China Economic Update: Reform

China continues with its old economic model and trends towards an event-horizon of economic uncertainty.

china-18th-communist-party-congress

Given the level of discourse regarding China’s massive domestic imbalances in which Chinese households received a historically low amount of national wealth, the Xi administration was praised in 2013 for setting forth new policy objectives. Specifically, a new core principle of economic reform was spirited.  Market forces were to play a “decisive” (决定性) role in allocating resources (previous Party decisions gave the market a “basic” (基础)role in resource allocation). If markets, and not Beijing, were allowed more economic control in China, China’s massive imbalances could begin changing.

This agenda was instantly compared to the sweeping market reforms that emerged after Deng Xiaoping’s southern tour in 1992. The current reform design was touted as a leap forward comparable to Deng’s, and far more significant than the reform programs of Jiang Zemin and Hu Jintao.

 

Reform Failure

However, reform outlined in 2013 has failed in making structural changes to the Chinese economy. Sources for the data below can be found at The China Dashboard.

– Local governments spend 43% more than local revenues. There is no plan as of yet to fix the spending gap.

– In the fourth quarter of 2017, it took RMB 7 of investment to generate RMB 1 of growth. Chinese headlines laud cleaning credit risk, but have done nothing at improving financing efficiency, a problem that has existed since at least 2009.

– SOEs are expanding, not withdrawing. SOEs are expanding into non-protected industries. SOE leverage isn’t changing. SOEs are the most inefficient businesses in China and receive a disproportionately high amount of financing.

– Migrant worker wage growth relative to GDP growth is still negative. China’s labor market still has Mao era restrictions such as residence permits that constrain China’s labor market.

– China’s ministry of Commerce issues divestment requirements only for foreign involved mergers.

These data points point to the same structural issues that have plagued other investment driven growth models: lack of domestic demand, reliance on foreign demand, need for increasingly financing, and unsustainable debt.

 

Problems

There seem to be at least two problems with reform and its honest reporting.

Firstly, Xi Jinping is China. Xi Jinping’s reform, thought, and words are China. China is a political monolith. To question the reform or its effects is to question Xi. To question Xi is to question the Party. This leads to dishonest reporting and characterizations. It is not unlike spineless cadres reporting that Mao’s Great Leap Forward was a success while Chinese people starved.

Secondly, the Chinese government and its agencies are still gauging outcomes by pledges instead of economic measurements. China has not developed the culture or institutions to make goals economically explicit.

 

Frustrations

The China Institute for Reform and Development, a public and non-profit research institution in China, has published volumes of excellent material recommending policy that mirrors reform mentioned in the 3rd Plenum of the 18th Party Congress. The CIRD has published well researched material about transitioning to consumption led growth. Their policy recommendations aren’t in the least extreme.

Chinese social insurance expenditures are mainly borne by local governments who, as I previously mentioned, are operating at huge fiscal deficits. Today, the Chinese government, local and federal, spends roughly 10% of expenditures on social insurance policies. The CIRD advised a process to gradually raise this number.

Most frustrating, Chinese economic publications have moved from CIRD recommendations to insisting that the Chinese path is not only sustainable but exportable. This is best evidenced by Guoyong Liang’s book, Chinese Economy 2040. He writes the following (typos are original to the text):

Unlike the dominance of financial capital in “American style globalization,” the globalization promoted by China places more emphasis on substantial economy…the future wave of globalization led by China will be centered by substantial economy, especially in infrastructure, basic industries, etc.

liang guoyong

He expounds (typos are original to the text):

The formation of the Chinese Mode has a worldwide significance and embodies China’s contribution to the world. The concluded and summarize experience can be referred by other developing countries… an important feature of the Chinese Mode is the financial support and investment-driven industrial and infrastructure development under the guidance of the government.

He never explains which countries will accept the trade imbalances these policies create. He never explains if the model is sustainable.

China under Xi Jinping has been unable to implement need reform. This is antithetical to data on Chinese confidence (economic or politically). Extreme confidence  does not pair-well with unsustainability.

China consumer confidence

Lastly, 2017 was an outlier in economic stability. 42% of the growth in manufacturing profits can be attributed to areas like ferrous metals. Mining and related sector profit was up 151%. Outside of this narrow group, profit growth was quite low.  “Deleveraging” and industrial profit growth in 2017 China was driven almost exclusively by financial market driven commodity price gains. Expecting triple digit price gains to drive the economy is risky at best. 2017 was not a broad based economic recovery in China. The outlook of the Chinese economy is uncertain.

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