China Has to Shift Its Growth Pattern

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Recently, various voices can be heard about china’s economy. In general, such opinions can be categorized into 2 camps. One believed China’s economy is undergoing a soft landing while the other insists it’s on a downward spiral towards a hard landing. In my view, China’s economy has some inherent defects, whether the landing is hard or soft, it is to be a long-term process which involves a lot of elements. To achieve soft landing, China has tremendous work to do, of which boosting domestic consumption becomes the top priority. Switching growth pattern is a slogan put forwards more than a decade ago. Only little progress has been made as of today. So, what’s hindering our efforts? What necessary reforms we need to take? With these questions, I interviewed William Cline, the well-known economist with Peterson Institute for International Economy.

1.Do you believe in China’s economic model, which is characterized by high investment and low efficiency, if not, what do you think is sustaining China’s growth for such a long time?

China has grown rapidly as a consequence of high saving and investment. In addition, the removal of earlier restrictions on private activity, beginning in agriculture in the late 1970s, and then integration with the world economy after China joined the WTO, contributed positive structural changes favoring growth. Retained earnings by enterprises are unusually high as a fraction of GDP, however. Although this stimulates saving, it limits domestic consumption. China cannot continue to rely heavily on constantly increasing trade surpluses as it did in the past, because the econo- my is too large relative to the world economy for the rest of the world to continue running everlarger trade deficits.

2.China wants to switch to a more consumptiondriven growth pattern, how do u think china could make that change?

My colleague Nicholas Lardy emphasizes that the financial repression holding interest rates on bank deposits very low needs to be changed. This practice seems to result from the exchange rate policy, which holds the yuan artificially low and builds up large foreign exchange reserves. To“sterilize” these reserves, the central bank issues bonds that banks purchase, and also increases bank required reserves. To keep the banks from losing money, rules are set limiting the interest they can pay on deposits. Low interest rates on deposits constrain households’ income and consumption. The low rates also prompt households to invest in real estate, risking an unsustainable real estate boom. The needed changes are: 1) allow the yuan to rise more rapidly, and do not built up large additional reserves; 2) liberalize the interest rates banks can pay on deposits. The result would be to increase domestic demand and reduce vulnerability of the economy to foreign demand.

3.Our government has talked about restructuring and environmental protection for more than a decade, but the current performance evaluation system disallow local officials to make any progress on that front, what do u think is holding back china’s restructuring efforts? The urge to maintain high investment in order to ensure employment and social stability?

Restructuring should pressure enterprises to declare larger dividends so more of the national income goes to households, boosting domestic consumption. On the environment, China should implement its target of increasing output efficiency relative to carbon dioxide emissions by adopting a carbon tax. Revenue would be used in part to develop renewable energy. Presence of the tax would send the right signal to firms for their future energy investment. The tax should be coordinated internationally (but collected domestically). China should adopt a tax parallel to the emissions allowance rates in the EU, and should call on the United States to do the same thing.

4.Do you think China’s government is sincere in controlling the overheated housing price since we all know government’s interest is intertwined with developers as they need to sell land for fiscal revenue?

China’s investment in residential real estate is very high, at nearly 9 percent of GDP in 2010, up from 4 percent in 2003. This is much higher than in the United States before the housing bubble burst (about 6 percent of GDP in 2005) and also high in comparison with other emerging market economies. To avoid bursting a housing bubble it would be prudent to introduce widespread property taxes that could substitute local government revenue for the current arrangement of selling land to developers.

5.Tsinghua University just released a report written by vice president Xi jinping’s mentor Sun Liping, in this report, he warned that China’s reforms were stalled by“powerful vested interests”. It said. “This is an undisputed truth. In recent years, a number of important reform measures have been shelved and political reform has failed to move forward”. So what kind of political and economic reforms China should take?

Needed reforms include more exchange rate flexibility, elimination of financial repression, proper tax signals for residential construction and carbon dioxide emissions, enforcement of intellectual property rights, and an improved social safety net. In principle the strong central direction of economic policy should make it possible to overcome resistance by special interests.

6.China wants to shift to a more consumption driven economy, what are the essential elements for an economy to make that switch, do you think china has the ability to do that? Or we might end up mired in the middle-income trap?

China has demonstrated the ability to maintain high growth over long periods. The government has considerable capacity for infrastructure development, and does not suffer from a problem of overindebtedness. With ongoing increases in the level of education, and assuming a bursting of a property bubble can be avoided, there is no reason the economy cannot continue to grow rapidly, even though there might be a moderately slower long-term growth rate if the savings rate eases from the exceptionally high level.

7.China’s urban population exceeds rural area, which could be good news for consumption. However, to sustain the consumption power, we need a lasting momentum to drive income growth, in your opinion, how could China achieve a lasting income growth?

The next phase of growth should involve an increased share of the services sector and a more normal (instead of unusually high) share of manufacturing in GDP. Labor intensive services offer an opportunity to integrate the lowerincome population more fully into the economy and boost domestic demand.