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Abstract
China is the in the news everyday. Indeed, despite its continuous success maintaining strong growth, the Chinese economy has exhibited worsening structural imbalances in recent years. The purpose of this paper is to put together from the background to today’s China, in order to examine the core structural problems and further reflections regarding to China’s economic growth and slowdown. It seeks to build a general perspective to argue that China’s core problems and whether has possibilities to solve those issues or move into a new transition successfully.
The paper describes the background to today’s China, with a general survey using some data and facts to examine how the economy grew to its current level, as well as the reasons for the slowdown. The problem with China’s economy is liked to the growth model, which is characterized as ultra investment driven and export oriented under the government-directed. Following the limits of Chinese growth model, the core problems for China’s current situation can be broken into four major elements:
1) Institutional structures
2) Structural constraints
3) The rebalancing problem
4) Transformation to a post-industrial society
China is a limited access society with some insufficiently developed institutional structure and was held “captured” by its political system with the Chinese Communist Party, in this way, the civil society is also weak. As a result, almost all major structural problems are created under the inefficient institutional structures, and drag the improvement of developmental processes in solving supply and demand imbalance and moving up the value chain.
Further implication is a discussing section including particularly crucial issues concerning the possibilities to solve. To re-establish an adequate societal and economic resource-allocation in China goes to the heart of the question of reform but can’t not take place without major institutional changes. Until now, the reform plans are highly idealized and flawed to solve the urgent issues in China thoroughly, so in the face of these threats, the principal challenges facing China today are serious.
Introduction
This introduction part involves a general description for the thesis: the context of analysis, research questions, data description, boundaries and structure.
1.1 Introduction
China has been, bar none, the country that has changed fastest over the last thirty years. To take a quarter of the world’s population, there are also analysts say that China is the world’s growth engine, or at least a country, which contribute a lot to the global growth. Some experts and markets continue to be bullish about the Chinese economy, expecting that high rates of growth will continue indefinitely.
Like other rapidly developing Asian economies, China relied on repressed household consumption to make modernizing investments. But the problem is that focus on numbers obscures stark realities and the tendency doesn’t show an optimistic future with coming challenges. Its economic model distorted interest rates, the currency and even legal structures. And it led to burgeoning debt that is becoming increasingly difficult to finance (Pettis, 2013). The time has come for China to adjust its model to the new circumstances success has produced.
The principal challenges facing China today are serious. Many of essential issues covered in the further discussion embrace the economy, social development, environment, welfare, demography, employment, resources, science and sustainability. What’s more, China is often criticized for its political system and institutional structures; it is not, after all, a liberal democracy (Beardson, 2014).
It is no doubt that the rise of industrialized China and his resurgence as an economic powerhouse is a transformative event in the history of the world economy. However, there now appears to be an emergent consensus that the Chinese economy is facing a turning point, as a result, this paper looks at the background to today’s China, how it got where it is, in order to examine the core structural problems and further reflections regarding to China’s economic growth and slowdown. It seeks to build a general perspective to argue that whether China has possibilities to solve those issues or move into a new transition successfully.
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1.2 Research Questions
The rise of industrialized China and his resurgence as an economic powerhouse is a transformative event in the history of the world economy. However, there now appears to be an emergent consensus that the Chinese economy is facing a turning point.
In order to have a deeper understanding to China’s economic situation, what are the further reflections on China’s main problems? And whether China has possibilities to solve all the issues facing it?
Studying the China’s socio-economic situation can analytically be broken down into four following elements:
1. The rebalance of the economy.
2. The transformation to a post- industrial mode of production.
3. Structural constraints.
1) Negative Demographics 2) Pollution 3) Social inequality
4. The changes in institutional levels
1.3 Data Description
Part of theoretical literature has been found using literature reviews and compendiums from earlier courses. The articles and theories have been chosen with the approach that "newer is better" and "more cited is better", it is assumed that the newer theories builds on and improves the mature theories.
Factors and indicators in the China’s economy as well as crucial index affecting the further reflections will be identified and discussed. Analysis of the chosen factors will be done using knowledge from Emerging Markets, Macroeconomics, International Business Methods, etc.
Websites that has been used in this thesis are websites regarding the figure of China’s economy and relevant experts’ comments. However, there are several challenges in regards to gaining accurate secondary data. For instance, the Chinese governmental websites often present different answers to the same question that contradicts itself. The Aarhus University’s database has been used as the main tool to find scientific
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journals and articles that depict the topic issues.
Furthermore, there are still some articles discussed in Chinese for the China’s current situation and future plan, as well as international statistical databases public pages. To get more comprehensive data and analysis, some of Chinese version articles are also used for contributing the thesis.
1.4 Boundaries
When dealing with core economical indicators for China, it is important to leave some margin for error. Since Chinese statistics are of vital importance in painting a picture, but there is woeful lack of clarity about the numbers. It is not so much that information is being concealed as that the facts are not accurately known (Beardson, 2014). Thus official data is not as sacrosanct during the process of analyzing.
Talking about China’s socio- economic situation covers a wide range of issues, and there exist a large number of factors that could e taken into consideration in each issue. This paper goes to draw a general perspective in relation to focus on both objective and developmental processes, therefore the paper will be used to narrow down the selection of factors and not go into depth and details with each issue.
1.5 Structure of the Paper
The structure of the paper can be seen in Figure 1. The paper starts by describing the development process of China’s economy, and goes on to determine the limitation of its growth model. Therefore the following part offers a discussion for the core problems.
In order to analyze the China’s economic slowdown, this paper will apply three central questions concerning to understand its true position.
1. Why did China slowdown?
2. What are the China’s core problems now?
3. Will China have possibilities to solve all the issues facing it?
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The first part of the paper describes the background to today’s China, with a general survey using some data and facts to examine how the economy grew to its current level, as well as the reasons for the slowdown. Second part presents the core challenges China faces, particularly of its structural constraints and institutional structure that frame the basic developmental processes in rebalancing and transformation toward to the post- industrial society. Following this is a discussing section including particularly crucial issues concerning the possibilities to solve.
Theoretical Framework
Leading up to study China’s economy situation, the following chapter will give a brief description of the new institutional economics theory by North C. Douglass (1990), which incorporates a theory of institutions, then apply its analytical framework to make impact on economic performance over time.
As North states that “institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction.” It is based on human behaviors and establishes a stable structure to human interaction in order to reduce social uncertainty. Similarly, organizations are groups of individuals who work toward a common goal where the institutional pattern take a direct actualized form. Court, political parties, schools or unions are all examples of organizations, and their social roles serving the institutional pattern such as justice and open. In North’s new institutional economics theory, he also considers that organization primarily as the agent for institutional change with emphasis on the interaction between institutions and organizations.
Contrast to the neo-classical theory, which has made it an institution-free assumption. It describes the world of instrumental rationality institutions are unnecessary, both political and economic factors are efficient. Therefore there’s no distinguish between the real world and the decision maker’s perception, also the choices will be made by rational decision maker from the public knowledge of the real world without the perceptions or modes of calculation himself. As a result, the values as given can be trusted and the decision maker’s computational powers are unlimited (Simon, 1986).
However, in practice, individuals’ mental models are partly reflected by cultural environment. It is produced with different knowledge, values and norms which among varies groups and societies. It is clear that different perceptions of the world from different background may not suit for the assumption in the neo-classical theory which postulate the decision maker in rationality. North argues that the incomplete information and limited mental capacity for human beings impose constraints to an absolute efficient market with transaction costs, and institutions are formed to reduce uncertainty in human exchange. Hence, the unrealistic of costless in transaction under
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the rationality postulate in neo-classical model should considering institutions, which are crucial determinants of the efficiency of the markets.
In this way, North believes that the rational choice theory could work under some certain fixed conditions structured by the institutional framework, which allows for continuous observation of behaviors. So his new institutional approach adds institutions as an important constraint and extends economic theory by incorporating ideas and ideologies into the analysis, modeling the political process as a critical factor in the performance of economies, as the source of the diverse performance of economies, and as the explanation for “inefficient” market. Moreover, North contends that ideas and ideologies do make a difference so that institutions play in a different role. It explains that economic performance is related to the human learning process and tacit knowledge driving by the institutional framework.
According to North’s theory, there are several characteristics of economic performance regarding to the institutions. First, both formal rules and informal norms contribute to the establishment of institutions; while the formal rules can be shifted overnight, the informal norms based on social revolution only change gradually. Second, polity is another crucial factor to shape economic performance because it defines and enforce the economic rules. North states that economic growth can occur in the short run with autocratic regimes, while in long run it requires the development of the rule of law and freedoms in civil society and politics. What’s more, the theory also describes that a good economic performance should be under a flexible institutional matrix that will adjust in the context of technological or demographic changes. Therefore, the adaptive efficiency of the institutions and polities is a crucial analytical factor to examine the economic performance nowadays.
To apply North’s new institutional economic theory into the analysis of China’s economy in following chapters, institutional structure plays an important role in building China’s current situation, in many cases, the core problems indicate that China goes to the heart of the question of reform but can’t not take place without major institutional changes.
. Historical Background and General Survey
China is in the news every day. It is increasingly seen as one of the major economic powers in the world. Is the attention justified? Experts like Michel Pettis argued that only a country’s contribution to global growth cannot be calculated by measuring its share of global growth, while China’s influence is because its size (Pettis, 2014). To understand first, this part goes back to describe China’s historical development and general survey on economic growth.
3.1 Historical Development of Today’s China
Since China’s establishment in 1949, the Chinese government has been a one- party system, with real power lying with the Chinese communist party. In this way, China maintained a centrally planned economy, which means the state directed and controlled a large share of the country’s economic output; the state set production goals, controlled prices, and allocated resources throughout most of the economy. As a result, nearly three- forth of country’s industrial production was produced by centrally controlled state owned enterprises. However, central planning economic systems and government control caused there were almost no private enterprises or foreign invested firms which made the country’s economy inefficient.
The rapidly economy grow is because of China’s tremendous success in the three decades after the reform in 1978. The previous thirty years it was outside the global economy. The growth rate prior to the Deng Xiaoping reforms that began in 1978 was slow and productivity throughout the period was negative (Dwight, 2010). According to the World Bank, GDP grew doubled in 1980 from 4.9 per cent in 1966- 1978.
By 1978, China’s leaders knew they must introduce serious measures to restructure the country. Deng Xiaoping and his colleagues presided over some of the most radical reforms in modern history. The famous four-character policy gaigekaifang, a reform of the economic system and an opening up to the outside world, was promulgated. As Huenemann said: “There can be no doubt that the reforms since 1978 generally have succeeded in both the system reform aspect, marked by the decollectivization of agriculture and the dismantling of Soviet-style central planning in industry, and the opening-up aspect, leading to China’s entry into the WTO in 2001. (Huenemann, 2010)”
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The sharp rise in the rate of growth after 1978 is almost entirely explained by the rise in total factor productivity. China opened up to imports of high-technology and higher- quality goods in general even before the formal reform period hat began in late 1978. Meanwhile, the government began to try to reform the industrial sector then dominated by large state-owned enterprises. The 1990s saw first a large increase in enterprises established by foreign direct investment. China after decades of prohibiting FDI, formally welcomed it and carried out preferential policy to attract foreign investors. The boom in FDI from that point on accounted for much of the very rapid increase in exports and China’s industrial economy became firmly imbedded in global supply chains. Then in the latter half of the 1990s Zhu Rongji led the effort to join the World Trade Organization, not so much to promote exports that were rising rapidly without membership, but to force the state enterprises to face vigorous foreign competition if they were to survive.
3.2 General survey on Economic Growth
China has been growing rapidly for more than three decades. This is shown in Table 1, which gives output growth, unemployment, and inflation for the periods 1980-1999, 2000-2007, and each of the years 2008 to 2014.
. The Limits of the Chinese Growth Model
“The biggest problem with China’s economy is that the growth is unstable, unbalanced, uncoordinated, and unsustainable.” Said by ex-premier Wen Jiabao at National People’s Congress Press conference on March 2007. Its excessive investment driven model that resulted by artificially controlled with financial repression, and using export to fill the gap between domestic consumption and investment, accompanied the furious growth of China’s economic growth. It seems that the Chinese growth model has much limitations, which would drag China into dilemma. In this section, the analysis listed the main characters of China’s growth model, to explore the reason why China’s economic slowdown.
4.1 Investments driven model
China’s growth relies heavily on external demand and investment with much of that investment concentrated in property market, and this dependence has increased especially after the 2009 global financial crisis.
To see it clearly, what kept growth high was a steady increase in the rate of investment as a share of GDP, Figure 2 indicated that a jump over three years of nearly 6 per cent or an annual average rise of 2 per cent. This growth in investment took place in the context of underemployed labor and excess industrial capacity. Because of these underemployed resources, this rise in the rate of investment contributed directly to a higher growth rate of GDP (Dwight, 2010). However, maintenance of the rate of growth of fixed capital would require a steadily rising rate
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of capital formation as a share of GDP, as a result, the GDP growth rate in recent years has been driven mainly by the massive increase in capital made possible by a high and rapidly rising rate of investment.
Investment, accounting for almost half of China’s output, most was composed of manufacturing, real estate and infrastructure. Infrastructure development remains a top priority for China’s government, which has long recognized that a modern economy runs on reliable roads and rails, electricity and telecommunications (Chen, 2013), China is far and away the big spender among all of emerging market countries. And stronger housing sales should feed through to an improvement in real estate investment. However, the Wall Street Journal showed that the real estate inventory was higher with the ratio of under construction to sold continuous increasing. In addition, the weak demand abroad and rising costs also influenced China’s exporters (manufacturers). The result of decreasing demand cannot fulfill the huge amount of investment in China.
On the other hand, according to IMF working paper in 2012, the study found that China’s state investments have becoming alarmingly wasteful and ineffective. It concluded that the level of over-investment in China was equivalent to about 10 per cent of GDP, and perhaps as high as 20 per cent. So the problem is how efficient of China’s investment. By using incremental capital output ratio (ICOR), a country’s ICOR also estimate investment efficiency; if a country’s ICOR goes up indicates that more capital intensive.
The productivity of capital can be listed as figure 3 above. Under the increasing contribution of investment to economic growth was still the prescription to stimulate the economy; the changing in its efficiency can be explained: From 2000s, a new economic cycle started and the economy performed in a healthy running. Although capital investment was large, speeding up of economic growth still decreased ICOR, which leaded to efficiency increases. However, due to against the global financial crisis in 2008, government introduces 4- trillion stimulus package caused huge capital investment, which resulting in the continuous decline of efficiency, what’s more, the investment driven model with the increasing ICOR and decreasing GDP growth indicated that overinvestment has become a huge problem, it could resulted in rigorous financial imbalances, increased diminishing returns and increasing leverage levels, which has already happened in China.
4.2 Export- led Growth
The Chinese model was in the beginning strongly export-led growth. In other words, the Chinese model assumed that foreign consumption persistently would fill out the gap between domestic investment and domestic consumption. The open policy Gaigekaifang and accession to the WTO has allowed China to fully integrate into the world system and catch the comparative advantage in abundant cheap labor supply; China’s exports have jumped more than tenfold especially during 1990 to 2005. To
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understand more detailed, figure 4 presents the share of export in GDP for the period of 1990- 2014. Since China has joined the WTO in 2001, a surprisingly increased by 15 per cent within 5 years. However, China cannot avoid the influencing come from the global financial crisis in 2008, an obvious decline in exports reflected on the negative growth of export; what’s more, there was no better in the growth of the ratio in recent year.
4.3 Financial Repression
The financial system in China was characterized by a system of financial repression, which refers to a pattern of governmental policies that result in a situation, where has the low or negative real return on deposits. It was essential for the way societal processes were restrained and it resulted in a system, where savings could be moved
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from the households to the agents of the state to the exclusive benefit of the latter. Michael Pettis has said about financial repression in China: “Financial repression, in other words, is not only at the heart of both China’s rapid growth and China’s economic imbalances, but it also explains a number of otherwise puzzling aspects of the Chinese developmental model.”
The people’s Bank of China controls interest rates in a way that has led to significant financial repression as inflation has risen in recent years. Figure 5 shows the benchmark nominal deposit and lending interest rates as well as the official inflation rate in China. It can be noted that benchmark deposit rate and lending rate are more stable after 1999, while the inflation during the same period performed unstable. But it is clear that the trend of inflation has correlated with interest rate, the central bank fights inflation by aggressively raising the interest rates.
In addition, figure 5 presents the gap between the deposit rate and lending rate in China was almost fixed after 1999, while it was contradicted with the implications from a financial market where interest rate is determined by the market. As a result, this unchanged gap is because government controlled the interest rates to lock the profit of its state-owned official bank system. Or the interest rates gap would shrink when the credit in China had a surplus. Moreover, figure 5 also reveals inflation in China is not always below the nominal interest rates, especially for the deposit rates.
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In this way, the economy in China was suffering zero or even negative real interest rates (Lardy, 2008). It is indicated that the official inflation rate was probably underestimate the true inflation in China, this zero to negative interest rate problem is likely to be more serious in fact.
It is unbelievable that China has such high annual economic growth rate while the net real return to capital was reach to zero. On the contrast, Bai et al. (2006) calculated that the return is significantly greater than zero. It is commonly believed that the real interest rate calculated from the benchmark rate cannot reveal the true market return to investment. Therefore government set the interest rates well below the market rates to lower the financing cost for its state owned sectors. In this way, government guaranteed that there are enough funds going to their pockets instead of other places with higher return. Besides, financial repression has led to lending rates that are far too low, resulting in excess demand for bank loans.
Financial repression is the issue in great distortions in China’s economic situation. Since the official interest rates are modified, people could not save enough in the official banking system. What’s more, the result was a system that could not allocate resources efficiently and where the financial options for non-state actors were extremely limited. In this way under the system of financial repression both the households and the private sector have lived under an iron-wall of restraints and one of the reasons why the property market in China grew out of all proportions is because for quite a long time it was the only place people could place their money. In addition, financial repression is the reason why rapidly emerging pattern of e-banking and shadow banking in China. These shadow banks collect funds from rich households looking for higher return, but introduced higher risk into the economy at the same time.
To conclude, financial repression is a political control system, which is a relic from the Communist command economy and which essentially paralyzed a rational allocation of financial resources, especially for the underdogs of China’s society, which are the households and private entrepreneurs. In this way, the financial repression restrained the development of a free market mechanism in China; especially the financial function of the economy was systematically contained.