A Scorecard Of China’s Economic Rebalancing

A NEWLY PUBLISHED IMF Working Paper takes the measure of Beijing’s progress in rebalancing the economy away from investment and export-driven growth to high-value-add innovation-led industry and domestic consumption.

In summary, the paper says:

External rebalancing has advanced well, while progress on internal rebalancing has been mixed, with substantial progress on the supply side, moderate progress on the demand side, and limited progress on the credit side. Rebalancing on income equality and environment has also been mixed, with the energy intensity of growth falling and labor’s share of income rising, but income inequality and local air pollution remaining very high.

The author of the paper has also created a visual traffic-lights type scorecard, with data going back to 2010 and forecast out to 2021.
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We have taken the liberty of taking a snapshot of where we are now based on 2015 or most recent available data (see Table 1, left).

The IMF has long been cheerily upbeat about the prospects for China’s economic development — no dramatic headlines generated by dire warnings of the rising risks of a banking crisis, as came from the Bank for International Settlements in its latest quarterly review published this week.

While the paper does acknowledge in this regard that the risk of “a disruptive adjustment” will increase significantly in the medium term, it also says that buffers such as foreign-exchange reserves are still large and able to help absorb potential financial shocks, although they will likely diminish over time, especially if reforms lag.

The paper also notes that demographic and structural changes will provide tailwinds to China’s rebalancing. It is certainly true that the rapid ageing China will experience over the next 15 years will turn the demographic dividend that has helped power growth for the past three decades into a demographic deficit.

The paper underlines that “successful rebalancing requires coordinated progress on various fronts. Going too fast on one area, while too slow on others, may derail the whole process.”

That is also not to say that significant policy efforts are not needed to get there.

Specific recommendations include:

  • continuing to move to an effectively floating exchange rate regime to prevent future foreign-exchange misalignments;
  • raising government health care spending to encourage a lowering of the savings rate (always a treat to see the austere IMF urging a communist country to increase state spending);
  • deregulating services to drive service sector productivity to offset the impact of labour being re-allocated away from the high-productivity industrial sector. This also comes with a warning of the dangers of deindustralising too early and too fast;
  • pushing ahead with the glacial pace of reform of state-owned enterprises to improve the efficiency of credit allocation.  Currently, 40% of industrial assets are managed by SOEs, with asset returns some 7 percentage points lower than their private counterparts, the paper notes; and
  • improving the redistributive role of fiscal policy through a more progressive tax structure, increased transfers and strengthened social safety net.

No surprises in that list. All the prescriptions are out of the IMF’s policy toolkit for China that the Fund has been using to cajole for reform.

 

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China’s R&D Gets Ever Bigger Bucks

TARIFF CUTS ON imports of some 200 IT products ranging from touch screens to semiconductors took effect on Thursday. The goal is to eliminate them within seven years.

China is one of 50 countries that signed up to a World Trade Organisation Information Technology Agreement last year to promote trade liberalisation of technology goods. China imports an estimated $325 billion worth a year of the components covered by the agreement. Reducing the duty on them will cost an estimated $2.25 billion a year, rising to a potential $8 billion a year with complete elimination.

However, the benefits of cheaper imports for the IT sector are seeing as outweighing these costs. Beijing is undertaking a drive to promote the development of technology-based industries. To this end, it is also raising research and development spending to 2.5% of GDP by 2020 from 2015’s 2.1%, a change that eventually will fatten China’s R&D pot by $50 billion a year.

Intensification of investment into R&D facilities outside China parallels this. So far this year, Chinese companies have announced nine new overseas R&D centres for a total capital expenditure estimated at $224m, according to fDi Markets, a Financial Times division, with pharma and biotech investments particularly prominent. Only Germany and the United States have spent more.

That will support the transformation of the manufacturing economy from low-end exports to self-sustaining indigenous technological innovation, an essential prop for the rebalancing of the economy overall towards being consumption-led.

Winning domestic market share is the aim for now of Chinese firms’ R&D efforts.  The success some are having is creating an indigenous innovation culture built around rapid, incremental product development that can take advantage of the economies of scale of the domestic market.

However, Chinese firms are closer than ever to competing with developed-economy companies in R&D. Products they are now selling in Africa and Asia, as well as at home, are starting to show the results of that, a harbinger of what will eventually come to developed markets, too.

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China Gets Its UK Nuclear Prize, Probably

THE UNITED KINGDOM’S decision to go-ahead with three nuclear power plants, the first at Hinkley Point, has had a somewhat surprisingly gruff welcome from state media.

Shortly after taking office in July, UK Prime Minister Theresa May ordered a second look at the projects, which were approved by the previous administration. This was to include cost and environmental concerns but also a security review of China’s involvement, which includes part-financing new reactors at Hinkley Point and Sizewell, both to be built and operated by France’s EDF, but also leading the construction and operation of a reactor at Bradwell to indigenous Chinese designs.

“However, in spite of the approval, China-phobia sentiments continue to hover and could possibly introduce more troubles as construction of the project gets underway, a Xinhua commentary thundered. “It is reported that while announcing the go-ahead, Theresa May has also promised ‘significant new safeguards’ to make sure that investment from China does not threaten national security. Of course, the British leader’s misgivings make little sense.”

The new safeguards give the British government a veto over sales of full or partial ownership of the reactors both while they are being built and then operated, and institutes national security reviews for future critical infrastructure projects, a practice that is common in most large economies, including China.

There had been dire warnings from the Chinese side when May announced her review that abandoning the projects would end the ‘golden era’ of Sino-British relations championed by her predecessor David Cameron and his finance minister, George Osborne.

“Let us hope that London quits its China-phobia and works with Beijing to ensure the project’s smooth development, Xinhua’s commentary continued.

Its testiness underlines the uncertainties that still surround the projects. China is desperate that Bradwell goes ahead to give it a key early sale to a developed nation of its still untried Hualong One reactor. Beijing hopes that will lead the way to a global export market for what a senior official at China General Nuclear Power estimates will be some 200 nuclear power plants.

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China Can Now Rattle Global Markets With The Best Of Them

Shanghai Stock Exchange seen in 2009. Photo credit: Aaron Goodman. Licenced under Creative Commons.

BOTH LAST YEAR and early this, global stock markets were fazed by a sharp fall in prices on the Shanghai and Shenzhen exchanges. Chinese equity and currency movements are having an increasing impact on investors everywhere. A new working paper published by the Bank for International Settlements, ‘the central bankers’ central bank’, suggests that China’s influence in this regards is rising to the level of that of the United States in some circumstances.

Market moves in China no longer reverberate just in Asia, the authors argue. However, the growth of financial and economic linkages within Asia raise questions about the pace and extent of financial market spillovers in the region and whether there are substantive differences in those flowing out of China to those from the United States.

Empirical study is only starting in this area, though the anecdotal evidence of the effects of financial market shocks is growing steadily. Chang Shu and her colleagues in the bank’s Monetary and Economic Department conclude that China’s influence in this regard has been growing significantly in recent years. This is especially true of equity and currency movements, as increasing financial linkages supplement extensive trade ones established by China’s central position in Asian supply chains.

A working paper from the IMF published last month came to a similar conclusion.

However, that has not diminished the importance of the United States, which also has impact across all asset classes including bonds, and particularly at times of market stress. China’s global financial linkages, though growing, remain modest compared to the United States’ not least because China’s capital account is not fully liberalised. Chinese monetary policy is nowhere near as potent a driver of global liquidity as the US Federal Reserve’s.

For investors, the implication of the work is that diversification of portfolios through Asia investment is becoming less effective at mitigating risk because Asian market movements are now driven by external factors to a greater degree than before.

For regional policymakers, the findings pose the challenge that yield-seeking capital flows to their country (and their exit) will be driven by developments in both Chinese and US financial markets, often in a mutually reinforcing way that could undermine macroeconomic and financial stability in vulnerable economies. It will likely take the emergence of intraregional institutional investors to weaken that linkage.

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Beijing Struggles To Rein In Pyongyang

NORTH KOREA’S LATEST nuclear test further undermines the argument that only Beijing can rein in Pyongyang but won’t do so. China’s ability to direct Kim Jong Un is diminishing as quickly as it is losing patience with his regime.

It is not alone in that. Kim has shown himself to be undeterred by international sanctions against his rapidly progressing nuclear programme — to which the latest and harshest Beijing has signed up.

China wants stability in the region and a buffer it can rely on between it and U.S.-aligned South Korea. Kim’s hell-for-leather pursuit of nuclear arms makes the region less not more stable, and Kim feels that he can disregard China’s national security interests with impunity for as long as U.S.-China relations are tense. 

He felt sufficiently secure of his position to test fire three ballistic missiles during the G20 summit that China was hosting in Hangzhou at the start of this month, much to the fury of Beijing which was otherwise basking in playing the role of world leader and was notified of the test through back channels only a few hours in advance.

For a long time, Pyongyang’s unpredictability has been supported by Beijing as a way to keep Washington on the back foot in the region. Now that is outweighed by the risk to Beijing that a nuclear-armed North Korea would lead to a nuclear-armed South Korea and Japan, and that being the sole ally to an archaic remnant of the Cold War only undercuts China’s international standing as a modern world power.

So Beijing’s calculus is changing. Its endorsement of the tough UN sanctions passed in March following Pyongyang’s previous nuclear test was a sign of that. Beijing had been lukewarm to previous sanctions rounds, and uneven in their enforcement. Even though that was a stance to which it seemed to be returning after South Korea decided in July to deploy the United States’ THAAD anti-missile system that China sees directed more at it than North Korea, Beijing’s condemnation of the latest nuclear test was harsh. 

However, if, as seems the case, Kim is using his pursuit of making North Korea a nuclear state central to cement his dynastic legitimacy, then halting nuclearisation can only come from regime change. Sticks and carrots from China, or the international community more broadly, will not induce a change of course on Kim’s part. They have certainly not shown any sign to date that they will.

Regime change in North Korea will most likely come from economic collapse that causes elites to contest diminishing economic resources. That shows no sign of happening soon of its own accord.

China could precipitate it. North Korea is dependent on imports from China of energy and food, so Beijing has the means to act.

But engineering economic collapse is the ‘nuclear option’, so to speak. It would bring a large-scale influx of refugees into northeastern China. Beijing has contingency plans for dealing with that eventuality (they were leaked to Japanese media in 2014), just as South Korea does.

What is not known is what preparations China is making to take control of an imploded North in what would be a scramble to beat the United States and South Korea in the rush to provide humanitarian aid and security for the peninsula as a whole in the name of reunification.

South Korea does have contingency plans to move troops into the North fast. If they were to run into the Peoples’ Liberation Army forces coming in the opposite direction, North Korea could become as chaotic as the Middle East, especially if remnants of Kim’s regime undertake guerrilla warfare, or China was to afford political protection to them.

In the meantime, Beijing is becoming as stymied as Washington in dealing with Pyongyang, and left scratching its head for a way to remove the Kim dynasty that throws the North into neither chaos nor the hands of the South. That it is saying publicly that it is the responsibility of the United States not itself to solve the problem, is a sign of how far from a Plan B it is.

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The Global Greening Of China

CHINA HAS THREE imperatives when it comes to climate change: to use the issue to cement its growing position as a world power; to deal with its domestic pollution problems so that they don’t become a political issue that could challenge the Party’s primacy; and to establish industrial leadership in ‘green’ technologies including renewable fuels.

The symbolism of Presidents Xi Jinping and Barack Obama jointly ratifying the Paris climate change agreement (Cop 21) will not be lost domestically or internationally. Xi will take the opportunity of the G20 meeting in Hangzhou to reinforce that message that China is at the centre of world affairs and that, as state media put it, developed and emerging countries are “in the same boat, with China charting the course ahead this time”.

The move by the world’s two biggest polluters is clearly a significant step for the climate change deal, which needs 55 nations accounting for at least 55% of the world’s emissions for it to come into effect. China and the United States raise the percentage at a stroke to more than 40% from 1%. It just now needs the EU and a couple of other countries to follow suit to get the deal over the line.

Beijing’s Paris accord commitment is to cut its carbon emissions per unit of GDP by 60-65% from 2005 levels by 2030 and to increase non-fossil fuel sources in primary energy consumption to about 20%. While those targets don’t necessarily mean a cut in absolute emissions levels, it will slow their growth meaningfully. China committed at Paris that they would peak in ‘around 2030’.

The large steps China has taken in energy efficiency and the rebalancing of the economy away from industrialisation and towards more services will aid it in hitting those goals. Becoming more of a low-carbon economy will also help achieve its domestic goals of lessening pollution, a perpetual point of popular perturbation and protest. Environmental NGOs are kept on a short leash for fear they are a seed of political organisation.

At the same time, China has developed into the world’s largest market for hydropower, nuclear, wind and solar energy and increasingly aims to make those indigenous industries, serving both the ambitions of developing low-carbon urbanisation and bringing economic development to some of the poorest but also windiest and sunniest provinces. As relatively new industries, there is also more opportunity for China’s new found desire to be innovative to flourish, as well as for its manufacturers to find new export markets for wind turbines, solar panels and even nuclear reactors.

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China Revs Up Its Jet Engine Making

JET ENGINES FOR aircraft have long been high on Beijing’s lengthy priority list of technologies to be indigenized. The current Five-Year Plan has aviation engines in the top 10 of 100 state-sponsored projects over the next 15 years intended to increase the country’s technological capability.

China has now formally launched the Aero Engine Corp. of China (AECC) to build them, with a ceremony in Beijing on August 28th. Two former Aviation Industry Corp. of China (AVIC) executives, Cao Jianguo and Li Fangyong, were appointed party secretary and chairman and deputy party secretary and general manager respectively earlier this year.

They will be running a company being created out of more than 40 firms working on some aspect of jet engines. These include three listed companies, AVIC Aviation Engine Corp, Sichuan Chengfa Aero-Science & Technology Co. and AVIC Aero-Engine Controls Co.

AECC will have initial capital of $7.5 billion and start with 96,000 employees. AVIC, which makes military aircraft, and Commercial Aircraft Corp of China (Comac), which makes the C919, China’s biggest domestically-produced passenger plane, are investors in AECC along with the government.

Creating a jet-engine behemoth by merging lots of smaller companies fits the pattern adopted for the rail equipment makers and in some basic industries—consolidating the state-owned sector to create national champions that can be globally competitive.

Galleon, a Shanghai-based aviation consultancy, has estimated that China will invest $300 billion over the next 20 years in aircraft engine development, a sector in which progress to date has been weak.

This is all part of a grand vision for advanced manufacturing, encapsulated in the Made in China 2025 document made public in March, which includes the longstanding ambition to rival the world’s two leading aircraft makers, Europe’s Airbus and the United States’ Boeing. Chinese-built airliners will need Chinese-built engines, not those bought from General Electric, United Technologies’ Pratt & Whitney or Rolls-Royce.

It is not just civil airliners that will need Chinese engines. Increasingly so, too, will China’s domestically built military aircraft, which now use mostly Russian engines or inferior Chinese-designed ones. The PLA-Air Force’s J-20 and J-31 stealth fighters, for example, cannot fly at supersonic speeds like their closest rivals without using after-burners, which makes them detectable by radar.

“The founding of [AECC] is a strategic move that will help enhance national power as well as the capacity of the armed forces”, President Xi Jinping said in a message to this weekend’s ceremony, and called for a speeding up of R&D and manufacturing of aircraft engines “to make China an aviation industry power”.

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