Page 3 of 3 CHINA AND THE GLOBAL CRISIS, Part 2 Beijing holds key to prosperity
By Henry C K Liu
Among the major currencies of the emerging economies, the yuan in 2008 has
registered the largest appreciation against the US dollar (7.8%), in nominal
effective terms (13.4%) and real effective terms (13.5%). By policy, the yuan
has risen almost 24% against the euro since the beginning of July. Over the
same period, the yuan has appreciated about 9% on a nominal effective
exchange-rate basis. Yet, as a result of the international financial crisis,
the yuan on July 28 had the largest one-day fall from market forces since China
cut the yuan peg to the dollar in 2005.
The economic growth of Guangdong, north of Hong Kong, has given it the biggest
GDP among all of China's provinces. This has
been in larger measure due to the enormous growth of small and medium
enterprises (SMEs) in the past three decades. These SMEs are mostly owned and
operated by investors from Hong Kong and Taiwan. Although over three decades,
these SMEs have themselves gone through several stages of metamorphosis, they
are mostly still labor-intensive, high-pollution, export-oriented manufacturers
prospering from outsourcing contracts from US and EU brands, with the largest
portion of economic benefits going to foreign investor and US importers.
The competitive advantages in China's foreign trade have rested on two
components: cheap labor cost and loose environmental regulations. These
competitive advantages are in reality trade disadvantages for China. Foreign
trade is further disadvantaged its being denominated in fiat dollars of
uncertain exchange value and zero intrinsic value.
As the yuan appreciated in recent years, and commodity prices skyrocketed,
these labor intensive and short-term contract manufacturing business models
have been struggling to survive on razor-thin margins. Government policy to
encourage high-value added manufacturing, higher wages and benefits, tighter
environmental regulations and improved workplace safety standards, and product
safety inspection have made profitability increasingly elusive for SMEs unable
to upgrade from sweatshop cottage industries to modern factories. Large numbers
of outmoded SMEs routinely go out of business to be replaced by more efficient
firms at each stage of industrial metamorphose.
The international financial crisis that began in 2007 now threatens even the
stronger and better managed SMEs, causing several to shut down abruptly, some
failing to pay wages owed to workers. The Hong Kong Special Administrative
Region, which operates under market capitalism, is putting pressure on the
central government in Beijing to provide assistance to Hong Kong-owned SMEs in
the Pearl delta.
While SMEs are recognized as an important component of economic growth, the
leadership of Guangdong province has publicly rejected any government bailout
of operationally obsolete SMEs. Their fate should be determined by market
forces. The government, however, will ensure that the closing of obsolete SMEs
do not lead to unfair treatment of displaced workers. Only SMEs that fit well
in China's development plan to upgrade its economy should receive government
help.
The Pearl River Delta will concentrate on high value-added, high-tech and
services industries and create opportunities for a better grade of employment.
The international financial crisis provides an opportunity and urgent
imperative for Guangdong to accelerate its economic restructuring.
China needs to recognize that market capitalism with central banking is not the
most effective or efficient system to achieve full employment with rising
wages. China needs to adopt a full employment policy as a national objective. A
socialist system must provide every able citizen who wants to work opportunity
for work. China is still grossly underdeveloped economically. With so much to
do to bring China into a modern nation, it is hard to imagine a country like
China not having a labor shortage. China must create an economic system that
puts full employment as a top priority, not allow itself to be trapped by
neo-liberal market fundamentalism of using unemployment to keep wages low to
protect the value of money.
What China must do
With recurring capitalistic market crashes, the world is beginning to realize
that market capitalism can destroy wealth as fast as it can create wealth.
While keeping markets as an auxiliary mechanism for efficient allocation of
resources, China must rely on central planning to direct investment in an
orderly manner in sectors need for national development, such as modernization
of food production and distribution. It must rely on planning to direct
investment towards physical and social infrastructure, in universal education
and universal health care. These investments must be increased and accelerated
with much higher targets for each five-year plan.
To do this, China must develop more respect for and reliance on domestic
indigenous talent and make more opportunities available to young people. Brain
drain is the greatest loss China has suffered in the past century. In recent
years, a massive loss to other countries of well-educated people has blighted
the Chinese finance sector. China must develop policies to stop further brain
drain and to revert the flow of human resources back into China.
China must invest more on domestic development than on exports, particularly on
rural development. It must not look for growth through cross-border wage
arbitrage by foreign capital. Wage income is the only reliable index of growth
for any economy. Export-led growth is unsustainable for meeting the needs of an
economy that comprises one fifth of the world's population, particularly when
export earning is denominated in fiat dollars that cannot be spent in China
domestically.
Modernization is not merely blindly copying the advanced economies. China must
avoid excessive faith in market forces while taking care not to ignore them. It
must set a framework in which market forces that create benefits for the
community are encouraged and those that create costs to community are
penalized.
At its root, China is an agricultural economy. Chinese leaders have depicted
the new socialist countryside program as having higher productivity, improved
livelihood of farming families, a higher-degree civilization with greater
socialist ethics, a clean environment and democratic management in the 11th
Five-Year Program (2006-2010) period, showing the resolve of China's leadership
to spread the fruits of reform to its rural areas, especially poor regions.
The central government allocated 13 billion yuan in 2007 to its poverty
reduction program, 13 times that in 1980 and 37.2% of which was earmarked for
the autonomous regions of Inner Mongolia, Xinjiang, Ningxia, Guanxi and Tibet,
and provinces with large ethnic populations, such as Guishou, Yunan and
Qinghai.
While this a good start, it is woefully inadequate. What is needed is 100 times
the amount ($160 billion) every year until these regions reach self-sustaining
prosperity. After all, a nation that holds close to $2 trillion in foreign
exchange reserves, should not tolerate poverty anywhere within its borders.
After more than 30 years of economic reform, the poverty rate in rural areas
has dropped to less than 3%. But that still leaves 40 million poor due to
China's big (1.3 billion) population. China also has 26 million people who live
at subsistence level beyond the reach of the poverty reduction program. The
Chinese government has turned more attention on its rural poor by reducing
various taxes and promoting free universal compulsory education. The
agricultural tax, which has had a history of 2,600 years, was rescinded
completely in 2006 and an increasing number of children in rural areas gained
access to free compulsory education.
China also has begun to lower the price of medical services by reinstituting a
rural cooperative medical service system. Still such a timid anti-poverty
program for the world's largest creditor nation is a glaring contradiction. Yet
this program is too timid in allowing poverty to continue to be a drag on
economic growth.
China has since unveiled ambitious plans to help the 800 million people living
in the countryside catch up economically with city dwellers. More rural
investment and agricultural subsidies and improved social services are the main
planks of a policy to create a "new socialist countryside," which President Hu
has declared as a national priority.
The new policy regards constructing a new socialist countryside an important
historic task in the process of China's modernization. "The only way to ensure
sustainable development of the national economy and continuous expansion of
domestic demand is to develop the rural economy and help farmers to become more
affluent," the policy asserts. It aims to modernize the countryside, which has
fallen behind in China's development in recent decades.
From 2006 until 2010, the government promises sustained increases in farmers'
incomes, more industrial support for agriculture and faster development of
public services. Yet current plans remain timid in relation to the size of the
problem and must be redoubled to prevent rural poverty from emerging as a drag
on national economic development.
Local governments have been warned that they will be held to account for
ineffective administration and misallocation of precious resources on false
symbol of prosperity. The new measures promise greater protection and improved
democracy in rural areas, and local government bureaucracies will be
streamlined to increase cost effectiveness. Instead of gauging progress by GDP
growth, attention should be paid to income growth, particularly farm income
growth. Income is all; without income, all else is mirage.
In part, the new socialist countryside policy is driven by concerns about
China's ability to sustain food self-sufficiency going forward as a global
crisis of food is fast building. The past 25 years of rapid urbanization have
seen much farmland turned into urbanized development zones, and more than 200
million farmers have migrated to the cities to serve export sector needs.
The new food policy proposes that China should remain "basically
self-sufficient" in grain. It promises increased subsidies for farmers growing
grain, as well as continued revenue "bonuses" for local governments in the
grain belt, and says the government will continue setting minimum prices for
grain purchases.
With 800 million people living in the countryside, the only way to ensure
sustainable development of the national economy and continuous expansion of
domestic demand is to develop the rural economy and help farmers to become more
affluent than city dwellers to reverse the migration trend. The program also
stressed that construction of the new countryside should focus on practical
development and involve democratic consultations. Most of all, ample farm
credit must be provided by the central government to help poor rural region to
kick start development.
Chinese agriculture is at a crossroads as the benefits of the agricultural
changes first ushered in late 1978 have lost momentum. Grain production, which
reached record levels in 1984, dropped suddenly in 1985 and is only now
beginning to push above 1984 levels. The area under cultivation, already small
compared with the population, is steadily declining as new housing, schools,
factories and roads nibble away at rice paddies and wheat fields. State
investment in agriculture has dropped precipitously over the past two decades.
China's exposure to the international financial crisis is primarily a result of
its high dependency on exports, which in turn is the result of high dependency
on financial market forces to allocate the use of capital, particularly foreign
capital.
Markets seldom direct resources where they are needed, only to where profit is
easiest and highest. Market forces when unregulated and undirected always lead
to uneven and sometime undesirable development. Much of China's economic
dilemma today is the result of blind acceptance of the Hayekian efficacy of
market forces. The reliance of a labor market to direct economic development is
counterproductive. China needs to understand that labor is not a commodity but
a national resource. The value of labor should not be allowed to be set by
supply and demand in a labor market. It should be set by national policy around
which markets are organized to fulfill it. This is the fundamental flaw of
China economic reform for the past three decades.
China's ability to rescue the stalled global economy through reform in trade is
extremely limited. The best way for China to contribute to stabilizing the
world economy is to develop the country's domestic market and to increase the
purchasing power of the population through a progressive income policy with
full employment. It fact, China needs to adopt a bottom-up development strategy
of direct assistance to people, the opposite of the US top-down development
strategy of assistance to institutions.
This means a strategy to set the increase of personal income and social
benefits as a goal around which the economic system is organized, rather than
letting personal income and social benefits be the outcome of imported
dysfunctional economic systems such as predatory neo-liberal cowboy market
capitalism.
Henry C K Liu is chairman of a New York-based private investment group.
His website is at http://www.henryckliu.com.
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