China can sustain an annual GDP growth of 8% over the next three decades and by 2030 will not only have completed its transition to a full market economy, but will be the world's largest, according to Justin Lin Yi-fu, professor and founding director of the China Centre of Economic Research at Beijing University.
But that assumes an overvalued stock market does not spin out of control, he warns.
Lin has helped advise Beijing on its 10th five-year plan and has received the Sun Yufang Prize, China's highest honour for economics.
The success of China's average 9.5% annual growth rate since 1979 has recently made authorities jittery about whether they can sustain this performance, he explains. They look to what happened to Japan over the past decade, or the US after 1929, and in all cases note a huge overcapacity in many sectors. Some manufacturing sectors in China today suffer from utilization rates below 50%. That leads to a slowdown in investment, while workers fearful for their jobs stop consuming.
While in the past, the role of China's government was to continually apply the brakes to an overheating, inflationary economy, in recent years Prime Minister Zhu Rongji has been more preoccupied with trying to maintain GDP expansion.
To make matters worse, the traditional tools of policymakers won't let China escape the bugbear of deflation, Lin says. Monetary policy û cutting interest rates û may make borrowing cheaper, but the investment returns themselves remain poor, so no one will borrow. Japan has tried zero interest rates and failed to stimulate its economy. Nor will it convince frightened workers to spend money.
Fiscal spending is also losing its punch. Lin calculates that while in 1998, the multiplier effect of every central government dollar prompted banks and local governments to spend another $2, today they spend only $0.5. The banks have too many bad loans and are reluctant to lend, while local governments are broke. Therefore, the amount of fiscal spending required is such that it would create an out-of-control budget deficit. Again, Japan is the example: in 1991 its public debt was 16% of GDP, and today it is 130%. China, Lin predicts, will run into similar dangers.
Now, Lin sees two ways out of this problem of deflation. One is simply time: let the problems of overcapacity work themselves out. But this can go on for a long time, time that an economy in transition cannot afford. Furthermore it requires a lot of creative destruction, which is politically difficult. Or China needs a mobilizing event to spark growth, as when the US escaped the Great Depression thanks to spending for World War II. "But," Lin quips, "I don't propose China should go to war."
Perhaps, however, there is a different way to analyse the nature of China' excess capacity, and that is to see whether or not there is excess supply. In an efficient market economy, such things don't exist, or at least not a grand scale, and not for long. The free market clears these blockages. But China is only partly a market economy; it is still transitioning from a command economy. And so the anomaly of excess demand does exist.
To find excess demand, Lin looks to the countryside. China's economy is bifurcated into an urban and a rural one. The countryside û where the majority of Chinese dwell û is notably behind in terms of consuming televisions, refrigerators, washing machines and the like. If rural people are rather poorer than their urban counterparts, this makes sense. Except they are not. In terms of real purchasing power, rural incomes have kept pace with urban ones, Lin says.
The discrepancy: infrastructure. Television is less appealing if electricity supplies suffer from frequent brownouts and if there is no reception. Washing machines make little sense without tap water, which half of China's rural population lacks. Electricity costs five times more in rural areas, rendering fridges extremely expensive.
"The government must spend more on rural infrastructure," Lin concludes. That way fiscal stimulus plans will regain their punch, allowing pent-up demand for consumption to tackle excess supply.
There is a second source of idle demand, and that is the non-state-owned sector. Private-sector companies and joint ventures often lack the permits to invest in particular areas. Policies have been made to shelter state-owned companies. Lin says this will end over time now that China is a member of the World Trade Organization.
"WTO means not just national treatment for foreign investors, but for the domestic private sector," he says. Liberalization under WTO will provide another outlet for excess demand.
Together with boosting rural infrastructure, such reforms will allow China to maintain high growth for three more decades. Lin points to Japan's 40-year growth from the 1950s to 1989, and to the Asian 'tiger' economies' heady growth from the 1960s to 1997. Countries can enjoy sustainable, long-term growth, particularly when they are playing catch-up. And China is in the same position, he argues.
His primary concern is that the government can become a hostage to overvalued stock markets. Price-to-earnings levels on the Shanghai Stock Exchange have come down, but still average 40x. This situation is not sustainable, and when it collapses, it will create political problems. Lin fears the government will be tempted to pump money into the stock market, which would only drag out the problem. He would prefer the government let it implode.
In the meantime, the government must encourage listed companies to become more profitable, to justify those high ratios. Most listed companies will not be profitable in the post-WTO world, but they can't all be de-listed. So the government must encourage joint ventures, help them get access to foreign capital, and support moves to improve management.
Furthermore, priority for new listings must be based on merit, not on supporting state-owned companies. Such moves won't prevent market turmoil but will surely blunt its impact on overall economic growth.
