down its own foreign reserves by running massive trade deficits over the coming years, the US dollar will remain the world's reserve currency of choice for the foreseeable future."

The above arithmetic, however, is predicated upon the premise that currency preferences would remain static forever. As China's economy is growing to be bigger than the U.S. in the coming decade(s), an internationalized Chinese yuan of the world's largest economy supported by a robust foreign currency reserve is likely to gain preference as a reserve currency. This is even more likely as China is trying to extricate herself from being locked in what Paul Krugman calls China's "Dollar Trap".

What is preventing the Chinese yuan to attain this level of global dominance, however, remains its continuing non-convertibility on the capital account, which has proved to have served China remarkably well in times of global financial crisis. There is yet no sign that China is likely to take on the risks of unwelcome capital flows by giving up this protection on the capital acount any time soon.

This is explained in a commissioned paper "Is the Renminbi the New Dollar? Chinese Monetary Policy and the Global Reserve Currency System" in a Chartered Insurance Institute report in April 2012, which was published to mark the CII’s centenary year as a chartered professional body. Click here

So, what is the upshot of all of the above arguments?

Well, there is little doubt that the U.S and most European economies remain infected with structural malaise which are unlikely to be cured quickly. Meanwhile, the EAGLES (Emerging and Growth Leading Economies) are soaring, of which China dwarfs the rest as the centre of a global supply and production hub to which the other EAGLEs become increasingly linked. In these circumstances, China stands a fair chance of overtaking the United States as a dominant economy sooner rather than later. Click here

However, as Holland cautioned in his earlier article,

"Although .... over the last five years the value of China's foreign assets and liabilities has doubled to more than US$6 trillion .... that's tiny by the standards of the US, or even Britain. China's gross external position is now roughly the same size as that of Switzerland, whose currency the franc, according to the International Monetary Fund, makes up only about 0.1 per cent of the world's foreign reserves. Clearly China still has a long way to go on opening up to capital flows".

So unless the world's confidence in the greenback quickly plummets to a tipping point before there is a credible substitute, it is unlikely to be able to take over the leading role of the dollar only years away, as Subramanian may fear. However, if his prognosis on the global ascendancy of the RMB as the leading reference currency materializes, the Chinese yuan may well become one of several major world reserve currencies much sooner than people expect.  

China's leadership transition and U.S. presidential election - Whys, Wherefores, Risks and Opportunities for Asia

A presentation at the Jefferies Conference for Corporate Investors at the Island-Shangri-La Hotel, Hong Kong on Wednesday, 17 October, 2012

Download China's leadership transition and US presidential election - Key points in pictures and Full version

Land grabs and forced evictions in China

Interview on Inside Story with Aljazeera English together with Nicola Duckworth, a senior research director at Amnesty International and Martin McCauley, an international affairs analyst and a Professor of the University of London. Click here

China's multiple crises, its "Lewis Turning Point" and implications for the world economy

Jean-Pierre Lehmann is Emeritus Professor of International Political Economy, IMD, Switzerland, founder of The Evian Group, Senior Fellow at the Fung Global Institute in Hong Kong, and visiting professor at Hong Kong University. He is also one of my best friends. In his latest article here for Yale Global Online, he outlines how China is reaching a turning point of multiple crises - political, social, economic, environmental, demographic and geopolitical. How China would be able to overcome these crises would "influence the fate of the world", he opines.  As China is so embedded in the global order, Professor Lehmann's assessment is no exaggeration.

On the economic front, in a working paper "The Lewis Turning Point in China and its Impacts on the World Economy" dated February 2012, Click here Andong Zhu and Wanhuan Cai, respectively Associate Professor and Post-Doc Fellow, School of Marxism, Tsinghua University, Beijing, show how China's successful implementation of a host of reform measures to overcome the Middle-Income Trap marked by the Lewis Turning Point could impact the rest of the world''s economies.

The Paper's abstract states -

"On the basis of perusing Lewis’s own writings and his followers’ works on the Lewis economic growth model, this paper adjusts the meaning of the Lewis turning point (LTP) according to China’s specific institutional system and economic reality: the Lewis turning point is a period of time rather than a time point; and undergoing the LTP is considered as a trend or process of development, during which the supply of labor decreases and the cost of labor increases. With the passing of the LTP, China will not promote its economic growth with a cheap and unlimited labor force; the labor-intensive export oriented economy should be altered, independent technology innovation should be promoted, and industry structure should be adjusted. Changes and transitions in China’s economy will have great significance to the world economy, and the impacts are estimated in the paper with Cambridge-Alphametrics Model (CAM) initially developed by the University of Cambridge. The arrival of the LTP also means China needs to make serious policy efforts to realize the transformation of its economic development pattern, and to avoid the so-called “middle-income trap”.

The Paper's quantitative findings show that China's success in overcoming the middle-income trap would result in the case of China's many trading partners but also others, better employment rates, lower government expenditure as % of GDP, higher income per capita, little impact on low inflation, strengthening of real exchange rates and the build-up of more exchange reserves in those countries to which China's tradional low-cost manufacturing will have been diverted.

How China would be able to successfully negotiate the Lewis Turning Point would therefore be of momentus benefit not only to China herself but to the rest of the globe.

On the political, social, environmental, demographic and geopolitical fronts, however, China's challenges are more intractable, especially during China's leadership transition.

A whole swath of reforms is already on the cards, supposedly supported by Li Keqiang, China's presumed Premier-in-waiting, as embodied in a historic 468-page report of the World Bank in partnership with the Development Research Centre of the State Council. This report calls for major reforms to provide a more meaningful social security net, addressing the "hukou" system which marginalizes migrant workers. regulating the modus operandi of local authorities, promoting civil society, reforming the State-owned enterprises in favour of a larger role for private business, further liberalisng the economy and financial sector including the RMB, and creating a green economy. The report is aspirationally entitled "China 2030: Building a Modern, Harmonious, and Creative High-Income Society." Click here

There is no guarantee that China would be successful in transforming herself in face of all these crises. It thus behoves the rest of the world not so much to fear China's continuing rise but to channel it constructively so that a benigh, rising Chinese tide could benefically lift all boats.