The China Economy Yearbook, Volume 1 : Analysis and Forecast of China's Economy [1 ed.] 9789004193628, 9789004156388

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The China Economy Yearbook, Volume 1

The Chinese Academy of Social Sciences Yearbooks: Economy VOLUME 1

BEIJING 2008

The China Economy Yearbook, Volume 1 Analysis and Forecast of China’s Economy

Edited by

LIU Guoguang, WANG Luolin, LI Jingwen Deputy Chief Editors

LIU Shucheng, WANG Tongsan

LEIDEN • BOSTON 2008

This yearbook is the result of a co-publication agreement between Social Sciences Academic Press and Koninklijke Brill NV. The articles were translated into English from the original Jingji Lan Pi Shu 2006 Nian: Zhongguo Jingji Xingshi Fenxi yu Yuce with financial support from China Book International, supported by the General Administration of Press and Publication and the Information Office of the State Council of China. This book is printed on acid-free paper.

ISSN 1872–7220 ISBN 978 90 04 15638 8 Copyright 2008 by Social Sciences Academic Press, Beijing, China, and by Koninklijke Brill NV, Leiden, The Netherlands. Koninklijke Brill NV incorporates the imprints Brill, Hotei Publishing, IDC Publishers, Martinus Nijhoff Publishers and VSP. All rights reserved. No part of this publication may be reproduced, translated, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission from the publisher. Authorization to photocopy items for internal or personal use is granted by Koninklijke Brill NV provided that the appropriate fees are paid directly to The Copyright Clearance Center, 222 Rosewood Drive, Suite 910, Danvers, MA 01923, USA. Fees are subject to change. printed in the netherlands

CONTENTS List of Figures .............................................................................

ix

List of Tables ..............................................................................

xiii

Foreword .....................................................................................

xvii

Acknowledgments .......................................................................

xix

List of Contributors ....................................................................

xxi

1. The Chinese Economy: Analysis and Forecast for Spring 2006 ........................................................................... Spring 2006 Report Research Group

1

2. Analyzing Business Cycles in the Chinese Economy ........... Liu Shucheng, Zhang Xiaojing, and Zhang Ping

15

3. China’s Prospects Regarding Sustained Economic Growth ................................................................................... Fan Jianping

39

4. Operations of the Chinese Economy in 2005 and Growth Projection in 2006 .................................................... Wang Jinming, Gao Tiemei, and Chen Fei

59

5. Policy Analysis Regarding China’s Economic Prospects in 2006 ................................................................................... Qiu Xiaohua and Zheng Jingping

77

6. Policy Choices Regarding Economic Growth in China in 2006 ................................................................................... Li Boxi

89

7. Investment and Its Economic Impact in 2006 ..................... Zhang Hanya 8. China’s Macroeconomic Trends and Policies for 2005–2006 ............................................................................. Economic Research Institute, Renmin University of China

99

113

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9. Analysis of China’s Trade in 2005 and Prospects in 2006 ...................................................................................... Pei Changhong and Lin Jiang

123

10. Tax Policies and Their Connection to Economic Operations, Analyses, and Forecasts for 2005–2006 .......... Zhang Peisen

143

11. The State of Environmental Protection in China, 2005–2006 ............................................................................ Shu Qing

149

12. Current Conditions and Future Trends in China’s Real Estate Market in 2005 ......................................................... Policy Research Center, Ministry of Construction

159

13. Business Cycles and the Growth of China’s Real Estate Industry ................................................................................ Qin Wanshun, Jin Yunhui, and Bu Yongxiang

171

14. Growing Supply and Demand in the Automotive Industry ................................................................................ Fu Yuwu

181

15. Analysis and Growth Forecast for the Service Sector, 2005–2006 ............................................................................ Shi Zhuxian, Wang Liyong, Mou Xiaoyun, and Liu Junsheng

191

16. Consumer Spending Slows, Inflationary Pressures Dissipate: Analyzing the Current Production System and Its Prospects for 2006 .......................................................... Chen Kexin and Chen Zongqun 17. Consumption in China in 2005 and 2006 ......................... Guo Shouzhong

207 217

18. Growth Trends in China’s Three Major Economic Centers ................................................................................. Deng Lishu and Wei Shuhua

231

19. Analyzing Regional Economic Adjustments in the People’s Republic of China ................................................. Jing Tihua

255

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20. The Yangtze River Delta: Managing Sustainable Development ........................................................................ Tian Boping

273

21. Analyzing Industrial Conditions in the Pear River Basin ..................................................................................... Shu Yuan

313

22. Analysis of Financial Markets and Their Prospects in 2005 ...................................................................................... Wang Yi and Chen Hao

345

23. Reforming the Currency Exchange System ........................ Li Yang and Yu Weibin

359

24. Reviewing the 2005 Shanghai Securities Market and Its Prospects for 2006 ................................................................ Wu Qian, Zhang Xiaozhong, and Zhu Pingfang

375

25. Reviewing Capital Market Performance in 2004 and 2005 and Projections for 2006 ............................................ Huang Ruifen, Yin Kedong, Zhao Xin, and Li Li

391

26. Analysis of Current Conditions and Future Prospects of the Taiwanese Economy ...................................................... Zhang Guanhua

403

27. Hong Kong’s Economy Enters a New Phase: Improvements in Hong Kong’s Economy and Changes in Its Relationship with the Mainland ..................................... Guo Guoquan 28. Analysis of Current and Future Economic Conditions in Macao .................................................................................. The Macao Macroeconomic Workgroup, Huaqiao University Appendix: General Statistical Data ............................................ Shen Lisheng

417

433 445

LIST OF FIGURES

Figure 2.1: GDP growth rate from Q1 2003 to Q2 2005 ........ Figure 2.2: Growth in watch manufacturing ............................. Figure 2.3: Growth in bicycle manufacturing ............................ Figure 2.4: Growth in sewing machine manufacturing ............. Figure 2.5: Growth in color television manufacturing .............. Figure 2.6: Growth in refrigerator manufacturing .................... Figure 2.7: Growth in total real estate area entering the market ..................................................................................... Figure 2.8: Actual GDP growth rate and trended GDP growth rate .............................................................................. Figure 4.1: Composite Index (CI), Leading Composite Index (LCI) ............................................................................. Figure 4.2: Charting the Composite Index month-by-month ... Figure 4.3: Early Warning Signal Indicator .............................. Figure 12.1: Real estate investment growth rates, January to August in 2005 ........................................................................ Figure 12.2: Commercial housing investment growth rates, January to August in 2005 ..................................................... Figure 12.3: Commercial housing sales in Shanghai, January to July 2005 ............................................................................. Figure 12.4: GDP growth and urbanization in 2000–2004 ...... Figure 12.5: Urban per capita disposable income; urban per capita living space, 2000–2004 .............................................. Figure 12.6: Growth in real estate development investment and urban fixed assets investment, 2001–2004 ...................... Figure 13.1: Investment growth rates in the Chinese real estate industry ......................................................................... Figure 13.2: Comparing annual growth rates in housing investment and GDP in China .............................................. Figure 13.3: The ratio of housing investment to total fixed asset investment ....................................................................... Figure 13.4: Comparing real estate sales to growth in consumer spending .................................................................

16 21 21 22 23 23 25 31 60 63 64 162 162 162 166 166 170 173 175 176 177

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Figure 13.5: Estimated coefficients for commercial housing sales and consumer spending ................................................. Figure 13.6: Building an index for changes in housing prices ....................................................................................... Figure 13.7: Quarterly housing prices and sales ....................... Figure 14.1: Market shares for micro-cars (engine displacement 1.0–1.6L) in 2002–04 ....................................... Figure 14.2: Growth in micro-car sales 2000–04 ...................... Figure 14.3: China’s auto exports, by segment 2000–04 .......... Figure 14.4: China’s auto exports, by segment 2000–04 .......... Figure 15.1: Growth rate curves for the agricultural, industrial, and service sectors .................................................................. Figure 15.2: Business cycles in the industrial and service sectors ...................................................................................... Figure 15.3: Changes in employment rates for the agricultural, industrial, and service sectors, 1978–2004 ............................. Figure 15.4: Changes in total employment for the agricultural, industrial, and service sectors, 1978–2004 ............................. Figure 17.1: Percentages of retail sales: urban, suburban/ exurban, and rural, January to August 2005 ......................... Figure 17.2: Comparing urban and rural retail sales ................ Figure 17.3: Comparing household spending in urban and rural areas ............................................................................... Figure 21.1: Proportion of total national value-added originating in Pearl River Basin ............................................. Figure 21.2: Proportion of national employment total based in Pearl River Basin .................................................................... Figure 21.3: Labor productivity, Pearl River Basin and the PRC ......................................................................................... Figure 21.4: GDP per capita of Pearl River Basin by province in 2004 .................................................................................... Figure 21.5: Value-added by sector in the Pearl River Basin, 2004 ......................................................................................... Figure 21.6: Labor productivity by sector in the Pearl River Basin by province in 2004 ...................................................... Figure 21.7: Total employment within service sub-sectors ........ Figure 21.8: Weighted total capital, by sub-sector .................... Figure 21.9: Business income by sub-sector ............................. Figure 22.1: Recently M2 increases faster than M1 ................... Figure 22.2: Household deposits in—year-on-year rate; month on month ................................................................................

177 178 179 184 187 187 187 196 197 198 198 224 224 225 316 317 318 319 320 322 333 334 336 347 348

list of figures Figure 22.3: Interest rate changes and their impact on short-term and medium- and long-term loans ...................... Figure 22.4: Inter-bank monthly weighted average interest rates ......................................................................................... Figure 22.5: M2 outpaces loan growth ....................................... Figure 22.6: Monthly increases in capital construction loans ... Figure 22.7: Monthly decreases in consumer loans .................. Figure 23.1: The RMB/USD exchange rate ............................ Figure 23.2: The RMB/Euro exchange rate ............................. Figure 23.3: The RMB/Yen exchange rate ............................... Figure 23.4: The RMB/HKD exchange rate ........................... Figure 23.5: Changes foreign currency balances ....................... Figure 24.1: Blue chip financing Q1–Q3 2005 ......................... Figure 24.2: The Shanghai security market state debt return rate curve ................................................................................ Figure 25.1: Closing values, in points, of the Shanghai market index, October 2004 to October 2005 .................................. Figure 25.2: Closing values, in points, of the Shenzhen Stock A market index, October 2004 to October 2005 ....... Figure 25.3: Chinese bond index trends .................................... Figure 27.1: Gross regional product, 2000–2005 ...................... Figure 27.2: Tourist visits to Hong Kong, 2000–2005 .............. Figure 27.3: Goods and service exports, 2000–2005 ................ Figure 27.4: Total real estate transactions and their value, 2000–2005 ............................................................................... Figure 27.5: Apartment sales prices and rental rates, 2000–2005 ............................................................................... Figure 27.6: The Hang Seng Index, 2003–2005 ...................... Figure 27.7: The unemployment rate and underemployment rate, 2000–2005 ...................................................................... Figure 27.8: Fiscal surplus and deficit ....................................... Figure 27.9a: Commercial trade between Hong Kong and the Mainland .......................................................................... Figure 27.9b: Travel between Hong Kong and the Mainland ................................................................................. Figure 27.9c: Direct investment between Hong Kong and the Mainland ................................................................................. Figure 27.10: Year-end market value of Mainland enterprises listed on the Hong Kong stock market, 2004 Mainland enterprise values .....................................................................

xi 349 350 351 354 354 362 362 363 363 365 378 382 395 395 398 419 419 420 420 420 421 421 422 425 425 426 429

LIST OF TABLES Table 2.1: GDP growth rate under different levels of constant inflation .................................................................... Table 4.1: Monthly economic trend indicators ......................... Table 4.2: Monthly early warning indicators ............................ Table 4.3: Profitability of industrial firms, 2004 and 2005 ...... Table 4.4: Mean disposable income for urbanites and rural residents, totals and growth rates ........................................... Table 4.5: Forecast results of macroeconomic indicators ......... Table 7.1: Estimates of major economic indices in 2006 ......... Table 8.1: Key economic statistics for 2006 .............................. Table 9.1: Differences between import and export of China’s foreign trade from January to August in 2005 ...................... Table 9.2: Overview of China’s import and export trade composition ( January–August, 2005) ..................................... Table 9.3: Overview of the nature of China’s import and export enterprises ( January–August, 2005) ........................... Table 9.4: Increasing trend of world economy and trade 2003–2006 ............................................................................... Table 9.5: Predictions made by leading international organizations on the growth of world economy, 2003–2005 ............................................................................... Table 14.1: Automobile production and sales in China, 2002–2004 ............................................................................... Table 14.2: Sales, market shares and production capacities of the top 13 auto groups in 2004 ............................................. Table 14.3: Market segmentation for micro-cars (1–1.6L) in 2002–04 ................................................................................... Table 14.4: Market shares for micro-cars (displacement 1.0–1.6L) in 2002–04 ............................................................. Table 14.5: Forecasts of demand and ownership of automobiles in China over the next 15 years ........................ Table 14.6: Car sales by segment, 2000–04 .............................. Table 14.7: 2000–2004 Changes and trends in freight vehicle production ............................................................................... Table 15.1: Growth rates of consumer expenditures on services, 1996–2004 ................................................................

33 62 62 67 69 70 104 114 124 129 130 137 137 181 182 183 184 185 186 188 192

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list of tables

Table 15.2: Results of augmented Dickey-Fuller testing ........... Table 15.3: Growth rate standard deviations for agriculture, industry, and services .............................................................. Table 15.4: Elasticity of demand for labor in the agricultural, industrial, and service sectors ................................................. Table 15.5: Elasticity of labor demand for various industrial clusters within the service sector, 1990–2003 ........................ Table 15.6: Forecasting the value of economic indicators in the service sector, 2005–06 ..................................................... Table 16.1: Input price changes, January to August of 2005 ... Table 18.1: Key economic indicators, Yangtze River Delta, 2004 ......................................................................................... Table 18.2: Key economic indicators, Pearl River Delta, 2004 ......................................................................................... Table 18.3: Key economic indicators, Jing-Jin-Ji, 2004 ............ Table 18.4: Key economic indicators by region, 2004 .............. Table 18.5: Key economic indicators of leading cities, 2004 ... Table 18.6: Contributions to the national economy from the three key regional economies ................................................. Table 18.7: Key economic indicators, Yangtze River Delta, 2003 and 2004 ........................................................................ Table 18.8: Key economic indicators, Yangtze River Delta, Q1, Q2 2005 and Q1, Q2 2004 ........................................... Table 18.9: Key economic indicators, Pearl River Delta, 2003 and 2004 ................................................................................. Table 18.10: Key economic indicators, Pearl River Delta, Q1, Q2 2005 and Q1, Q2 2004 ................................................... Table 18.11: Key economic indicators, Jing-Jin-Ji, 2003 and 2004 ......................................................................................... Table 20.1: Economic growth in the Yangtze River Delta region, 1991–2004 .................................................................. Table 20.2: Main economic indexes for the Delta in 2004 ...... Table 20.3: GDP per capita in 2004 ......................................... Table 20.4: The contribution from the Delta in national economic growth .................................................................... Table 20.5: The growth in exports from the Delta ................... Table 20.6: Urbanization in the Delta ....................................... Table 20.7: The concentration of large cities in the Delta, by province ...................................................................................

194 196 199 200 201 209 236 238 239 240 240 241 241 242 244 245 247 275 275 276 276 277 278 279

list of tables Table 20.8: Increases in per capita income in the Delta, 1990 to 2004 .................................................................................... Table 20.9: Engel’s coefficients for persons living in the Yangtze River Delta region .................................................... Table 20.10: Waste emissions in Shanghai, 1999 to 2004 ........ Table 20.11: Waste emissions in Jiangsu, 1999 to 2004 ........... Table 20.12: Waste emissions in Zhejiang, 1999 to 2004 ......... Table 20.13: Comparisons of atmospheric pollution between Shanghai, Beijing, and various large cities ............................ Table 20.14: Main environment indexes in Zhejiang, 1996–2003 ............................................................................... Table 20.15: Shanghai’s energy consumption, 1990–2004 ....... Table 20.16: Jiangsu’s energy consumption, 1995–2004 .......... Table 20.17: Zhejiang’s energy consumption, 1995–2004 ........ Table 20.18: Losses of arable land in Jiangsu, Zhejiang, Shanghai, 1996–2004 ............................................................. Table 20.19: Contributions of consumption, investment, and exports to output, 1991–2004 ................................................ Table 20.20: Productivity of investment in the Delta by province, 1992–2004 ............................................................... Table 20.21: Government R&D expenditures in Shanghai and Jiangsu ............................................................................. Table 20.22: New products and R&D in Jiangsu, Zhejiang, and Shanghai .......................................................................... Table 20.23: Rising input prices, 2000–2004 ............................ Table 20.24: Contributions to output by economic sector, 1992–2004 ............................................................................... Table 20.25: Structural changes in the service sector in Shanghai, 2001–2004 ............................................................. Table 20.26: Structural changes in the service sector in Jiangsu, 2001–2004 ................................................................. Table 20.27: Declining industrial value-added in the Delta ..... Table 20.28: Per capita income disparity between urban and rural residents, 1992–2004 ..................................................... Table 20.29: Contributions to the Delta economy by city, 2000–2004 ............................................................................... Table 20.30: Comparing economic development by cities in 2004 ......................................................................................... Table 20.31: Percentages of average output spent on medical care and education .................................................................

xv 280 280 282 282 282 283 284 285 285 286 286 288 289 290 290 293 293 294 294 295 296 297 298 299

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Table 20.32: Increasing medical care and educational expenses ................................................................................... Table 20.33: Rising medical expenses faced by the Delta’s peasantry ................................................................................. Table 20.34: Indexes summarizing capacities for innovation by region, 2004 ....................................................................... Table 21.1: Value-added by sector in the Pearl River Basin and the PRC ........................................................................... Table 21.2: Employment in the Pearl River Basin and the PRC ......................................................................................... Table 21.3: Labor productivity comparisons by economic sector ....................................................................................... Table 21.4: Industrial Structure Similarity Coefficients by province ................................................................................... Table 21.5: Enumerating locational advantage by industry and province ........................................................................... Table 21.6: Comparing labor productivity across different industries by province ............................................................. Table 21.7: Comparison of growth in industrial value-added by province .............................................................................. Table 21.8: The industrial concentration ratios in three provinces with the highest value-added ................................. Table 21.9: Two-industry concentration ratios by province ...... Table 21.10: Employment in service sub-sectors of services .... Table 21.11: Total capitalization by sub-sector ......................... Table 21.12: Business income per capita by sub-sector ............ Table 21.a: Value-added locational quotients, by provinces ..... Table 21.b: Industrial labor productivity, by province .............. Table 21.c: Industrial value-added growth, by province ........... Table 24.1: Bond market activity 2002–2005 ........................... Table 24.2: Bond issues through stock markets ......................... Table 26.1: Major economic indicators (2003–2005) ................ Table 28.1: Projecting key economic indicators for 2005 and 2006 ......................................................................................... Table 28.2: Estimated growth rates of key exogenous variables .................................................................................. Table 28.3: Estimating hypothetical economic policy changes .................................................................................... Tables A.1–A.7: Statistical data .................................................

299 299 303 315 316 317 320 324 325 326 328 331 332 334 335 339 340 342 381 381 413 443 443 444 445

FOREWORD For the last 20 years, one of the most surprising and impressive global phenomena has been the economic rise of China. In the most populous country in the world, where the majority of the population is engaged in agriculture, per capita natural resources are thin, and the country is under a socialist economic system that remains yet unrecognized by many countries in the world, how can the economy experience more than 20 years of essentially uninterrupted boom? How can such an economy undergo stable growth without experiencing the scourges of overheating, inflation, or collapse? How long can it maintain an economic growth rate that reaches as high as 10% nearly every year? How can China singlehandedly address the basic subsistence needs for a population containing one-fifth of the world’s people? How has Hong Kong managed to increase in prosperity over the last ten years despite the dire prediction of Fortune magazine forecasting economic recession for Hong Kong following its return by Britain to China? Is the Chinese government’s recent change of economic goals from “not only rapid growth, but quality growth” to “not only quality growth, but rapid growth” more than mere rhetoric? In China, we know the answers to this series of questions. The Chinese government and the Chinese people have resolutely and proactively pursued economic development through reforms, and have addressed the questions the world has about China’s economy through their actions. During this rapid process of economic development, the academic field of economics in China has benefited richly from both the experience of old Chinese economists who are influenced deeply by traditional culture and economic thought, and the rigorous and the systematic approach of middle-aged and young economists who have been impacted by the Reform and Opening-up Policy and overseas study. All of these generations of economists have contributed greatly to the development of economic theory and practice in China. The China Economy Yearbook annually combines the research findings of three diverse generations of renowned economists. This research started in 1991 when it became a key subject for the Chinese Academy of Social Sciences (CASS) and was funded by the State Council Premier’s

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Fund. The most prestigious and authoritative academic research organ in China, CASS, at that time established a research group to focus on “analysis and forecast of China’s economy” at the beginning and end of every year, and to release an authoritative research report entitled The China Economy Yearbook (Blue Book of Economy in Chinese). This research group gathered dozens of renowned economists from research institutes of CASS including the Institute of Quantitative and Technical Economics, the Institute of Finance and Trade Economics, the Institute of Economics, and the Institute of Rural Development, as well as from Tsinghua University, Peking University, Jilin University, and other major universities throughout the country. Liu Guoguang, Wang Luolin, Li Jingwen, Liu Shucheng and Wang Tongsan successively served as team leader for the project. Starting in 2006, responsibility for this research now lies with the newly established Institute of Economics at CASS. Starting with the 2007 edition of The China Economy Yearbook (designated as Volume 2 in the English version), vice president of CASS and director of the CASS Institute of Economics, Professor Chen Jiagui, will be chief editor of the yearbook. Brill has signed an agreement with Social Sciences Academic Press to officially co-publish The Chinese Academy of Social Sciences Yearbooks series, and both of our presses are proud to present the English version of the 2006 volume of the CASS Economy Yearbook: The China Economy Yearbook, Volume 1. This volume contains macroeconomic analysis, studies of China’s financial system, research on rural and industrial economies, foreign trade reports, as well as many other invaluable resources for economists seeking to better understand what is happening in China. We hope that the English version of The China Economy Yearbook, Volume 1 will serve as a useful reference for economists, and that this and future volumes of the series will further open up academic communication between economics scholars throughout the world. Xie Shouguang Secretary General of the Chinese Sociological Association President of Social Sciences Academic Press September 27, 2007

ACKNOWLEDGMENTS The successful publication and translation of The China Economy Yearbook, Volume 1 was the result of hard work and vital support from several different parties. The project received substantial funding from The Chinese Academy of Social Sciences (CASS), while the CASS Institute of Economics, the Project Group of Analysis and Forecast of China’s Economy, and the CASS Institute of Quantitative and Technical Economics organized and coordinated the writing and editing process. Other organizations who contributed to the publication of the yearbook include the Bureau of Scientific Research and the editorial staff of Social Sciences Academic Press, the publishing wing of CASS. We are grateful for the hard work put into this project by the translators Liu Jun, Lu Dachuan, Shi Wei, Xie Shengzhe, Zhang Ruijie, and Zhang Tao. These talented freelance translators translated 28 articles from the original Blue Book of Economy 2006 into English for publication in this volume. Special thanks and commendation is reserved for Dr. Titus Levi, an economist based in Los Angeles, for revising and editing the initial translation to meet international standards of academic level English. This was a challenging and arduous task, and without his hard work and expertise this yearbook would not be accessible to English language readers worldwide. The translation of this volume, a co-publication of Brill and Social Sciences Academic Press, was made possible through financial support from China Book International, supported by the General Administration of Press and Publication and the Information Office of the State Council of China. Social Sciences Academic Press, Beijing Koninklijke Brill NV, Leiden

LIST OF CONTRIBUTORS Throughout this volume, Chinese names are always ordered according to standard practice in China, with surnames preceding given names. To clarify this ordering, surnames are in all capital letters in the following list of contributors. BU Yongxiang received his Ph.D. from Peking University in 2003. His dissertation is entitled “Study on the Determination and Macroeconomic Effects of Renminbi’s Exchange Rate.” CHEN Fei is affiliated with the Center for Quantitative Economics of Jilin University. CHEN Hao works at the People’s Bank of China. CHEN Kexin graduated from the Economics Department of the Yunnan University and has since had taken office in the central government’s economic research department. At present he is engaged in research concerning rubber, copper, steel, and other means of production. CHEN Zongqun is an instructor at the Party School of the Hunan Changde Municipal Party Committee and researcher at the China Logistics Information Center. DENG Lishu is an assistant researcher at the Economics Institute of the Beijing Academy of Social Sciences, and holds a master’s degree in management science. Her research specialties are regional and industrial economics. FAN Jianping presently holds the post of assistant director of the Economic Projection Department of the State Information Center. He is also an expert consultant of the Beijing and Zaozhuang governments, specializing in macroeconomic research, market distribution, income assignment, and expense economy.

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FU Yuwu is executive vice-chairman and secretary general of the Society of Automotive Engineers of China. He was previously first deputy factory director and chief engineer of the Harbin Transmission Plant of the China FAW Group Corporation, as well as general manager of the Harbin Automotive Industry Corporation. GAO Tiemei is professor, Ph.D. advisor, and director general of the Quantitative Economy Institute at Northeast University of Finance and Economics. She has been continuously engaged in macroeconomic research since 1982 and has published more than 40 papers and coauthored two monographs. GUO Guoquan was chief economist of Standard Chartered Bank in East Area. He has since been appointed as an economic advisor to the central government. GUO Shouzhong is senior engineer and ministry-level expert at the Commercial Information Center of the Ministry of Commerce, as well as a resident expert at the Customs Tariff Commission of the State Council. He has been continuously engaged in monitoring and researching the consumer goods market. HUANG Ruifen is deputy director of the Finance Department at the Ocean University of China. He has led several national-level projects related to maritime industries and the coastal economy. JIN Yunhui is professor and tutor for doctoral students at Peking University Guanghua School of Management. Her main area of research is market forecasting and planning. JING Tihua is a researcher, director general of the economics department, and director of Information Research Center at the Beijing Academy of Social Sciences. He has been active in contributing to each Chinese version of The China Economy Yearbook since the series’ inception. LI Boxi is researcher and bureau director of the Development Research Center of the State Council. He holds concurrent professorships in economics at Tsinghua University, Xi’an Jiaotong University, and Nankai University in Tianjin.

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LI Jingwen is an academician at the Chinese Academy of Engineering, and dean of the College of Economics and Management at the Beijing University of Technology. He is engaged in research work in technology economics, engineering management, technological advancement, and productivity theory. LI Li is a lecturer at the School of Economics at the Ocean University of China. LI Yang is vice director general of the Institute of Finance and Trade Economics at the Chinese Academy of Social Sciences. He is director, researcher, and professor at the China Center for Financial Research. He is concurrently director of the Chinese Finance Society and member of the China Committee of Asia-Pacific Economic Cooperation (APEC). His research specialties include currency, banking systems, financial markets, and taxation. LIN Jiang is professor and deputy director of the economics department of China Youth University for Political Sciences. His research foci include international trade, finance, and insurance policy. LIU Guoguang was sent to the teaching and research section for national economic planning of the Soviet Moscow Institute of Economics as a graduate student in 1951, where he received an assistant doctor’s degree in 1955. He has successively held the posts of assistant research fellow, research fellow, academic secretary, director of the research office, deputy director general and director general of the Institute of Economics at the Chinese Academy of Social Sciences (CASS). He has also served as vice-editor-in-chief and chief editor of the journal Economic Research. He was deputy director-general of the state Bureau of Statistics (1981–1982), vice president of CASS (1982–1993), and was elected as alternate member of the Central Committee in the 12th and 13th National People’s Congress of the Communist Party of China. He served as a member of the 8th Standing Committee of the National People’s Congress from 1993 to March, 1998. He holds concurrent professorships at Peking University, Zhejiang University, Northeast University of Finance and Economics, and Shanghai University of Finance & Economics.

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LIU Junsheng is a graduate student at the Business School of Jilin University. LIU Shucheng received his master’s degree in economics from the Postgraduate Research Institute of the Chinese Academy of Social Sciences in 1981. He was a visiting scholar at the University of Colorado-Boulder of Economics and at Stanford University from 1989 to 1990. Since 1998, he has served as research fellow, chief editor of the journal Economic Research, tutor of doctoral students, and director general of the Institute of Economics of the Chinese Academy of Social Sciences. MOU Xiaoyun is a graduate student in quantitative economics at the Business School of Jilin University. PEI Changhong is director general of the Institute of Finance and Trade Economics of the Chinese Academy of Social Sciences, executive committee member of the International Social Science Council (ISSC) of the United Nations Educational Scientific and Cultural Organization (UNESCO), and deputy director general of the Center for International Investment Research of the Chinese Academy of Social Sciences. QIN Wanshun is professor and Ph.D. advisor at the Peking University Guanghua School of Management. His fields of research are quantitative macroeconomics and mathematical economics. SHEN Lisheng is a research fellow and tutor of doctor students at the Institute of Quantitative and Technical Economics, CASS. He is also director of the Research Office of Economic Modeling at the Institute. SHI Zhuxian is a professor and tutor of doctoral students at the Center for Quantitative Economics of Jilin University. His research areas include quantitative economic forecasting and analysis, as well as regional economics of Northeast Asia. SHU Qing is vice director-general of the Policies, Laws, and Regulations section of the State Environmental Protection Administration of China.

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SHU Yuan is an economics professor, a Ph.D. advisor, and president of Lingnan College, Sun Yat-Sen University in Guangzhou. He is currently a member of the Academic Guidance Committee in Economics under Ministry of Education, a peer reviewer for the National Natural Science Foundation of China, a concurrent professor of Fudan University, a contract researcher for the Guangdong Provincial Government’s Research and Development Center, the director of the Chinese Association of Foreign Economics, the standing director of the Chinese Society World Economy, and the vice chairman of the Guangdong Society of Commercial Economy. His fields of research include Western economics, general macroeconomics, growth economics, and industrial economics. TANG Jun received his M.Phil in Applied Social Studies from Hong Kong Polytechnic University in 1996. He is currently an associate professor at the Institute of Sociology at CASS, and deputy director the Office of Social Policy Research, CASS. His research focuses on social work, social security, and poverty. TIAN Boping is president of the Urban Industry Institute of the Jiangsu Academy of Urban Development, director of the Chinese Association of Asia-Pacific Studies, secretary-general of the Jiangsu Society of Urban Economics, and senior consultant of Jiangsu Shuntian International Group. WANG Jinming is based in the Center for Quantitative Economics of Jilin University. WANG Junxiu received his Ph.D. from the Graduate School of the Chinese Academy of Social Sciences in 2004. He is currently an assistant researcher of the Office of Social Psychology Research. His research fields include social psychology, organizational psychology, political psychology, and legal psychology. WANG Liyong is a graduate student at the Business School of Jilin University. WANG Luolin is assistant secretary general and executive vice president of the Party Group of the Chinese Academy of Social Sciences, as well

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as vice-chairman of the Subcommittee of Economy of the Chinese People’s Political Consultative Conference (CPPCC) National Committee. He is a professor and tutor of doctoral student at the Graduate School of the Chinese Academy of Social Sciences, concurrent president of the College of Economics of Zhejiang University, honorary chief of the School of Economics and management of the East China Jiaotong University, and concurrent professor of Xiamen University, Jilin University and Nankai University. Prior to 1987, he was engaged in research of global economics, focusing on economics of the Soviet Union and Eastern Europe. Since 1987 his research has increased in scope, including foreign direct investment, domestic macroeconomic issues, and finance. WANG Tongsan is director of the Institute of Quantitative and Technical Economics, CASS. His research specialties include quantitative economic theories and methods and economic modeling. WANG Yi is the leader of the Economic Analysis Team of the Survey Division of the People’s Bank of China. His research areas include the macroeconomics, investment, consumption, inflation, and imports and exports. WEI Shuhua is an associate research fellow at the Beijing Academy of Social Sciences. His research focuses principally on community development. His international comparative urban community development research for the Beijing Municipal Science and Technology Commission was a key project in the national the 9th Five-year Plan. Recently his researched has been concerned with social capital at the community level, non-profit organizations, and NGOs. WU Qian works in the investment management department of Tebon Securities Co., Ltd. He conducts research on financial investment and the securities market. YIN Kedong is professor and tutor of graduate students at the Economics College of the Ocean University of China, director of the Chinese Association of Quantitative Economics, and executive director of the Shandong Finance Society. His research deals with quantitative economic analysis and system optimization, maritime economic calculations, risk management, and capital markets.

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YU Weibin received his Ph.D. from the Graduate School of CASS in 2002 and currently works in the International Finance Research Office of the Institute of Finance and Trade Economics, CASS. ZHANG Guanhua is assistant manager and researcher of the Taiwan Institute of the Chinese Academy of Social Sciences, director of the National Society of Taiwan Studies, executive director of the China International Economic Relations Association, executive director of the China Society for World Trade Organization Studies, a member of the innovation base for the Taiwan Studies in Phase II of Project 985 at Xiamen University, and a concurrent researcher of the Research Center for Cross-Strait Relations under the Taiwan Affairs Office of the State Council. ZHANG Hanya works as an analyst for the Investment and Financial Research Office of the National Development and Reform Commission’s Macroeconomic Research Institute. ZHANG Houyi is executive director and deputy secretary-general of the China Society of Private Economy Research. He conducts research in the areas of rural economics and sociology. ZHANG Peisen is research fellow at the Research Institute for Fiscal Science of the State Administration of Taxation, director of the Office of Theory and Policy Research, taxation analyst for the State Council, executive director of the Chinese Association of Quantitative Economics, director of the China Taxation Society, and assistant director of the Research and Development Center for Finance and Taxation of the Chinese Association of Productivity Science. ZHANG Ping is a research fellow at the Institute of Economics at the Chinese Academy of Social Sciences, and professor and Ph.D. advisor at the CASS Graduate School. He has worked on international projects with the World Bank, the Asian Development Bank, and the World Federation of Trade Unions. ZHANG Shifei received his Ph.D. from the Chinese University of Hong Kong in 2001. He is now an associate research fellow at the Office of Social Policy Research, CASS. His research foci include social work and social welfare.

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ZHANG Xiaojing has a Ph.D. in economics, is a research fellow at the China Reform Foundation, and is director of the Macroeconomic Analysis Program. ZHANG Xiaozhong works for the Shanghai Changning District Reformation and Development Commission. ZHAO Xin is vice dean of the Economics College of the Ocean University of China, consultant to the Legislation Committee of the Standing Committee of the Shandong Provincial People’s Congress, and executive director of the Chinese Association of Quantitative Economics. He is mainly engaged in the research concerning quantitative economics and technology economics. ZHENG Chaoyu is director of the Economic Research Institute, Renmin University of China. He is also a professor and tutor of doctoral students at Renmin University’s School of Economics. ZHENG Jingping is spokesman for National Bureau of Statistics of China and concurrent professor at Renmin University of China and Hunan University. His areas of research include economic analysis and econometrics, mathematical statistics, purchasing power parity, and international economics. He served as editor-in-chief of the International Statistical Yearbook (1998 to 2001) and as editor-in-chief of the China Statistical Yearbook (2002 to 2003). ZHU Pingfang is professor, tutor of doctoral students, and vice-president of the School of Economics at the Shanghai University of Finance and Economics.

THE CHINESE ECONOMY: ANALYSIS AND FORECAST FOR SPRING 2006 Spring 2006 Report Research Group The Chinese economy realized new heights during 2005. Newly strengthened and refined macroeconomic management produced notable benefits: sustained rapid growth, high productivity, and stable prices. Social benefits, like improved living standards, accompanied these economic successes. 2005 also marked the completion of “The Tenth Five-year Plan”. As the first year of “The Eleventh Five-year Plan”, 2006 presents enormous tasks for China. This include maintaining growth rates, continuing the development of various economic and social projects, organizing the economy to realize benefits over the long term, and addressing deep-seated obstacles and impediments that undermine these goals. To achieve all-round, well coordinated and sustainable development of the economy and society, guidelines and policies set since “The Sixteenth National Conference of the CPC”1 must be implemented and macroeconomic operations must be guided by the concept of scientific development. This report analyzes current trends in this process and forecasts likely outcomes based on this analysis.

I. Forecasts of Major Economic Indicators China’s economy will grow at a more than 8% per annum in the long run provided that inflation remains stable and low. This goal seems attainable provided that China maintains the basic thrust of regulatory reform, while maintaining prudent fiscal and monetary policies. It is expected that GDP will grow at 9.6% in 2006, a relatively high level. In order to stay on a fast and stable growth track, potentially destabilizing factors must be identified early and addressed quickly. However, economic operation must also be proactive: adjustment of key economic structures and strengthening of weak links in national economy will improve the economy’s capacity for staving off destabilization.

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Communist Party of China.

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Note that all sectors contribute significantly to growth, albeit unequally. Value-added in agriculture is expected to grow by 5.0% in 2006, a slight drop-off from the 2005 pace of 5.2% growth. This slowdown is both natural and expected since the sector experienced relatively fast growth in 2003 and 2004. Growth in value-added in the industrial sector is expected to be around 10.8% in 2006, again slightly lower than the 11.4% rate achieved in 2005. Heavy industry will continue to grow faster than light industry. Value-added in services is projected to grow at 9.3%, slightly lower than the 9.6% pace of 2005. Overall investment in fixed assets in 2006 will amount to 10.788 trillion yuan, the first time that this figure surpasses the 10 trillion yuan threshold, with real and nominal growth rates at 20% and 21.7% respectively. Although the growth rate will be lower than that of the previous year—partly due to regulatory changes—investment in fixed assets will remain the main driving force for economic development in China. In fact, its share of GDP will climb in 2005 52.7% in current prices. This ongoing growth trend bears further attention. Prices remained stable in 2005. In fact, inflation is projected to slow down 2006: the social retail price index and consumer price index are estimated at 0.6% and 1.5 for the year. Income growth for urban and rural households remained high in 2005. Rural residents saw their income increase by over 6% for two consecutive years. Urban per capita disposable income is expected to increase by 9.8% in 2006, about the same as in 2005. In 2006, consumption will continue to grow steadily and constitute a major factor for driving macroeconomic growth. It is expected that consumer retail volume will amount to 7.559 trillion yuan, with real and nominal growth rates at 11.8% and 12.5% respectively. That is, 2006 will maintain the growth rates enjoyed in 2005. The year 2005 also witnessed the strong growth in the trade sector. Net exports played an important part in driving economic growth. Exports now make up more than 20% of GDP. Foreign trade will remain buoyant in 2006 because pro-import measures will be taken and the momentum driving export growth will remain strong. Although the growth rates for imports and exports may not match the figures for the previous year, they will hover at high levels: 20.8% and 16.5%. Generally speaking economic growth will maintain its momentum in 2006, but the uncertainties associated with various factors, both domestic and foreign, require policymakers to pay careful attention

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to changing circumstances. Efforts should be made to strengthen and improve regulation with the intention of maintaining rapid, stable, and well organized economic development. The main forecasted economic indicators of national economy for 2006 are as follows: 1: Indicators for total output GDP growth rate Growth rate for value-added Growth rate for value-added Growth rate for value-added

and contributions by economic sector 9.6% in agriculture 5.0% in industry 10.8% in services 9.3%

2: Overall investment in fixed assets Total investment Nominal growth rate Real growth rate Investment as a % of GDP 3: Price Growth rate for the commodity retail price index Growth rate for the urban consumer price index Growth rate for the investment commodity price index GDP deflator index

10.788 trillion RMB 21.7% 20.0% 52.7% 0.6% 1.5% 1.4% 2.4%

4: Resident income and consumption Real growth rate of per capita disposable income for urban residents Real growth rate of per capita pure income for rural residents Real growth rate for consumption by urban residents Real growth rate for consumption by rural residents

12.5% 5.4%

5: Market for consumption commodities Retail volume of social consumption commodities Nominal growth rate Real growth rate

7.559 trillion RMB 12.5% 11.8%

6: Fiscal administration Fiscal revenue Growth rate in revenues Fiscal expenditures Growth rate Fiscal deficit

3.7 trillion RMB 17.0% 3.9 trillion RMB 15.7% 200 billion RMB

9.8% 5.8%

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spring 2006 report research group 7: Finance Total deposits by individuals Growth rate in deposits Total value of outstanding loans Growth rate in the value of outstanding loans Newly-granted loans

16.621 trillion RMB 17.8% 21.969 trillion RMB 12.8% 2.5 trillion RMB

8: Foreign trade Import volume Growth rate Export volume Growth rate Trade surplus

797.4 billion USD 20.8% 887.4 billion USD 16.5% 90 billion USD

II. Macroeconomic Analysis In the face of various difficulties and challenges in 2005, China made great efforts to carry out reform and liberalization within the framework of scientific development. Regulations were expanded, improved, and more rigorously enforced; key reforms have begun to show positive results. Key economic frictions were dealt with in order to maintain growth and development. As a result of the efforts over the previous two years, the economy has become more stable and economic and social development better coordinated. Major goals of “The Tenth Five-year Plan” are met while theoretic and practical experience is accumulated for macro-regulation in the system of social market economy, which paves the way for the initial stage of “The Eleventh Five-year Plan”. Achievements secured in strengthening and improving macro-regulation in 2005 fall under the following categories: First, on the basis of double-digit growth for two consecutive years, GDP growth rate amounts to 9.9% in 2005, with quarterly rates being 9.9%, 10.1%, 9.8% and 9.9% respectively and the quarterly rates for industrial added value being 16.2%, 16.5%, 16.2% and 16.4% respectively. The figures show the prominently growing stability of macro-economic development. As the same time, economic structure is well-adjusted, as demonstrated by the lessening of supply deficit in “bottleneck” industries and the improvement of investment structure. Economic efficiency is improved, as demonstrated by 22.6% profit growth for large-scale industrial enterprises, 19.8% growth for fiscal revenue and the breakthrough of the three trillion yuan threshold for fiscal revenue.

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Second, agricultural production continues to achieve good results, as demonstrated by improving overall production capacity. On the basis of the 2004 increase of 37.55 billion kilograms for grain production, another 14.55 billion kilograms is added in 2005. Altogether a record increase of 50 billion kilograms was recorded for the two consecutive years. Growth in agriculture accounts for 6% of GDP growth, a relatively high level. The growth of per capita pure income for rural residents amounts to 6.2%, a level second only to that of 2004 since the late 1990s. Both the growth of agricultural production and the continuous increase of rural income play significant roles in stabilizing macro-economy. Third, income levels for both urban and rural residents continue to grow as relatively high speeds and the growth speed of residential consumption approaches 13%, a level second only to that of 2004 since late 1990s, which demonstrates strong momentum. The social retail volume grows by 10.2% annually in real terms in 2004. Consumption growth has played an increasingly prominent role in macro economic development and become a major field in total growth. Fourth, investment continues to forcefully drive macro-economic development while at the same time the growth rate of overall investment in fixed assets continues to fall by about one percentage point. Although investment continues to grow at a higher than normal rate, investment structure has been improved and investment growth in several overheated industries continue to decline. Compared with the previous year, investment in primary industry grows by 27.5% in 2005, higher than the 20.3% in the previous year, while investment in secondary industry grows by 38.4%, roughly the same pace as the previous year. It is worth noting that investment in social undertakings grows at higher speeds, as demonstrated by 8.4% in the field of education and 28.9% in public health. Fifth, another important feature of macro-economy in 2005 is stable price levels. The tendency of accelerated price rise in late 2003 and 2004 has been reverted. Despite the ostensible rise of prices of petroleum and bulk commodities in the international market, China’s domestic consumer prices grow less than 2% and prices of most of the upstream commodities grow at lower speed, gradually narrowing the gap of price change between them and the downstream commodities. Stable price levels create a favorable environment for the development of various economic and social undertakings.

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After summarizing the achievements and experience in China’s macro-economy in 2005, it should be clearly seen that numerous difficulties and problems exist in economy and society at present. While some chronic and deep-rooted contradictions remain to be addressed fundamentally, new problems that deserve our attention keep popping up. Those contradictions and problems include: growing difficulty of increase of grain production and income of rural residents, higher than normal investment increase in fixed assets, irrational structure of investment, extensive way of economic development, widening production capacity surplus in some industries, unaccomplished reform of state-owned enterprises and financial system, growth mode of foreign trade that needs to be improved, widening gap of residential income that needs to be addressed, numerous problems concerning the interest of the public that remain to be appropriately solved, etc. In 2006 we are still faced with a number of difficulties and challenges that are more serious, yet the general environment, both domestic and foreign, is favorable. Under the guidance of the concept of scientific development and on the basis of achievements in macro-regulation, national economy may maintain its momentum of steady and relatively fast growth and the goals of economic and social development of the year can be met or even surpassed. III. Issues That Deserve Attention in Macro-Regulation in 2006 A. Address the Problem of Production Capacity Surplus In 2005, the adverse consequences of overinvestment in some industries over the previous several years began to become apparent. The worsening problem of widening production capacity surplus has become a major problem and deserves a timely solution. The surplus can be directly attributed to overinvestment in a number of industries, especially upstream industries, in 2003. Although measures were taken in 2004 to address the problem of overinvestment in steel, concrete and aluminum electrolysis industries and others, which contained the momentum of incessant growth, the adverse consequences of overinvestment pop up so that further measures should be taken to address them. At the same time, analyses should be conducted to find cause for the problem of capacity surplus so that further such problem can be prevented and its adverse consequences lessened. The fundamental

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causes of capacity surplus are as the following. First, there are growth pattern and structure. Economic growth in China is still extensive with high resource and energy consumption per unit of output. Rapid growth of economy increases the demand for resources and energy, which stimulate investment in upstream industries that constitute bottleneck of economic growth. On the other hand, the price mechanisms for upstream and resource commodities are yet to be upgraded from the current mechanisms featuring monopolistic, mostly determined by the government. Those factors stimulate the overinvestment in the sector, which result in the problem of production capacity surplus. Secondly, there is the economic management system. Under the current economic management system in China, all local governments tend to achieve high-speed growth of local economy within a short period through investment expansion. Since development of upstream industries may help local government control local resources and bring monopolistic profits, local governments tend to support investment in this sector through preferential policies in term of land use and loans. The result is national capacity surplus. That is the reason why it is effective to prevent overinvestment in certain sectors by imposing control on land use and loans. In addition, the production and sale of most upstream commodities are controlled by governments; therefore, the problem of capacity surplus may bring about more severe consequences. As a result, production capacity surplus in upstream industries, such as steel and aluminum electrolysis, may attract the attention from administrative departments while surplus of ordinary consumption commodities, such as air-conditioners and color television sets, is mostly adjusted by market mechanism. Thirdly, there is the income distribution system. Over a long period, increase of investment has been ostensibly faster than that of economy, consumption and residential income. Exceedingly high investment rate results in relative shortage of domestic consumption demand. That may bring about production capacity surplus from both structural surplus of supply and shortage of real demand. In particular, the existence of dual economic structures and the gap between rural and urban areas may further exacerbate the consequences of capacity surplus. The consequences of production capacity surplus include falling prices of relevant commodities, growing inventories, diminishing profits, increasing losses and difficulties in macro-regulation. The exacerbation of corporate operation may bring about a series of social problems, including bad bank loans, potential financial risks and pressure on

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employment market. Currently, capacity surplus may have only limited consequences as it occurs only in some sectors. But if not effectively addressed, the problem of capacity surplus may spread to other sectors and even the whole economy, ultimately resulting in deflation of macro-economy, which is ardently avoided. To address the problem of capacity surplus, the State Council has issued a series of policies and measures that are necessary and will surely bring about positive effects. Attention should also be given to solutions to the fundamental problems of capacity surplus, which are listed as follows. First, efforts shall be made to create conditions for preventing and solving capacity surplus from the perspective of demand while addressing the issue from the perspective of supply. Income allocation policies and ratio of investment and consumption shall be carefully adjusted so as to implement the policy of expanding consumptive demand through increase of residential income, with the ultimate purpose of making better use of the existing production capacity. Second, reform shall be furthered relentlessly so as to establish and upgrade socialist market economy mechanism in order to prevent capacity surplus by giving full play to market mechanism in allocating resources. Third, lessons of excessive administrative intervention for the purpose of controlling industrial development in late 1990s shall be drawn so as to avoid the situation in which some sectors with inadequate supply attract excessive investment, resulting in a new round of production capacity surplus. On the basis of scientific forecast and arrangement, necessary investment shall be guaranteed for each sector and that for basic sectors shall be forward-looking so as to enable the long-term steady, coordinated and balanced growth of macro-economy. 1. Preventing Rebound of Investment in Fixed Assets Since the strengthening of macro-regulation starting from the end of 2003, restrain of haphazard investment in certain sectors has been a key aspect of the regulation. Currently, investment in China is characterized by the following. First, investment remains the main driving force for macroeconomic development as the momentum of continuous high-speed growth of China’s economy over the recent years is based on investment. Therefore, in the coming years, investment shall not be neglected. Second, the trend of overly high-speed growth of investment over the previous several years has been reasonably controlled, the growth of overall investment in fixed assets has been slowed and investment structure has been adjusted through macro-regulation. The overall

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trend is towards the expected goals of macro-regulation. Third, the possibility of rebound of investment exists so that prevention of the rebound shall be a key aspect of macro-regulation. The macro-trend at present is that investment growth will continue to slow down under the effect of macro-regulation, yet factors that may result in investment rebound are not negligible. The factors may include the following. First, the composition of investors has changed and investment from non-state economy accounts for an increasing share of the total. Investment is increasingly being directly by market forces and real estate and automobile sectors that may bring huge profits are likely to attract large amount of investment from non-state investors. As a result, overinvestment is still possible in those sectors in spite of capacity surplus. Second, the balance of residential deposit in China surpassed RMB 14 trillion at the end of 2005, which provides the financial basis for high investment and investment rebound. Existing problems in the mechanism of investment and financing may exacerbate the impact of investment rebound. Third, at present, projects under construction and in planning are of overly large sizes and projects to be started are of overly large number. Since 2006 is the first year of the “Eleventh Five-year Plan”, newly-elected local governments ostensibly intend to accelerate the development of local economies through investment, which provides political conditions for investment rebound. The key in preventing investment rebound is to maintain investment at an appropriate level on the one hand so as to drive economic growth and to prevent overly high-speed growth of investment on the other hand so as to maintain a rational ratio between investment and consumption. On the basis of experience and lessons of the past, the problem of overinvestment can only be solved if China regards the expansion of domestic demand as a long-term strategic guideline, giving full play to the role of domestic demand in driving economic growth by taking effective measures to boost consumption demand. Currently, the expansion of domestic demand requires (1) the increase of residential incomes, both urban and rural, (2) the provision of upgraded public service security to residents through further reform with the purpose of improving residential expectations, (3) the development of rural consumption market on the basis of accelerated construction of rural commercial systems with the purpose of boosting consumption of rural residents and (4) the improvement of consumption environment on the basis of better policies with the purpose of promoting the upgrading of residential consumption. Only by enhancing the impact of consumption

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on macro-economic development can we solve the chronic problem of overinvestment fundamentally. That requires the implementation of the concept of scientific development in macro-economy so as to achieve the harmonious development of society and economy. 2. Maintaining Price Stability The year 2005 witnessed both the continuous, steady and high-speed development of the economy and stable prices, the best situation in many years featuring fast growth and low inflation. At present, prices have the following characteristics. First, prices are generally stable. In particular, the consumption price index, which is closely related with people’s living standards, is very stable. Second, upstream commodities, which have experienced relatively highspeed increase over a certain period, are witnessing slowing growth. Narrowing the growth gap between upstream and downstream commodities will help to maintain the stability of macro-economy. Third, the overall price level will continue to remain stable over a certain period in the future. Much attention should be paid to several aspects of price if the overall price level is to be stabilized in the future. First, efforts should be made to contain the over-growth of production materials for agriculture and prevent the decline of grain prices. At present, growth of prices of production materials is substantially higher than price changes of grain, which requires necessary measures to maintain the enthusiasm of grain peasants by granting more government subsidies, with the ultimate purpose of guaranteeing stable growth of grain production. Second, estate prices, which are concerned with the interest of residents, should be the focus of attention. Although the strengthened macroregulation of the real estate sector brought about the slowed growth of estate prices, the sales prices of in 70 large and medium-sized cities surged by 7.6% in 2005, ostensibly higher than that of the general price levels. The year 2006 requires further measures of macro-regulation for the purpose of adjusting structures, regulating markets, stabilizing prices and guarding against another estate bubble so as to safeguard the interest of residents. On the other hand, over-slowdown should be avoided and a healthy estate sector should remain the pillar industry in social and economic development. Third, over-growth of prices of some upstream commodities should be closely monitored. Owing to factors of domestic demand and the international market, prices of fuels and non-ferrous metals grew at considerably high speeds of 17.8% and 19.2% respectively in February 2006. That caused the

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imbalance of price structures, indicating that the cost-driven upward pressure on prices remains as a problem. Since price fluctuations of resource commodities may have great impact on the overall price levels, the establishment of price mechanism for those commodities will be a major issue in the furthering of reform. The current situation is characterized by the coexistence of factors instigating price increases, e.g. price increase of domestic upstream resource commodities driven by supply and demand, the trend of price increase of bulk resource commodities in the international market, the trend of price increase of commodities for public services, the trend of increase of labor cost and the transitional effect of high prices of upstream commodities over the previous several years on downstream commodities, and factors stymieing overall price increases, e.g. the market status of glut or balance of supply and demand for most commodities, stabilizing grain prices, slowing price increases driven by capacity surplus and the appreciation of the Chinese yuan, etc. Generally, there is no possibility of substantial increase of the overall price levels, while, on the other hand, deflation featuring the lack of investment and low price levels will not occur as it did in late 1990s, because investment is still buoyant, growing at the rate of approximately 20%, and prices of upstream commodities still experience relatively high-speed growth. However, preventive measures should be on hand to guard against all forms of deflation. IV. Policy Suggestions A. Maintaining the Continuity of Macro-Economic Policies by Further Strengthening and Improving Macro-Regulation, with the Purpose of Achieving Relatively Fast and Stable Economic Growth The maintaining of the continuity of macro-economic policies requires further strengthening and improving of macro-regulation. Macro-regulations conducted over the last two decades since the beginning of reform and opening-up provide China with both experience and lessons. The constantly strengthened and improved macro-regulatory measures over the last two years enable China to find solutions to ostensible problems popping up in economy. As a result, economy and society maintain the momentum of growth. The successes of those practices have made it clear that the continuous, high-speed, coordinated and healthy economic

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growth within the framework of socialist market economy can only be achieved by both giving full play to the basic role of market mechanism in the allocation of resources and taking foresighted macro-regulatory measures to guard against probable fluctuations driven by market. Healthy market mechanism and effective macro-regulation are the two essential aspects of socialist market economy. That important theory calls for the continuity and stability of macro-economic policies and the strengthening and improvement of macro-regulation in 2006. Since 2003, the Central Committee of the CPC and the State Council have taken foresighted measures in various aspects in order to address the problem of “overheating” in some sectors in the background of accelerated economic growth. The strengthening and improvement of macro-regulation have effectively promoted the continuous and relatively fast economic growth by removing the unstable and unhealthy factors in economy. Facts have proved that the macro-regulatory measures taken over the previous two years are correct, effective and appropriate. In order to maintain the favorable momentum, China should keep the continuity and stability of economic policies and further strengthen and improve macro-regulation. China is at a crucial threshold of economic and social development, facing both opportunities and severe challenges. Therefore, only by keeping the continuity and stability of macro-economic policies and constantly strengthening and improving macro-regulation can China achieve further successes in this year as well as in “The Eleventh Five-year Plan”. B. Making Breakthrough in Reform by Seizing Opportunities of Favorable Macro-Economic Situations In “The Eleventh Five-year Plan”, China is at a crucial threshold of economic and social development as well as its reform and opening-up. Issues and problems that confront China are more profound, complicated and significant than before. The addressing of those issues and problems and the building of harmonious society can be successful only by the furthering of reform, aiming at the accelerated improvement of socialist market economy focused on the transformation of government functions and the continuation of reforms in fields of enterprises, fiscal and taxation policies and finance, the solution of fundamental problems that remain in economic and social development, the establishment of mechanisms that contribute to the transformation of economic growth pattern and the overall coordinated and sustainable development.

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As a result of macro-regulation over the last two years, China now has favorable macro-economic environment featuring relatively high speed of economic growth, the ostensible growth of overall national strength, budgetary surplus surpassing expectations for several consecutive fiscal years, sufficient financial resources to promote the building of harmonious society, relatively stable prices levels with no danger of imminent inflation which provides a favorable condition for making breakthroughs in reform. Stable prices enable China to promote the reform of price mechanisms for resource commodities. That opportunity should be seized to promote further reforms so as to lay a solid foundation for the completion of “The Eleventh Five-year Plan”. C. Formulating and Implementing Specific Policy Measures for the Implementation of “The Eleventh Five-Year Plan” Under the guidance of the fifth plenary session of the sixteenth national conference of the CPC, “The Outlines for the Eleventh Five-year Plan for National Economy and Social Development”, adopted by the National People’s Congress, stipulates the goals, guidelines and tasks for the coming five years. On the basis of the preliminary building of socialist market economy, the achievement of goals and the completion of tasks of the Eleventh Five-year Plan requires the basic role of market in the allocation of resources. During the implementation of the Plan, governments at various levels should fulfill their duties through coordination and cooperation so as to guarantee the smooth completion of the Plan. First, in the coming two years, national long and medium-term plans, serving as guidelines, should be integrated into local plans. Tasks in national plans should be dissected and allocated into local plans, while over-expansion of local plans should be avoided. Second, over-enthusiasm at the beginning stage of the implementation of plans should be avoided as this may bring about investment rebound. Third, special attention should be given to the completion of difficult tasks stipulated in the plans, especially the reduction of unit energy consumption and emission of pollutants, so as to secure the completion of the plans. The year 2006, as the starting point of “The Eleventh Five-year Plan” and the transitional stage from “The Tenth Five-year Plan” to “The Eleventh Five-year Plan”, is the key year for laying solid foundations for the coming five years. China will try to create favorable conditions for its long and medium-term economic and social development in

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addition to achieving the goals for the year. Under the guidance of the plenary sessions of the Central Committee of the CPC and in the spirit of the concept of scientific development, great efforts will be made in various aspects of economy and society with the ultimate purpose of fulfilling “The Eleventh Five-year Plan” and completing the building of better-off society.

ANALYZING BUSINESS CYCLES IN THE CHINESE ECONOMY Liu Shucheng, Zhang Xiaojing, and Zhang Ping I. The Current Situation Regarding Business Cycles In 2002, the economic growth rate in China reached 8.3%, the first time it had topped 8% in several years.1 Growth accelerated from 2003 through the first half of 2005, when the growth rate reached 9.5%. If forecasts that this rate can be maintained until year’s end prove true, the Chinese economy will have maintained a 9+% growth rate for three consecutive years. This rate of sustained growth has not been achieved since establishing the People’s Republic of China. The primary aims of economic controls and policies regarding growth are two-fold: to regulate growth such that the economy does not overheat and, at the same time, to maintain a brisk growth rate. In our estimation, we see the Chinese economy as poised to successfully balance these aims. During 2005, the economy returned to a 9% rate of growth. This rate is more moderate and manageable than the breakneck growth rates attained in late 2003 and early 2004. Quarterly growth figures allow for a more granular view of these changes. Beginning with the first quarter (Q1) of 2003 through two quarters of 2004, growth rates equaled 9.9%, 6.7%, 9.6%, 9.9%, 9.8% and 9.6%. All quarters except 2003 Q2 exceed 9.5%. This anomalous quarter marks the impact of the SARS outbreak. (See Figure 2.1.) Quarterly figures from Q2 2004 to Q1 2005 show a slight slowing trend with growth figures staying at or below 9.5%: 9.1%, 9.5%, 9.4% and 9.5%.

1 There are also scholars who believe that the new economic cycle of China may have started in 2000.

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liu shucheng, zhang xiaojing, and zhang ping (

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Figure 2.1: GDP Growth Rate from Q1 2003 to Q2 2005

II. The Theoretical Framework for Analyzing Business Cycles Macroeconomic policy typically aims to achieve high and stable growth rates in the long term. But what of the medium term? How will business cycles likely affect the Chinese economy in the next 5–8 years? Based on our research we conclude that two basic outcomes seem likely. First, growth will hover around 9%. Second, business cycles will be better managed and their volatility reduced. In order to realize these desir-

analyzing business cycles in the chinese economy

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able outcomes, risk must be managed, economic difficulties identified early and treated carefully, opportunities realized, and challenges met intelligently. We ground our analysis in a theoretical framework that combines Marxist insights regarding the linkage between capital and growth with an array of Twentieth Century economic analysis examining business cycles. This work includes the findings and analysis of Joseph Schumpeter, John Maynard Keynes, and those who followed their work. Marx observed that in a commodity economy the disjunction between purchase and sale contains the potential for crisis, but also emphasized that it is only a potentiality. An entire sequence of relations must be coordinate for economic exchange to take place. This “sequence of relations” arises from the function and structure of modern industrial systems. These build on each other, forming chains of supply and consumption, output and distribution. Marx views the resulting “economic cycles” as the “[life] process . . . specific to modern industry”. He pointed out that “industry as we know it cannot be found in human history, including the early stages of capitalist production.”2 Marx built his analysis around the linkage between value and its connection to the productive lifetime of fixed capital embedded within the broader productive cycles observed in various industries. Each particular investment in fixed capital, the industry emerging from the complex of these fixed capital investments, as well as the industries supplying the funding to create and purchase these fixed capital assets and their aggregation, often survive for many years. Marx postulated that critical parts of the productive process would survive for ten years on average.3 However, he did not believe that the exact number was the issue, but rather, that these overlapping productive systems could last for years.4 One should note that when Marx said this, modern, highly integrated corporations were only beginning to develop; managing the massive integration of fixed assets was a relatively recent innovation. In first half of the 20th century, Joseph Schumpeter proposed the endogenous cycle theory centered on the pivotal of technical innovation in explaining long term, medium and short-term fluctuations in the economy. He pointed out: “What we call the business cycle is in fact a

2 3 4

Karl Marx, Capital, Vol. I. (People’s Press, 1975), 133, 694. Ibid., 207. Ibid., 695, note 1.

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liu shucheng, zhang xiaojing, and zhang ping

wave-like movement that changes together with the industry”, and “it is possible to relate each cycles in history to a particular industry or group of firms that take up the dominant position in that industry.” He went on to state that: “In each example, the particular industries and particular innovations that cause ongoing fluctuations and adjustments can be identified.”5 In short, Schumpeter linked technical innovations with industrial changes. However, his analysis has the shortcoming of viewing business cycles almost exclusively through the lens of technical innovation. The analysis overlooks changes on the consumer side of the market, including fundamental changes in consumers’ decision making, as well as the impact of resource constraints on business cycles. In response to the collapse of financial markets in 1929, and the ongoing malaise of the Great Depression, Keynes’ insights regarding the linkage between growth and demand-side economic stimulation began to enjoy wider visibility and acceptance. In the post-War era, some variant of Keynesian economics formed the basis of economic policies in most Western states. However, Keynesian analysis directed toward short and long term business cycles eventually broke apart, becoming two distinct fields. Economists have developed differing explanations for the factors driving long term and short term business cycles. Long-term growth is explained by three factors: population growth, capital accumulation, and technical progress. By contrast, explanations of short term fluctuations regard these factors as fixed, and therefore exogenous, to their analysis. These models typically include factors driving growth in the same model as factors leading to an eventual downturn. For example, making large investments in innovative technologies can drive productivity and growth. However, as the asset base ages, productivity slows; at the same time, more recent entrants into markets use newer, more productive technologies and overtake economies reliant upon an established base of older investments and technologies. In this way, each boom contains the seeds of the next recession and vice-versa. More recent theoretical insights seek to forge a link between business cycles, the factors that drive them, and the particular ways that these factors affect one another. Different economic schools of thought have

5 Joseph Schumpeter, The Theory of Economic Development (Chinese Version). (Commercial Press, 1991), 290, 295, 299.

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come up with distinct views regarding which factors drive the process. Keynesians and neo-Keynesians emphasize the impact of aggregate demand. Monetarists stress the short-term effects of monetary policies. Those adhering to rational expectations—the belief laid down by Robert Lucas that economic agents accurately adjust to changes in economic conditions and policies—stress that the economic fluctuation originates from monetary shocks. More recent empirical work focuses on identifying which factors drive business cycles and measuring the impact of each. Note that this view classifies variables driving business cycles in various ways: those that promote growth, those that hinder growth, those that produce long term effects, those that produce short term effects, those with the greatest impact on domestic conditions, as well as those producing greater impact on the import-export component of an economy. The “transmission” side of the analysis examines economic structure to better ascertain how individual explanatory variables will act on growth or contraction. Particular structures may amplify or dampen certain factors driving cycles. Structural considerations include the mix between various economic sectors—e.g., agriculture, industry, services, government, as well as the scope of trade, personal income levels, and resources constraints, among other variables. Even with these theoretical and empirical refinements, though, views regarding factors and transmission mechanisms vary among economists. Since 1980, some economists have attempted to resolve these differences and consolidate theoretical insights into a single, comprehensive framework. The authors apply elements of these various schools of thought to analyze business cycles in China. Key to doing this effectively is properly measuring the impact of the asset and industrial base in China in recent years and other basic changes regarding resource inputs, particularly real estate. Our analysis also considers the fundamental changes that have swept through the consumption side of the market. Personal incomes are at an all-time high. Consumers are using this income to move up from consuming basics. Now they not only demand more goods, but entirely new classes of goods and services. By integrating these and other key features at work in the Chinese economy, and linking long and short term growth fluctuations, we will describe the prospects for maintaining rapid growth, as well as explaining what factors propel growth.

20

liu shucheng, zhang xiaojing, and zhang ping III. The Impact of Technology on Growth

As noted above, economic growth in China entered a new phase in 2002. Large investments in technology and changes in economic structure have been driving this change. The booming growth of the automobile and real estate industries in China embodies the most important of these changes. At the same time, changes in industrial structure and scope helped to drive changes on the consumer side of the market. Consumer purchases moved beyond basic food and clothing needs, to dining out, larger and more comfortable domiciles, and a cornucopia of non-essential items. Vast numbers of consumers moved up from 100-yuan consumer durables to 1,000-yuan durables; the more fortunate moved up from the 1,000-yuan level to the 10,000 or even 100,000-yuan level. These changes tied directly to the automotive industry: a generation ago, a typical office worker in Beijing traveled by bicycle (a 100 yuan durable good); now that same individual may well travel by car (a 100,000 yuan durable good). This pattern conforms to general patterns of industrial change and consumer behavior, but at a much broader scale and a vastly accelerated pace. The changes that have swept through China since the 1970s can be divided into four stages. The first stage began with the beginning of liberalization in the late 1970s and continued into the early 1980s. In this period, the so-called “four major pieces” formed the engine that pulled the economic train. These four industries—wristwatch, bicycle, sewing machine and radio manufacturing—enjoyed rapid growth in this period. For example, output growth in wristwatch production started at 21% in 1977 and peaked at 29% in 1981. (See Figure 2.2; the data reflected in Figures 2.2–2.7 come from calculations based on data taken from The China Statistical Yearbook.) The growth rate for bicycle manufacturing rose from 11.2% in 1977 and peaked at 37.9% in 1982. (See Figure 2.3.) Growth rates for sewing machine manufacturing ranged from 20%–35% over the years 1979 to 1982, before settling into a pattern of more modest growth. (See Figure 2.4.) The second stage began in the mid-1980s and lasted until the end of the decade. In this period growth in the four major industries described immediately above slowed, giving way to the “new four major pieces”: color television, audio and stereo equipment, washing machine and refrigerator manufacturing. In short, household electric appliances moved to the forefront of industrial production. Annual production

analyzing business cycles in the chinese economy (

35

% )

30 25 20 15 10

1983

1981

1979

0

1977

5

(Year)

Figure 2.2: Growth in Watch Manufacturing

( %

50

) 40 30 20

1990

1987

1984

–10

1978

0

1981

10

(Year)

–20 Figure 2.3: Growth in Bicycle Manufacturing

21

22

liu shucheng, zhang xiaojing, and zhang ping 40

30

20

10

1983

1981

1979

1977

0 (Year)

–10

–20 Figure 2.4: Growth in Sewing Machine Manufacturing

of color televisions rose from 290,000 in 1982 to more than a million units only two years later. Production exploded in the middle years of the decade, reaching 10 million sets in 1988. Growth in annual output fluctuated between 50% and 225% from 1982 to 1988, except for 1984. After 1988, growth in the industry slowed. (See Figure 2.5.) Output growth in refrigerators followed a similar pattern: 100,000 in 1982, 1 million in 1985, and 7.58 million by 1988. The annual growth rate in the industry climbed from 55% to 190%, and began decelerating thereafter. (See Figure 2.6.) The third stage covers 1990–1996. Automotive manufacturing, and many of the supporting industries going with it, as well as real estate, come into their ascendancy. Although some data regarding the real estate industry, such as total construction figures, are not available for each of the last twenty years, various indicators clearly show that the industry has boomed. For instance, during the years 1991–1996, 160 million m2 of new commercial and domestic space came onto the market

analyzing business cycles in the chinese economy ( )

% 250

200

150

100

50

1996

1993

1990

–50

1987

1984

0 (Year)

Figure 2.5: Growth in Color Television Manufacturing (

% 250

)

200

150

100

50

1997

1995

1993

1991

1989

1987

1985

–50

1983

0

(Year)

Figure 2.6: Growth in Refrigerator Manufacturing

23

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liu shucheng, zhang xiaojing, and zhang ping

each year on average. Year-on-year growth in total area of buildings coming onto the market averaged 9.5% for the period, before declining in the final years of the decade. Automobile manufacture expanded just as prodigiously. In 1992, China produced just over 100,000 cars. With annual growth rates averaging 35% during the years 1993–1997, annual output ballooned to more than 450,000 units before the end of the decade. In the last two years of the decade, the industry’s growth rate slowed. The fourth stage, beginning at the turn of the century, brings us to the present satiation in China. Both the automotive and the real estate industries continue their strong performance. Each began to take on new forms and structures. These new forms took on a more mature look as of 2002. In real estate, growth continued at a strong clip, but as importantly, became a widespread force in the economy. New buildings in the amount of 330 million m2 came onto the market from 2002–2004; the average annual growth rate equaled 10.7% for the period. Although growth in real estate picked up its pace between the late 1990s and 2004, growth in car manufacturing since 2000 leaves performance figures of the 90s in the dust. In 2002, output stood at just over 1 million vehicles; by the end of 2003 Chinese establishments produced two million cars. Growth in 2002 amounted to 55%; in 2003 it jumped to 90%. Such a rate could not be maintained; in 2004, growth “only” reached 11.7%. As would be expected with such growth in automobile manufacturing, construction grew quickly. Urban construction turned out especially strong performance in these years. Even though these basic industries thrived, it is worth noting that emerging manufacturing industries enjoyed success in this period. Information Technology (IT) and other high-tech businesses began to make their presence felt. Growth in manufacturing led to a correspondingly rapid increase in disposable income. As of the mid-90s, per capita GDP ranged between 400 and 700 US Dollars (USD). By 2000 per capital GDP hit 800 USD, and by 2003 broke through the 1,000 USD level. Given that more than half of the Chinese population still lives in rural areas and that this part of the populace has not enjoyed as rapid a rise in personal income as their urban counterparts, the reader should note that many urban dwellers enjoy much higher personal income than 1,000 USD per year. These high-earning individuals enjoy a lifestyle completely distinct from that of their rural countrymen.

analyzing business cycles in the chinese economy

25

( )

% 30 25 20 15 10 5

2204

2002

2000

–5

1998

0 (Year)

–10

Figure 2.7: Growth in Total Real Estate Area Entering the Market

Other changes running parallel with this development served to restructure the consumer side of the economy. First, more persons moved into cities—the proportion of Chinese people living in cities exceeded 40% by 2004—and this concentrated more income in urban areas. Second, reforms affecting housing, such as changes in real estate leasing, conversion of real estate from farming to commercial and personal uses, and the development of financing for acquiring real estate, all worked together to restructure real estate markets, and by extension, consumer behavior in general. IV. Fluctuation of Economic Growth Two powerful phenomena can be observed in business cycles running through both real estate development and auto manufacturing in China: rapid growth and wide swings. Because of their widespread impact on the Chinese economy, these forces have insinuated themselves on virtually all parts of the economy.

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liu shucheng, zhang xiaojing, and zhang ping

A. Rapid Growth Changes in real estate and automotive manufacturing have fundamentally affected economic growth patterns in China. Note that real estate has many particular characteristics that produce broad and long-running economic impacts. First, investment in real estate plays out over long periods of time since larger projects take many years to come to fruition. Financing for projects typically plays out over ten or even twenty years. Second, real estate development touches on a vast complex of industries: construction, finance, engineering, shipping, lumber, hardware, architecture, mining, chemicals, electrical power, petrochemicals, oil and gas, and more. The demand for new, larger, and more luxuriously appointed homes has exploded, and this has produced spillover affects throughout the economy. According to some experts,6 the 155 million urban households expected to arrive in China’s cities will need 15.5 billion m2 of living space between now and 2025. This accounts for an existing surplus of 9 billion m2. To meet demand, 325 million m2 of space will need to be constructed each year on average. This assumes that urban populations will increase at about 0.8% per annum. Meeting this growth will drive long term growth in many industries. The automobile industry also operates within a wider network of industries: petroleum distillates, synthetics, and chemicals; tire manufacturing; steel manufacturing and metallurgy; mining; tool and instrumentation manufacturing; construction and materials; gasoline refining and distribution; specialized labor needed for manufacturing and repair work; computers and software; as well as many others. So when the automotive industry booming the way it has since 2002, the ripple effect it sets into motion is more like a tidal wave. In essence, the boom in this single section produces echoes throughout the economy. Growth in demand for cars is expected to grow several times over during the coming twenty years.7 Using various estimates regarding price sensitivity, increases in income, and population growth, total automo-

6 Wang Guogang, “Improving supply capacity while promoting the healthy development of the real estate market” (2005). Wang is with the Residential Finance Research Group of the Finance Research Institute of the Chinese Academy of Social Science. 7 R. W. Fogel, “Global Economic Growth and its Impact on China’s Economy,” Material Extracts of the PKU Chinese Economy Research Center, 47 (2001).

analyzing business cycles in the chinese economy

27

bile purchases are expected to reach 10 million by 2015.8 To meet this demand, output will need to increase by 500% between 2003 and 2015. Therefore, output must grow by 40% per annum for over a decade. Extending the horizon out another ten years, the Chinese will demand 45 million cars, a figure equal to total global demand in 2005. Clearly, growth in both the real estate and automotive industries will produce long term and widespread impacts on economic growth. B. Large-Amplitude Fluctuations Demand and resource constraints, however, complicate the above analysis. Put in plain terms: you can’t always get what you want. Resource constraints enter the problem in many ways. First, different firms and different industries compete for the same resources, even though in the long run, their long terms goals may coincide. This will produce shortages for some inputs, driving up their prices. This, in turn, will send cost increases through a network of related industries. Second, resources need to be combined optimally. Given ongoing changes in costs, technologies, and skills, this optimum is a moving target and needs ongoing attention and adjustment. Although the optimum is not necessary to achieve growth or to mitigate the effects of business cycles, the need for ongoing rapid growth in China cuts the margin of error considerably. Second, for political and financial reasons, the magnitude of demand may be exaggerated. Optimistic estimates help to attract financing and political support. Although, accurate reporting helps managers, executives, and policymakers make sound decisions, bringing in bad news may well sour relationships. And while analysts are only the messengers, messengers carrying bad news are far more likely to be shot than those who do not. Moreover, getting access to the capital and financing needed to generate growth, particularly at the levels discussed here, will depend on investor and consumer confidence continuing to be strong. This provides a very strong incentive to downplay bad news while trumpeting good news.

This estimate assumes that growth in the Chinese car market will mirror the growth pattern of the American car market. This estimate is based on two key figures: income elasticity of demand for cars in the USA from 1910–1970, which equals 2.6; and the expected annual per capita increase in income, equal to 6%. 8

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liu shucheng, zhang xiaojing, and zhang ping

Constraints will also come to bear on consumer spending. While personal incomes continue to rise, other factors enter into accumulations of purchasing power: access to credit, remaining solvent, building savings, and having confidence in future earnings potential. When any these factors experiences a downturn, the others can be negatively impacted as well. This can generate overreaction in financial markets and consumer behavior. Typically, these patterns do not follow business cycles exactly; they either follow them or mirror them in an exaggerated form. When any combination of these metrics falters, various undesirable outcomes may come to pass. For instance, inventories may increase. This may produce price cuts, and eventually, lower margins and profits. These ripple effects can affect levels of investment and economic activity throughout the constellation of related industries. Taken together, these ripples can coalesce to become a “perfect storm.” Such a storm swamped the US Economy in 1929, setting off a worldwide depression.9 Resource constraints overlap demand constraints in various ways. As noted above, rapid growth requires vast inputs. At any given time, these are limited. Moreover, increasing demand for these resources bids up their price. In short, the underlying resource constraint generates demand constraints. At the extreme, rare and needed inputs may not be available at all for limited periods; such conditions threaten productive processes in the short run. Trade complicates this analysis. If needed inputs are readily available from within the market, supplies can be reliably accessed in most cases. But when producers must import these inputs, firms and whole industries risk exposure to price fluctuations, supply volatility, and even geopolitical factors (such as WTO rules changes and regional wars) that can affect supplies and input prices. At high output levels, certain factors that would ordinarily be external to productive processes and the price mechanism begin to bite back. For instance, putting some effluent into water supplies as a result of industrial production (e.g., in chemical manufacturing and refining), may generate relatively minor costs for a time or for certain levels of output, but at some threshold, costs become substantial. In the extreme, costs can have a catastrophic effect on future production in a given industry, as was the case for Three Mile Island and Chernobyl in the nuclear power generation.

9 Liu Shucheng, “Comprehending the Causes and Effects of Regulation,” Analysis of China’s Economic Prospects—2005 Spring Report (Social Sciences Academic Press, 2005).

analyzing business cycles in the chinese economy

29

One of the most crucial parts of any economy—and any given society—is its food supply. Rapid conversion of land to highly productive, high-value uses can threaten agricultural supplies, especially for a given locale. Moreover, China’s breakneck rate of growth has sacrificed environmental conditions in some places; this also places direct costs on access to farmland, food raised on this land, and even food from wild sources as well, such as certain kinds of fish. The type of economic transition through which China must navigate manifests the most violent business cycles.10 In the last 30 years China has moved from an economy that meets basic, subsistence needs in food, shelter, clothing, and other basics, to an economy that supplies these factors at better-than-minimum standards and while encouraging the development of new types of expenditures, such as spending on leisure travel. A growing percentage of China’s residents have certainly shifted the bulk of their expenditures from the first category to the second in the past generation. Researchers call this transitional period the “mid-industrialization period”. In summary, we expect the rapid, steady economic growth pattern over the coming 5–8 years to be driven by changes in both the automobile and the real estate industries. The continuing upgrades of quality and growth in scope in these industries will send waves of change out through the entire economy. The challenge will be to steer this process clear of the typically strong fluctuations in business cycles that occur in the transitional mid-industrialization period. Managing this process will require carefully and more generally applied regulation. Achieving high growth with relatively small fluctuations in business cycles is not a natural outcome; realizing this outcome will require oversight, and when needed, intervention. V. Refining Regulations A. Executing Developing Comprehensively Development based on rational planning and calculations forms the cornerstone of modern socialist economic policy. The Communist Party of China (CPC) has laid down this path as the means to create

10 Liu Shucheng, A New Phase of Business Cycles in the Chinese Economy (Shanghai: Shanghai Far East Publishers, 1996).

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liu shucheng, zhang xiaojing, and zhang ping

modernization and development. The CPC sees this method of organizing production and various institutions as the best means for promoting the transition from extensive to intensive growth. That is, moving from an economic policy where growth is pursued single-mindedly, to a more broad-based economic and social development system that seeks to improve economic efficiency, move production towards high value-added work, and achieve a new industrial and economic structure conducive to realizing long-term benefits. Industries like real estate and automobile manufacturing have a crucial role to play in realizing these aims since their impacts are both long run and widespread. In line with the move from quantity of activity and production, to an economic policy that considers the quality of these things, development in these industries will be, “Conducted according to resource capacities as well as demands.” That is, production must observe the rules of sustainability. B. Incorporating Considerations of Growth, Development, and Sustainability Correctly estimating the magnitude and timing of business cycles can help inform economic policy and regulation. This depends on correctly estimating growth potential, in other words, finding the highest growth rate attainable when efficiency and productivity are maximized given demand, resource, and inflationary constraints. This upper bound on growth in a particular period should be linked to estimates for worstcase and probable-case scenarios in order to develop robust projections about economic outcomes. Note, however, the difficulty in accurately estimating potential. Economists use three methods to develop these estimates: the Hodrick-Prescott (HP) Filter method, the production function method and the Philips curve method. 1) The HP filter methodology is used extensively to estimate the long-term central tendencies of an economic time series. Here we use the HP filter to smooth estimates of GDP growth rates in China during 1978–2004. The trended growth rate obtained through the filter is a curve ranging between 8%–10%. (See Figure 2.8.) 2) The production function method is used to generate an estimate of output based on a simple production function, and two inputs: potential employment and physical capital.11 Missing data poses a problem in

The method relies upon a number of key assumptions: a Cobb-Douglas type production function—inputs are constant and their elasticity equals that of output elasticity; 11

analyzing business cycles in the chinese economy

31

16

12 10 8 6 4

2004

2002

2000

1994

1992

1990

1988

1986

1984

1982

1980

1978

0

1998

Actual GDP Growth Rate Trended GDP Growth Rate

2

1996

(%) Rate of increase

14

(Year)

Figure 2.8: Actual GDP Growth Rate and Trended GDP Growth Rate

applying this method, however. In particular, data on employment, the size of the labor pool, and labor quality, as well as up-to-date data on capital stocks may be incomplete or inaccurate. To use the production function method, one must estimate values for missing data or proxy values. Depending on what values are used, final results may vary considerably. However, two accepted results exist. One is found in Li Yifu et al. (2003),12 which shows a growth rate of 8.56% for 2014 and an average annual growth rate of 7.08% for the period 2014 to 2024. The other credible result is found in Wang Xiaolu et al. (2000),13 which finds that from 2001–2010 the growth rate estimate is 6.58% and for 2011–2020 it is 6.21%. Obviously, there are large differences between these two results. 3) The Philips Curve method draws a relationship between the inflation rate and the GDP growth through the level of employment. In order to avoid spurious regression results, a unit root test is conducted

that only two inputs enter the production function—potential employment and physical capital; and that potential output depends on potential total factor productivity. 12 Lin Yifu, Guo Guoxu, Li Li, Sun Xifang, and Wang Haishen, “Long-Term Growth Estimates for the Chinese Economy” (Beijing: PKU Chinese Economy Research Center, 2003). 13 Wang Xiaolu and Fang Gang, ed., Sustaining Chinese Economic Growth (Economic Science Press, 2000).

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on inflation rate estimates (represented by growth in the Consumer Price Index, which is abbreviated as CPI)14 and the GDP growth rate during the sample period 1980 to 2004. Both are stationary variables. Therefore, the regression may be conducted using the least squares (OLS) method.15 The following regression equation is obtained: CPI = 1.006 * CPI–1 – 0.412 * CPI–2 + 0.966 * GDP – 6.558 (6.3891) (–2.6316) (3.4179) (–2.1478) R2 = 0.71; adjusted R2 = 0.67; DW = 2.04; F = 17.13.16

In the equation, for the sake of simplification, CPI stands for the growth rate in consumer prices, CPI–1 for the growth rate of consumer prices in the first lagged period, CPI–2 for growth rate in consumer prices in the second lagged period, and GDP equals the growth rate in gross domestic production. The figures in the parentheses below the equation are the statistical values, represented by t. The regression equation reveals important economic insights. First, increases in the CPI may feedback on themselves. A one-unit change in the CPI growth rate in the first lagged period (i.e. the last period before the present period) will result in a one-unit change in the same direction of the CPI’s growth rate in the current period. This result is consistent with the adaptive expectation hypothesis. At the same time, a one-unit change in the CPI growth rate in the second lagged period will result in a change of 0.41 units in the opposite direction of the CPI increase rate in the current period. Taken together, the one-unit change in the CPI growth rate in the first and second lagged periods will result in a 0.61 change in the same direction as the CPI growth rate in the current period. Second, the CPI growth rate is influenced by the GDP growth rate. A one-unit change in the GDP growth rate will result in a change of

14 The CPI has been published since 1985. For years before 1985, the retail price index is used as a proxy for the CPI. 15 Ordinary Least Squares (OLS) is a linear estimate of a given dependent variable, for instance, the inflation rate, based on observations of independent variables related to the dependent variable. 16 R2 equals the percentage of variation in the dependent variable accounted for by independent variables in a particular regression estimate; in other words, R2 provides an estimate of explanatory power of the given variables. The Adjusted R-Squared computes R2 taking into consideration sample size (n). The Durbin-Watson (DW) statistic tests for the presence of autocorrelation in a given regression estimate. Autocorrelation arises when a repeating pattern, as would be found in a time-series estimate, remains undetected through noise in an estimate. F is a statistic used to test the overall fit of the regression estimate.

analyzing business cycles in the chinese economy

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Table 2.1: GDP Growth Rate under Different Levels of Constant Inflation, in % Inflation Inflation rate GDP growth rate

0

1

2

3

6.8

7.2

7.6 8.1

4

5

6

7

8

9

10

8.5

8.9

9.3

9.7 10.2 10.6 11.0

Deflation Inflation rate GDP growth rate

–10

–9

–8

–7

–6

–5

–4

–3

–2

–1

0

2.6

3.0

3.4 3.8

4.3

4.7

5.1

5.5 6.0

6.4

6.8

0.97 units in the CPI growth rate in the current period. Given this, the CPI growth rate may be used to evaluate whether the economy is overheating. According to this regression equation, the GDP growth rates under different constant levels of inflation may be calculated (See Table 2.1.) Based on experience, inflation should stay below 5%; the corresponding GDP growth rate is 8.9%. Note that the periods covered by the various methods do not correspond exactly. The sample period used in the HP filter calculation runs from 1979 to 2004, the period 2004–2014 is used in the production function estimation, and the years 1980–2004 are used in the Philips curve calculation. Given the strengths and peculiarities of each method, we use the HP filter method to obtain estimates between 8%–10%, which tend toward the middle of this range. The production function method is used to estimate potential economic growth when the rate is slightly lower, around 8.56%, which is in line with findings made by Li Yifu, et al. The Philips curve method is used to obtain the potential economic growth rate of 8.9%. Simply averaging these findings for the years 1978 to 2004 yields a GDP growth rate of 9.4%. Based on these results, and from experience gleaned from observations made over the last 30 years, growth exceeding 9% tends to produce overheating. Important inputs, such as coal, electricity, oil,

34

liu shucheng, zhang xiaojing, and zhang ping

various raw materials, and transportation services experience supply shortages. Double-digit growth exacerbates all of these conditions and ignites inflationary pressures. However, when economic growth falls below 8%, serious unemployment can appear. Given this, the growth target of 9%, give or take 1% point, seems both prudent and effective, at least for the coming 5–8 years. Long term growth might be targeted a bit lower, however. First, consumer tastes and preferences are fundamentally shifting. That is, consumers are moving from a condition of “having and not having” to “having and having high quality.” Producing higher quality goods will likely slow down the rate at which they can be produced. Also, quality tends to be undercounted in GDP calculations. For these reasons, booming output increases will likely slow over the long run. Second, resource restraints will become more binding. The high rate of consumption to date will necessarily drive down limited reserves of various inputs. Moreover, as development becomes more extensive in China, even with a slowing rate of growth, resource consumption will grow. Resources in fixed supply like land will go up in price; even those with flexible supplies will show increasing prices, and this array of price increases will certainly restrain growth. Third, changes in financial markets and policies will rein in borrowing and investment, and therefore, aggregate demand. Investments will be more tightly linked to economic performance and soft performance will not be papered over with loans and bailouts. Many banks carry a substantial number of problematic and underperforming loans and portfolios will be called to account for these missteps. Managers will need to write off these loans and portfolios or lose their competitive position. Fourth, the median age of the Chinese populace is rising. Over time, the percentage of persons working will decline and this will exert downward pressure on productivity, output, and savings. Note that this is not a problem unique to China; virtually all industrialized countries must face this difficulty in coming years. An important factor runs through this entire analysis: the need to reform the pricing system. This includes everything from coal to real estate. In both cases, the prices of these two goods, as well as many others, do not conform to what market outcomes would set. Given the importance of just these two inputs in a vast number of business decisions, it seems clear that economic decision making throughout the Chinese economy cannot be considered wholly rational or informed.

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These distorted prices give a distorted view of the supply and quality of the goods making use of these crucial inputs. C. Guarding against Overheating and External Influences Factors affecting business cycles can be divided into long and short term categories. As noted above, real estate and automobile manufacturing fall into the former category. With these on track to experience considerable growth in the coming decades, China’s economy can be expected to expand as well. However, various transitory effects may have sufficient force to drive economic growth away from long term targets. Particular “major events” or changes in conditions may produce this effect. These events include implementing the 11th Five Year Plan beginning in 2006, reelecting the CPC Central Committee and the Central Government in 2007–2008, and preparing for the 2008 Olympic Games in Beijing. Taken together or individually, these factors can push—or even shove—economic growth forward. Past experience suggests that this may be the case. GDP growth surged in 1983 to 10.9%, to 11.6% in 1987, and 14.2% in 1992; these were election years. The surge in construction in Beijing, and the ripple effect this produces throughout the economy, seems likely to only add to pressures liable to “shove” the economy forward. To avoid negative impacts from this, and to stay on track with long term growth targets, countervailing measures must be applied. For instance, local governments and businesses should not become overzealous in riding this wave in 2008, only to find themselves holding excess capacity in 2009 and beyond. In general, the “big upsurge” in 2008 could produce a corresponding downturn in 2009 and 2010. Economic planners and policymakers must be on guard to prevent this. Countries with a significant stake in trade must successfully manage the impact of external conditions on economic outcomes, and China is no exception. Trade made up 44% of GDP in 2000; this is up form only 9.8% in 1978 and 30% in 1990. Given its increasing involvement in international markets and affairs, China faces more and more exposure to potential ill-effects as well as the benefits of trade. Dependency on imports poses an especially thorny problem. Supplies of raw materials, particularly minerals and petroleum, will be irregular and subject to price fluctuations as well as long run increases. In addition to such “hard goods”, China relies heavily on foreign investments to flow into the country in large volumes so that expansion

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can continue. Those making these investments like their funds to remain highly liquid. However, this places China at risk of experience capital flight, which many Southeast Asian countries experienced during the “Asian Flu” of 1997. Capital outflows resulted in the near-collapse of currencies in the region such as the Thai Baht. To preempt this kind of situation, policymakers must carefully monitor investments and create regulations that can stem the flow of funds to prevent a massive and sudden capital outflows. D. Expanding the Scope and Depth of Economic Reform Expanding the scope and depth of economic reform will remove various distortions and obstructions to rational and efficient economic function. We must set aside the strict and narrow emphasis on growth. Regulatory systems must be integrated and harmonized across regions and departments. We need to develop a richer set of metrics for evaluating economic performance and development. Reform and privatization of state-owned enterprises should continue apace. This level of reform is tied to a broader agenda of economic, regulatory, and structural reform. Verifiable and reasonable means for assessing political performance must be established as part of this process. Economists, political scientists, and public policy scholars have argued for more than 40 years whether to pursue regulation based on policy rules or case-by-case discretionary judgment. The latter group emphasizes the need for flexibility in responding to particular economic conditions. This view developed without a clear overarching economic rationale. Furthermore, political considerations may trump economic reason. For instance, the US president may promise to hold the line on inflation, but may well pursue an expansionist economic policy as a way of generating jobs and currying favor with key constituencies, especially as an election approaches. If inflation sets in, the administration may well fulfill their original pledge to control prices, but only after the election passes. While this course of action optimizes political gains, it produces substantial economic costs. Furthermore, this kind of meddling can actually exacerbate business cycle volatility. It also undermines any kind of rational, rules-based economic policy or regulatory framework. To manage economic changes, especially those which play out over years, such intervention can knock the economy off of its long range targets. Finally, such tampering creates uncertainty. Investment and other decisions, based on economic

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analysis, become unpredictable. Risk-averse managers may become more reserved in response to such uncertainty, which feeds yet more uncertain into the economy. To avoid these problems, many economists advocate adherence to a set of rules for policymaking. In practice, these rules boil down to target values for various key economic indicators, such as inflation, growth in money supply, the unemployment rate and so on. Policymakers take steps to remain within guidelines on these variables in order to keep the economy on track. However, policymakers reserve their right to intervene if they feel the situation demands it. For instance, The US Federal Reserve, a.k.a. “The Fed,” announces targets for these aforementioned variables from time-to-time. However, The Fed will deviate from their stated targets in some cases, e.g. if inflation suddenly heats up, targets on interest rates and economic growth may be revised in order to contain price increases. At present, China adheres to a “double moderate” set of policies. That is, both fiscal and monetary policies aim for the “middle road.” Much like the American Federal Reserve, targets are aimed for—typically through Five-Year Plans—but intervention is occasionally undertaken.

CHINA’S PROSPECTS REGARDING SUSTAINED ECONOMIC GROWTH Fan Jianping Economic management has redirected China’s economy from a path of rapid and accelerating growth to a path of managed, steady growth. This new situation has led to improvement in the job market and sustained low inflation rates. Economic management has been successful and becomes more refined through each intervention. The economy seems likely to build on this foundation by maintaining high growth rates into and through 2006. Economic management and regulation will continue to observe the fundamental principles of moderation and balance. Policymakers will more carefully train their attention on various pressing issues; educational investment, medical care improvements, and more reliable social service systems. Fulfilling these goals will depend on raising consumer spending and disposable incomes across the nation. Also, incentives should be developed to encourage savings, which helps to support investment and economic expansion.1 But even as investment grows in response to increased savings, it should continue to be guided and managed within the current policy framework which places limits on borrowing and investment. By effectively balancing these competing and complementary demands, the 11th Five-Year Plan should have a solid start. I. Economic Regulation Improves Operational Coordination and Economic Function In order to address various tensions and problems in economic operations, the Chinese government launched a series of regulatory measures designed to halt problems and support strengths. This clutch of policies successfully diverted the economy from a high inflation, high inefficiency

1 Note that incomes will have to rise significantly in order to support increased consumer spending and increased saving rates.

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track, reorienting it toward a high-growth, low-inflation path. By intervening when and where necessary, and applying effective and prudent policies and strategies, overall economic operation and efficiency has been considerably improved. A. Narrowing the Gap Between Urban and Rural Consumer Spending and its Relationship to Investment The central government has recently enacted polices to support what it calls the “Three Agricultural Issues” or broad areas of policy emphasis: agriculture, rural areas and farmers. Income is at the heart of these three areas of concern. The average income of rural residents amounted to 1,586 yuan for Q1 through Q2 in 2005. This figure is a 12.5% improvement over the 2004 Q1–Q2. Note as well that the growth rate easily beats the 2003 to 2004 growth rate of 6.8%. The strong increase in rural incomes has energized consumers’ goods markets in outlying areas. From January through August of this year, 3,502.52 billion yuan was spent or consumer goods. This amount represents a 13% year-on year increase. Retail sales rose at a slightly slower rate, about 11%, which still lags retail sales growth in urban areas, which climbed by 14%. However, this gap has closed from a recent high of 5.1%. This growth in consumer spending has helped to absorb expanding goods output, but fixed asset investment in the first eight months of 2005—which surpassed 2004’s eight-month total by 27.4%—clearly outpaced increases in consumer spending. Closing this gap will require major shifts in incomes, spending, and investment. B. Changing Economic Structure Eases Heavy Industry’s Resource Demands During the middle of the 10th Five-Year Plan, from about 2002 to 2004, GDP growth picked up speed. This acceleration both attracted and required vast capital and resource investments. Much of this investment went into heavy industry; as a result, capacity expanded rapidly in manufacturing and heavy industry generally. This produced tremendous productivity improvements, increases in wages, as well as the expansion of consumer markets and consumer spending. Expenditures on specialized and boutique consumer goods and services rose as well. Comparing heavy industry to light industry is revealing regarding the impact of investment decisions and policies. In 2003, heavy industry outpaced growth in light industry by 4.0%, or 18.6% to 14.6%. The gap

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closed slightly in 2004, with heavy industry growing by 18.2% and light industry moving ahead by 14.7%. However, in the first eight months of 2005, this condition changed. Growth in heavy industry dropped to 16.9%, a 1.7% year-on-year decline. The heavy industry-light industry gap closed by two full percentage points. By August the gap had dropped to only 0.7%. This indicates that the transition away from heavy industry toward light industry and services has taken hold. Because of this, various problems involving resource shortages and process bottlenecks have eased. This trend is reflected in the development of capacity for many basic resources. Demand for raw materials and other key productive inputs continued to expand, but at slower rates. For instance, total energy production rose 10.3% between January and August 2005, but the rate for January–August 2004 was 12.9%. Electricity generation jumped by 13.4% between January and August 2005, but this growth rate is slower than the eight-month growth rate for 2004, which was 14.8%. Freight transportation grew by 9.5%, shedding 3.7% from the January through August rate in 2004. On a related note, freight shipments through ports grew by 18.2%, down from the 23.9% January through August 2004 growth rate. C. Investment Growth Cooled as Portfolios Grew More Solid Regulations affecting fixed asset investment allowed investment activity to settle into a stable, but still rapid, growth pattern. This has balanced and strengthened real estate markets in particular. From January through August, fixed asset investment in urban areas reached 4.1151 trillion yuan, rising at 27.4% year-on-year, but 2.9% below the 2003–2004 growth rate. Real estate investment, a subset of this total, amounted to 892 billion yuan, up 22.3% over the same period in 2004. We can see further evidence of the slowdown in August’s standalone data: total real estate investment came to 133.3 billion yuan, down 6.1 billion yuan, or 4.38%, since July. The view by sector shows additional evidence of an economic slowdown and restructuring process at work. More investment flowed into agriculture, generating growth. Growth in the industrial sector eased. Growth of the service sector basically held steady. Agricultural investment reached 39.6 billion yuan, up 20% from last year. This outstrips the 2003–2004 growth rate by 3.7%. Investment into industry amounted to 1,733 billion yuan, a 35.2% increase. This marks a 6.5% drop from 2004’s growth rate.

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Delving into these gross figures provides insight into how broad the slowdown has become. It also reveals that investment has grown more refined and precise. More money has been directed to address weaknesses in the economy, especially shortages in productive inputs, while diverting money from many other aspects of industrial production. Therefore, growth in coal, electricity, and transportation capacity has continued to climb at a faster pace, even while the growth of investment in building materials such as steel and other metals slows down. First, we will turn our attention to the investment areas that have enjoyed accelerating growth. Investment in coal mining and refining equaled 54.6 billion yuan from January through August, making for a head-spinning year-on-year increase of 81.9%. This comes in the wake of an increase of 63.1% between 2003’s first eight months and 2004’s eight-month total. Investment in petroleum and natural gas extraction amounted to 77 billion yuan, 25.6% above the previous year’s amount, and 10.6% above the previous year’s rate. Investment into railway transportation reached 50.4 billion yuan, up 39.2% over 2004’s eight-month sum and 43.2% above 2004’s eight-month growth rate. Other areas of investment show significant signs of slowing growth. Investment in iron prospecting, mining, smelting and plating climbed to 149.2 billion yuan, a 25.4% year-on-year increase. Note, however, that this is 20.9% lower than the 2003 to 2004 growth rate. Investment in non-mineral extraction and refining came to 75.7 billion yuan, a 16.3% increase, but a steep drop-off of 35.3% from the 2003-2004 growth rate. D. Job Growth Continues while Inflation Remains in Check Growth has led to an improvement in the employment situation. Given the rate of urbanization, job growth remains one of the most important goals for the economy. From January to August 2005, urban areas added 7.38 million new residents. The eight-month total comes to 82% of the annual target, putting it about 10% above projections. With urban unemployment at 4.2% in June, about the same level as last year, job creation has kept pace with the urbanization rate. Even though strong job growth might raise the specter of inflation, the data suggest that inflation remains under control. Agricultural prices have dropped in recent years and stabilized at these lower levels. Gains in productive capacity have swelled industrial output, which also puts downward pressure on prices. From January to August, the consumer

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price index (CPI) rose 2.1% on a year-on-year basis, about 1.9% lower than 2004’s eight-month rate. In August, food prices rose 0.9% above August 2004 levels; grain prices declined 0.8% for the month. Industrial input prices—including raw materials, fuel, and energy prices—continued to rise, albeit at declining rates. These prices rose 9.5% on a year-on-year basis, down 0.9% from the previous year’s eight-month growth rate. However, prices of commercial products, excluding shipping and freight costs, increased by 5.5% year-on-year, which exceeds last year’s growth rate by 0.3%. Regulatory controls came to bear on real estate prices, slowing down price increases in early 2005. Based on data collected in 70 midsized and large Chinese cities, housing prices were 6.3% higher than in August 2004. The July 2004 to July 2005 comparison put the increase at 6.4%; this provides some preliminary indication that price increases have eased. Gross figures tie all of these analyses together. Estimated GDP growth for 2005 equals 9.4%. Looking at GDP by sector reveals that industry continues to outpace other sectors , even as its growth cools: growth in agriculture is estimated at 5%, for industry at 11%, and for services 9.3%. Fixed asset investment is estimated to grow by 25.3%, off 0.5% from the previous year’s pace. Consumer goods spending is estimated to increase by 12.8%, down 0.5% from last year’s nominal growth rate. However, when adjusted for prices, growth in consumer spending actually goes up a full percentage point since last year. Trade growth also continues to expand impressively. Estimates show a 29% increase in exports and a 19% increase in import volume. The trade surplus for 2005 will reach nearly 100 billion USD, eclipsing last year’s trade surplus of 60 billion USD. Data regarding rapid growth, low inflation, and job market stability bear witness to the success of economic policymaking and regulation. II. Challenges Ahead: Excess Productive Capacity and Threats from Globalization With the economy growing quickly and steadily, and with policies and regulations in place regulating financial markets,2 China stands poised

2 Chinese policymakers and commentators sometimes refer to these controls as the “double tight controls,” since they maintain a dual focus on controlling access to credit for fixed assets and real estate investment.

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to enjoy solid economic returns in 2006. Other macroeconomic controls have also served to improve economic function, particularly exchange rate reform and energy price adjustments. However, two key challenges remain: reining in excess productive capacity and dealing with threats produced by the globalization process. Two of the most acute concerns arising from globalization will be discussed below: increasing exposure to economic volatility from abroad as a result of political pressures and the dangers of exposure to oil price volatility. A. Investment Growth Continues to Expand Productive Capacity and Output Investments made now contribute to aggregate demand in the current period, but aggregate supply in future periods. Extrapolating backward, one can easily see that the massive volume of investment in recent years will swell aggregate supply—specifically, productive capacity—in the current period and beyond. It just so happens that a substantial number of the projects paid for by past investments are coming online in 2005 and 2006. This spike in productive capacity will produce a variety of unwanted effects. The example of building materials production clearly portrays the problems that can arise. For instance, of the 4,400 concrete producers nationwide, 1,900 operate in the red or on razor-thin profits. Total profit dropped 77% through Q1 and Q2 of 2005. Of the 125 aluminum producers, 39 shuttered their operations and another 55 recorded net losses. Steel producers may be next to feel the pinch. Production will reach 322 million tons, up about 5.9 million tons from last year’s total. Output will almost certainly exceed domestic demand. If this happens, we may see many producers barely earning profits, losing money, or worse, going out of business altogether. We can also expect prices to fall, which is good for some and hard on others. A variety of industries may face capacity over-expansion in 2006, including the automotive, pane glass, synthetics, electric power generation, and coal production industries. Even with regulatory and macroeconomic controls in place, investment growth has not slowed down enough to avert the creation of overcapacity in these and other industries. More troubling, an upsurge in investment seems to have initiated a new round of projects between June and August. Going back to the beginning of the year, we can see that 114,000 projects began in 2005

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through August. This exceeds the 2004 eight-month total by 19,808. Moreover, the rate at which new projects have started has gone up to 21.1% in the first eight months of 2005 as compared to 7.4% from the same period in 2004. This increase seems to be concentrated in the summer months: during June 24,000 projects started, July added 14,000 more, and 19,000 began in August. This rapid run up in project development produced a more chaotic investment environment, which flies in the face of the overall effort of maintaining steady, well managed, growth. B. Globalization Processes and Pressures Expose China to New Risks 1. Increasing Tensions in the Trade Sector The trade sector has entered a period of transition in 2005. Up to this point, exports and imports have registered rapid growth rates, but now export growth has increasingly outpaced import growth. Exports amounted to 475.67 billion USD through the year’s first eight months. This amount is 32% higher than last year’s eight-month total. Import volume reached 415.44 billion USD for the period, a 14.9% increase. This put the trade surplus at over 60 billion USD; last year China ran a trade deficit of about one billion dollars through August. Several factors caused this shift, some predictable, and some not. A key contributor has been the large influx of foreign direct investment (FDI), which has generated export capacity—especially in goods processing.3 However, FDI has only a negligible impact on import demand. Aggregate domestic demand further softened under the pressure of macroeconomic policies designed to curtail investment demand, making the investment sector more manageable and steady in its growth pattern. These trends and outcomes could be anticipated; however, a rapid run-up in international energy and raw materials prices—especially petroleum goods and certain key metal imports—caused import activity to spike in 2004 and rapidly decline in 2005 as prices eased. Taken together, this produced a sudden jump in the surplus. Other figures help to illuminate trade activity at a more granular level. Goods exports for the first eight months of 2005 saw a 35.3% year-on-year jump, besting last year’s growth rate of 32.7% growth by

3

Goods processing accounted for 62.1% of the trade surplus.

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2.6%. On the other hand, goods imports rose 9.2% over the period, down more than 28.6% off of last year’s growth rate. The trade surplus on goods amounted to 22.8 billion yuan in the first eight months of 2005; a goods deficit of 14.8 billion yuan was realized through August of 2004. The international regulatory system also played a role in realigning China’s trade sector. By gaining admission into the World Trade Organization (WTO) on December 11, 2001, China has faced a new regime regarding trade rules and tariffs. With tariff rates changing throughout the years, many firms concentrated import activities in one time period versus another. In particular, changes in 2004 prompted firms to concentrate import activities in the first part of the year in order to enjoy savings available through the lower tariffs in effect during this time. Import activity dropped in the second half of the year as the rate increased. This contributed to trade deficits through Q1 and Q2, and surpluses in Q3 and Q4. Over time, the discrepancy between early and late-year tariffs will decline; as the two rates converge, this kind of fluctuation will attenuate. The currency exchange situation also puts pressure on firms and policymakers involved in China’s trade sector. Many foreign countries have complained that the renminbi’s (RMB) value has been kept artificially low. With the RMB’s value pegged to the value of the USD through most of 2005,4 these complaints continued unabated through more than half of the year. Even after the central bank moved to a managed float on July 21, 2005, many foreign trade interests abroad remained querulous about currency values. Chinese firms that rely on export markets have long braced for a protectionist backlash initiated by those countries that continue to complain the most vociferously.5 Firms have an incentive to move as much product as possible before the backlash comes and/or further appreciation of the RMB takes place. For instance, textile companies have worked at a feverish pace to move product, by completing orders at a breakneck pace and lowering prices when deemed necessary. On the other hand, the possibility of the RMB’s value increasing encourages importers to wait to make

The pegged rate was 8.28 RMB to 1 USD. The managed float system implemented by the People’s Bank limited the RMB’s appreciation against the dollar to 2%. 4 5

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orders from abroad since they could enjoy a de facto discount if they make purchases at more favorable exchange rates. Calculations and estimates show the current and growing importance of net exports on the Chinese economy. The data show that export growth makes up 35% of GDP growth. International demand for Chinese goods continues to increase, reaching unprecedented levels. This begs the question: how much is too much? That is, has the Chinese economy become overly dependent on the demands of foreigners and exogenous economic conditions? Continuing on this path could expose China to substantial and potentially damaging risks. Increasing trade surpluses, foreign currency holdings, upward pressure on the RMB all create more frictions in the international trade environment. To some degree, these problems cannot be managed by China alone, making this area of policy and regulation perhaps the most complicated and difficult set of issues faced by policymakers. 2. Price Fluctuations on International Markets Produce Instability in the Chinese Economy Worldwide prices of commodities used in industrial production have risen to unprecedented levels during 2005. The International Commodity Price Indexes prepared by the Price Monitoring Center of the National Development and Reform Committee (NDRC) indicate that the rate of increase for international commodity prices picked up speed in August after a smaller rise in July. China’s International Price Index A, which mainly reflects the level of international commodity spot prices, increased by 21.3% between July and August. The August 2004 to August 2005 increase is 15.33%. China’s International Price Index B, which reflects changes in commodities futures’ prices, increased by 4.82% between July and August. The year-to-year comparison for August 2004 to 2005 yields an increase of 28.61%. Although China has adopted an array of measures designed to regulate commodity and productive input prices, domestic and international demands have continued to drive prices upward. However, evidence of a slowing rate of increase has come into view. For instance, from January to August, purchase prices of raw materials, fuel and energy rose 9.5%, down 0.9% from last year’s eight-month rate of 10.4%. Growing productive capacity also puts downward pressure on retail prices and helps to blunt the impact of input price increases, at least for goods consumers. Producers, on the other hand, cannot recoup these additional costs in final prices, and therefore, experience falling

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margins, as explained above. This condition of rising input costs and falling profits has raised concerns in many quarters. Increases in international oil prices have produced alarm, largely because of the nation’s enormous energy demands. According to the best available estimates, international oil prices in 2005 ranged between 55–60 USD, up 35%–45% year-on-year. Econometric results show that this price increase could produce a 0.5%–0.7% reduction in Chinese GDP. Furthermore, the CPI will likely increase 0.8%–1.2% in response to oil price hikes. Estimates put the change in the producer price index (PPI) at 3.2%–4.0%. Clearly, this issue demands the attention of leaders and policymakers to contain the impact that oil price increases, and input price increases generally, could have on the economy. III. How the Economy Can Stay on a High-Growth, Low-Inflation Path in 2006 A. The Slowing Economic Growth Rate The global economy will grow steadily in 2006. The United Nations (UN), the International Monetary Fund (IMF), and the World Bank all estimate that the growth rate in 2006 will roughly equal the 2005 rate. Growth of world trade in 2006 should move up from the 2005 rate. A variety of factors dampen global economic and trade growth. For instance, the US Federal Reserve (The Fed) continues to raise interest rates in the US.6 This suppresses demand in the US, both for domestic goods and imports. Because the US buys such a large volume of imports, a contraction in import demand there affects economies worldwide. Second, high and rising oil prices will definitely put a drag on economic growth, especially in oil-poor developing nations. Third, increasing trade frictions threaten to slow down trade worldwide, and particular trade restrictions and regulations will certainly have a dampening effect on Chinese export activity. Domestic conditions and policies also will have a profound impact on economic growth. Careful and increasingly expert application of macroeconomic controls has certainly kept the economy on its steady high-growth path. Government has applied controls more widely and

6

The technical term is “discount rate.”

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quickly whenever economic threats loom. Intervention has been particularly successful in the finance industry, where reforms have improved operations of financial institutions while at the same time better regulating real estate markets. Economic management has also exhibited a strategic element aimed at expanding capacity of crucial productive inputs. These efforts helped correct shortages of coal, electricity, oil, and transportation. By expanding supplies and output, these input prices will fall, and profits (other things being equal), will rise. Unfortunately, this effort may have worked too well, since productive capacities may have over expanded, producing surpluses, price declines, and once again, thinner margins. Finally, exchange rate policy will affect overall economic growth. Post-reform, the RMB’s value has gone up, but with the 2% cap on appreciation firmly in place for the foreseeable future, no real surprises or shocks seem likely in currency markets. Taken together conditions seem primed for the Chinese economy to continue its rapid expansion, provided that no catastrophic economic shocks undermine the conditions and trends currently at work. Specifically, estimates put GDP growth at 8.8% in 2006, off 2005’s rate by 0.6%. Agriculture will grow at a rate of 4.5%, substantially below 2005’s rate of 5.0% and 2004’s pace of 6.3%. The industrial sector, reacting to a contraction in investment, will grow at about 15.5% in 2006, up from the 11.0% growth rate of 2005 and down from 2004’s growth rate of 16.7%. The service sector will grow by 9.2% in 2006, riding a rising wave of consumer spending being redirected toward service providers. Unlike the other two sectors, growth in the service sector in 2006 will roughly equal its 2005 growth rate. 2. Fixed Asset Investment Growth will Decelerate Even though the growth rate of fixed asset investment continues to climb, it will do so at a slower rate in 2006. Note that this slowdown should not be taken as a danger sign; fixed asset investment growth is merely cooling to more manageable levels. Moreover, investment activity continues to be strong. From January to August 2005, projects valued at 3,997.5 billion yuan were in the planning stages. This figure marks a 28.4% year-on-year increase. However, many projects made the transition from planning to construction: last year only 27.3% of projects were under construction; this year the proportion soared to 64.3%. This pace may increase as the 11th Five-Year Plan gets underway, which will likely be marked by a flurry of infrastructure construction.

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Fixed asset investment rates will decline through 2005 into 2006 for several reasons. Regulatory controls put in place by the central government have tightened credit, curtailed speculation in real estate markets, and slowed increases in the money supply. New restrictions on agricultural land being converted for commercial or housing limited some investment options. Medium and long-term loan activity has slowed as well. By the end of August, total medium and long term loans outstanding amounted to 7.69 trillion yuan with a year-on-year increase of 17.8%, off 8.1% from the previous year’s 25.9% growth rate. Now that the scale of excess capacity is better known, investors have reacted predictably by putting less capital into more productivity expansion. With supplies increasing, and prices and margins falling, returns on investments will decline as well, further cooling investor enthusiasm. Finally, with returns on investment dropping, and with trade frictions increasing, fewer firms will send production contracts to China. From January to August, foreign investment used in productive endeavors amounted to 37.993 billion USD, up 3.02% of last year’s eight-month total. Note the small rate of growth in this figure relative to other investment growth figures cited here. When all is said and done, estimates of growth for fixed asset investments during 2006 will rise about 20% from the 2005 amount, but this rate is 5% lower than the 2004 to 2005 growth rate. 3. Consumer Spending will Increase Slowly but Steadily Consumer spending will continue to increase in 2006. A variety of favorable factors will push this process forward. First, income growth in rural areas continues to pick up speed, building on two years of momentum. Price supports on grain have been especially important in realizing this end. Such moves will help to increase farmers’ incomes by 6% in 2005. Policymakers hope to build on these gains to encourage spending on consumer goods, such as electric appliances. Second, incomes in urban areas continue to climb quickly. With the middle class growing in number and spending power, consumer spending among upwardly mobile urbanites has become the engine that pulls the train of consumer market development. Various policies implemented in 2005 have helped fuel spending, such as raising the minimum wages in many localities and padding unemployment benefits. Local governments will continue on this path in 2006, using various policies to shore up incomes among moderate and low-income

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earners. For instance, many lower-level public employees will receive wage hikes. Lower income earners will also be helped by changes in the tax code. Raising the minimum income for being required to pay income taxes from 800 to 1,500 yuan immediately cuts expenses for those living on the tightest budgets. However, this standard has not been implemented nationally; doing so would liberate a substantial sum to be redirected toward consumer spending, especially in rural areas. Fourth, various state payments and directives will help to drive consumer spending. Strengthening the social security system is but one element in this process. Placing caps on tuition levels and limiting the use of special educational fees will help households save money, which can be redirected towards consumer goods spending. Better still, free and compulsory elementary and middle school education has become available in some localities. Moves have been made by various authorities to strengthen comprehensive medical care and offer it more widely. Housing subsidies to some government employees also serve as a net income transfer, allowing households who would have struggled to pay for housing, to meet their housing needs and to purchase needed consumer items. Various factors will work against increases in consumer spending during 2006. First and foremost: high oil prices, which tend to push prices up for all manner of goods and services. This will especially hurt automobile consumption, one of the lynchpins of economic growth in China. Second, continued controls on real estate markets will dampen growth somewhat. Third, hoped-for increases in rural incomes may come up short. In sum, though, consumer spending will continue to grow at doubledigit rates: about 13% in 2006. This beats last year’s growth rate by 0.5% in nominal terms, and 11.7% in real, which is 0.2% higher than 2005’s real consumer spending growth rate. 4. Easing the Expansion of Trade As noted above, global economic conditions favor rapid trade expansion in 2006. China has risen to meet this challenge as its firms become more competitive and the quality of its exports improves. With investment on the rise while domestic demand cools, firms have had to direct output toward export markets as a way of distributing surpluses and fending off the effect of internal competition. On the other side of the trade ledger, a combination of factors may renew import growth. The slowing growth rate of investment will result

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in softening demand for productive inputs. As prices ease, more money can be redirected towards new import purchases. Furthermore, as newer and better productive technology comes online, and capital stocks are upgraded, productivity will rise. This should help firms become more profitable, and at the same time, raise wages. Both effects should help to stimulate import demand. Participation in the WTO will further integrate China into the global economy such that more imports will flow into the country. Conversely, various factors will work against the expansion of trade. First, as the trade surplus approaches 100 billion USD in 2005, various trade barriers will be erected. At the same time, many policymakers inside China will work to reduce the surplus as a way of preempting, or at least ameliorating, trade frictions. Second, the threat of currency appreciation could dampen demand for Chinese exports. However, if appreciation goes through, import demand would certainly surge. However, policymakers seem unlikely to allow the renminbi to increase more than 2% in 2006. Third, with input prices still on the rise, albeit at slower rates of increase, Chinese goods will face mounting price pressures, which will affect the quantity moved through export markets. At the same time, many of these inputs will be imported (e.g., oil), which means that a large component of import demand will remain strong. In sum, trade will continue to grow steadily in 2006. Exports and imports are estimated to grow about 20% each. The trade surplus will rise to about 117 billion USD. 5. Household Consumer Goods Prices will Remain Stable In essence, downward pressure on price increases will cancel out upward pressure. Slowing rates of investment growth, and output increases, will soften prices, as well as increased capacity in raw materials markets. On the other hand, oil price increases and strong consumer demand will continue to push prices upward. Various indications suggest that pent-up demand for energy and other inputs have not been fully released, placing further upward pressure on prices. Monetary policy will essentially have a neutral effect on prices as M1 and M2 both expand steadily and predictably. In sum, inflation will pick up some momentum during Q1 and Q2, but will slow down in Q3 through Q4. Consumer goods prices should rise by 2.5% for the year.

china’s prospects regarding sustained economic growth

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IV. Macroeconomic Regulation will Moderate both Growth and Price Increases in 2006 7 As with economic policy in many countries, the dual aims of policymakers in China will be to encourage growth and contain prices. Fulfilling this aim will depend on building aggregate demand component by component. Domestic consumer and producer demand will play an increasingly important role in this process. Keeping regulatory controls in place on investment will slow growth, but also support stable and manageable market function. And while trade surpluses will not grow as rapidly as they have in recent years, they will still expand, further adding to GDP growth.8 Timely and assertive application of economic control measures will help the economy to attain this outcome. A variety of measures, some of them described in this paper, can boost consumer and producer spending. Regulatory controls at work in the investment sector not only have a short term impact, but a longer term impact as well, making their use especially important. While certain aspects of trade remain outside the control of domestic policymakers’ control, some crucial policies, like capping the Renminbi’s value, have a profound effect, and should be used without hesitation, and where possible, preemptively. A. Fiscal Policy should Encourage Consumer Spending Energizing aggregate demand will require that new attention come to bear on expanding consumer spending. Consumer demand in rural areas continues to be a weak link in China’s economy, and increasing incomes in rural areas would go a long way toward correcting this problem. Fortunately, the “Three Agricultural Issues” policy framework provides a solid foundation upon which to build in achieving this aim. Experiments that have tinkered with tax reductions should become standard policy and be more widely applied. Price supports for crops should be increased and applied to 7 Chinese policymakers and commentators sometimes group these policies under the name “double moderate” policies. 8 The other component of aggregate demand, government spending, is not explicitly described here because a thoroughgoing analysis of such spending lies outside of this paper’s scope. However, increases in social spending programs and public infrastructural development described here certainly underscores that government spending will increase through 2006 and beyond.

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a wider range of crops. Furthermore, administrators should expend greater effort on paying subsidies in a timely fashion to all who qualify and with a minimum of paperwork. Not only should crop prices be stabilized, but the price of inputs should be better managed to remove volatility in production costs, and by extension, profits. Other policy measures mentioned above can help peasant households even if they do not directly treat farm production problems. For instance, providing sufficient support to guarantee free compulsory education should become a national policy. Cooperative medical care for rural dwellers can raise peasants’ living standards and reduce their expenses. In essence, such policy measures transfer income to recipients of services. Note, however, that these kinds of programs make the transfer in the current period, but produce impacts over a very long term, or even a lifetime. Fiscal policy, tax collection, and government spending can serve to achieve a more beneficial and efficient balance between consumption and investment in both rural and urban areas. Where possible, tax burdens should be eased, and the breadth and quality of public services, such as education and medical care, improved. Wages for public servants should increase. Income guarantees should be raised. The social safety net should be broadened. However, efforts to encourage employment should not suffer as a result of these policy moves. Of course, many of these projects depend on government spending, and to realize these benefits, fiscal deficits and the national debt should retain their present scale. In sum, this will keep the central government’s deficit at about 300 billion yuan. This level of deficit spending should allow the government to complete key national infrastructural projects and shore up weak points in social spending programs. Bonds in the order of 60 billion yuan should cover current long term construction expenses. Of particular interest are those projects that will encourage household expenditures, like utility and transit development. Funding these expenditures will require tax revenues, of course. To ensure that funds exist and that revenues be redirected toward meaningful programs, tax reforms should be applied more broadly and the process accelerated. Most important, corporate taxes require consolidation and simplification. This will help to simplify and enhance the competitiveness of Chinese-based operations, while making collections more straightforward. On a related note, the value-added tax (VAT) should be further reformed based on the successfully test-case put into effect in northeast China. Reform should focus on limiting VAT tax

china’s prospects regarding sustained economic growth

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assessments to new machinery and equipment purchases. Such changes should be applied nationally. Taxes on resource inputs should be revisited. This part of the tax code is not well understood. Moreover, changing conditions regarding global resource prices and domestic environmental costs practically demand that new rates come into place and that these taxes apply to a broader set of goods and raw materials. Beyond this short term need, resource taxes can be a lever by which China can catapult itself into newer, cleaner, and more efficient modes of production. Common sales taxes need adjustment as well. Rates currently in place may cause unneeded market distortions. Goods that directly or indirectly generate pollution need to be taxed more heavily. This reasoning would call for fuel taxes to begin taking effect in the near future. B. Monetary and Financial Policies should Concentrate on Fine Tuning “Moderation” should be the guiding principle behind monetary policy in 2006. Credit should remain sufficiently relaxed to maintain economic growth. At the same time, restrictions should remain in place and be fine-tuned. Money supply should grow slowly and steadily to keep economic growth and inflation rates on target. Open market operations should be applied as needed in order to favorably influence foreign currency values. Interest rates should move predictably. In short, the “loose yet tight” system currently in place should not be radically adjusted. Commercial banks should aim to further rationalize operations. Loans from different regions, industries, and firms should be assessed on a case-by-case basis using the best available data and subjecting each application to thoroughgoing due diligence. Those applicants who have established a successful track record in providing high and timely returns on investments should move to the head of the line. At the same time, new applicants with real promise should receive support. Applicants looking for a deal through social connections should be handled cautiously. Systems and instruments for financing small and midsized enterprises should come online, with a particular emphasis on funding businesses in outlying areas. Real estate finance also requires some adjustment. More should be done to finance applicants wanting to move into high-density and affordable housing developments. The current tendency to apply nearly uniform tests regarding loan applications should go by the boards. Developing databases containing personal credit information, and

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services that provide such information to interested parties, will go a long way toward allowing banks to judge each application on its own merits. Taken together, these moves should support an expansion of consumer spending, and with it, domestic aggregate demand, while keeping the lid on financial market volatility. Financial market reform demands that process focus on state-owned commercial banks be continued, expanded, and accelerated. Those banks with the most developed structure and financials should be given priority for being listed on national stock exchanges. In general, greater strength and facility should be developed in using stocks and bonds to finance operations and ventures, especially those that cannot gain access to bank loans. Finally, regulatory reforms that influence economic structure should seek to support the “Three Benefits”: encouragement of independent innovation; increased use of resources, especially energy; and increases in employment. C. Resource and Public Service Prices should be Managed in Line with CPI and PPI Targets Policymakers need to continue efforts to push resource input and public service prices down to optimal levels. Petroleum prices will require the most attention. By gradually letting oil prices rise, currently capped price pressures can be released, but not so quickly that a price shock is sent through the economy. Increasing prices should encourage the rebuilding of domestic refining capacity, which should increase supplies and serve to hold prices down in the long term. However, prices should not rise to worldwide levels. Prices of other energy resources need to be integrated within a comprehensive framework that considers total energy needs. Under such a system, prices of coal, electricity, and natural gas will all rise, but again, in predictable, steady fashion. Utility resources, such as water and public transportation, need to be managed in coordination with macroeconomic policy and strategy. Prices for other public resources, such as tourist attractions and parklands, should be held in check. D. Miscellaneous Policy Moves that could Boost Consumer Spending Increasing consumer spending requires that the quality and variety of goods and services be broadened and deepened. The dual lynchpins

china’s prospects regarding sustained economic growth

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of economic growth in China—the real estate and automobile industries—require attention on several fronts in order for each to attract the spending levels needed to drive economic growth. As with other key policy-influenced industrial activities, the catch phrase is “steady growth.” Conditions for new property have been addressed above, but the secondary housing market also deserves the attention of policymakers. Policy guidelines for this market segment need to be written and widely circulated post haste. As with the new housing market, prices have shot up for lived-in houses, and this has lead to various unwanted outcomes: speculation, consumer frustration, and strains on financial markets. The automotive industry also requires some degree of government intervention and guidance. Of particular interest is encouraging the use and development of economical cars, especially cars with engines smaller than 1.6 liters. Furthermore, developing the infrastructure needed to support automobile use needs to be accelerated and carried out more broadly, especially road and parking lot construction. Sales taxes should be eased to spur sales. While big-ticket items like houses and cars have a larger percentage impact on household spending, day-in-day out contributions to spending come from purchasing smaller items. To enrich this market segment, product quality improvements should be encouraged. Distribution should be improved; for instance, building more urban malls can simplify shopping trips and allow consumers to spend more time shopping for goods and less time traveling between stores. The rural market could be better served by making shopping destinations more readily available in small towns. Various investment entities should be encouraged to build such stores and the necessary infrastructure to support them, like roads. Consumer products distributors need encouragement to better serve outlying areas; incentives like tax breaks could help to fulfill this goal. Rural fairs, marketplaces, and bazaars should be transformed and upgraded into chain stores and/or franchised operations in order to facilitate better end-to-end product distribution, while assuring that higher quality national and international-level brands become available to those who can afford them in the countryside. Savvy distributors could specialize in serving these areas, and as this market segment grows, they could find themselves riding a rising tide of spending. Even though the service sector has yet to achieve the total scale of the industrial sector, it holds greater long term promise for China’s continued economic growth. The quality and technical standards of services

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need to rise, as well as the expertise of service providers. Researchers and policymakers need to work together to develop market niches that serve a variety of human needs and wants. By actively searching out and developing niches and services, the service sector can continue to grow, providing increasing percentages to GDP growth in the future.

OPERATIONS OF THE CHINESE ECONOMY IN 2005 AND GROWTH PROJECTIONS IN 20061 Wang Jinming, Gao Tiemei, and Chen Fei GDP in China equaled 9.5% for 2004, and the same growth rate was achieved through the first two quarters of 2005. Macroeconomic regulation dampened investment rates through this period, averting various unwanted difficulties. These include: price spikes for productive inputs, speculation in real estate, and vast, rapid influxes of capital going into certain geographic areas or certain kinds of investments and projects. All of this has been achieved while keeping inflation low, giving rise to an unprecedentedly positive trend in China’s macroeconomic development. This begs the question: can it continue? Will the economy grow rapidly and steadily going into 2006 as the 11th Five-Year Plan (FYP) begins? This paper addresses these questions by examining a variety of macroeconomic indicators regarding current economic conditions and trends at work in China in 2005. The hope is to craft an “economic early warning system” that allows for projections into 2006, with a close eye to averting potential problems that could thwart steady economic growth. I. Analyzing Current Macroeconomic Conditions in China To better analyze the economy’s operations, we cooperated with the State Information Center. The Center provided data; we selected three groups of monthly macroeconomic trend indicators, grouping them by type: leading, current, and lagging. Table 4.1 summarizes these data.2 1 The paper is sponsored by the National Social Science Foundation Project, Project Number 05BJY013. 2 The indicators are sequences of year-on-year, seasonally-adjusted GDP growth rates. Irregularities have been eliminated from the data. Data cover the period January 1995–August 2005. The data come from the People’s Republic of China’s Quarterly Statistical Bulletin, the China Monthly Economic Indicators of the State Statistical Bureau, and the China Economic Information Network (www.cei.gov.cn).

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wang jinming, gao tiemei, and chen fei

126.00

118

118.50

112

111.00

106

103.50

100

96.00 1997

94 1998

1999

2000

2001

2002

2003

2004

2005

(Year)

Figure 4.1: Composite Index (CI) (Solid line, coordinates on the left) Leading Composite Index (LCI) (Dashed line, Coordinates on the right)

The trend indicators used here depend on other data: a diffusion index,3 a tendency index4 that reflects the fluctuations in macroeconomic growth, a diffusion index,5 a composite index,6 and a principal-component analysis.7 Together these elements lay the foundation for developing and testing a macroeconomic monitoring and early warning system. A trended simple weighted index (SWI) based on a state space model8 is also used. These methods yield very similar results. The remainder of the paper will focus on results generated by the composite index (CI) and the leading composite index (LCI) of overall dynamic macroeconomic growth conditions. According to the monthly macroeconomic composite index (CI) established by this research team (with the 1998 average taken as the 3 A diffusion index shows how many components of a given indicator are moving with the overall indicator. 4 A tendency index, also known as a business tendency index, is an unweighted average of the indicators used in the data. 5 A diffusion index summarizes the shared tendency of a series of related observations. 6 The composite index here distills a variety of growth indicators into a single index. These indices typically outperform single indicators because they contain more data in a single figure. 7 Principal component analysis refers to a statistical estimation tool that simplifies multivariate, multidimensional data to a lesser number of dimensions. 8 A state space model provides a method for grouping trend data in order to improve estimation accuracy.

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base value of 100), economic growth in China reached the bottom of a trough in May 1998 before launching into a long and period of rapid growth.9 The economy has gone through two small troughs since then. In early 2002, the economy entered a period of exceptionally rapid growth, only taking a short pause in 2003, before accelerating again. The CI reached 125.87 in March 2004, its highest point since 1997. Since peaking, it dropped off slightly until March 2005, before once again taking off on an upward trend beginning in April 2005. This upward trend continued through August 2005, the last month for which data are available. The leading composite index (LCI) projects nine months in advance of the composite index. From June 2004 until April 2005, it climbed before beginning a period of decline in May 2005. This slide continued through August. (See Figure 4.1.) Estimates have the LCI going back on an upward trend for two to three quarters, reaching a peak late in the first quarter (Q1) of 2006 or early in Q2, before entering a new period of decline. Connecting this with the CI suggests that the Chinese economy will enjoy rapid growth from late 2005 and through Q2 2006. Then growth will slowly decline through the remainder of the year. This pattern of moderate climbs and slight declines reflects the impact of macroeconomic regulations put in place in early 2005. Based on the trend data used here, these controls have been completely successful in producing a more orderly and steady growth pattern in China. Investment has continued to be strong, but less chaotic. Production has not overheated under the influence of capital influxes. Inflationary pressures, especially for input prices, have eased. And most of all, growth has slowed, but continues to be quite brisk. In the analysis below, the authors use ten indicators (e.g., industrial value-added) to form the monthly early warning system, which they use to analyze current macroeconomic conditions. (See Table 4.2.) The growth trend beginning in Q3 2002 pushed the index into a level the authors define as “the yellow zone,” indicating moderate overheating. The index remained in this zone until 2004, when regulations began cooling certain areas of economic activity. The index moved back into the “green zone” in August 2004, and continued moving down into the lower part of the zone until April 2005. In May 2005 the trend finally

9

The CI value for May 1998 is 96.79.

62

wang jinming, gao tiemei, and chen fei Table 4.1: Monthly Economic Trend Indicators

Leading Indicators

Current Indicators

Steel Output

Industrial Value-Added Finished Product Inventory Electrical Power Balance of Current Assets Generation Finished Product Sales Consumer Goods Sales (Retail) Fixed Asset Investment Retail Products (less freight) Money Supply, M1 CPI11

Crude Oil Output Real Estate Investment FDI (Actual Utilization)10 Industrial Productionto-Sales Ratio Fiscal Expenditures

Fiscal Revenues

Finished Goods Inventory* Retail Products (less freight)*

Lagging Indicators

Savings in Financial Institutions

Note: All indicators are sequences of year-on-year seasonally adjusted growth rates and time sequences that eliminate irregularities. * Indicates a reverse indicator.

reversed course and continued rising until August, the last month for which data are available. The trend suggests that the economy could once again approach the yellow zone by Q4 and move into in Q1 or Q2 of 2006. Various policy correctives and internal adjustments should have the index moving downward through Q3 or Q4 of 2006. (See Figure 4.2.) Table 4.2: Monthly Early Warning Indicators Industrial Value-Added Growth Industrial Products Sales Revenue Growth Electrical Power Generation Growth Fixed Asset Investment Growth Consumer Goods Sales (Retail) Growth

Goods Trade Growth Financial Revenue Growth CPI Money Supply (M1) Growth Growth in Outstanding Loans

10 FDI = foreign direct investment; note that the figure here indicates FDI being used, not FDI under contract. 11 CPI = consumer price index, one of the most common inflation measures.

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100 85 70

40 20 0

1997 1998 1999 2000 2001 2002 2003 2004 2005 (Year) Note: Overheating

Heating

Normal

Cooling

Overcooling

Figure 4.2: Charting the Composite Index Month-by-Month

II. Analyzing Economic Operational Characteristics in 2005 Since 2003, the government has adopted a series of policies to address potential and realized economic overheating. These policies have performed admirably: inflationary pressures have been defused, chaotic markets have settled into steadier operational patterns, and GDP has continued to grow vigorously. These and lingering problems indicate deeper and perhaps fundamental imperfections in the market economy. These shortcomings merit close analysis. A. Rapid Growth with Low Inflation During 2005 the Chinese economy enjoyed strong performance, as growth remained high while inflation stayed remarkably low. In August 2005, the CPI moved upward at a 1.3% annual pace. Prices for the quarter barely moved, going up only 0.2%, the lowest rate since September 2003. During August, food prices increased by 0.9% faster than in August 2004—with grains dropping 0.8%. Non-food prices climbed by 1.5%. Consumer goods rose by 0.5%. Commercial products prices (less freight) surged by 5.3% compared to the August 2004 level. However this goods category experienced 5.2% inflation during August 2004 and

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Name of Indicator

9

10 11

2005 12 1

2

3

4

5

6

7

8

61

53

61 64

1. Industrial value-added growth 2. Finished Product Sales Growth 3. Electrical Power Generation Growth 4. Fixed Asset Investment Growth 5. Consumer Goods Sales (Retail) Growth 6. Goods Trade Growth 7. Financial Revenue Growth 8. CPI 9. Money Supply (M1) Growth 10. Growth in Outstanding Loans Comprehensive assessment Note: Overheating

62 62 66 64 58

Heating

Normal

55 50 48 Cooling

Overcooling

Figure 4.3: Early Warning Signal Indicator

July 2005, so the trend has remained remarkably stable. Raw materials and fuel prices rose 8.1%. Rising crude oil and unprocessed coal prices drove this increase: crude oil prices shot up by 36.2% over last year’s level; coal prices jumped 23.7%. Service prices picked up by 4.0%. Figure 4.3 graphically portrays the impact of macroeconomic policies that steered the economy toward steady, predictable, and balanced growth. Note the periods where the CPI stays in the green zone as opposed to those periods where prices quickly increase, as in 2002–2004. By August 2004, the CPI peaked at 5.3%. Even while this happened on the surface, structural shifts had reshaped the economy at a deeper level. Consumer goods producers had built up productive capacities, allowing them to readily meet surges in consumer demand as needed. This ability to generate supplies produces downward pressure in the end-product market segment. This shift offset the sharp increases in input prices during 2004. Immediately before

operations of chinese economy and growth projections

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and during that year investment surged, causing the demand for key resource inputs such as coal, electricity, and oil, to run in short supply. This generated a sellers market, which they exploited by raising prices to record levels in a very short period of time. Government intervention tightened credit policies in response, in an effort to reduce the flow of capital going into various projects. The gambit worked: investment growth slowed, and in response, input prices began to level off. In fact, price increased decelerated so quickly that some observers feared the onset of deflation. Various indicators suggest that deflationary threats should be taken seriously: excess productive capacity continues to grow and money supply growth has been weak. Economies that have lapsed into deflationary spirals have manifested these conditions. However, a variety of factors offset and probably overwhelm these threats. Production costs are still rising, albeit more slowly. Wages continue to climb as the productivity and skill level of Chinese workers improves. Oil prices continue to increase, and will probably continue their upward climb for the foreseeable future. These input prices will insinuate themselves through all manner of production systems, putting upward pressure on a variety of goods and services. While this works against deflation, it creates other problems. This dynamic squeezes profits, and in many cases, pushes firms into the red. Increasing costs and reductions in profitability cut into current and future economic growth as well. To offset these effects, product demand needs to increase. B. Fixed Asset Investment Growth Rates have Rebounded Slightly In April 2004, the government implemented several related regulatory policies aimed at reining in credit and fixed asset investment. These regulations brought the economy to heel, bringing greater stability to a variety of markets. During 2005 fixed asset investment indicators eased into the green zone and then turned upward. By August 2005 growth had increased to a 28.5% year-on-year pace. During June industrial value-added briefly crossed into the red zone. (See Figure 4.3.) Macroeconomic management has done more than tighten credit. It has redirected investment into building production capacity for key inputs such as oil, coal, natural gas, electricity, various raw materials, and transportation infrastructure and services. Beginning in 2004, this process began to expand production for these resources, which helped to reduce production prices broadly in 2005.

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From January through August, coal mining, processing, and refining operations took in 54.6 billion yuan of new investment, a whopping 81.9% year-on-year increase. Investment in oil and natural gas extraction reached 77 billion yuan, up 25.6% from 2004’s eight-month total. Railroad infrastructure and services obtained 50.4 billion yuan, a 39.2% hike. Utilities involved in electrical power generation and distribution, fuel distribution, and water provision, received 399.1 billion yuan, up 35.1%. Investment continues to climb on the back of continued investor interest, locally initiated projects, and a number of industries still enjoying very strong profitability growth rates and returns on investment (ROI). From January through August 2005, the total investment in local projects reached 3,676.1 billion yuan, up 29.5% from last year’s eight-month total. Total investment in projects organized under central government auspices amounted to 439 billion yuan, a 12.3% year-on-year increase. Clearly local governments dominated government-sponsored investment. With energy supplies up, and demand easing, shortages and price increases have eased. This trend could continue since investment declines have redirected investment away from the most energy-hungry industries. But since growth will continue to drive up demand in the long run, energy production must continue to expand. Building productive capacity in the energy sector will take time, so periodic shortages and price hikes can be expected for another two or three years. In the meantime, economy-wide fuel reduction efforts have been discussed, along with an increasing emphasis on employing cradle-to-cradle economic systems.12 This change may well prove pivotal in assuring the sustainability of economic growth. As noted above, the rapid run-up in input prices, and expansion of end-product capacity and supplies, has squeezed profits. Profits have been in a steep decline through 2005. (See Table 4.3.) This has hurt investor confidence, further reining in total investment. 12 William McDonough coined the term “cradle-to-cradle” to distinguish this mode of thinking, design, and economic production from the more typical “cradle-to-grave” mode widely employed since industrialization. The cradle-to-cradle modality emphasizes reuse of materials in much the way natural systems use waste from one kind of process to serve as basic food or fuel in another. Note, though, that many Chinese policymakers, researchers, and commentators use the term “circular economy” to describe this system.

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Table 4.3: Profitability of industrial firms, 2004 and 2005 (%) Year 2004 2005

Jan

Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 47 15

48 18

48 16

46 17

43 21

41 22

40 23

41

41

40

39

D. Money Supply has Grown Slowly In August 2005 M1 reached 9.94 trillion yuan, an 11.5% year-to-year increase, and a monthly hike of 0.5%. Even though M1 increased it slipped into the blue zone of overcool growth for most of 2005, as shown in Figure 4.3. However, in August this condition eased and the indicator returned to the light blue zone, indicating that growth remained slow but would probably not stall completely. M2 growth also surged in August, reaching 28.13 trillion yuan, for a 17.3% year-on-year increase, and a full 1% increase since July 2005. A year-to-year comparison shows the strength of this rally, as M2 growth in August 2004 amounted to 13.6%. Since M2 grew more rapidly than M1, it seems clear that money supply growth was being driven by large increases in fixed-term deposits, mostly from corporations. E. Outstanding Loan Growth has Slowed too Quickly as Total Savings has Swelled Financial institutions continued to tighten credit policies, resulting in a declining rate of growth in the total volume of outstanding loans. Leading indicators show that the trend will continue until growth falls into the light blue zone, indicating some danger of stalling, as indicated in Figure 4.3. Surprisingly, loan markets have cooled as total savings have accumulated at an increasing rate. The month-to-month growth rate for August 2005 hit 18.3%. When taken together with the tightening of credit, it becomes clear that the value of total funds sitting idle is increasing at an even faster pace. This squeezes banks: they need to pay more to depositors while making smaller returns on outstanding loans. Fortunately, some pressure on banks has eased since reforms in corporate ownership and stock markets has given them new ventures to fund and provided many of their loan customers new avenues for acquiring capital.

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F. Capping Appreciation of the Renminbi Prevented a Contraction of Export Demand On July 21st 2005 the People’s Bank of China instituted a change in exchange rate policy that took the renminbi off of a peg against the dollar to a managed float that limited its value against the dollar to changes of ±2%. This small appreciation in value had virtually no immediate impact on exports, which rose to 67.82 billion USD, a 32% year-on-year increase. Note that this increase comes after a flurry of export activity completed in anticipation of RMB appreciation since doing so allowed exporters to enjoy trading at a more favorable exchange rate. Given present conditions, even this small appreciation will have a significant impact on the financial state of some firms. As noted above, margins have become very thin, and those firms waiting for large outstanding settlements will not receive as much in payment now as they would have some months ago. This burden may fall especially hard on textile and household appliance exporters.13 For now, the 2% cap on appreciation seems firmly in place, but for how long, no one knows. As well, no one has a solid handle on how much the cap may go up, if and when the Renminbi moves closer to a free float. Moving toward market-based evaluation may accelerate the transformation of foreign trade as it regards China. That is, a more valuable RMB will encourage operations, especially those owned by foreign firms, to upgrade the quality of their products and move up the value-chain. This should bring more high technology into China’s production centers, which will raise the skill level, and probably the wages, of Chinese workers. This kind of revision of production systems in China will help the economy grow—and grow more diverse and robust—in the long run. This process of change will not proceed evenly on all fronts. Traditional industries that currently enjoy strong comparative advantages will feel the impact most quickly and directly. Industries reliant on large volumes of raw materials—such as metallurgical manufacturing and processing, petrochemical refining and processing, automobile manufacturing, synthetics manufacturing, and plastics manufacturing—will benefit the most.

13 Note, however, that many contracts allowed for the change in exchange rates after the policy change, softening the impact of the transition.

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G. Even as Incomes in Rural Areas Increase, They Cannot Match Urban Income Levels A variety of policies have been implemented to improve the lot of peasants and farmers. Tax reforms have had a positive impact in this regard, so in 2005 this effort deepened. Governments suspended agricultural taxes in twenty-seven provinces and reduced rates to 2% in the remaining four. These cuts redirected 22 billion yuan to farmers’ and peasants’ pocketbooks. This and other policy changes, as well as market forces, have boosted rural incomes significantly. From 2001 to 2003 rural incomes increased by about 5% per year; however increases in 2004 and 2005 easily bested this rate. Unfortunately, these improvements have not substantially closed the gap between rural and urban incomes. (See Table 4.4.) Table 4.4: Mean Disposable Income for Urbanites and Rural Residents, totals and growth rates (RMB, %) Indicators

Q1 2004 Q1–Q2 2004 Q1–Q3 2004 Q1–Q4 2004 Q1 2005 Q1–Q2 2005

Mean Growth rate Mean Growth rate Disposable Disposable Income, Urban Income, Rural 2638.8 4814.6 7072.0 9421.6 2937.8 5374.0

12.1 11.9 11.4 11.2 11.3 11.6

834.3 1344.5 2109.5 3234.2 967.0 1586.0

13.2 16.1 17.1 10.4 15.9 18.0

III. Macroeconomic Projections for 2005 and 2006 Based on the above analysis, this paper conducts forecasts of major macroeconomic indicators using a variety of estimation methods: an ARIMA model,14 five different growth-curve models,15 and a variable

ARIMA stands for autoregressive integrated moving average, a statistical model used to fit time series data in order to make predications based on these data. 15 Growth curve models group data that show growth based on different patterns, e.g., “s-shaped” growth curves versus linear growth patterns. 14

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wang jinming, gao tiemei, and chen fei

growth rate model.16 The average model method17 is then used to summarize the results and calculate forecast values. Indicators for Q4 2005–Q4 2006 are estimated. See Table 4.5 for these results. These calculations also provide estimates for trend indicators enumerated in Table 4.1. This is done using the composite index method18 using forecasting results of trend indicators. The resulting calculations provide predictions of economic growth trends in China during 2006. Table 4.5: Forecast Results of Macroeconomic Indicators (%) Indicator Real GDP Growth Real Growth, Agriculture Real Growth, Industry Real Growth, Services Real Growth, Industrial ValueAdded Growth of Fixed Asset Investment Growth of Consumer Goods Sales Export Growth

All 2005 Q1 2006 Q2 2006 Q3 2006 Q4 2006

All 2006

9.5%

9.5%

9.6%

9.0%

8.7% 8.7%–9.2%

5.0%

5.5%

4.7%

4.8%

4.5% 4.0%–5.5%

11.2%

11.3%

11.2%

10.9%

10.8% 10.5–11.5%

8.0%

8.8%

8.5%

8.3%

7.9% 7.5%–8.5%

16.0%

16.5%

16.6%

15.2%

15.8% 15.5%–16.5%

30.0%

31.9%

28.9%

27.9%

24.1% 26%–29%

13.2%

12.8%

12.7%

12.1%

12.4% 12.1%–12.8%

30.5%

26.6%

26.1%

25.3%

23.5% 24%–27%

16 The variable growth rate model provides estimates that account for discontinuities in growth; sudden jumps produced by policy changes on economic could produce this kind of discontinuity. 17 The average model method produces an estimate based on the other estimates, distilling information from all indicators in order to reducing the anomalies of each. 18 The composite index method distills information from various economic indicators into a single indicator that approximates a weighted average.

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Table 4.5 (cont.) Indicator Import Growth Growth of Fiscal Revenue Growth of Fiscal Expenditures Growth M1 Growth M2 Savings Growth Growth Rate, Outstanding Loans Growth in Disposable Income, Urban Growth in Disposable Income, Rural CPI PPI

All 2005 Q1 2006 Q2 2006 Q3 2006 Q4 2006

All 2006

16.5% 18.0%

18.5% 19.0%

16.6% 19.7%

16.4% 17.8%

15.5% 16%–18% 17.0% 17%–20%

16.0%

15.0%

14.4%

14.0%

13.5% 13%–16%

11.0% 15.7% 17.0% 9.5%

11.5% 15.6% 16.2% 10.8%

11.6% 15.8% 15.8% 11.5%

10.5% 14.9% 15.7% 11.2%

10.0% 14.8% 15.5% 10.9%

11.4%

11.9%

11.7%

11.3%

11.4% 11%–12%

17.0%

11.4%

10.5%

10.6%

10.4% 10%–12%

101.9 105.5

101.8 104.4

102.0 104.5

101.9 104.1

102.2 104.4

10%–12% 14%–16% 15.5%–16.5% 10.5%–11.5%

101–102 104–105

A. The Economy will Grow Quickly in Q1 and Q2 and Slow Down in Q3 and Q4 in 2006 Overall, the economy will continue to grow rapidly and steadily—staying between 8.7%–9.2%—although the year will start strong and lose steam after June. The agricultural sector will grow 4.0%–5.5%, the industrial sector will expand 10.5%–11.5%, and services will bulk up by 7.5%–8.5%. Forecasts from the various methods all indicate that GDP growth in Q4 2005 and Q1–Q2 2006 will be brisk. Growth will dip below 9.0% in Q3–Q4 2006. B. Investment will Grow Steadily The growth rate of fixed asset investment will slow, partly because the base has grown large and partly because of macroeconomic policies put in place to better manage investment activity. Even so, investment will grow relatively rapidly. Therefore, measures should be implemented to preempt a “rebound” in fixed assets investment; that is, to keep

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investment growth on its present course and not be allowed to accelerate to unmanageable levels. Because Chinese banks hold such a large volume of deposits, and with more pouring in, they will have the capacity to finance investments once regulatory policy or economic conditions allow it. However, this could generate a “rebound” effect as pent-up demand for investment capital is uncorked. Fortunately, market conditions will put a damper on things since low profitability in many industries will lower and delay ROI. Estimated growth of fixed asset investment in 2005 will reach 30% and pick up speed in 2006. Forecasts also show that the growth rate of loan portfolios will reach 10.5%–11.5% in 2006. On a related note, M1 will increase by 10%–12%. C. Consumer Spending will Grow Steadily Growth of consumer spending will continue going up steadily through 2005 and 2006, especially in urban areas. Much of the growth in consumer spending will be directed to housing and automotive purchases. Estimates put growth of consumer goods sales between 12.1% and 12.8%. The Communist Party of China (CPC) Central Committee proposed a people-first economic development frame work during the 16th CPC National Congress. This framework calls for greater attention to be paid to low and medium-income individuals and households. As part of this adjustment of focus, more resources and support will go toward shoring up low incomes, especially in rural areas. In general, lower and medium incomes will be targeted for increases. Social safety net payments will increase. Taxes will be eased. These moves will effectively raise disposable incomes, and thus, boost consumer demand, especially in rural areas. This will bring greater balance to the economy and society. Urbanites saw disposable incomes climb by 11.4% in 2005. Unsurprisingly, cash income rose between 11% and 12%. Rural residents’ incomes more than kept pace with this rate, rising 17%. Policies, economic conditions, and a bumper grain crop all worked together to produce this result. However, 2005 may prove to be an exceptional year since forecasts show rural incomes rising by 10%–12% in 2006.

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D. Trade Uncertainties Since worldwide textile quotas abolished at the beginning of 2005, trade frictions have mounted. Tensions have grown especially intense regarding Chinese exports. Because various trading partners have acted on these tensions, the growth rate of China’s export volume has slowed through the year. Rising global oil prices will also constrain exports. Despite all this, forecasts put export growth at 30.5% in 2005 and 24%–27% in 2006. Import volume will expand by 16.5% in 2005 and 16%–18% in 2006. Note that these figures imply that trade surpluses will expand. E. Inflation and Money Supply will Grow Slowly Inflation will grow slowly and predictably in 2005 at a rate of about 1.9%. Prices on commercial products (less freight) will increase by 5.5%. However, some details require further explication. Agricultural prices will remain volatile over the year and into 2006. Labor costs will gradually increase. These cost increases will have an unknown effect on the prices of downstream products. The estimated value on the price index for commercial products (less freight) will reach 104–105. Excess capacity at the end-product stage will keep prices on finished products low. Grain prices will also remain low since harvests were large. Calculations from the model described above show inflation indices in 2005 and 2006 as nearly equal. IV. Policy Suggestions Given current economic conditions, economic management will continue on its moderate course in 2006 in order to keep the economy on its stable growth path. To fulfill this aim and to build on this momentum for the long term, this research team proposes the following policy suggestions. A. Encourage Consumer Spending by Increasing Incomes while Improving the Supply Side of Consumer Markets Thus far in 2005 the growth rate for consumer spending has outpaced the investment growth rate. Taken together, these trends bode well for

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easing the problem of excess productive capacity and output. These trends need to be supported to avoid conditions that will cause surpluses to grow larger. To this end, a variety of policies should be swiftly and comprehensively applied. Methods for bolstering incomes, described above, should be implemented. Activity in the real estate and automobile industries should be supported. Such moves would include encouraging improvements in product quality, gathering and distributing information about products and services, and developing infrastructure that makes distribution and delivery systems more efficient. In fact, these changes should apply to consumer goods markets generally. Policymakers and business leaders need to advice a wider array of consumer goods and services, including (but certainly not limited to) leisure activities, such as tourism, sports, and entertainment, as well as more traditional goods. By spending more on the entire constellation of goods and services available, consumer spending will finally make a significant contribution to GDP, and this will help to make the economy better balanced and more robust. B. Keep the Lid on Fixed Asset Investment to Avoid a Rebound Because investment plays such a huge role in economic growth in China, policymakers and regulators must continue to carefully manage it. This is more than just an economic management issue, though; it also involves politics. Local governments continue to have strong incentives to initiate and develop projects that fatten local coffers and build political reputations. For these and other reasons, demand for new projects continues to be strong. Therefore, the need to control investment remains in place. Projects should be built to serve the public and the economy, not private or local political and financial ends. C. Shift Economic Strategy and Policy Toward a Mix of Activities that will Generate Sustainable Growth China has a ravenous appetite for energy. Waste and inefficiency aggravate this problem. Environmental pollution broadens its impacts and raises the costs of energy use. Rising costs and supply volatility leave China’s economy vulnerable. In order to meet the goal of quadrupling GDP by 2020 and generally improving living standards and the quality of life, China’s energy problems must be addressed systemically and

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comprehensively. Energy must be used more efficiently. This will require greater care in energy management, but as well, upgrading China’s capital and technological base. It will also require that the economy move from an industrial basis to a post-industrial modality, where a larger share of GDP is generated in “knowledge industries” and high value-added services.

POLICY ANALYSIS REGARDING CHINA’S ECONOMIC PROSPECTS IN 20061 Qiu Xiaohua and Zheng Jingping As the year 2005 ends, we can look back on the accomplishments of the 10th Five-Year Plan while also looking forward to future prospects. Questions abound: What is China’s current economic state? How will current trends shape economic outcomes in 2006? Of course, these two broad questions raise a number of subsidiary questions. This article draws a rough analysis of current conditions and uses this to look ahead to the future in order to address these and related queries. I. Some Important Economic Metrics for 2005 China’s economy rose in prominence in 2005. With so much money being made and so much growth being realized, many investors, both domestic and foreign, put money into the market. With so many people improving their standard of living, more Chinese persons and foreigners began looking at how quickly and radically fortunes had changed for China. With so much having been accomplished, what will happen next? Three key trends at work in 2005 may provide clues to future prospects: changes in the currency exchange system, real estate speculation and its effects, and slowing economic growth. These trends, and the effectiveness of government intervention in managing them, will shape China’s economic fate in 2006, which should stay on a high-growth track throughout the year. Through the first three quarters of 2005, gross domestic product (GDP) has grown steadily at a very high rate; the year will finish with GDP growth well above 9%. This rate puts China near the top of worldwide GDP ratings. However, this raw figure does not show that Wang Wenbo, Feng Chunping, Jiang Leiguang, Dai Minle, and others took part in discussions that helped to shape this article. The authors wish to thank them for their insight and efforts. Any problems remaining in the article are solely our responsibility. 1

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China’s economy is cooling. Calculations put growth 2005 first quarter (Q1) growth at 9.4%, Q2 at 9.5%, and Q3 at 9.4%. Note, however, that estimated growth for Q4 is around 9.0%. Strong farm production has contributed significantly to overall economic performance. Summertime grain production reached a total of 106.25 billion kilos, which is a bumper crop. Grain output builds on strong summertime performance in 2004 when the grain harvest equaled 101.1 billion kilos. However, not all grains in the harvest saw production increase. For instance, the early rice crop reached 31.8 billion kilograms, a reduction of 430 million kilos. Corn and other autumn harvest crops have expanded production and harvest projections look strong. Further, the land devoted to all of these crops has expanded between 2004 and 2005. Consumption seems poised to continue its rapid growth into and through 2006. For Q1–Q3 total retail sales of consumer goods topped 4.5 trillion yuan, a 13.0% year-on-year increase. Adjusting for price increases bring the total down to a still-strong 12.1%, which beat last year’s nine-month total by 2.4%. If current trends hold steady in Q4, consumer spending in 2005 will finish the year 12% higher than 2004’s total. Investment has grown even more expansively. From Q1–Q3 fixed asset investment rose to 5.7 trillion yuan, an increase of 26.1% over the same period last year. Fixed asset investment in urban areas contributed 4.9 trillion yuan to the national total. Investment growth in urban centers beat the national average, rising 27.7% year-on-year. Given current trends and estimates, year-end investment totals should surpass 2004’s totals by at least 25%. Other forms of investment have enjoyed strong forward momentum. Real estate investment grew by 22.2% over the first there quarters of 2005, although that represents a fairly rapid slowdown from the Q1 growth rate of 26.7%. Part of this has been an intentional outgrowth of adjustments in macroeconomic policies.2 Some of it may well result from rising prices which have cooled housing demand. Foreign direct investment (FDI) has also decelerated from its high-growth rate of recent years.

2 The nature and impact of these adjustments in real estate are described in other chapters in this volume.

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Certainly much of the investment pouring into China has expanding its productive capacities and integrated these capacities into the global economy. As a result trade has boomed right alongside investment. Between Q1 and Q3 of 2005, total trade volume topped one trillion USD, an increase of 23.7% over 2004’s three-quarter total. Note, however, that trade growth dipped by 13% in 2004, so this year’s increase gains back lost ground and moves ahead somewhat. Total exports exceeded 546 billion USD, a staggering 331.3% hike. Import volume equaled 478 billion USD, a far more modest 16.0% jump. China’s trade surplus rose to 68 billion USD, up almost 4 billion from last year’s three-quarter total. Based on current trends the trade surplus for the year should approach 100 billion USD. The financial sector has enjoyed growth as well. Through Q3, financial institutions have brought in close to 2.4 trillion yuan in revenue, up 16.7% over the same period last year. Turnover in heavy industry has been one of the stars of China’s economic renaissance and 2005 will not hurt the sector’s reputation. Three-quarter profits totaled 864.3 billion yuan, a 20.7% year-on-year increase. Disposable income did not rise quite as fast as these other metrics, but still turned in a strong performance thus far. Urbanites saw their disposable income rise to 7,902 yuan, up 11.7% from 2004’s eightmonth total. Adjusting for prices, the growth rate falls out of double digits to 9.8%, but this figure still outpaces 2004’s eight-month total by 2.8%. Rural disposable incomes continue to lag far behind, however, at 2,450 yuan. However, with an increase of 16.1%, or 11.5% adjusted for price changes, the gap narrowed over the year. Monetary operations have operated predictably with steady growth in major metrics. By the end of Q3, M1, the sum of currency in circulation and demand deposits, reached 2.227 trillion yuan, an 8.5% year-on-year increase. M2—that is, M1 plus certain savings deposits—reached 10.1 trillion yuan, an 11.6% increase. M3—the sum M2, plus other types of deposits and certificates—summed to 28.7 trillion yuan, up by a much larger 17.9%. At September’s close, loans activity had increased by 13.8% over the total of outstanding loans on September 30, 2004. Note that September 2004 closed more than 163 billion yuan higher than September 2003’s sum. Through Q3, the CPI rose 2.0%, a remarkable figure given growth and other gross economic measures. The year is expected to close with the CPI staying at 2.0%.

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Some analysts and commentators in China fret that this low rate of price increases could continue to fall until deflation takes hold. Such fears are largely unfounded. First, money supply increases have been significant and this will militate against the onset of deflation. Second, the CPI has remained lower than other inflation indices. For instance, the GDP deflator has remained around 4% through the first three quarters, industrial products prices rose by 5.4%, and input prices—which include raw materials, fuel, and energy—shot up by 9.2%. Furthermore, consumer prices have remained low not because of deflationary pressure, but rather, because of low prices worldwide. Globalization has put intense downward pressure on consumer goods prices: goods are made where efficiency and cost benefits are highest. Additionally, global supply chains have become better coordinated and integrated into the overall production system. These innovations have increased price competition and improve overall efficiency, and these factors have kept the lid on price increases. II. Addressing Economic Concerns in the Coming Year What should we look for in the year ahead? Of course, opinions differ, but there is a near-consensus that oil prices should be carefully watched. Appreciation of the RMB also raises concerns, especially for those focused on exporting goods. Still others worry that the vast scale of fixed asset investment has produced excess capacity, surpluses, and falling prices. Certainly each of these problems could grow worse and taken together could threaten economic growth in China. Despite these clouds on the horizon, the outlook for 2006 looks sunny indeed. However, realizing this potential will require China’s leaders to resolve difficulties and tensions quickly and effectively. While concerns over oil prices are well-founded, other authors have covered this subject already. Besides, oil prices changes are, for the most part, exogenous, and policymakers can do little but adjust to them. As far as currency appreciation goes, the central bank shows no signs of changing its 2% cap on currency appreciation in 2005 or 2006, so fretting over this “potential problem” seems completely misplaced. However, surpluses—and their relationship to demand—remain a concern that policymakers and business leaders in China can address head-on. Given that productive capacity continues to expand, a weakening of demand could significantly aggravate the problem of surpluses, and

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with them, falling prices and thinner margins. However, with appropriate management, this situation could expand the job base, increase the capacity to serve export markets, and keep prices low. Capacity has grown because of the rapid run-up in fixed assets investment. Enthusiasm for such investments has run especially high because of local governments’ support of such projects. The value of projects started during Q1–Q3 2005 exceeded 4.5 trillion yuan, a 27.9% jump from last year’s three-quarter sum. The total value of projects currently in the planning and/or construction stages amounted to 15 trillion yuan, also a 27.9% increase. However, expansion may be slowing somewhat since 2003 to 2004 investment growth equaled 32.1%. In 2003 and 2004, the total invested in fixed assets climbed by 27.7% and 26.6%, respectively. Investment has certainly boosted GDP, both in the near and longer term, but these gains have exacted a steep price. Rapid growth in investment set off a development boom that caused a rapid run-up in raw materials, energy, and transportation services prices. This input price spike ate away at profits and triggered a new round of government intervention aimed at arresting inflationary pressures preemptively. Looking at the full sweep of the 10th Five-Year Plan to date—that is, between January 1, 2001 and September 30, 2005—total fixed asset investment exceed 26 trillion yuan. This sum exceeds the total amount plowed into fixed assets from 1981 to 2000. This huge increase in investment has created new productive capacity. For instance, concrete production rose to 320 million tons, steel to 120 million tons, coke to 150 million tons, and aluminum to 3.38 million tons. These figures represent significant percentages of global totals. For instance, China’s steel output is well over 10% of the global total. This capacity can be readily integrated into productive systems partly because China has a large labor supply. Moreover, the skill level of the labor pool has improved over the years. Of course, this also means that wages have increased, but as long as they do not outpace productivity increases, overall efficiency gains will be realized. Policymaking has played a pivotal role in advancing investment since 1998. A key component of total investment has been put into infrastructure. These infrastructural improvements have generated new opportunities for a variety of businesses to operate with greater efficiency. Seeing this opportunity, many investors put money into the Chinese market and many of them have been handsomely rewarded for doing so.

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Consumer demand continues to grow, but not at these rates. Therefore, consumer spending will absorb a portion of the outputs produced by these investments, but cannot keep pace with the growth rate in capacity expansion. This will lead to increasing surpluses unless export markets can take up the slack. Taking supply and demand together allows us to examine trends regarding shortages and surpluses. With output easing in response to changes in macroeconomic management polices, various components of aggregate demand will slow going into 2006. This will ease shortages, especially for energy, raw material, and transportation inputs. Shortages will be further eased by a substantial ramp-up in building supply capacity for these inputs and reserves. In fact, we may well see surpluses for some inputs during 2006 or soon thereafter. In sum, GDP will likely grow at around 9%, although growth will decelerate slightly. III. Economic Growth Estimates for 2006 The British company Consensus Economics3 conducted a meta-analysis of economic growth estimates for 2006. Their findings show that the world economy will grow at roughly the same speed as in 2005. The International Monetary Fund (IMF) echoed this finding in their report titled the World Economic Outlook, which estimates worldwide economic growth in 2005 and 2006 at 4.3%. The same report puts growth in the United States at 3.3% in 2006, off 0.2% from its 2005 growth rate. Japan will hold steady in 2005 and 2006 at roughly 2.0% growth. The EU will move ahead slowly at 1.8% growth, only 0.6% higher than 2005. The growth of world trade volume, however, will substantially outpace economic growth, rising 7% in 2005 and another 7.4% in 2006. Such conditions can help China’s export economy to thrive. The export sector further benefits from favorable policy changes, such as export tax rebates put into place at the beginning of 2005. However, some changes work against exporting, especially the appreciation of the RMB and heightened trade frictions.

3

See http://www.consensuseconomics.com/ for additional information.

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IV. Policy Recommendations To address the concerns cited above, and to realize or exceed growth projections, we recommend a four-point plan: • • • •

Maintaining stable growth; Increasing the focus on quality above quantity; Directing resources to rural development; Balancing competing interests.

This program should be carried out within the context of broader, long-term concerns. The market mechanism should be assisted where appropriate, but generally speaking, be left to handle most resource allocation decisions. That is, reform and liberalization need to be successfully balanced with control and management. In the long run, China must move into higher productivity work since this will produce greater value-added from production, and with it, higher wages and improved living standards. The economic fundamentals are in place to achieve all of these things. The whole country has the opportunity to use the economic momentum it currently enjoys to reach a new economic structure and level of social development. A. Using Policy to Achieve Stable Growth By effectively balancing liberalization, which unleashes markets and increases economic efficiency, with the steadying hand of regulation and economic management, stable growth can be maintained and sustained. A number of subsidiary concerns must be addressed to realize this outcome. First, deficits and debts should not increase. Related to this point, tax collection needs to become more efficient and effective. The maximum income for being excused from paying taxes needs upward adjustment. Tax rules regarding corporate income and capital gains through domestic and foreign investment need to be harmonized. Fuel tax collection need to be more rigorously enforced. The retail value-added tax (VAT) needs to be more broadly applied; doing so can shift corporate taxation away from income taxes, which have a dampening effect on productivity and investment. Taxes on various inputs and raw materials need modification. Private financial markets also require attention. Reforms that protect market agents from undo risk need to be more widely implemented and

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enforced. Loan interest rate adjustments need to be considered. While speculation needed to be reduced in housing markets, raising interest rates tightens credit and that can reduce housing demand. In general, credit needs to work hand-in-glove with economic growth and social development. Savings are part of this; if deposit interest rates paid better, it will encourage savings, which will swell the supply of money available to be loaned, which will put downward pressure on loan interest rates, which will help drive investment and economic growth. On a related note, the People’s Bank of China, China’s central bank, has a crucial role to play in maintaining growth. First, as overseers of monetary policies, they can help to shape policy regarding money supply and interest rates. Second, they manage exchange rate policy. The cap on currency appreciation should remain in place through 2006 as a way of maintaining stability and predictability in various parts of the Chinese economy, especially as it regards exports. B. Emphasizing Quality over Quantity All economic systems face resource constraints, and the breakneck pace of growth in China has pushed the economy up against a clutch of resource constraints in recent years. This can be seen in input shortages and the resulting price increases in production that occurred through much of 2002–2004. It can also be seen in the various pressures that the economy has exerted on the environment. However, by improving the efficiency of production, growth can be maintained while easing such pressures. In the long run, realizing greater efficiency gains will require the Chinese economy to rely less heavily on manufacturing while transforming itself into a post-industrial, knowledge-based economy. While this change remains a few years away, the basic foundation for this change is being laid right now. This shift will move investment from industries, projects, and firms that have high energy and resource demands, and that generate large amounts of pollution. The latter kind of production relies on growth virtually as an end in itself. By curtailing such activity, and moving investment in new directions, China will fundamentally overhaul its economic system, and by extension, its role in the global economy. As part of this paradigm shift, we need to emphasize innovation in production and management systems. The entire mindset of operations and operational forms must change to meet this challenge.

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As this process matures, homegrown, high quality brands and products will break into markets. Unique products, conceived, designed, engineered, and built in China, will begin to take root in the domestic market and find their way into international markets as well. Products containing technology controlled by Chinese firms, institutes, and individuals will become more common. In short, production throughout China will move up the value chain. This will also free China of its current level of dependency on foreign oil supplies. At root, this process depends on working within market structures. For instance, by allowing oil prices to rise to the global market price, more Chinese firms will have an incentive to operate more efficiently in the near term. In the long term, they will seek out completely new production systems that reduce their oil demands and the colossal expense that comes with it. C. Directing Resources to Rural Areas Demand needs to be strengthened in outlying areas. Building on the foundation of the “New Socialist Countryside,” market adjustment, encouragement, and intervention should shore up those economic weaknesses that have left demand lagging in outlying areas. First and foremost, prices on agricultural goods need to be stabilized and subsidies increased and more widely applied. This will help to increase household and individual incomes. Easing and/or eliminating taxes on various farm goods and activities, as well as forest harvests, can further increase disposable incomes. Secondly, more public spending should flow into outlying areas. Funds should go into infrastructural development and improvement. They should also go toward developing a more stable, effective, and robust credit and banking system focused on financing rural businesses and households. Finally, public funds should go toward improving services and the quality of life in rural areas. This means that medical services, social security, social services, and other life-enriching amenities like cultural and sports programs, should be adequately funded in order to build more dynamic communities. D. Balancing Competing Interests Markets, through competitive forces and the way of thinking that comes through working with them, can heighten tensions. However, markets can also, through cooperation and trade, ameliorate and lessen such

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tensions and create the conditions for greater social and economic harmony. By emphasizing the conditions that support harmonious interactions, China can peacefully and productively coexist with its geographic neighbors and trading partners. Moreover, this will help to support internal security and stability on both economic and social fronts. Through trade and improved communications with its neighbors and trading partners, relations can be improved. China’s growing strength as an exporter has caused neighbors and trade partners to respond defensively. Moving to ease trade imbalances can relax these tensions. As well, neighbors and trade partners have exerted mounting pressures on China’s exporting activities in various ways. One specific sore spot is exchange rates reform. While caps on appreciation should remain in place in the near term, the central bank may want to move closer to a free float over time. Of course, achieving balance and stability starts at home. Various internal tensions exist in China; successfully dealing with them and developing mechanisms for developing and implementing policy over time must be grappled with. A rising tension that requires prompt attention is balancing economic development against quality of life improvements. In many ways, economic development brings about improvements in quality of life directly; for instance, with greater income a given household can buy or rent a more comfortable home, gain access to better medical care, and provide improved educational opportunities for children in the family. However, economic growth can also drive prices up and isolate low income persons, leaving them unable to pay for adequate housing, medical care, educational services, and other basics. These problems demand intervention and solutions. One area of social services and development that affects all groups concerns public health. Recent outbreaks of disease—like SARS4 and Avian Flu—threaten individuals and society at the same time. Such diseases do not distinguish by social class, although leaving the treatment of such problems solely to market forces may leave some populations more vulnerable to these diseases. As long as some persons or classes of persons remain vulnerable, the entire society remains vulnerable. Tackling

4 SARS is the acronym for the disease known as Severe Acute Respiratory Syndrome, which threatened to become a serious epidemic in 2002 and 2003 in China, as well as the rest of the world.

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these problems will require a coordinated, comprehensive, and systemic effort. Spending on information campaigns, medical training, medical treatment, as well as research and development regarding drug therapy, natural medicines, and treatment programs, needs to be taken up and supported by national, provincial, and local level governments.

POLICY CHOICES REGARDING ECONOMIC GROWTH IN CHINA IN 2006 Li Boxi 2006 marks the beginning of China’s 11th Five-Year Plan. It also marks a year of increasing uncertainty regarding the economy, as rising oil prices and trade frictions, among other factors, threaten continued economic growth. Given these conditions, the need for effective and prudent macroeconomic management is especially important this year. I. The Impact of Slowing Inflation and Investment “Rebound” Pressures Mount Views differ regarding the main thrust of economic policymaking. Should price management be the primary goal? Keeping the economy from overheating certainly allows for a variety of productive functions to operate more smoothly and predictably. On the other hand, should policy intervention focus on maintaining and encouraging growth? With sufficient economic momentum, and with the higher profits and government revenues that accrue in periods of growth, many economic difficulties can be treated. No hard-and-fast answer exists to this dilemma; policymakers must seek out and apply an effective balance that emphasizes one focus or the other as conditions dictate. Those focused on preventing economic overheating would underscore the point that investment grew by 25% in 2004 and seems poised to meet or even exceed that rate in 2005. An investment rate this high floods markets with money and produces so many changes so fast that managing these changes or ending up with a predictable or even rational outcome may prove elusive. Conversely, those who fret over any signs of undue economic slowing would accept increasing inflation, as long as GDP growth stayed well ahead of the inflation rate. Particular interest groups might call for some compromise between these two extremes or a “third way” of some sort. For instance, those focused on expanding the trade sector, especially exports, may want

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to see growth expand enough to meet growing global demands, while policymakers apply rigorous efforts to keep prices low in order enhance the international competitiveness of Chinese goods. Unsurprisingly, given the variety of data on these conditions, models explaining the likely outcomes of these conditions, and intellectual and ideological points of view, analysts have arrived at diverse conclusions. Therefore, any thoroughgoing macroeconomic analysis must use different methods in order to capture the complexity of these questions, as well as the complicated nature of the national economy. Often, these methods may yield similar final results, but such results allow for comparison, more penetrating understanding of the phenomena at hand, and even more solid confirmation of a given set of results. The various components of aggregate demand have been increasing for quite some time, but at different rates. So while consumption has continued to climb, it has decelerated. On the other hand, fixed asset investment has grown and accelerated in recent years, partly as a result of increasing prices as the supply of suitable land becomes scarcer. Export growth continues to outpace import growth, although various problems may cut into this gap over time.1 Given the CPI’s recent history and the estimates of mid- and longterm growth of the CPI, we conclude that the Chinese economy still faces deflationary pressures. This is due to the fact that fixed asset investment growth has raised productive capacity, and demand has not risen to meet expanding supply. The resultant surpluses have driven down prices; this is the fundamental force driving down the CPI. Appropriately applied policies could maintain low inflation, which could help to keep the economy on a stable track, but inappropriate policy moves could turn low inflation into deflation, both in the short and long term. The possibility of investment “rebound” further complicates this analysis and any policy changes likely to emerge from it. Investment rebound arises when attempts to cool investment growth and volatility work only temporarily, resulting in a rapid, unanticipated increase in investment growth. Very often, local governments set this process in motion by encouraging investment in a given locale that creates problems in the aggregate. This shows that the central government The final component of aggregate demand, government spending, is not directly examined in this paper. However, given the scope of infrastructural development in virtually every part of China, government spending is also increasing, which adds even more to aggregate demand, and therefore, total output. 1

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and banking authorities not only need to develop policies to address such problems, they must take the additional step of enforcing these policies comprehensively. II. Maintaining Healthy Financial Policies China’s financial policies aim to produce and support stable economic growth. Given that growth has remained above 9.0% since 2002, the policies currently in effect would have to be deemed very effective. Given recent pronouncements from the Ministry of Finance, we can expect that the basic thrust of financial policy will remain the same. Not only does this bode well for growth, but these moves also support the broader strategic changes need to fulfill the ongoing restructuring and reform of the Chinese economy. Within this broad framework, the need to fine-tune and make periodic adjustments remains. In fact, these kinds of policies can support long term ends, provided that short term moves do not undermine the long term thrust of structural adjustment and liberalization. Microadjustments must also honor the principles of “The Five Key Areas of Coordination”: coordinating rural and urban development; coordinating development between and across regions; coordinating and balancing economic and social development; balancing and integrating environmental and economic demands; and coordinating and balancing domestic economic development with trade and global economic integration. A key element of business financing comes from investing profits. Profits have been on a long term growth trend, but the rate of growth has slowed since 2005. Part of this is natural and expected: as the size of profits grows, the amount needed to maintain growth rates grows as well. Since this is not happening, the growth rate has decelerated. Even so, this trend merits close attention. Profits have been squeezed by increasing costs, rising output, and keener competition. Increasing and volatile oil prices remain a concern, even though price increases for many other inputs have eased. Increased retail competition and expanding supplies for many finished goods also put downward pressure on prices. As a result, many firms find themselves walking an increasingly fine line to stay in the black. These conditions seem likely to prevail into and through 2006, which will require policymakers to develop some means that will address these conditions.

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Certainly monetary policy has an affect on financial policymaking. Given this, it is no surprise to see the People’s Bank of China, China’s central bank, to weigh-in with its own moves designed to maintain stable growth. Most importantly, the Bank reduced money supply growth and the growth of loan activity in early 2005. Another area of Bank influence, inter-bank credit and bond markets, continued to grow steadily, providing further evidence of effective economic, financial, and monetary management. However, some have complained about the Bank’s tight credit policies. Even though policies work well in the macro picture, they may adversely affect particular individuals, firms, and agents. Simply put, you cannot make everyone happy all the time. The tightening of commercial credit since 2005 has produced a short-term credit crunch. This compounds financing problems for many firms as profit growth rates decline. The full impact of this two-part problem will not be felt until Q4 2005. In the meantime, policymakers need to consider the best means for addressing this problem in order to keep growth on track and to help out those industries and firms that will suffer the worst effects of these forces. IV. Exchange Rate Policy and Reform On July 21, 2005, the Chinese Government implemented a new exchange rate policy. The exchange rate of the renminbi (RMB) against the US dollar (USD) moved from a pegged system to a managed float, where the value of the RMB would move by ±2% vis-à-vis the USD. The upshot of this is that the value of the RMB increased from 8.27 yuan per USD to 8.11:1. As per the strictures of the management system, the RMB’s value went up 2%.2 Using the change in the RMB’s value against the dollar provides perspective on the extent of the policy change, but it should be noted that the RMB’s value now depends on it’s fluctuation against a basket of currencies. This change addresses mounting international pressures demanding an appreciation in the RMB’s value. While an increase of 2% hardly brings the RMB up

2 Given that the appreciation of the RMB topped out almost immediately, it would be safe to say that the RMB’s value would continue higher if it went onto a pure float.

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to its full market value, this move does strike a workable compromise between making the currency more responsive to market forces and the need to remain on a stable growth path. The long term success of exchange rate reform depends on many, sometimes competing, factors. Most immediately, the Bank needs to consider the rate at which to adjust values. Rapid adjustment will likely hurt Chinese exports, and this will cut into economic growth. Furthermore, it may destabilize the Chinese economy in unknown ways, and this could produce instability throughout the global economy. Based on past experience involving rapid changes in currency values of large or even medium-sized countries, any rapid or sudden move seems ill-advised. In policy terms, this may come down to widening the allowed band of fluctuation for the RMB’s value vis-à-vis other currencies. Moving in this direction may placate interests outside of China calling for a considerable appreciation in the RMB’s value. However, Chinese researches have consistently shown that these interests have overestimated the value of the RMB under a pure float. China’s exchange rate reforms have rolled out gradually. In 1994, China abandoned the dual rate system3 and adopted a hybrid exchange rate system that increased the RMB’s value, but limited its movement.4 China managed to successfully execute these policy changes in spite of international pressures. The Southeast Asian currency crisis of 1997 pushed many of China’s neighbors to devalue their currencies. However, China committed to maintaining the RMB’s value as a way of stabilizing financial markets in Asia. This move helped to blunt the effects of currency and financial speculation and rapid currency withdrawal from the Asian region. This move raised China’s stature among the major nations involved in trade and finance. By 2002, however, this goodwill had soured. Japan, the US, and several other countries began to apply intense pressure on China to raise the RMB’s value. Their increasingly shrill demands have been made 3 The “dual rate” refers to the policy of using a “market” and an “official” exchange rate for managing Sino-US trade. The official rate moved between 5:1 and 6:1 (RMB: USD). Most state-owned enterprises settled payments at the “official” rate, which exceeded the market rate, allowing these firms to import goods at a discount. 4 After 1994, authorities set the RMB’s value at 8.5:1. Eventually it appreciated to 8.28:1 during 1997. Since then it has fluctuated in the very narrow band between 8.276:1 and 8.28:1 until moving to the managed float on July 21, 2005.

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to satisfy particular special interests in their countries, and as such, this demands reek of political maneuvering rather than rational economic thinking. The Chinese government has wisely deflected these calls for change, instead implementing exchange rate policies that serve Chinese interests first and foremost. The managed float system that the Bank adopted struck a successful compromise between international and external forces. By limiting exchange rate fluctuation to only ±2%, China can assure its producers that markets will remain stable. Secondarily, this limited band of variation quashes currency speculation, which will eliminate the possibility of volatility in currency values. .

V. Rapid Growth in 2006 The Chinese economy entered a new phase of growth and development in 2001. In the twenty years previous to this, the economy moved forward by focusing on key industries and building out manufacturing capacity and the national export economy. Since 2001, the country has built on these strengths, but become more robust and diverse. Now economic growth depends on expanding consumer demand, rapid urbanization, diversified investment, and global economic growth and integration. While there may be some fluctuations in each of these components that produce mild business cycles, overall economic strength seems likely to keep the economy on a high-growth track through the remainder of the 11th Five-Year Plan. In fact, economics researchers put GDP growth in 2006 at 8.5%. As noted above, high growth has not dispelled all problems or worries. The flattening of the consumer price index (CPI) has become one of the focal points of commentators, policymakers, and researchers, since this could be a foreshadowing of a deflationary trend. The data illuminate the specifics of this condition. The CPI peaked in the third quarter (Q3) of 2004 and continued to fall through Q2 2005. This stirred debate amongst policymakers, economists, and pundits. Some claimed that given overall economic growth, a falling inflation rate indicated economic strength, while others worried that this trend may indicate a softening of demand or weakening in economic fundamentals. This trend may well date back to 1998, with a reprieve during 2003 and 2004, when prices surged.

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Even though some aspects of the Chinese economy resemble conditions at work in countries, like Japan, which went into a deflationary spiral, it seems unlikely that China will have any problems with deflation or stagnation since China’s situation is distinct in several ways. First, countries that experienced deflation and stagnation went through speculative bubbles beforehand, and when the bubbles burst, rapid contraction in demand followed. Speculation certainly exists in China’s economy; however, this “speculation” helped to create productive capacity. This capacity raises output, and surpluses, which put intense downward pressure on prices. This sliced into profits, which in turn dampened investment. This situation differs from what happened in Japan in that the runaway economic component is investment rather than “paper” speculation, which did little to change productivity. Even though prices and profits in China have declined recently, demand for goods and services has continued to increase steadily. Moreover, because the increase in holdings has resulted in an expansion of real productive capacity, rather than an accumulation of “paper wealth,” wealth holding seem unlikely to simple disappear as it did in late 1980s and early 1990s Japan. Other distinctions are worth pointing out. A slowing inflation rate will hardly dampen trade, or for that matter, many forms of investment.5 Granted, this analysis of inflation only looks at short term impacts—say, from two to six quarters. If the rate of inflation suddenly picked up speed, or if prices suddenly collapsed, an entirely different course of action would be necessary. But as long as the inflation rate continues to go up, albeit at a slower rate, no real deflationary danger exists. VI. Changing China’s Trade Strategy Since beginning the liberalization and reform process, China has played an increasingly important and distinct role in the global economy. Trade, especially goods processing and exporting, has become a key driver of economic growth, alongside growing investment and consumer spending. Since 2005 export growth has accelerated, even though various

5 Inflation will not affect some forms of investment directly, although there is clearly an indirect dampening effect on investment, as described immediately above.

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sorts of direct and indirect trade barriers have come into effect in developed countries. Export growth will slow over the coming months. Part of this stems from the natural maturation of export markets. Furthermore, government has placed various restrictions on agricultural exports, which puts an additional drag on export growth. But the big drag on exports is the high and increasing price of petroleum and petroleum products. Even with this expected slowdown, the trade sector has reached a considerable scale. The Ministry of Commerce noted that, “Trade has entered a new phase of growth, moving from an important player to a powerful player.” In order to become an even more powerful player, policymakers and business leaders must adopt a new trade strategy and codify it in an upcoming Five-Year Plan. This strategy should place its emphasis on developing new technology and high-tech industries, building China’s capacity to develop and market valuable intellectual property and brands, improving the national capacity for innovation and research and development (R&D), and continuing the refinement of the national investment and financing system. VII. Improving Control over the Real Estate Industry One unfortunate side-effect of the current growth cycle has been overheated investment, particularly in the real estate industry. This problem has caught the central government’s attention and prompted them to take action to curtail the problem. The effectiveness of their intervention is discussed below. Since 2005, real estate prices, investment rates, and sales, soared in many urban areas. Speculators, both domestic and foreign, drove much of the run-up in prices and investment activity. Controlling speculation, and the volatility it produces, will require stronger economic regulations. Two policies put into place by the Central Bank helped cool urban real estate markets: raising interest rates and increasing the minimum down payment percentage required to make a home purchase.6 The State Council, alongside seven ministries and administrative departments, jointly issued “Recommendations for Stabilizing Housing

6 See Zhang Hanya, “Investment and Its Economic Impact in 2006,” which is included in this volume, for details regarding the impact of these policies.

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Prices” in May of 2005. Based upon early reports, the policies included in the “Recommendations” have produced the desired effect: data from thirty-five large and midsized cities show housing price increases slowing and the growth rate of investment decelerating. Figures in some cities even show prices dropping and real investment rates declining. Speculation-driven demand fluctuations seem to have been brought to heel. Urbanization continues to drive housing demand, and with it, prices and investment rates. In fact, real estate accounts for about 25% of economic growth in China now. This condition seems likely to continue into the long term. Development patterns in advanced countries clearly show that real estate plays a central role in economic growth in industrial and post-industrial nations. Because so much depends on the health of this industry, it will come under ongoing management from government regulators and policymakers. Short-term and long-term controls should complement each other in order to produce steady, sustained growth in the industry and throughout the economy. Policies should aim to achieve more balanced and manageable urbanization. Government should work hand-in-hand with industry to develop greater self-discipline on the part of market agents. Stronger institutional structure and functionality needs to develop, probably under the watchful eye of government. The government also needs to devote more resources to creating solutions to serve the low-income housing market. All players need to work within market forces to ensure efficient resource allocation and decision making, and as well, within a carefully framed and executed regulatory structure. Real estate and financial markets are closely linked. New financing instruments, know-how, and gumption helped the real estate industry to grow by leaps and bounds. By the same token, real estate growth helped to enlarge and enrich the financial sector. By the time final statistics on economic activity in 2004 are tallied, we will likely see that 50% of the 17 trillion yuan circulating in loans will have gone into real estate. To push this process along and to ensure its health, relevant governmental agencies should strengthen coordination and planning between the two industries. This would require the development of a thoroughgoing real estate financing policy system that would include bank loans, trusts, securities, bonds, insurance and other contracts and instruments.

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Even though reform and liberalization has moved the Chinese economy in the direction of using markets to determine various allocation decisions and processes, the basic structure and rules of the Chinese market remain under careful management. Within this system, short term and long term aims must be balanced. Clearly these goals are related, and often complementary, but they can also compete with each other. Economic control measures require ongoing refinement. For instance, the current round of controls seeks to reduce the expansion of excess productive capacity, and with it, surpluses. Successfully implementing these measures will require regulators to carefully watch how demand fluctuates—and where possible, encouraging demand—since increases in demand will help to absorb surpluses.7 IX. Conclusion Successfully implementing the 11th Five-Year Plan will require thoughtful analysis and rigorous execution. Uncertainty in the global marketplace will create problems for China. Internal adjustments will require ongoing refinement of economic management measures and policies. If properly executed, China should remain on its long-term high-growth, low-inflation track. Many economists and policy experts recommend long-term growth to stay between 7.5 and 8.5%. To realize this goal in the long term, China must maintain its economic momentum in the short run, but also, manage broader changes in successive five-year plans. These moves include increasing domestic demand, especially consumer spending; achieving a more stable equilibrium between supply and demand; and moving toward a more highvalue knowledge-based post-industrial economy. Fulfilling these aims will require government and business leadership to expand the scope and impact of the economic reform and liberalization process.

7 Methods for encouraging demand are discussed in chapters on economic growth in this volume.

INVESTMENT AND ITS ECONOMIC IMPACT IN 2006 Zhang Hanya In 2005 the Chinese Government implemented a series of reforms affecting investment markets. These affected land ownership, access to credit, and other key financial concerns. While these reforms fit into a larger project of market reform, some steps also addressed more immediate economic concerns. Specifically, after investment markets became relatively sluggish in the last three quarters of 2004 and into the first five months of 2005, the People’s Bank of China1 took action by loosening some currency controls. The growth rate in basic money supply, M1, moved from 10.4% in May to 11.5% in August; broader money supply, M2, growth rose from 14.6% in May to 17.3% in August.2 In the first two quarters (Q1 and Q2) of 2005, the growth rate in loan activity had declined from the Q1–Q2 2004 rate. By August, business boomed: 189.7 billion yuan of new loans went into circulation, a jump of 74 billion yuan over August 2004’s sum. Short-term loans increased by 84.7 billion yuan year-on-year, and medium- and long-term loans grew by 3.1 billion yuan. These moves produced the hoped-for impact on economic performance. Business profitability increased, outpacing 2004’s rate by 15.8% in May and 20.7% in August. Business deficits declined as well. Growth in the rate of investment in new capital assets in urban areas crept up from 26.4% in May to 27.4% in August. In May, the number of projects under construction was 11.3% higher than in May 2004; by August the year-on-year gap had grown to 14.9%. Investment makes up a relatively large share of GDP in China and fuels rapid economic growth. If investment and other gross economic figures stay on-trend, GDP growth for the year will be 9.3%–9.5%,

The People’s Bank of China is China’s central bank. M1 and M2 refer to definitions of money supply. M1 = physical currency + any notes or accounts in the central bank that can be exchanged for physical currency + demand accounts (also known as “checking” or “current” accounts). M2 = M1 + savings and money market deposits + time deposits and certificate of deposit accounts (CDs) under $100,000. 1 2

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investment growth will be 20%–25%, consumption will expand by 11%–12%, and exports will grow by about 25%, with imports growing by around 15%. All of this will occur in an environment of remarkable stable prices: the consumer price index (CPI) is estimated at 1%–2% for the year. This year promised to be one of the strongest in terms of overall performance and low inflation since China entered the reform process. I. Economic Conditions and Investment Growth in 2006 The 11th Five-Year Plan begins in 2006. The Plan includes mediumand long-term plans formulated by the 16th National Congress of the Communist Party of China (CPC) designed to raise living standards. The Congress’ Third and Fourth Sessions focused on development based on rational and scientific grounds. Working within this analytical mindset requires that researchers, policymakers, regulators and business leaders carry out a careful examination of key conditions and problems at work in the Chinese economy as the plan their strategies and make decisions regarding these strategies. A. The Economy Continues to Boom From 1998 to 2003 monetary, fiscal, and regulatory policies helped the economy to move beyond the turbulence brought on by the 1997 Asian financial market crisis and to vault into a period of unprecedented growth. New regulatory strategies and policies implemented in 2004 and 2005 helped in adjusting to supply shortages and diffusing building inflationary pressures. These measures have kept the economy growing quickly, while keeping inflation under control. Economic growth has produced a panoply of positive effects. Per capita income for urbanites has trebled, rising from 1,000 US Dollars (USD) only a few short years ago to more than 3,000 USD today. Industrialization has expanded rapidly. Urbanization has turned cities in the most economically productive regions into huge boomtowns. China now has the wealth needed to help spur growth in the West, and to foster rejuvenation of the old industrial Northeast.

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B. Opening and Reforming Society and the Economy The process of opening the Chinese economy and overhauling its basic mode of production and distribution has delivered remarkably rapid and sustained growth. With basic economic function generating so much new wealth, reform efforts must address key social and political issues. At the same time, economic evolution must continue to move forward. Various new laws have been instituted to address these demands: the Law of Administrative Authorization in the People’s Republic of China, the State Council’s Decision on Investment System Reform, and the State Council’s Proposal for Encouraging, Supporting and Managing Privatization among them. Government leadership has played a pivotal role in encouraging investment and construction. The reform process has served these ends by removing systematic impediments regarding ownership, improving transparency, opening access to legal recourse, and implementing market-based pricing. These changes have only recently started; continuing to press ahead with these reforms will further liberalize the economy and improve efficiency and productivity, all of which should raise profitability. Internal reform efforts will dovetail with international reform processes since China will end its probationary affiliation with the World Trade Organization (WTO) in 2006. This change will allow the PRC to become more open and fully integrated into the global economy. China will benefit by further building on massive gains in trade volume, especially on the export-side of the ledger. C. Consolidating Economic Gains Fulfilling the aims of the 10th Five-Year Plan has built a more solid economic base for future development. Savings and investment holdings continue to provide the capital base for continued economic growth. As of August 30, 2005, 27.5 trillion yuan had been deposited in Chinese accounts. The outstanding loan balance stood at 18.78 trillion yuan. Banks and businesses held some four trillion yuan in reserves, treasury bonds and other notes. This leaves more than five trillion yuan available for use in new investments. Additionally foreign exchange reserves exceed 700 billion USD. Raw materials continue to be a trouble spot, especially oil supplies. However, basic energy needs will be met largely through expanded coal production and improved utilization. Although shortages of imported raw materials continue to drive up prices, more reliable and consistent

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access to raw materials has been achieved. New mining and refining capacity continues to come online, both in China and throughout the world. Severe bottlenecks and price spikes will probably be held at bay because of these moves. Labor continues to be readily available. Even highly skilled labor looks to grow in supply as university recruitment has become more aggressive and aggregate enrollment figures continue to climb. The rate and scope China’s infrastructural development has taken on a near-legendary aura. Capacities have been vastly increased regarding energy systems, transportation, and telecommunications. D. Improvements in Firm Performance Chinese firms have steadily improved their competitiveness and efficiency. A key element of this overall improvement is streamlining the operations of state-owned enterprises (SOEs). In recent years SOEs have become more profitable and internationally competitive. On the flipside, numerous private businesses have stepped into various market niches no longer served by SOEs. These firms have successfully developed and integrated new technologies into their operations, and brought new efficiency to the provision of quasi-public goods (e.g., energy). Many of these firms have become leading employers and economic engines for local and municipal economies. E. Improving Agricultural Production Government intervention successfully began to address long-standing and newly emerging problems affecting agricultural markets and rural regions as part of the 10th Five-Year Plan. Key policies and actions include abolishing the farm tax, developing infrastructure in the countryside, supporting research and development (R&D) efforts in agriculture, providing business assistance, and managing farm prices on both the input and retail levels. Incomes have increased in rural areas, which have raised living standards. Increased productivity and profitability has given farmers a stronger incentive to stay on farms rather than quitting agriculture and taking on industrial jobs.

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F. Problems to be Dealt With Although 2006 holds great economic prospects, some problems remain. First and foremost, limited supplies of key economic inputs, especially energy, continue to create a variety of problems. Second, increasingly intense international competition and an increasingly tense trade environment threaten to slow down growth. Financial markets still have a variety of problems, most obviously the continuing problem of opening access to capital for small and medium sized businesses. This problem ties into the larger issue of increasing income inequality, particularly the widening gap between urban and rural incomes. A problem that has emerged more recently deserves attention as well: the inability of domestic demand to keep pace with the growth in productive capacity. This problem will likely reach a head in 2006 as major capital projects planned years ago come online en masse. As supplies exceed demand, China will need to more aggressively move products through export markets in order to keep a substantial number of firms from falling into the red, since prices throughout such industries will certainly fall as a glut of products swells inventories. In the long run this will hurt investment, perhaps in industries not afflicted with surpluses. If investments cool too much, it will certainly hamstring economic growth. If growth slows too quickly, growth in income, and consumer confidence, will take a beating. This shift will affect urbanites most acutely. However, with farm prices falling since a rapid run-up in 2004, incomes throughout the countryside will likely decline, taking a bite out of consumer spending in rural areas. With energy prices up and many national markets retrenching, the global economy will grow at a slower pace in 2006. This general slowdown will dampen demand for Chinese exports. These factors will likely aggravate the problem: appreciation in the yuan’s values vis-à-vis other commonly used currencies and increasingly pervasive protectionist measures.3

3 By favoring homegrown goods or goods made within a given region (such as the EU) or by putting restrictions on particular kinds of goods or raising certain standards of goods (regarding inspections, ingredients and so forth), such measures have a protectionist function. In some cases, these are a thinly-veiled attempts to block particular kinds of goods or goods from a particular country, such as China.

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Index GDP growth Growth in fixed asset investment Growth in retail sales Export growth Import growth Consumer price index (inflation rate) Urban unemployment rate

Target rate

Worst-case

8.5–9.0 18–20 10–11 15–20 15–20 2–3 4.0–4.3

Below 8.3 ≤15 8–9 ≤15 ≤10 ≤1 4.8–5.0

Note: The target growth rate stems from relaxed financial and currency policies and abolishing restrictions on real estate development (see suggestions below). The worstcase scenario refers to the projections based on the continuing application of restrictive control measures implemented in the spring.

Projections show the demand-since components of GDP—consumption, investment, and net exports—slowing in 2006.4 This will reduce the rate of economic growth, which in turn, may slow down the growth in job creation, income, and improvements in consumer confidence and living standards. II. Projections of Economic Conditions, Particularly Investment The economy’s momentum seems likely to overcome the various problems cited above and uncertainties likely to crop up in 2006. Regulation, strategy, and policy will also help to keep the economy moving ahead in spite of various shocks. Table 7.1 shows the likely outcomes regarding economic growth in 2006. III. Policy Suggestions for 2006 To prevent the economy from slowing down too rapidly or entering a period of violent fluctuations in prices, the following measures are recommended. 4 The other key component of aggregate demand is government spending. Although this component of aggregate demand lies beyond the scope of this paper, it is worth briefly mentioning that government spending will continue to increase, largely because spending on infrastructural improvements proceeds at a furious pace.

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A. Ensuring Stability Poor decision making, herd mentality, and irrational behavior can upset markets. This can lead to speculative bubbles—most famously, the “Bubble Economy” of 1980s Japan, or more recently the “irrational exuberance”5 of the late 1990s tech-driven “new economy.” In both cases, rapid increases in prices—for real estate in Japan and for stocks in the United States during the late 1990s—preceded precipitous slides in value of these goods. For the most part, though, developed nations have experienced relatively mild fluctuations in growth since the end of World War II. Business cycles have been long and of limited amplitude. Prosperity has generally expanded through these decades. Some experts attribute this stability to improvements in information technology and economic analysis, which enables investors and other economic agents to attain information quickly, process it more thoroughly, and to the use insights gleaned through these processes to make better informed decisions. As China becomes a profit-driven economy and culture, it must harness the power of information in order to make better policies, strategies, and day-to-day decisions. However, the lack of information and experience on the part of investors and other economic actors hampers optimal market performance, especially in the investment sector. Too many investors look for short term gains or “the quick kill.” Sometimes investors make decisions based on one or two pieces of advice or on the recommendations of a friend or trusted associate. Some deals move forward in an environment of deceit, payoffs, graft, and backroom dealing. Too few persons and businesses conduct real market analysis or due diligence before investing. These conditions cannot continue without harm being done to markets, investors, and investment backers, like banks. Conditions should be established to provide decision-makers with accurate and timely information regarding investment opportunities. In order to realize this outcome, the following steps should be taken:

5 This is a phrase coined by then-Federal Reserve Chairman Alan Greenspan to describe the rapid run-up in stock prices given the lack of profitability of many firms offering shares for sale with little to recommend the company other than being associated with the “new economy” or the “technology sector.”

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1) Developing a national, publicly accessible investment information system. The system should include up-to-date information on policies, laws, and their likely consequences and implications. This database would include national laws as well as provincial and locally developed measures. This body of information should also include statistics on economic conditions and investment activity. Armed with this information, investors could make better decisions. The database should include information gathered from government and public sources as well as private sources and independent analysis. Currently, the wealth of information these agencies, departments, and ministries control remains inaccessible. For the most part, it serves no useful purpose. By sharing this information across public agencies and making this information available to the general public, many individuals and investors can look for patterns in the performance of particular investments that could meaningfully inform investment decision making. At some point, the departments offering this service might charge a fee for certain specialized information or packaging of information delivered through this service. Packaging information successfully could become quiet lucrative. 2) Once the information has been gathered, make sure that investors make use of it and understand how to interpret the data. Steps have already been taken in this regard. For instance, in 2004 the National Development and Reform Commission (NDRC) began issuing announcements regarding investment information and the growth prospects of certain industries. This is a solid first step. The next step should be to provide firm-level data. Eventually, this information and its dissemination will be taken over by private operators, such as brokerage houses. At present this expertise is relatively underdeveloped.6 Developing this expertise and supporting its growth will help to drive sustained growth in the investment sector. 3) Carefully regulating investment activities overseen by local governments. In some cases, local governments make investment decisions

6 At least this is true on the Mainland. However, Hong Kong has tremendous expertise regarding investment, brokerage services, and financial planning and consulting. Using this as a base upon which to build is a matter touched upon in other chapters in this volume.

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based upon their potential political payoff and/or the way in which such investments can burnish the images of local departments or politicians. Rent-seeking behavior—and at worst, graft—introduces distortions to market processes. Many special economic development zones and “projects with iron passes” grow unchecked by sound economic analysis, even regarding the most basic considerations, such as returns on investment. Growth becomes an end in itself because it generates benefits that can be distributed to various department heads and their immediate subordinates. As decision making moves closer to fulfilling leadership’s ideas and interests, it can become farther removed from public and economic interests. This has lead to the creation of “Leader’s Projects” and “Image Projects” appearing in many places. Such projects aggravate problems such as inefficient resource utilization and overexpansion of productive capacities. This kind of activity also undermines the pubic trust in government institutions. Citizens, the media, and the People’s Congress must work together to monitor and, when possible, preempt these problems. Those individuals who create these problems for personal gain should be punished. B. Recommendations Regarding Continued Growth Economic policymakers and regulators have kept China on a fastgrowth, low-inflation track for many years. Moreover, they have done so while successfully regulating the intensity and duration of business cycles. The four recommendations described bellow should serve to strengthen this effort. 1) Moves undertaken designed to improve the health and stability of financial markets should continue and be expanded. Such efforts gained substantial support when the Central Economic Work Meeting held in December 2004 ratified the need for new regulation and intervention regarding the management of business cycles. Minister of Finance Jin Renqing said, “Businesses should be allowed to make and hold onto more money. Tax reductions help in this regard. Competitive pressures and an easing of government supports should help enterprises grow stronger. However, policymaking can play a role; for instance, businesses should be encouraged to increase investment, especially in technical innovation.” However, results of such interventions have been mixed thus far, largely because financial and

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currency controls have restricted access to new funding. This slows growth and the development of the market system. 2) Broaden the use of treasury bonds to fund construction, especially for infrastructural projects. This practice has a long and successful track record in developing countries. China began this practice in 1998 as a way of financing infrastructural improvements and social spending programs. Given the shortage of funds needed to finance development, especially of large capital projects, some borrowing must be undertaken. These investments must be made in order to keep China’s economy on a high-growth trajectory. Moreover, many regions of the country have yet to receive adequate financing regarding infrastructural improvement and social spending support: the West, rural areas in general, and the old industrial Northeast all require a substantial infusion of funding in order to develop. Estimates show that an amount in excess of 80 billion yuan in new bonds would be needed to finance currently identified public investments. Financing government operations through bond markets can improve public finance in an indirect fashion as well. By exposing government operations to some pressures through market discipline, current overstaffing and deficit spending will have to be brought under control and better managed. This will improve the efficiency of government operations generally. 3) Make financing more accessible to small and medium-sized business. Restrictive financing policies work an especially severe hardship on smaller businesses since they have fewer options for financing growth, innovation, and renovation of their operations. This problem is aggravated by a lack of diversity in the kinds of financial institutions at work in the market. China has a number of large banks, which are mostly state supported, but all too few small and medium-sized banks. Big banks tend to be poorly equipped to handle small accounts. Moreover, the lack of smaller banks means that having access to a local bank is a problem for many business owners. Growth and diversity should be encouraged in this segment of the financing industry. Non-state financial organizations have substantial asset holdings, much of it from small depositors. However, some of these operations routinely engage in shady deals, for instance, giving loans for businesses

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that have not been fully licensed or that cut corners in their operations. Loans from small and non-governmental banks carry very high interest rates: 12–24% per annum. In essence they often function as “loan sharks”. Clearly this situation calls for government action. First, government should encourage entry into this market segment, especially for small and medium-sized banks. This could be done by making special lowinterest or no-interest financing available to entrepreneurs who want to move into this sector or by making special financing or tax easements available to established banks willing to expand their operations in this market segment. Setting up branches throughout the country should be a key aim of such efforts. Many of these banks will be allowed to operate only within a given locality, such as a county or within a few geographically connected townships. By working locally, they can become expert in local market conditions, local opportunities, and local businesses. This expertise should help to stabilize their loan portfolio, and barring exogenous shocks, reduce failures. They also have a vested interest in supporting the local economy since their own success will depend on it. Second, government should encourage financial organizations that play by the rules to become legal and legitimate. Such organizations have cropped up in smaller localities, such as at the county level, particularly in the Southeast.7 Wenzhou may be the best known example of this kind of activity; unofficial estimates show that 60% of the capital in circulation moves through unofficial channels. Most of these unofficial operations have established a track record for fair-dealing, gaining the trust of both depositors and loan customers. Essentially they have found an unserved niche in the market and have set up shop serving this niche. These operations should be supported and encouraged since they serve a valuable function. Moreover, legitimizing these businesses will help to drive out unofficial operators engaged in illegal or unfair activities. Such operators can also provide information on economic activities and conditions in smaller locales, which should help to improve policymaking aimed at uplifting rural areas. Finally, by bringing these

7 For those with less familiarity with Chinese geography, the Southeast includes the coastal area encompassing the two great river deltas, the Changjiang, or Yangtze, and Pearl River deltas, where much of China’s economic resources are concentrated. This area includes the provinces of Jiangsu, Zhejiang, Shanghai, Fujian, and Guangdong.

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operations above board, they can be taxed, which should help to finance local government operations. Legitimizing these operations should be carried out with care. These businesses must follow administrative regulations, observe bounds on the sphere of operations, stay within guidelines on acceptable operational forms, carry out informational reporting requirements and monitoring methods, and adhere to regulations regarding interest payments. Once these fair-dealing organizations have been officially sanctioned, those organizations that engage in illegal activity, such as money laundering, should be tracked down and prosecuted for their crimes. 4) Ensure continued growth of the real estate industry. Commercial and residential real estate demand has boomed. Both will remain in high demand, high-growth trajectories for the near future. Future economic growth depends on the industry maintaining this highgrowth trajectory. After abolishing the government housing distribution system, real estate companies have taken over the process of matching households with domiciles. That is, market forces determine the kinds, amounts, and prices of living spaces made available. Being embedded within market processes allows information about real estate activities and demands to be transmitted to other industries with utmost efficiency. For this and other reasons many nations use housing starts as a bellwether indicator of future economic activity and growth and China seems to be falling into this pattern. Building and construction, raw materials, transportation services, shipping and logistics, and financing all depend on real estate demand. Both market forces and policymakers have placed it in a central position regarding future economic development. The scale of investment in the industry further underscores its importance. Investment in real estate contributes 18.78% to national aggregate investment. However, in some localities, it makes up more than 50% of investment. This level of growth in real estate has precipitated a “gold rush” mentality in some places. In order to control some of the worst aspects of this condition, such as skyrocketing prices, the government introduced a variety of measures designed to slow growth in the industry. After a slowdown in response to such measures in the first half of 2005, markets appear to be rebounding. This new momentum may well carry through to the end of 2006.

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Demand still outpaces supply in real estate markets, so prices will increase in coming quarters. Moreover, consumers now demand larger and better appointed housing, and this will also drive up average prices. All government can do is enforce laws preventing operators from profiting through illegitimate means. Price gouging must be monitored, controlled and punished. However, other forms of price controls or market intervention should be resisted. For instance, recently introduced policies have placed a heavy burden on low-income households. One such policy has raised the minimum down payment required to make a real estate purchase. Another regressive policy has raised mortgage interest rates. Those with high incomes can afford these changes; developers and real estate agencies remain relatively unaffected. Government supports for housing have been controversial largely because they do not provide relief to those who most need it and because they do not address the shortages that drive up prices. Moreover, subsidized and low-income housing has been occupied by middle and even high-income households willing to “work the system” to save money. We recommend looking at the best practices at work in other countries and regions—such as Britain, Singapore and Hong Kong—to develop a more appropriate, effective, and workable system of housing supports. Low income housing should become more basic and spartan; this class of housing can range in size from twenty to fifty square meters.8 Such units can be constructed quickly and at relatively modest cost. Moreover, distinguishing this market segment will make higher income households less likely to “poach” in this market segment. Such simple domiciles can meet the rapidly expanding demand in the downscale part of the market as immigrants move into cities in record numbers, and new graduates from secondary and technical schools arrive in industrialized areas in droves.

8

In English measures, this equals about 215 to 540 square feet.

CHINA’S MACROECONOMIC TRENDS AND POLICIES FOR 2005–20061 Economic Research Institute, Renmin University of China I. Projecting Key Economic Indicators After moving through an economic trough from 1991 to 2001, the Chinese economy has expanded quickly. Better still, it has done so while shaking off inflationary pressures that had built up since 1997 and that threatened growth over the long term. Through 2003 China’s economy had achieved remarkably high growth rates with exceptionally low inflation. This momentum carried into 2004. However, early in the year danger signs began to appear. Investment in fixed assets skyrocketed, stressing financial markets, and setting up conditions for an overexpansion in productive capacity. At the same time, demand for certain basic productive inputs—especially energy, and transportation services—vastly outpaced supplies, causing productive bottlenecks and price spikes for these resources. In response, the government issued a number of pronouncements aimed at easing these tensions in the short run and creating more balanced growth and development in the long run. Given that such policies take time to have an effect, problems worsened by mid-2004, but the economy rebounded late in the year. By mid-2005 actual GDP growth approached potential GDP growth. However, real growth is slowing slightly over time, although it still moves headlong at about 9% per year with less than 3% inflation. This slowdown is unsurprising given that the economic base has grown. Furthermore, the slowing growth rate makes economic management and business decision making more rational and predictable. GDP growth will continue its gradual slowdown, but will remain above 8%, which by almost any measure is remarkably vigorous. This is a research project of the China Economic Analysis and Projection Centre at Renmin University of China. The paper is based on the work of the following discussants: Hu Naiwu, Huang Taiyan, Bao Minghua, Fang Fang, Zou Zhengfang, Huang Jun, and Wang Jingfeng. Zheng Chaoyu wrote the final draft. 1

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Variables

2005

2006

1. GDP growth (%) Growth in agriculture Growth in industry Growth in services 2. Total fixed assets investment (billions of yuan) Total consumer products sales (billions of yuan) 3. Exports (USD billion) Imports (USD billion) 4. Money supply (M1) growth (%) Broader money supply (M2) growth (%) 5. Consumer price index (CPI) (%) GDP deflator (%)

9.29 5.4 11.0 8.2 8,774 6,080 748 657 15.2 17.6 2.5 5.9

8.83 4.2 10.5 8.0 10,617 6,822 912 775 15.4 17.3 2.8 4.0

Note: Model was run during October 2005.

China should stay the course regarding macroeconomic policy and strategy through 2006. Doing so will help to keep investment and consumption on strong growth trends. This will also help to expand the export sector. Taken together, these elements will feed economic growth and give the economy the momentum necessary to soften the impact of business cycles. The predictive model used by Renmin University of China provides projections of various economic statistics and indicators for China’s economy. A key finding is that the Central Government will run a budget deficit of 290 billion yuan in 2006. Table 8.1 summarizes other important projections. II. Economic Conditions in China A. Chinese Growth Potential Economic growth in China varied widely in the 1990s. In the first half of the decade, during the 8th Five-Year Plan, GDP grew at 12% per annum on average. However, during the 9th Five-Year Plan, GDP growth averaged only 8.3%. Many economists and wonks predicted that China’s halcyon days of sustained high-speed growth had drawn to a close. However, China’s economy rebounded during the 10th FiveYear Plan, attaining 9% growth or better from 2003–2005. Taken in

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a broader perspective, the late 1990s appeared to be the worst part of a long business cycle. Emerging from the trough of this business cycle has placed China’s economy on an entirely different footing. Until 1980, China functioned as a subsistence-level economy. Because of the rapid expansion that started in the 80s and ran into the 90s, China has vastly expanded output, improved its labor pool, and begun to accrue surpluses to invest in economic reform and expansion, quality-of-life improvements, infrastructure, and improved integration into the global economy. China’s “market socialism” has become a fully realized and successful economic system. Within this structure, market mechanisms play the leading role in handling resource development, production, and allocation. This system yields a substantial improvement in efficiency over all other mechanisms currently available, so China will continue to apply this system for the foreseeable future. Efficiency gains have led to an expansion in capacity. Expansion has occurred most prodigiously in the industrial sector, where China now plays a dominant role in many kinds of manufacturing. This offers the Chinese tremendous opportunities, but at the same time, more intense exposure to international pressures regarding trade rules, prices, policy changes, politics, and competition. This form of development has also placed heavy strains on China’s financial system, resources, and environment. China has made use of its unique advantages regarding production and economic inputs. Most notably, it has drawn upon its nearly limitless labor pool to offer high quality manufacturing work at very low costs. Other input advantages have been exploited. Because the domestic savings rate is high and the population large, and also because growth has made the Chinese market attractive to foreign investors, the economy is awash in capital needed to finance various projects, especially industrial and infrastructural improvements. Finally, China’s ready access to domestic energy resources has allowed it to fuel its expansion at relatively low cost. China’s overall development might be described as “medium to late period industrialization.” Given the experience of other economies that have been through this phase of economic development, we can expect the Chinese economy to rely less heavily on manufacturing and heavy industry in the coming years. It will emerge from this period with greater core competence in services and information processing. That

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is, China will adopt a knowledge based economy. Successfully managing the transition will help to maintain growth rates. Estimates show that China’s GDP growth rate will hover around 9% per year through the end of the decade. Because China must bring prosperity to more of its citizens, and find jobs for literally hundreds of millions, it should target the highest sustainable growth rate (HSGR) as its target growth rate. B. Inflation Trends through Time China’s economy faces inflationary pressures from at least three sources: demand-driven inflation, cost-driven inflation, and trade-driven inflation. Complicating matters is that these elements are interrelated. For instance, inflation in costs—say, though increased energy prices—feed into demand-side inflation, as costs for final products rise, and consumers snap up goods in order to avoid paying higher prices later. As well, increases in import prices put upward pressure on the CPI as well as the producer price index (PPI): consumers pay more for goods; producers pay more for needed inputs (like oil). The signal from the original energy price hike can cycle through the economy several times. Some internal changes have increased inflationary pressures as well. For instance, environmental protection measures have added costs to production, at least in the short run while these new systems and technologies develop. Over time, such pressures should be offset and held at bay through efficiency gains, rigorous competition, and technological progress. Such input price changes do not directly impact final consumption. The difference between the CPI and PPI gives an approximation of this difference, although some time lag in the impact of input price changes and their final expression in end-product prices drives this difference as well. Market competition and improving technical acumen have kept inflation low since the late 1990s. Even the rapid growth rate attained since 2003 does not seem likely to push inflation above 3%. Given the productive capacity for basic resources, the extensiveness of China’s system of contracts to assure supplies of needed imported raw materials, falling agricultural prices, and predictable increases for goods such as housing, inflation will remain tamed for the next few years. A few inflation-prone industries have come under heavier administrative control in order to forestall price increases. These industries

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include education, medical services, and public welfare services. None of these industries have seen levels of competition needed to drive down prices. Overall development of the service sector will help to address this problem. C. Post-Keynesian Research and Policy Keynesian analysis can shed light on the workings of the Chinese economy and help inform research and policymaking. Keynes’ insights on the problem of inadequate effective demand and business cycles are especially relevant. Most important for Chinese policymakers, though, is aggregate demand management and its connection to output. Government has considerable influence over the components of demand—consumption, investment, government spending, and exports net of imports—and these levers offer multiple ways of pushing up GDP and keeping China on its fast-growth trajectory. Keynesian analysis also provides policymakers tools for addressing unemployment. However, unemployment manifests some characteristics more in line with neoclassical labor markets. These components need to be addressed independently as much as possible. However, the Keynesian approach leads to rather straightforward intervention: increasing capital accumulation and effective demand. Increased investment in capital can increase the number of possible jobs available; increasing effective demand will prod suppliers to expand output in order to meet that demand.2 As noted above, China’s high saving rate and attractiveness to foreign direct investment (FDI) make the increased investment path especially appealing. In the long run this strategy can expand capacity and create a vast number of new jobs.3 Because of these short term and long term benefits, and the ready availability of capital, China has leaned heavily on economic policies and strategies built around high investment. Thus far this gambit has paid extraordinary dividends: the job base has grown and this has raised incomes and living standards; the supply of goods has expanded and 2 Those familiar with economics will quickly note that investment in capital can also replace labor. The nature of the production function must be well understood in order to use increased investment as a tool for increasing employment. Unsurprisingly, many Chinese firms lean more heavily on labor than similar types of firms and producers in more developed countries. 3 Unchecked investment can also lead to overexpansion of production, and with it, surpluses. Other chapters in this volume discuss this problem in detail.

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this has staved off inflation; the capital base has grown and this has allowed China to become a major force in manufacturing and heavy industry. Fine-tuning this process and using it as a springboard to enter the next phase of economic development is key. China’s economic structure needs to become more balanced, robust, and diverse. Coordination between different kinds of production, distribution, and supply lines needs to be refined. Bringing greater rationality to decision making by working within market forces need to be further encouraged. Operations need to become more efficient. And the economy needs to move toward higher value-added production. The Chinese economy has thrived based upon the economics of growth, or the so-called “extensive” economic model. Now it must pursue smart growth, and become more “intensive” in its methods and practices. Managing consumption is a somewhat trickier issue. Consumer spending goes through cycles, and these can be unpredictable. Distribution of aggregate income is further complicated by cohort effects. In particular, bringing new persons into the job market of requires firms to move experienced workers out of jobs when they hit retirement age. With the median age increasing, and retirement lasting longer, more spending going into retirement and Social Security accounts. Active workers pay for these increased costs and will see their disposable income decline as a result. While this is a zero-sum process regarding aggregate income, it certainly affects income distribution, which in turn, affects key economic indicators like consumer spending. To cushion workers from these effects, policymakers and business leaders should promulgate policies that take advantage of multiplier effects. Encouraging consumer spending would fit this aim. This strategy seems to be in place already: growth in consumer spending has outpaced GDP growth through 2004 and 2005. Chinese economists and policymakers base some aspects of economic analysis and policymaking on the “two-gap model of economic development.” This model pays special attention to the difference between investment and savings (I–S)—the so-called “domestic savings gap”—and the difference between imports and exports (M–X)—also known as the “trade gap.” The demand for Chinese goods, summarized by (M–X), puts upward pressure on the value of the renminbi (RMB). By equating (I–S) with (M–X), the trade surplus can be seen to feed directly into a rise in the domestic savings gap; i.e., savings has been excessive. Increasing investment closes the gap and drives up imports

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relative to exports, which closes the trade gap, easing demand on the RMB, and bringing down its value. III. Comments on China’s Macroeconomic Policies A. Government Finance Financial models have played a pivotal role in spurring economic growth in China. By fusing Keynesian, neoclassical, and socialist policies and approaches, Chinese leaders and policymakers have achieved a singular economic achievement. Specifically, policy changes made in 2005 and 2006 helped to limit and stabilize growth rates in borrowing and investing. Also, government made use of new ways of financing its deficits. Financial policies have not been based upon balanced budget rules. Partly as a result of this, the government has run deficits sine the 1990s. These deficits do not indicate serious overspending or mismanagement. Rather, they are an artifact of the broader market reform and privatization process. Specifically, these deficits have come about as a result of reduced government revenues. Revenues have declined as the government has relinquished control of lucrative state-owned businesses. At the same time, the government has increased spending on infrastructure, public services, and other functions. To continue modernizing its economy, China will need to reform its government financing system and develop new revenue streams and financing instruments. This flies in the face of those who believe that reducing taxes yields the greatest benefits, such as the so-called “Supply Siders.” A dramatic cut in revenue would make government finance more unstable, while reducing funds in both the near and long terms. Without such funds, China faces the threat of even greater inequality and the inability of making important public investments. Since 2004, rapid growth has swelled government coffers and offset much of the cost of public projects. This has made the business of debt reduction politically tolerable because tax rates have remained the same while revenues have increased. China’s budgeting system does not account for cost of living adjustments (COLAs). This tends to undercut incomes and demand over time. However, it does keep the lid on inflation. The problem is that adjustments to government fees and wages come in response to political

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pressure rather than economic pressures. Moving to a system that builds-in COLAs would help governments function more predictability and stably. B. Coordinating Monetary Policy and Exchange Rate Policies Since 1998, the RMB has maintained an artificially low value. As China’s currency exchange system moves off of a pegged system to a managed float, the currency will become more exposed to international forces and pressures affecting its value. Moreover, the RMB’s value will almost certainly appreciate to the limit imposed by the People’s Bank of China. This move should help to bring various Chinese prices into line with realistic prices determined through market forces. Although the government will lose control of a powerful economic lever in influencing economic function, the improved overall economic function makes this a worthwhile tradeoff. Since interest rates have remained relatively low, monetary controls remain relatively lax. Unsurprisingly, money supply (M1) increased in each quarter during 2005. However, low interest rates brought some degree of volatility to credit markets. In response, regulators tightened controls. Adopting a market-based system and integrating its economy into the broader global economy will push China to consider a few related fundamental elements when it sets policy affecting its financial markets. First, it must consider the impact of exchange rate reform. The reform process will lead to the RMB’s appreciation, at least as long as demand for Chinese goods remains strong. Once the ± 2% cap on the RMB’s fluctuation is removed, we expect that the RMB will appreciate about 6% in the first year of freely floating. Second, managing inflation and interest rates must take into consideration real and potential GDP growth, increases in the RMB’s value, and inflation rates. Third, input prices must be considered in managing inflation. In the long run, prices must stay above average costs in order for businesses to survive. Rising costs in China, especially for skilled labor and energy, put upward pressure on prices. However, price hikes for these two inputs have vastly outpaced the price increase of finished products. Two forces have led to this outcome: increases in productivity and increases in output. That is, labor has made up for its increased price by working faster and more effectively. This has resulted in a vast expansion in the supply of goods, which in turn blunts upward pressure on prices.

MATHEMATICAL APPENDIX The following note details the calculations behind some of the reasoning applied in this paper. China’s monetary supply growth target can be summarized as follows: gM = 19.5% + 0.5% which stems from the mathematical statement for guiding monetary policy gM = π* + gY*–gV* where M represents the money supply, Y represents potential national income (output), V represents money velocity, and π represents the core inflation rate. Based on econometric estimates, the specification for the Chinese economy can be written as π* = 2.5% + 0.25%, gY* = 8.75%

where – gV* = 6.75% + 0.25%. This estimate yields a rather low core inflation rate, given the exchange rate, inflationary, input price, and output conditions defined above. The estimation of the money-holding coefficient’s growth rate,—gV*, might overestimate the speed of monetization of Chinese economy since 2004, at least based on data taken from 1991 to 2003. Therefore, the growth target of gM = 19.5% + 0.5% still serves as a reasonable upper bound regarding money supply.

ANALYSIS OF CHINA’S TRADE IN 2005 AND PROSPECTS IN 2006 Pei Changhong and Lin Jiang I. Current Trade Conditions According to customs statistics of the time spanning from January to August, 2005, by the end of August, the total value of China’s came to US$ 891.73 billion, up 23.5% from the same period of the previous year. In a breakdown, export stood at US$ 476.25 billion, up 32.2%; import was US$ 415.47 billion, an increase of 15.0% from the corresponding period, with a total trade surplus of US$ 60.78 billion. In August, China’s monthly trade surplus once again exceeded US$ 10 billion, only US$ 400 million less than that of July. Up to now, the monthly trade surplus of July was the highest this year. The total foreign trade value in August was US$ 126.21 billion, up 28.6% from the corresponding period. In a breakdown, export was US$ 68.4 billion, up 33.2%, and import was US$ 57.81 billion, up 23.5% from the corresponding period. The trade surplus of the month was US$ 10.59 billion up 134.2% from the corresponding period. From January to August, China’s foreign trade presented an obvious situation of ‘high- export and low- import’. A. Trade Balance Table 9.1 shows the differences between import and export in China’s foreign trade from January to August in 2005. Please note that from January to August, all these monthly recorded trade surplus, and present an increasing tendency. According to Customs statistics, in the first half of 2005, the total value of China’s foreign trade came to US$ 645.02 billion 2005, up 23.2% from the corresponding period. In a breakdown, export was US$ 342.3 billion, up 32.6%; import was US$ 302.72 billion, up 13.7%; and the trade surplus was US$ 39.58 billion, exceeding last year’s total trade surplus of US$ 32.10 billion.

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Table 9.1: Differences between import and export of China’s foreign trade from January to August in 2005 Units: Million USD Month

January February March April 2005 2005 2005 2005 4416

May 2005

June 2005

July August 2005 2005

9002

9701 10599 10593

Current Month

6474

4376

5615

Accumulation from Jan. to the month in question

6474

10850

16465 20882 29884 39584 50184 60777

Data Source: Customs Statistics, August, 2005.

In the first half of this year, China’s import displayed four major characteristics: first, the gradual decreasing tendency of import continued. In the first half of last year, the import growth rate was 43%, but slowed down to 30% in the second half. In the first half of this year, the import growth rate is 14%, while that of the export is 23.75. Import growth rate was distinctly lower than export growth rate. Second, the difference between the growth rate of import and export was near 20 percentage points, which was different from that of the previous two years, when the import growth rate was a little higher than the export growth rate. Third, in terms of import structure, there was a slowdown of import in ordinary trade. As raw materials and investment products account for about 80% of the total value of China’s import, the slow-down of import growth indicates that the growth rate of domestic production and demand is slowing down. The import of investment products and intermediate inputs decreased the most, while from 2003 to 2004, the import of these merchandises increased very quickly. That was the main reason that caused the slow-down of the import growth rate this year. The quick drop of investment products import led to the slow growth of import, indicating weak domestic demand. Fourth, the growth rate of both the ordinary trade and processing trade was lower than that of export trade. Although export situation is excellent, we can not be optimistic. Low export quality and low foreign trade economic benefit are still the main characteristics of China’s foreign trade exports. The reasons for the quick decrease of import: First, macro-regulations were effective. There was obvious decrease in total domestic demand, and investment demand was controlled particularly effectively. The change in total domestic demand was the key factor that has

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affected import. In terms of trade, the growth rate of ordinary trade decreased the most. In the first two months, the import of ordinary trade decreased by 1.7%. In a breakdown, the import of ordinary trade decreased by 11% for Sino-foreign jointly funded enterprises, and 46.5% for Chinese-foreign cooperative enterprises. Processing trade import was affected by processing trade export, and was seldom affected by the changes in domestic demand, so import of processing on giving materials and processing with imported materials increased by 28.9% and 16.7% respectively in the same period. As far as merchandise categories are concerned, the import volume of steel products and primary plastics—mainly used in investment in fixed assets—decreased significantly by 46.9% and 23.6% respectively from the same period of last year. Yet, because of the rise in price, the total import value did not decrease much, only by 7% for steel products and even increased by 1.2% for primary plastics. Second, the decreases of the import of several bulk stocks have their own representative reasons. For soybeans, excessive imports last year led to the import decrease and price falling this year. In the first two months, the import volume and total import value of soybean decreased by 12.2% and 29.8% respectively. The situation was similar for edible vegetable oil import. For cotton, because cotton import volume last year reached its record high and concentrated in the first half year (76%), in the first two months, both import volume and price of cotton dropped, the import volume and total import value decreased by 60.8% and 71.8% respectively, which also led to the decrease in the import of synthetic fiber suitable for spinning. For textile machinery, last year, in order to take advantage of the global lift of quota limitation of textile products, the domestic enterprises imported a large quantity of textile machines, which led to a decrease of 26.3% in textile machinery imports in the first two months of 2005. Also, the import volume and value of automobiles and vehicle chassis decreased by 59.2% and 55.3% respectively in the first two months of 2005, even though the quota on automobile import has been canceled and import duty has been lowered somewhat. These are the reasons: sudden cooling of domestic auto market demand, higher degree of home-made automobile parts, abolition of bonded auto import policy in bonded zone, and the new rules that only the enterprises that are authorized by foreign automobile companies can import and sell imported automobiles. China’s trade surplus will be expanded further, as import growth rate is much lower than export growth rate. The good news is that we

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can use external demand to drive up GDP growth. However, we need to pay more attention to its negative impact. Firstly, trade friction will be aggravated. Secondly, the regional imbalance of foreign trade will be more serious. China has very serious regional imbalance in foreign trade. As China’s processing trade imports mainly come from neighboring economies, and exports mainly go to European and American markets, we have increasing trade deficit with neighboring economies, and expanding trade surplus with the US and Europe. China’s import growth mainly came from processing trade imports in 2005, thus, its trade deficit with neighboring countries will continue to enlarge. In terms of trade with the US and Europe, China’s rapid export growth and weak import growth will aggravate the problem of Sino-US and Sino-Europe trade imbalance, which may lead to greater pressure on bilateral economic and trade relations from America and Europe to China. Thirdly, pressure on revaluation of the RMB exchange rate will become greater. Fourthly, more foreign exchange reserves will bring more problems. It will be more difficult for the monetary authorities to control money supply and manage reserve assets. B. The Import and Export Structure From January to August of 2005, in terms of export, the total value of export of primary products was 32.05 billion U.S. dollars, increasing 29.3% over the same period of 2004, accounting for 6.7% of total exports; the total value of the export of industrial products was 444.20 billion U.S. dollars, increasing 32.4% over the same period of 2004, accounting for 93.3% of the total exports. In terms of import, the total value of the import of primary products was 94 billion U.S. dollars, increasing 25.1% over the same period of 2004, accounting for 22.6% of the total imports; the total value of the import of industrial products was 321.48 billion U.S. dollars, increasing 12.3% over the same period of 2004, accounting for 77.4% of the total imports. Among the exporting goods, export of mechanical and electrical products maintains a stable increase, and export of bulk commodities is also increasing rapidly. According to customs statistics, from January to August, China exported US$ 259.37 billion worth of mechanical and electrical products, increasing by 33.2%, 1 percentage point higher than the total exports of the same period, accounting for 54.5% of the total value of export. A breakdown of this category shows that the

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export of machinery and equipment was worth 93.26 billion U.S. dollars, increasing by 29%; the export of electrical and electronic products was worth 101.81 billion U.S. dollars, with an increase of 32.5%. Besides, export of traditional bulk commodities keeps on growing. From January to August, the total value of garment exports was 46.65 billion U.S. dollars, increasing by 22.3%. Fabric garments’ export was US$ 38.81 billion, increasing by 22.8%, and the value of footwear export was US$ 12.47 billion, with an increase of 25.6%. From January to August, the total value of China’s import and export of hi-tech products reached 250.05 billion U.S. dollars, an increase of 26.1% over the same period of 2004. Of these, imports valued 120.40 billion U.S. dollars, increasing by 19.6%; exports valued 129.65 billion U.S. dollars, increasing by 33.1%, accounting for 27.2% of the total value of China’s export during the same period. The monthly export & import value of August and the monthly import value were both highest in history. The monthly total value of imports and exports reached 36.55 billion U.S. dollars, increasing by 31.7% over the same period of 2004, with export worth 18.60 billion US dollars, and imports 17.95 billion U.S. dollars, increasing by 36.2% and 27.3%, respectively. The increase rate of import and export for the first eight months was 2.6 percentage point higher than the growth rate of China’s foreign trade. The trade surplus was over 9 billion US dollars, and the foreign trade of high-tech products has trade surplus for 11 months on end. With correct policies, the total value of the import and export of high-tech products could reach 400 billion U.S. dollars in the second half of 2005, with an increase of 25% over the same period of 2004. Total export of integrated circuits, mobile phones & their parts, and computers & their parts valued 71.79 billion U.S. dollars. They account for 55.4% of the total exports of high-tech products, with an increase of 33%. Of these, export of computers & their parts was worth 45.69 billion U.S. dollars, with an increase of 28.5%, and their average unit price increased 11.1%; the export of mobile phones & their parts valued 1.72 billion US dollars, with an increase of 46.9%; the export of IC was worth 8.58 billion U.S. dollars, with an increase of 31.8%, and average unit price increased by 4.8%. Export of high-tech products in the year 2005 will show us four trends: export growth rate of high-tech products of the first quarter is lower than that of China’s overall foreign trade; in the second quarter the two figures will be almost the same; in the third quarter the export

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growth rate of high-tech products will surpass that of the national foreign trade, and in the fourth quarter the export growth of high-tech products will promote the country’s total export growth rate. During the first half of 2005, the import and export of automobiles showed contrasting trends. In terms of import, although the auto import quotas have been abolished, and tariffs lowered, the downturn trend of vehicle imports has not been alleviated. In terms of export, with the continuous improvement of domestic auto manufacturers’ strength, export kept on growing rapidly. Not only did automobile parts and other related products were exported in large quantities, but the export of entire automobiles, particularly cars, also showed rapid growth which was hardly expected before. According to customs statistics collected by China Automobile Industry Association, in the first six months of 2005 the total value of auto products imports and exports reached 15.375 billion U.S. dollars, in which imports valued 6.317 billion, down by 21.31%, and exports were worth 9.058 billion U.S. dollars, an increase of 57.20% over the same period of 2004. C. Trade Formation Analysis Customs statistics shows that, from January to August, China’s general trade exports had rapid growth, while import growth slowed down greatly. From January to August, China’s import and export of general trade reached 382.49 billion U.S. dollars, with an increase of 21.7%, in which general trade exports reached 202.78 billion U.S. dollars, an increase of 35.4%, and general trade imports reached 179.71 billion U.S. dollars, an increase of 9.2%. The trade surplus in this general trade category was 23.07 billion U.S. dollars. During that period, both export and import of processing trade increased rapidly, and trade surplus enlarged further. According to statistics, from January to August, the total value of import and export of processing trade reached 424.59 billion U.S. dollars, increasing by 56.4%, in which, the exports valued 255.26 billion U.S. dollars, increasing by 40.8%, and the imports valued 169.33 billion U.S. dollars, increasing by 28.9%. The trade surplus under processing trade was 85.93 billion U.S. dollars. In processing trades, from January to August, exports under trade processing assembly were 52.93 billion U.S. dollars, increasing by 27.3% over the same period of 2004, accounting for 20.7% of the total exports of processing trade. Imports under trade processing assembly valued 43.08 U.S. dollars, with an increase of

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Table 9.2: Overview of China’s import and export trade composition ( January–August, 2005) Units: Billion USD, % Category

Value of export

Percentage Proportion of increase of total exports

Total value General trade Processing trade

476.25 202.78 255.26

32.2 35.4 40.8

52.93

202.33

Value of import

Percentage Proportion of increase of total imports

415.47 179.71 169.33

15.0 9.2 28.9

27.3

43.08

27.5

29.4

126.25

20.7

17.99

–11.6

4.3

27.59

16.6

6.6

42.6 53.6

43.3 40.8

Under processing trade Accepting customers’ materials for processing and assembly Feed processing trade Imported equipment and materials by foreign-invested enterprises as part of their investment Goods of Bonded Zone warehousing transshipment

7.46

29.9

1.6

Data source: Customs Statistics, August, 2005.

27.5%, accounting for 25.4% of the total imports of processed trade. Total value of exports under feed processing trades was 202.33 billion U.S. dollars, 29.4% increase over the same period of 2004, accounting for 79.3% of the total processing trade exports. And the value of its imports was 126.25 billion U.S. dollars, increasing by 20.7%, accounting for 74.6% of the total processing trade imports. (See Table 9.2.) D. Import and Export Enterprises According to customs statistics, in terms of the nature of import and export enterprises, foreign-invested enterprises are still the main players in China’s foreign trades. From January to August of 2005, the total exports of foreign-invested enterprises were 271.87 billion U.S. dollars, a 32.9% increase over the same period of last year, a little bit higher

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than China’s export growth rate (32.2%), accounting for 57.1% of the total value of exports. During the same period, their imports were 239.98 billion U.S. dollars, with an increase of 16.3%, accounting for 57.8% of China’s total imports. State-owned enterprises still have a very important status in China’s foreign trade. From January to August of 2005, state-owned enterprises exported goods valued 111.39 billion U.S. dollars, accounting for 23.4% of the total exports, while they imported $127.56 billion worth of goods, accounting for 30.7% of the total imports. However, comparing with the same period of last year, their export and import growth rates were only 16.2% and 10.0%, respectively. In addition, other types of enterprises such as collective and private ones are playing more and more important roles in China’s foreign trade. From January to August, collective enterprises exported 24.13 billion U.S. dollars of goods, an increase of 20.5% over the same period of last year; they imported 13.78 billion U.S. dollars worth of goods, increasing by 16.1%. It is worth noting that other types of enterprises such as private ones exported goods valued 68.85 billion U.S. dollars from January to August, an increase of 72.7% over the same period of last year, much higher than the growth rate of the total value of exports, and their proportion in the total export also rose to 14.5%. During the same period, these enterprises—including private ones—imported goods valued 34.15 billion U.S. dollars, 25.0% increase over last year, and accounted for 8.2% of the total imports. (See Table 9.3.) Table 9.3: Overview of the nature of China’s import and export enterprises ( January–August, 2005) Units: Billion USD, % Nature of the enterprises

Exports

Increases Proportion Imports Increases Proportion of total of total exports imports

Total value State-owned enterprises Foreign-invested enterprises Collective enterprises Others

476.25 111.39

32.2 16.2

– 23.4

415.47 127.56

15.0 10.0

– 30.7

271.87

32.9

57.1

239.98

16.3

57.8

24.13 68.85

20.5 72.7

5.1 14.5

13.78 34.15

16.1 25.0

3.3 8.2

Data source: Customs Statistics, August, 2005.

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E. Trading Partners In recent years, although trade friction happened frequently between China and EU and US, the bilateral trade keeps on growing rapidly. According to customs statistics, during the first eight months of 2005, good trend remained in bilateral trades between China and its three largest trading partners—EU, US, and Japan. The European Union continued to be China’s largest trading partner, with total value of bilateral trade 138 billion U.S. dollars, 23.7% increase over the same period of last year. The total value of China’s exports to EU was 90.76 billion U.S. dollars, an increase of 38.7%. Its import from EU was worth 47.24 billion U.S. dollars, an increase of 2.4%, which means that China had a trade surplus of 43.52 billion U.S. dollars. The United States was still the second largest trading partner of China. From January to August, the total value of Sino-US bilateral trade was 133.67 billion U.S. dollars, increasing by 24.9%. Of this, China’s exports to US valued 101.82 billion U.S. dollars, an increase of 32.8% over the same period of 2004, and its imports from US valued 31.85 billion U.S. dollars, an increase of 5.1% over the same period of 2004. Thus, China had a trade surplus of 69.97 billion U.S. dollars. Japan, as the third largest trading partner of China, Bilateral trade was worth 117.57 billion U.S. dollars, an increase of 10.3%. Of this, China’s exports to Japan valued 54.29 billion U.S. dollars, an increase of 19.9%, and its imports from Japan valued 63.28 billion U.S. dollars, an increase of 3.2% over the same period of 2004. China’s trade deficit was 8.99 billion U.S. dollars. ASEAN continued to be China’s fourth largest trading partner, with total value of bilateral trade worth 82.31 billion U.S. dollars, an increase of 25.5%. Of this, the value of China’s exports to ASEAN countries was 35.67 billion U.S. dollars, an increase of 37.6%, and its imports from ASEAN was 46.64 billion U.S. dollars, an increase of 17.6%, which means China had a trade deficit of 10.97 billion U.S. dollars. The Chinese government has signed with the ten countries of ASEAN “Agreement on Goods Trade” and “Agreement on Dispute Settlement Mechanism” as part of the Sino-ASEAN free-trade zone scheme. The agreements stipulate that, from July of 2005, the two sides lower taxes on products of 7000 tax items, and give each other preferential tariff treatment to products originated in China and ASEAN countries,

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and let the other side’s goods go through customs with free-trade zone’s taxes. South Korea was China’s fifth largest trading partner, with the total value of bilateral trade worth 71.03 billion U.S. dollars an increase of 25.7%. Of this, China’s exports to South Korea valued 22.61 billion U.S. dollars, an increase of 35.2%, and its imports valued 48.42 billion U.S. dollars, an increase of 21.7%, which means that China had a trade deficit of 25.81 billion U.S. dollars. Australia was China’s sixth largest trading partner. Bilateral trade in this period totaled 17.16 billion U.S. dollars, an increase of 37.6%. Of this, China’s exports to Australia valued 6.81 billion U.S. dollars, an increase of 29.7%, and its imports from that country valued 10.35 billion U.S. dollars, an increase of 43.4%, which means that China had a trade deficit of 3.54 billion U.S. dollars. Canada was China’s seventh largest trading partner. Bilateral trade totaled 12.35 billion U.S. dollars during this period, showing an increase of 24.4%. Of this, China’s exports to Canada valued 7.33 billion U.S. dollars, an increase of 44.8%, and its imports from Canada valued 5.02 billion U.S. dollars, with an increase of 3.1%. II. Analysis of the Special Elements in China’s Foreign Trade in 2005 A. Trade Friction At present, the European Union is China’s largest trading partner, while China is the European Union’s second largest trading partner. The total value of Sino-EU bilateral trade is close to 200 billion Euros. During the first several months of 2005, the exports of textiles from China to Europe grew rapidly, which caused dissatisfaction of textile industries in some EU member countries. After negotiations, the two sides came to an agreement in June 10, 2005. It provided that before the end of 2007 EU would set yearly quotas on ten kinds of textile products exported from China to EU. Due to the liberalization of global textile trade since January 1, 2005, EU’s new restrictions caught its importers and retailers unprepared. This led to a series of problems. Since August, the supply of certain Chinese textile products subject to the restriction has fallen short of demand. Therefore, a large quantity of China’s textile products were overstocked on many European ports due to lack of import permission.

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It’s reported that about 80 million pieces of China’s textile products were piling up on European ports. Considering the overall situation of Sino-EU relations, Chinese government negotiated with the European Union in an attempt to find a good solution. On September 5, 2005, the two parties reached “Consultations Minutes” in Beijing. On September 1, the Sino-US negotiation on the rapid growth of China’s textile exports ended fruitlessly. Then United States announced that it would put new restrictions on China’s textiles. This action can be interpreted as US pressures to force China to concede. The SinoUS negotiations on textile trade will determine the long-term growth rate of China’s textile exports to the U.S. Since May of this year, the United States has announced the restriction on the yearly growth rate of China’s textile exports to the US—no more than 7.5%—valued about 1.31 billion U.S. dollars. According to American statistics, the total values of China’s textile exports to US in 2002, 2003, and 2004 were 12.187 billion US dollars, 14.925 billion US dollars, and 18.240 billion US dollars, accounting for 15.65%, 17.91%, and 20.31% of the total value of American textile imports, respectively. Each time, the US government would take restrictive measures on certain kinds of textile products. If a wider Sino-US agreement could be signed to replace the existing fragmented ones, a long-term trade environment could be created between China and the United States, and the uncertainty of policy-adjustment could be eliminated. There are five main problems in the Sino-US textile trade. First, abolition of quota has resulted in low price competition. Second, China’s textile exports to the US are facing big external competition pressure, which comes from the following five levels: (1) Many textile product supply countries. (2) The sales of world famous brand clothing are dominated by developed countries such as Japan, and EU, which made it difficult for China to make breakthroughs in exporting its own brand name clothing in the short term. (3) Manyfiber Arrangement countries. Like China, these countries and districts are given the same treatment as the United States abolished the textile quota on China. (4) The Caribbean districts. According to United States Trade and Development Act, United States will strengthen its economic and trade corporation with Caribbean countries, which have lower wages, and export transportation costs, thus very strong competitive advantages. (5) Under the NAFTA Agreement, Mexico’s textile clothing exports to the United States can enjoy duty-free treatment. Moreover, its proximity to the US gives it a competitive edge.

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Third, American textile industries restrict textile imports from China. Six American trade institutes such as ATMI, AFMA, and CCI, have continuously put forward requests on putting restriction on textile imports from China. Fourth, China lacks its own famous brands. Fifth, potential uncertain factors for textile restrictions cannot be eliminated in the short term. Frictions have frequently arisen in relation to textile exports from China to the US and EU. People are worried that China’s textile industry will be adversely impacted. According to statistics, this year, the total value related to Sino-US trade frictions is US$ 4 billion, so is the value of trade frictions between China and EU. The two came to US$ 8 billion, however, it is still a small amount compared with the total value of China’s textile trade, which is close to US$ 100 billion. China’s textile export industry is one of the best growing industries in China’s foreign trade, and its benefits and profits are also among one of the top industries. B. Trade Barriers As the Sino-EU trade disputes have just calmed down, a “Green Storm” swept China’s electrical industry. As EU’s green environmental directives will go into force soon, China’s electrical products will be trapped in the tough international markets. EU’s green environmental directives, also known as “Double Green” instructions, refer to “Directive on Waste Electronic Electrical Equipment” (WEEE), and “Prohibition on the Use of Certain Electronic and Electrical Equipment Orders Harmful Substances” (ROHS). WEEE came into force on Oct. 13, 2005, and ROHS came into force on July 1, 2006, respectively. What worry China’s electrical enterprises most is that, these two instructions were announced in EU’s official journal on February 13, 2003, and became laws on August 13, 2004. Unlike textiles trade disputes, the two instructions cannot be negotiated through WTO coordination mechanism. According to statistics of China’s Ministry of Commerce, these two instructions will affect US$ 30 billion worth of China’s electrical products exports, accounting for 71% of the total exports of electrical products from China to EU. Recently, many Chinese enterprises have been put on the spot, as a result of restrictions on China’s textiles imposed by EU and US, and disputes of intellectual property that overseas enterprises sued against

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Chinese enterprises. Competitions of primary goods are mainly focused on price, while that of high-tech products is mainly on technology. If Chinese enterprises want to avoid intellectual property friction, one of the most important measures is to enhance their ability to develop high-tech, apply for independent intellectual properties, and change the technological weakness that is commonly found among Chinese enterprises. Chinese enterprises should take the following necessary countermeasures to expand overseas market in the future. Firstly, we should change our technology weakness in high-tech competitions. Secondly, we should make use of the European and American restrictions to turn Chinese enterprises in the direction of high-tech faster. Thirdly, we should be fully aware that the intellectual property right is the key in the protection of high-tech. C. RMB Revaluation On July 21, 2005, the central bank of China announced that it would change the RMB exchange rate to US dollar from 8.2761 to 8.111, increasing the value of RMB by 2.1%. RMB exchange rate would be determined with reference to a basket of currencies instead of fixing on US dollars. The 2.1% appreciation of RMB has a comparatively small impact on exports. At present, many enterprises believe that such a cost factor can be neglected. From a long-term perspective, it is helpful for enterprises to make long-term plans to adjust foreign trade development plans with different countries and products. The appreciation of RMB has little impact on China’s imports in the short term, because China’s current imports are mainly related to domestic demand growth. From the perspective of commodity structure, we can see that about one third is investment goods, and nearly two thirds are intermediate inputs, while consuming goods have a very low percentage. From a long-term view of development, the appreciation of RMB has a good impact on imports of those irreplaceable goods, and the more important impact is found in the import of resources. Many resource products need large amount of foreign currencies, and with the appreciation of RMB, the pressure on the rising costs resulted from the price rise in the international markets will be lowered. At present, more than 60% of China’s total exports are processing trade. The appreciation of RMB is helpful to the import steps of

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processing trade, while it is harmful to the export steps of processing trade. Thus, there are both positive and negative impacts. III. An Outlook on China’s Foreign Trade Situation in 2006 A. Prospects for the World Economic Situation Since 2005, world economy has continued to maintain a momentum of steady growth. However, risks that influence the steady growth of world economy still exist, especially the constantly rising oil prices, the disorderly adjustment of the US dollar, and imbalanced global development. Table 9.4 and Table 9.5 are the predictions of world economy made by leading international organizations. The following are the major factors that would influence world economy and trade in 2005. 1) The instability of the international oil market still exists. In 2004, International crude oil prices soared 60%, and New York light crude oil was worth 55.67 U.S. dollars per barrel at the highest. In the early 2005, oil price stayed around 45 U.S. dollars per barrel for some time. From March on, oil price started to climb. Especially after the hurricane hit New Orleans of the United States, oil price rose to almost 70 U.S. dollars per barrel. It’s predicted that the international oil price will maintain a high level for the whole year of 2005. 2) World trade will maintain the state of expansion. Since 2005, the growth trend of international trade has remained strong. From January to February, US imports and exports increased 17.8% and 9.8%, and Japan’s imports and exports increased 13.4%, and 4.7%, respectively. Countries such as Canada, UK, and South Korea had growth rate over 10% in January, while developing countries in Latin America such as Brazil and Chile all had over 30% increase rate in January. Other developing countries in Asia also kept a good growth trend. Due to the impact of the slowdown in world economic growth, and the probable inhibition of growth of production and trade by the rising prices of oil and other commodities, it is expected that the growth rate of world trade in 2005 would not be as high as the previous year, and the slowdown growth rate would be similar to the average growth rate of world trade in the 1990s.

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Table 9.4: Increasing trend of world economy and trade 2003–2006 World Developed U.S.A. Euro Japan economy countries region

2003 2004 2005 2006

4.0 5.1 4.3 4.4

2.0 3.4 2.6 3.0

3.0 4.4 3.6 3.6

0.5 2.0 1.6 2.3

Emerging markets and the developing countries

Volume of world trade

6.4 7.2 6.3 6.0

4.5 9.0 6.5 –

1.4 2.6 0.8 1.9

Note: Data for 2005 and 2006 are predictions. Data source: World Economic Prospects, April 11, 2005, International Monetary Fund. WTO’s Trade Express, April 5, 2004 and April 14, 2005.

Table 9.5: Predictions Made by Leading International Organizations on the Growth of World Economy, 2003–2005 Units: % International Organizations World Developed Countries Developing Countries Transition Economy

IMF

World Bank

UNCTAD

2003

2004

2005

2003

2004

2005

2003

2004

3.9 2.1 6.1 –

5.0 3.6 6.6 –

4.3 2.9 5.9 –

2.7 2.0 5.2 –

4.0 3.5 6.1 –

3.2 2.6 5.4 –

2.6 2.0 4.5 5.9

3.8 3.2 5.8 5.9

Data sources: Lu Yan. “World economy in 2005: trend, impact and countermeasures.” International Economic Cooperation 1 (2005).

3) Excessive fluctuation of international exchange rates is harmful to world economic growth. In 2005, the constantly increasing huge deficit and the current account deficit in the US will give more pressure to the depreciation of the dollar, and dollar exchange rate will face more risk of turbulence. The excessive fluctuation of the exchange rate and disorderly change is harmful to the world economic growth. This is another major factor of uncertainty that world economy is facing. 4) Trade protectionism still exists. With the expansion of world trade, the problem of imbalanced development is becoming more and more obvious. Forced by pressures from various domestic interest groups, some developed countries are frequently using protectionist policies and measures, such as depreciation of currencies, anti-dumping,

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TBT, and other NTBs, to protect their domestic markets and force other countries to concede or to restrict imports from other countries. Under the situation of integration of the global textile and garment trade since January 1, 2005, trade friction in the textile field will be aggravate, and restriction measures targeting major textile exporting countries will probably increase. IV. Economic Situation and Prospects of Major Countries and Regions A. Analysis and Prospects of the Economic Trend in the US Since 2005, US economy has shown an upward trend, with stable inflation rate, strongly increased consumer demand that provided the force of economic recovery. Improved employment situation also stimulated the overall demand effectively. In February, America saw an additional 262,000 jobs were created. As the economic situation is turning for the better, investors have more confidence in American market. And due to customers’ strong demand on imports, American trade deficit reached 61 billion U.S. dollars in February. Therefore, Federal Reserves gradually raised interest rates in a stable and orderly way. American “President’s Economic Report” in 2005 made an optimistic prediction on American macroeconomic trends—3.5% economic growth rate, 5.3% unemployment rate (by the end of 2005), 2.1 million new jobs, and 2.4% increase of CPI. Looking into the future, more robust economic growth of America’s trading partners will be helpful to the growth of American exports. It’s expected that members of OECD (except United States) will have a 3% increase of their economy, higher than the 2.7% prediction made in 2004. This will definitely further stimulate American export. Meanwhile, the proportion of American exports in the global export trade will be higher as a result of the depreciation of the U.S. dollar against other major currencies. On the whole, in 2005, American actual export growth will be faster than that of GDP. In the meantime, due to the prediction that American GDP will show moderate growth during 2005–2006, and because of the currency depreciation effects, the actual growth of US imports will slow down. In 2005, as oil prices are going up, major barriers to the American economy will still be the depreciation of U.S. dollars and total deficit and current account deficit.

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B. Analysis and Prospects of European Economic Trends In 2004, the economy in Euro region achieved faster growth, and overall operation showed a “quick-slow” situation. Compared with the previous year, its economic growth sped up, unemployment stayed high, prices were on the same level as 2003, trade surplus increased somewhat, and inputs and outputs of foreign direct investment decreased somewhat. For the prospect in 2005, the economy in Euro region will still maintain a comparatively high growth rate, but with a limit. Favorable factors that support Euro region’s economic growth include: good external environment, relaxed macroeconomic policy environment, industrial production, and improved services. However, unfavorable factors still exist, major ones of which are the possibility that Euro will remain strong, and that international oil price will stay high. If we put all the favorable and unfavorable factors together, we can see that, in 2005, the economic development in Euro region will be similar to that of the previous year. Major international organizations have come to the same conclusion. For instance, in January of 2005, UN predicted that the growth rate would be 2.0%, 0.2 percentage point higher than the previous year; in December of 2004, OECD and EUROSTAT predicted that the growth rate would be 1.9%, 0.1 percentage point higher than the previous year; in November of 2004, World Bank predicted a 2.1% growth rate, 0.3 percentage point higher than the previous year; in September of 2004, IMF predicted that the growth rate would be 2.2%, 0.4 percentage point higher than the previous year; and in March of 2005, Consensus Forecasts predicted a 1.6% growth rate, down by 0.2 percentage point. C. Analysis and Prospects of Japanese Economic Trends Since 2005, Japanese economy has been in slow recovery. Industrial production and consumer spending have increased, but at a slow speed. From January to February, its export only increased by 4.7%, while high oil prices increased the cost of import. As two major exporting markets of Japan, the United States and China will see their economic growth slow down in 2005, which probably will reduce the contribution of Japanese exports to its economic growth. Moreover, the appreciation of the yen is another unfavorable factor, so are the rising oil prices. Japan’s Central Research Institute of Power’s report predicted that, if oil price remained to be 40 dollars per barrel, Japanese enterprises’

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pre-tax profit would decrease by 2.5%, which may affect equipment investment plans, and cause decline in consumer purchasing power. As a result, the actual economic growth rate would fall by 0.3%. It’s predicted that Japanese economy will continue to develop slowly in 2005, with 1% yearly increase. D. Analysis and Prospects of Economic Trend of Developing Countries and Regions World Bank predicts that, in 2005, economic growth rate of developing countries will be 5.4%, in which Asian developing countries’ economic growth rate will be 6.5%. Unfavorable factors that affect developing countries’ growth are mainly rising oil prices, raised interest rates, slowdown growth rate of developed countries, and the possibility that some Asian developing countries will adopt macroeconomic policies of retrenchment. Given the present high oil price, Russia’s economic growth rate is estimated to be 6.5% in 2005, higher than the prediction made at the end of 2004. E. Prospects of China’s Foreign Trade China’s import growth rate will not decline significantly or increase obviously if no big change occurs in its macro-control policy and exchange rate reform during the second half of 2005. Generally speaking, the whole year’s import growth rate will be no more than 20%, much slower than the growth rate of export in the same period. The growth rate of import of investment goods and processing trade will continue with the slowing trend in the first half of the year, and maintain a low growth rate. Although factors obstructing further increase of trade surplus, such as high oil prices, trade friction, and hysteresis effect of RMB appreciation, will exist in the second half of this year, the good situation of exports is irreversible, and the export growth rate will reach or be close to 30% this year. It’s predicted that the total value of exports in 2005 will be over 770 billion U.S. dollars, and the value of both imports and exports will be over 1400 billion U.S. dollars. Early this year, some analysts predicted that this year’s trade surplus would be around 60 billion U.S. dollars. However, after seeing the situation of July and August, they all adjust it to be 90 billion U.S. dollars. What’s more, some foreign organizations predicted that China’s trade surplus would be over 100 billion U.S. dollars.

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In 2006, China will have many advantages for maintaining its rapid export growth rate. The first one is the favorable world economic environment. Despite the negative impact of high oil price, the world economic growth rate will fall a little, compared with 2005, but still maintain a comparatively rapid increase. The second one is, if RMB exchange rate stays basically stable, and export tax rebates do not decrease, China’s export growth still has large potential. The third one is the good momentum of foreign investments in China. In 2005, China will attract more than 55 billion U.S. dollars of foreign direct investment, about 70 percent of which will go to manufacturing enterprises, and most of them are export-oriented. Exports of foreigninvested enterprises will maintain a rapid growth rate. The fourth one is, since China adopted the registration system for enterprises who want to engage in foreign trade in July 1, 2004, more direct exports by domestic private enterprises were stimulated. Its effect will continue to function in the future. The following are the major unfavorable factors to exports. Firstly, China’s trade friction with other countries is increasing. Secondly, the new policy, which local government will share 7.5% of the export tax rebates that more than the base, will put more pressure on the central finance, for they will face the new problem of rebating export tax to enterprises in time. Thirdly, while the RMB exchange rate will be basically stable, slight fluctuations are allowed. This will not be conducive to some export-oriented enterprises. The prospects of import growth in quantity will be determined primarily by future effects of macro-control. If we stay with the current macro-control measures, the growth rate of general import will slow down obviously. Processing trade imports are mainly determined by the growth of processing trade exports. Since the latter will maintain a high growth rate, the growth rate of processing trade import will also see a comparatively rapid increase. Increase in the value of imports is decided by the increase in prices of resource products on the international market and volume of import growth. In conclusion, without any big changes of the above conditions, it is quite possible that the increase in export will be faster than that in import. Export growth rate will probably still be over 20%, a little slower than in 2005. Import growth rate will probably be 15% to 17%. Trade surplus from customs statistics will be about 40 billion U.S. dollars, which is lower than that of BOP statistics.

TAX POLICIES AND THEIR CONNECTION TO ECONOMIC OPERATIONS, ANALYSES, AND FORECASTS FOR 2005–2006 Zhang Peisen I. Basic Economic Operation 2005 brought the 10th Five-Year Plan to a close and opened the path to the beginning of the 11th Five-Year Plan. China enters this next phase of development in good condition. Basic economic targets regarding growth, inflation, job creation and so forth will be attained. Difficulties, such as lingering problems in financial markets, have been addressed, at least in part. At the same time, China’s stature in the global economy has risen dramatically. A. Trade and European Integration The European Union’s (EU) expansion to twenty-five countries changed China’s relationship with Europe and offered new trade opportunities and challenges. More stringent regulatory guidelines regarding imports to the EU have made it more difficult to get Chinese goods into Europe. These changes have also placed additional strains on government departments and private firms. However, tariffs have been reduced and duty-free zones expanded. Trade strategy must adjust, and Chinese tax law can provide supports and incentives to firms serving the European market, among others. B. China’s Economic Reform and Liberalization Process Reaches a New Level of Maturity China’s trade sector is now the world’s third largest, generating over one trillion dollars in total volume. China’s rapidly growing trade sector has been helped through tax policy. This winning formula should be more widely applied in order to further develop China’s central role in the global economy.

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C. New Opportunities With GDP growth exceeding 8% for many years, the economy has expanded rapidly. This success story seems likely to continue, with estimates of 9% growth with low inflation during 2005. At the more detailed level much remains to be done including improving government spending systems, reforming financial and capital markets, renovating manufacturing processes, upgrading management, and stabilizing housing markets. II. Economic Growth Trends A. Economic Growth and Foreign Trade Projections show that the global economy will slow in 2005 through 2006. This will cut into demand for Chinese products, and with it, overall economic growth in China. However, China’s GDP is still estimated to grow at a very respectable 8.3%. B. Economic Management, Growth and Inflation Increasing complications and uncertainty adds to the challenges faced by government departments, regulators, and policymakers. Input prices must be successfully managed, investment rebound preempted, growth maintained, and inflation held at bay. Inflation has become something of a special case. Even though growth has boomed, the consumer price index (CPI) has declined for more than twenty consecutive months. Eight indexes used to calculate the inflation rate—including input prices, wages, and various consumer services—have not provided a complete explanation for this outcome. The need to include other variables in this calculation seems clear. Output has been driven by supply-side increases. China’s high savings rate provided ample funds for investors to draw upon and this has helped to expand long run capacity. On the other hand, demand remains relatively weak, since that strong savings ratio takes a bite out of the marginal propensity to consume. Raising consumption could help to power the economy and give it greater balance between supply-side pushing and demand-side pulling.

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III. Taxation and Growth during the Eleventh Five-Year Plan A. Taxation and Growth in 2005 Real GDP growth equaled 9.4% in the first quarter (Q1) of 2005. Q2 saw growth improve a notch to 9.5%. Growth for the year is estimated at 9.3%. Tax revenues grew by 22.4% in Q1 and by 21.7% in Q2. Total tax revenues for 2005 should be up 19.7% over 2004 totals.1 In sum, the government took in 3.1 trillion yuan based on total output of almost 15 trillion yuan. Note that tax revenues have outpaced economic growth. Much of China’s tax revenue comes from value-added taxes (VAT), which depend on incremental increases in a good’s value. As the value of a particular action in a productive process increases, so does the VAT. The wide range of goods produced in China and the rising value of this output has increased prices as well as VAT revenues. This has even been the case in outlying provinces; Shanxi and Inner Mongolia have seen quarterly revenues increase by more than 25% since 2003. On the other hand, growth in a variety of industries, including coal production and metallurgy, has rapidly increased business income tax revenues. Tax revenues grew faster than output in the Tenth Five-Year Plan as well. GDP growth averaged about 8.9% from 2000–2005, while tax revenues increased by 19.5%. Currently, about 65% of total tax revenues come through the VAT, business and personal incomes taxes add up to about 16%, and customs fees, agricultural taxes, and other taxes make up the rest. Since initiating the reform and liberalization process, the government has followed the following rule-of-thumb: “keep taxes low on agriculture, light on services, and moderate on industry.” In fact, taxes on agriculture have been reduced to match those applied on the service sector. However, the government must address broader policy issues regarding taxation. First and foremost, taxes must not get so high that they create a drag on economic productivity and growth. Secondly, the tax system must become more transparent. Finally, tax policy should help the service sector develop, which will help the Chinese economy to become more balanced and robust.

1 These totals do not include customs collections, import tariffs, or taxes on agricultural production.

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B. Taxation and Growth in 2006 With GDP growth in 2006 projected to equal 8.6%, the increase in taxes is estimated at 17.5%. Or stated in gross amounts: GDP will equal 16.2 trillion yuan and taxes will amount to 3.6 trillion yuan. About 22% of income is spent on taxes. C. Tax revenues during the Eleventh Five-Year Plan The economy will maintain its momentum into the 11th Five-Year Plan. By 2010, the last year of the current Plan, growth is estimated at 8% on 23.1 trillion yuan in total output. Tax revenues are expected to grow by 13.3%, reaching the sum of 5.6 trillion yuan. The marginal tax rate will increase to 24%. This puts China near parity with tax rates observed in developing countries. IV. Policy Suggestions Market reform and liberalization has had a widespread impact on taxation and tax policy in China. More activities are now being taxed and collections are more completely enforced. Tax policy has also become a key lever in bolstering growth in particular industries or in particular geographic regions. For all this success, the reform process needs to press on and address the issues discussed immediately below. A. Taxation and Economic Structure A variety of factors might hamper growth in the years of the 11th Five-Year Plan: high energy costs, raw material shortages, environmental carrying capacity constraints, operational capacity constraints, and limitations in government decision making. A number of tax changes could be introduced to make use of these conditions or to ameliorate their effects. For instance, making a slight adjustment on the valuation of raw materials and/or imposing taxes on various petroleum products could produce revenues that could be used to offset environmental impacts of mining, materials processing, and various oil burning activities. Of course, this would produce the unwanted effect of raising the cost of automobile operation; as a lynchpin of growth in China, any

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policies imposing additional costs on this industry must be introduced with utmost care. Tax collections and administration needs reformation as well. Digitalization, such as online filing, can save government and businesses time and money while having a neutral effect on revenues. Beyond this, reform should concentrate on integrating business filing for income and VAT taxes. B. Taxes and Economic Development Growth in eastern China has advanced rapidly and widened income gaps between the more urban East and the more rural West, as well as between skilled and unskilled workers. To combat this problem the government has created a series of policies under the rubric of “Developing the West, Promoting the Northeast, and Using Growth in the Urban East to Develop the Countryside.” Taxes revenues can be redirected to particular places or projects to help close gaps in income and development. This effort has only recently launched, so its full impact has yet to be felt. Other tax policies aimed at uplifting rural areas have had a more immediate effect. One in particular stands as a milestone in tax policy reform: canceling agricultural taxes during the 10th Five-Year Plan. This move harmonizes the urban and rural tax systems in many ways and helps to support overall tax system reform. The government needs to hold the line on this move by suspending agricultural taxes through the 11th Five-Year Plan. In fact, tax burdens on farmers should be eased in general, even on non-business (non-agricultural) fees, such as transportation costs. The government should undertake other efforts to improve the situation of farmers. First, some means of offsetting rising input prices must be examined, and where reasonable, implemented. Second, demand must be supported in order to help farmers rebuild their profit margins and achieve a greater sense of financial stability.

THE STATE OF ENVIRONMENTAL PROTECTION IN CHINA, 2005–2006 Shu Qing Urbanization and industrialization have rapidly expanded during the period of the Tenth Five-Year Plan. Moving these processes forward has required huge resource inputs. Furthermore, this expansion has come at the expense of the environment. These two conditions now impinge on true economic and social development, quality of life, social stability, and public health. Successfully addressing these problems can bring more comprehensive economic benefits to more Chinese citizens, improve income distribution, upgrade the quality of life for more persons, and lead to a more harmonious state of affairs in the country. I. Significant Progress Made in 2005 Regarding Environmental Protection Various innovations regarding environmental protection first appeared in China during 2005. First, the Fifth Session of the Sixteenth Central Committee of the Communist Party of China (CPC) included an announcement recognizing the need to build a more commodious balance between environmental conditions and economic development. By giving greater credence to environmentally protection and making this an important social value, China moves closer harmonizing human and natural needs. That is, the economy will develop more realistically and sustainably if this balance is met, and at the same time, individuals and society will be better situated to live healthier, richer lives. An environmentally friendly society considers environmental carrying capacity in its daily choices, from basic personal purchases to macro level decisions regarding investment in energy capacity. Making a cultural change will help to motivate adjustments to economic and social policies. For instance, on the personal level, a more economically aware individual will make efforts to purchase goods made of reusable and recyclable materials in lieu of disposable materials; on the macro level green and renewable technologies (like hydroelectric power) become

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the centerpieces of future development instead of expendable, nonrenewable energy sources like fossil fuels. In general, growth moves from an approach based on resource intensive systems to high efficiency systems; highly polluting technologies give way to cleaner, greener, and renewable technologies, especially regarding energy; conspicuous consumption makes way for reductions in consumption and reuse and recycling of many consumer goods and their components; and design and economics based on a “cradle-to-grave” model that generates vast amounts of waste can evolve into a model of “cradle-to-cradle”1 design and economic production and distribution. These changes in direction will improve environmental, social, and individual health. However, these moves depend on changes in other systems. A shift in values will require changes in social and political institutions as well. Democracy based on rational principles must be promoted as a means of organizing information regarding social beliefs and needs into a feedback system that connects the people to the government. Individual rights must be more clearly defined and better protected. Improvement in mechanisms designed to resolve social conflict over environmental problems should develop apace. The goal is to promote fairness as a core social and political value and to ensure that plain dealing becomes as cherished as it is commonplace. Second, The General Office of the State Council produced two key pronouncements aimed at supporting the move toward an environmentally friendly society: “Current Moves Needed to Build A Conservation-Minded Society” and “Moving toward Cradle-to-Cradle Economics.” Third, action has followed pronouncements. In recent months, the Chinese State Environmental Protection Administration (SEPA) halted thirty illegal construction projects undertaken by the China Three Gorges Project Corporation and other companies. This unprecedented

1 Bill McDonough, a designer, coined the term “cradle-to-cradle.” This term means design, production, and distribution systems that produce almost no waste and whose component parts can be integrated into new production and distribution. Chinese authors often refer to this as the “circular economy.” Cradle-to-cradle economic principles promote zero-waste, closed-loop design and production, and the use of almost completely renewable, reusable, and recyclable components. The official term used by Chinese officials and journalists is “circular economy”, but since this terminology is not used in the West, we have opted to use “cradle-to-cradle” which expresses the same concept, but does so using more familiar language.

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step shows that Environmental Impact Assessments (EIA) will actually be enforced and that sanctions will be issued for violations. Fourth, data collection on environmental conditions and their connection to economic productivity has begun. A joint effort taken by SEPA and China’s National Statistics Bureau called “Green GDP” now collects information on environmental costs and pollution impacts on a trial basis in ten key cities in the following provinces or municipalities: Beijing, Tianjin, Hebei, Liaoning, Zhejiang, Anhui, Guangdong, Hainan, Chongqing and Sichuan. Fifth, in another joint action, SEPA, the National Development and Reform Commission (NDRC), the Ministry of Supervision, the Ministry of Justice, the State Administration for Industry and Commerce, and the State Administration of Work Safety issued various sanctions to firms found guilty of illegally discharging pollutants into water supplies and dumping solid wastes. These steps help to protect the health of citizens and give them greater confidence in environmental protection laws and the departments overseeing the development, implementation, and enforcement of these laws. Environmental protection efforts within the government have focused on investigating and sanctioning organizations threatening public health and well being. Major polluters have been targeted and penalized. While much work remains to be done in dealing with effluent and solid waste pollution, other forms of pollution must be controlled as well, such as air and noise pollution. Many sources have documented China’s problems with air pollution. To deal with these well known problems, regulators have placed more attention on monitoring and controlling the output from various types of industrial processes, such as furnace and engine operation, metallurgical manufacturing and processing, chemical refining, and building material manufacturing and processing. As well, dust, smoke, and even bad odors have been more closely watched and managed. Metallurgical operations have been under particularly close scrutiny. The SEPA, the NDRC, and the Ministry of Supervision jointly developed a framework for addressing environmental pollution caused by iron processing and steel manufacturing in the outlying Jin, Shan, Meng and Ning areas.2 Typically, these regions escape notice, but the

2 These areas are located within the following provinces: Jin is inside of Shanxi, Shan is within Qinghai, the Inner Mongolia Autonomous Region contains the Meng territories, with Ning area within Sichuan.

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SEPA shut down six illegal construction projects developed by Yixiang Aluminum Company, Henan Yimei Group and other companies. Sixth, the SEPA organized and carried out hearings presenting the testimony of witnesses affected by the Yuanmingyuan projects.3 This came in response to extensive public attention. Work on the project ended on April 1st, and officials announced corrective measures on July 8. During these weeks, work started and stopped four times, an EIA was conducted, and independent investigations ran in parallel with public hearings and fact-finding efforts. In the end, the decision balanced the needs of various groups against a scientific and rational view of the conditions and constraints at work.4 Seventh, environmental education has been promoted far and wide. Activities based on the notion that the 21st Century will be an “environmentally friendly century” have been built around the idea of making clean water widely accessible. Efforts also include the publication of Recycling Information for Industrial Leaders. Eighth, cooperation and communication with international environmental efforts has increased. These efforts extend to the highest echelons of government. Zeng Peiyan, Vice-Premier of the State Council, attended the recent twenty-third United Nations Environment Programme (UNEP) meeting and ministerial-level forum, where he delivered an important speech on China’s vision and progress on environmental issues. Officials also attended the Central African cooperation forum on environmental protection that was recently held in Nairobi, Kenya.5

3 The Yuanmingyuan projects have to do with preservation of a special historic site within Beijing. The compound was part of the Imperial holdings, and included a number of palaces and gardens. British and French troops destroyed the complex in the mid-nineteenth century. In recent years, efforts have been underway to preserve the ruins and the unique water and plant ecosystem that has taken hold on the site. 4 This is not to say that the decision has satisfied all parties and concerns. Some critics believe that efforts to maintain the lakes as-is rob the underlying groundwater of replenishment. 5 Grassroots efforts have also taken on an increasingly international flavor. Some of these initiatives have been documented in The China Environment Yearbook (2005): Crisis and Breakthrough of China’s Environment, edited by Liang Congjie and Yang Dongping and co-published by Brill (Leiden, the Netherlands) and Social Sciences Academic Press (Beijing, China).

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II. Serious Environmental Problems Water pollution is perhaps the most pressing environmental problem in China now. Chemical oxygen demand discharge (COD), a leading toxic byproduct from paper production among other industrial processes, amounted to 13.38 million tons, which exceeding environment carrying capacity by 67%. Sulfur dioxide discharge equaled 22.5 million tons, a volume more than 88% in excess of environmental carrying capacity. Note that low pH water conditions are further aggravated by acid rain, which falls on 20% of Chinese cities and about 33% of the total land area. Such problems are as widespread as they are acute. Readings taken from 412 inspection stations in seven different water systems provide a truly alarming view of water quality. Water at 28% of these sites rated at the Sub-Five Level, which basically means that the fluid in these areas had become so toxic that it simply ceases to function as water.6 The structure of China’s economy plays a key role in driving the nation’s pollution problems. China’s economy depends on manufacturing. Much of this work requires enormous energy inputs; much of the needed energy comes from burning soft, sulfur-laden coal. Burning this coal produces massive volumes of particulate and chemical pollution. About 68% of China’s energy needs come through burning coal. China’s industrial firms produce more than 50% of the country’s airborne pollutants, which has been the case for some years now. Moreover, many small and medium-sized establishments have made a disproportionate contribution to air pollution. Monitoring so many far-flung enterprises has been a problem that regulators have yet to tackle. Aggravating this problem was that while the Chinese economy boomed and produced all of this industrial capacity, few entrepreneurs or government ministers understood the environmental consequences of this massive, breakneck industrialization process. Because of this, insufficient resources went into environmental monitoring, data collection, data analysis, regulation, and legal enforcement. Essentially, growth proceeded unchecked.

Water quality is given six categories in China: Level 1 for the purest; Level 2, which is for satisfactory for consumption; Level 3, which can be used for use for agricultural purposes, Level 4, which is suitable for use in industrial processes; Level 5 for polluted; and Sub-Level 5 for toxic. 6

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The speed and scale of Chinese economic development and industrialization basically concentrated various problems experienced in more developed countries over a century or two into a period of less than thirty years. Not only did this intensify the degree and breadth of pollution, it also meant than natural and legal/political remediation could not keep up with the rate of industrial change and its impacts. Over a century, the environment has time to recover from considerable damage; for instance, water can decontaminate itself given enough time. Moreover, as the Earth recovers, people learn the limits of natural systems and develop legal, political, and social systems to avert the kinds of crises that develop when human use exceeds environmental carrying capacity. However, when human use rapidly and vastly exceeds carrying capacity, and when use exceeds the carrying capacities of several environmental systems (e.g., water and air) at the same time, a new kind of crisis can take hold. The kinds of pollution observed in China come from traditional industries, like steel manufacturing, as well as other sources. Pollution from automobile manufacturing, use, and disposal has risen to all-time highs. New high tech industries produce inordinate amounts of chlorinate effluent, as well as Freon, lead, copper, and various solid wastes. All of these forms of pollution mounted on top of existing tradition forms of waste—household wastes, sewage, agricultural runoff, and so on. Both the breadth and the acuteness of these problems continue to worsen, making any kind of effort to ameliorate these problems more complex and costly over time. Even though real estate cannot be categorized as a traditional “smokestack” industry, the scope and speed of construction in China has contributed to the pollution problem on a broad level. First, as with so many other Chinese industries, the real estate boom and accompanying construction boom have devoured huge amounts of resources: wood, cement, and steel, have been consumed in unprecedented volumes. Not only have these goods been refined for use, they had to be harvested or mined, and then shipped, which also adds to pollution. Given the pace of growth in the real estate market, and the rate at which Chinese cities continue to grow, and general infrastructural improvement across the country, these trends show no signs of seriously slowing down. Even agriculture has stressed natural systems. Farming devoured water with a voraciousness on-par with other industry’s resource demands: to produce one thousand yuan in agricultural goods required

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more than ten times the volume of water needed to produce a similar sum in agricultural output in an industrialized country. In farness, though, many farmers have felt the stress on the environment directly and have been among the first entrepreneurs to call for change in environmental policies. These problems extend far beyond cities and industrialized outlying areas. Water supplies throughout the country have been affected. Desertification has been a problem for years and continues to be so. Even with efforts moving forward to expand wilderness and forest preserves, lumber demands have outpaced supplies and the loss of forest land continues. Other open lands have suffered as well. 90% of natural grasslands have suffered some degree of damage. Water resources have been pressed well beyond their limits. The internationally recognized usage rate for water goes as high as 40%; presently usage of water from the Yellow, Huai and Liao Rivers exceeds 60%; over 90% of the water from the Hai River goes into human use. Unsurprisingly, the ecosystem of the Hai River has become seriously imbalanced. Subsidence has become the most visible sign of problems as the largest sinkhole in the world has appeared on northern China’s plains. Less visible signs of danger abound: 10%–15% of higher plant species are considered to be endangered by current conditions. Foreign species that have taken hold in the water-poor environment have cost locals more than 120 billion yuan annually. Put into the perspective of resource demands, the Chinese economic boom can be seen more clearly in terms of its resource costs. In 2004, China’s GDP stood at only 4% of global GDP. However, it consumed 38% of the world’s coal production that year, over 27% of its steel output, more than 21% of the aluminum, and nearly 46% of global cement supplies. Energy consumption followed a similarly outsized appetite: 25% of the world’s supply of coal-produced energy went into meeting China’s basic energy needs, particularly its manufacturing demands. The intense resource demands raised the level of pollution discharge per GDP. Both sulfur dioxide and nitrogen oxide output per yuan (or USD) ran at more than 800% of the rate found in developed countries.

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On February 16, 2005, The Kyoto Protocol, a nonbinding agreement produced by the United Nations Framework Convention on Climate Change (UNFCCC), became part of the international system for addressing global warming. China signed and ratified its participation in the agreement. Doing so will benefit the country by bringing more advanced technology into the country to improve energy efficiency, pollution testing and monitoring, and treatment systems where necessary. Notably, two industrialized countries refused to sign and ratify the agreement: Australia and the United States. One reason given by the US for not signing the Protocol was that developing countries—e.g., China, India, and Brazil—did not adequately record or monitor greenhouse gas discharge. In essence, these countries would get a free ride under the cover of being signatories. No proof has been offered to support this argument. A handful of other counties did not sign or ratify the agreement, but their non-participation will not significantly affect greenhouse gas output, at least in the near term. The European Community (EC) also took steps to reduce pollution, particularly that which is produced by high tech industries. In its Waste Electrical and Electronic Equipment Directive (WEEE Directive), the EC laid out a system for disposal and recycling of high tech production byproducts. The directive had been harmonized with member states’ legal systems as of August 13, 2005, with the exception of Malta and the United Kingdom (Although the UK was well on its way to achieving harmonization by this date). The WEEE Directive joined The Restriction of Hazardous Substances Directive (RoHS) as tools for managing waste, assuring public safety and health, and achieving environmental protection in Europe. The EC introduced the RoHS in February of 2003; all European Union (EU) members eventually ratified the directive on July 1, 2006. While the directive focused on Europe, it affects other countries exporting high tech goods to the continent, including China. Both directives make up part of a larger “green trade barrier” that complicates trade and elevates the costs of trade. IV. Environmental Protection in 2006 The Fifth Session of the Sixteenth Central Committee Meeting of the Communist Party of the CPC produced a series of policy recommenda-

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tions regarding national economic and social development as part of the Eleventh Five-Year Plan. These recommendations called for: • Building on efforts to make China more conservation-minded and environmentally friendly; • Supporting efforts to move China’s economy onto a “cradle-tocradle” track; • Strengthening environmental protection regulations, monitoring, impact assessment, and enforcement; • Clarifying the means for resolving conflicts between environmental and economic interests; • Ameliorating public health impacts caused by man-made environmental problems. This starting point can bring environmental concerns onto a more equal footing with economic interests. This fundamental shift in mindset and values can set into motion much needed related and subsidiary changes within the Chinese economy and society. Specifically: • Bringing effort to the process of moving China from an “extensive” model of economic growth to an “intensive”, and more efficient, model of development, especially in productive processes; • Raising environmental quality in China’s 113 largest cities;7 • Developing model “green city/county” projects; • Considering environmental carrying capacity in future development strategy and decisions; • Setting aside land in resource preserves; • Using taxes and fees as part of a larger incentive/enforcement arsenal to push producers toward socially optimal decisions regarding resource use; • Encouraging market reforms that lead to more rational pricing outcomes, especially for scarce and/or endangered resources; • Expanding environmental education efforts. A few points brought up earlier in this essay deserve to be reiterated within the policy recommendations:

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113 urban areas in China have populations of roughly a million or more.

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• Improving water quality, including river basin ecosystems; • Dramatically reducing acid rain by controlling sulfur discharge into the air; • Improving soil health and agricultural conditions. While this list is by no means comprehensive, it does address the most immediate and fundamental environmental issues facing China’s environmental conditions in the coming year.

CURRENT CONDITIONS AND FUTURE TRENDS IN CHINA’S REAL ESTATE MARKET IN 2005 Policy Research Center, Ministry of Construction I. An Overview of Relevant Real Estate Policies in 2005 A. Seven National Ministries and Commissions Weigh-In on Stabilizing Housing Prices On May 9, 2005, the General Office of the State Council circulated its “Opinions on Stabilizing Housing Prices.” A number of key agencies contributed to this document, including the Ministry of Construction, the National Development and Reform Commission (NDRC), the Ministry of Finance, the Ministry of Land and Resources, The People’s Bank of China,1 the State Tax Administration, and the Banking Regulatory Commission. Among other directives, the notice called on relevant departments at the national, provincial, municipal, and county levels to take stock of the current state of the real estate market. By establishing well informed baselines, these offices could work to help markets perform more rationally and predictably. The notice placed an emphasis on stabilizing housing prices—particularly by expanding housing supplies in all price segments, improving opportunities for individuals and businesses to buy property, applying regulatory measures appropriate to the specific conditions at work in each local housing market, and by holding developers, real estate businesses and other operators accountable to their contracts and legal obligations. Of course, such a broad remit would touch upon a number of other key issues affecting real estate markets, such as strengthening regulatory enforcement, improving land management, adjusting land supply regulations, reinforcing tax management systems, and broadening real estate financing. Finally, monitoring, identifying, and preventing graft and corruption in the real estate industry must also be undertaken.

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The People’s Bank of China is China’s central bank.

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Rapid change in real estate markets, in particular sharply increasing prices, pushed the General Office to write and circulate the Opinions notice. During the first quarter (Q1) of 2005, housing prices across thirty-five large and midsized cities rose at an average of 9.8% over Q1 2004 prices. A study tracking housing prices in Shanghai, Hangzhou, Chengdu, Xiamen, Qingdao, Ningbo, Nanjing and Wuhan showed a 10% increase between Q1 2004 and Q1 2005. Prices of upscale houses in these cities rose by 12.9%. Some cities, including Shanghai, have seen real estate prices shoot up close to 20%. The Opinions entered into national practice as of May 2005. Since then, housing prices have continued going up, albeit at a slower rate. Measures in the Opinions have had an especially encouraging impact on prices in the Yangtze River Delta, which includes Shanghai. B. Reforming Tax Management Policies and Mechanisms in the Real Estate Industry On May 27, 2005 the State Tax Administration, the Ministry of Finance, and the Ministry of Construction jointly issued “The Notice on Strengthening Tax Management in the Real Estate Industry.” This notice clarified a number of rules regarding real estate taxation, paying particularly close attention to speculative buying and selling of residential properties. For instance, any individual selling a residential property within two years after purchasing it would have to pay a business taxes and carry a business license to complete such a sale. Such moves curtailed speculation, which in turn, slowed price increases. II. Macroeconomic Regulation and the Real Estate Market Recent market reforms and adjustments in macroeconomic policies and strategies have produced positive results in real estate markets. Transactions have taken place more quickly in numerous cities, helping to reduce shortages. For instance, the ratio of supply to demand in Shanghai averaged 0.85:1 in Q1, but eased to 1.12:1 in June. A. The Slowing Growth Rate Aggregate investments equaled 892 billion yuan through the first eight months of 2005. This sum is 22.3% higher than last year’s eight-month

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total. However, this growth rate fell short of the 25.9% growth rate achieved between 2003 and 2004. In short, investment is still increasing, but at a slower rate. China’s leading cities are also experiencing slowing growth in real estate investment. During the first four months of 2005 Beijing’s real estate investment rate rose 10.6% over the 2004 four-month total, but suffered a rapid contraction in the second four months of the year, bringing the January through August “growth” figure down to a dismal –1.7%. Shanghai managed more steady numbers in the same four-month and eight-month comparison. However, even as growth continued, the rate of growth slowed. Macroeconomic controls have slowed the building rate in the housing market. Housing starts from January through August in Beijing and Shanghai actually dropped from 2004 totals. New housing starts brought 15.8 million square meters of space onto the market from January to August 2005. In Shanghai 8.5 million m2 came onto the market.2 However, these figures represent declines of 4.7% and 0.9% compared to 2004’s eight-month totals. B. Macroeconomic Adjustments Slow Growth in Some Urban Real Estate Markets Since instituting the latest round of macroeconomic adjustments aimed at cooling growth, real estate markets have responded in kind, with the growth rate in the number of real estate transactions falling in many cities during May and June. Total commercial housing sold in China equaled 22.9 million square meters in May and 30.5 million m2 in June of 2005. The quantity for May increased by 7.77% over May 2004’s total; June’s total exceeded the June 2004 aggregate by and 14.31%. Note, however, that total sales for March 2005 surpassed the March 2004 sum by 25.7%. (See Figure 12.3.) Recent economic policy changes not only slowed aggregate growth rates, but also changed lending and financing practices. Access to credit has tightened and this has affected real estate markets. For instance, fewer previously owned houses have sold in recent months compared to the number of transactions completed only a year ago. During May

2 Square meters can be converted to square feet at a ratio of roughly 1:11. So 15.8 million m2 equals about 170 million square feet; 8.5 million m2 equals about 91.5 million sq. ft.

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35.00 30.00 25.00 20.00

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Figure 12.1: Real Estate Investment Growth Rates, January to August in 2005. All China Beijing 30.00 25.00 20.00 15.00 10.00 5.00 0.00 –5.00 –10.00 Jan–Feb Jan–Mar Jan–Apr Jan–May Jan–Jun –15.00

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Figure 12.2: Commercial Housing Investment Growth Rates, January to August in 2005. Commercial Housing Sales Commercial Residence Sales

100.00 80.00 60.00 40.00 20.00 0.00 –20.00 –40.00

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Figure 12.3: Commercial Housing Sales in Shanghai, January to July 2005.

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and June, total sales of such properties amounted to only 20% of the total transactions made in late 2004 and early 2005. C. Regulatory Restrictions on Speculation A number of rules put a damper on real estate speculation. These include the “Prohibition of Transferring Forward-delivered Houses,” “Imposing Business Taxes on Housing Sold within Two Years of Purchase,” and “Penalties for Price Gouging.” By slowing down the number of completed transactions and improving the quality of information regarding properties, the market has become more rationalized. Buying a home no longer involves excessive guesswork; this makes the process simpler and clearer. Consumers have a solid sense of the house they want to buy; they no longer have to rely so heavily on deals made with someone offering less-than-completely trustworthy inducements to make a deal. Enforcing these regulations has helped regulators get a better sense of market activity, which has helped them to identify and punish those individuals and organizations engaged in shady dealings. D. Macroeconomic Policies and Housing Price Increases Macroeconomic adjustments as well as regulations regarding real estate transactions and financing have brought greater price stability to the housing market during May and June. On the supply side, developers, anticipating long run demand increases, held prices steady even as short term demand slipped. On the demand side, clearing out speculative trading helped to ease rapid price increases. During Q2 2005, average housing prices in thirty-five large and midsized cities climbed 8.0%, down substantially from Q1’s 9.8% increase. E. Positive Adjustments in the Market Some forward-looking businesses did not wait to see how policy, regulatory, and strategic changes would affect their businesses. Rather, they took the initiative in fomenting change. They changed their tactics and strategies to accommodate a market with less speculation-driven price increases. They held the line on price increases as a way of dealing with tightening financial markets. They built more units to meet the needs of individuals and households immigrating to cities. They built

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and planned projects to meet market demand and supply conditions, rather than building strictly in response to investment pressures. In short, they responded to market pressures and conditions. F. Local Governments Move to Expand the Supply of Affordable Housing Making small changes in real estate transactions have produced big changes in real estate markets. For instance, making sure that housing contracts include the verified names of the buyer and the seller—that is, preventing purchases made through proxies or “fronts”—has reduced speculation and generally rationalized the home purchasing process. Using online forms has further opened access and simplified information management and verification. Improvements in housing standards and inspections have increased consumer confidence in the quality of housing stocks, especially in the “affordable” market segment. Price increases have eased as plans to expand supply have been developed and implemented. III. Major Developments in the Real Estate Industry A. Promoting Real Estate as a Keystone Industry Real estate has emerged as one of the crucial industries driving rapid economic growth. For this reason, policymakers have created various supports and regulations designed to build on this momentum. Real estate now accounts for 5.2% of Chinese GDP directly. Given that 2004 GDP equaled 13,658, this means that commercial real estate activity surpassed the 700 billion yuan mark. In Shanghai, China’s leading city economically speaking, the proportion is 7.4%. However, percentage figures do not include output generated in many subsidiary and supplier industries related to real estate such iron mining, steel manufacturing, cement manufacturing, construction, shipping and logistics, architecture and design, home furnishings, finance, various kinds of maintenance (e.g., plumbing services), and so forth. The real estate industry has a widespread impact on national as well as local economic activity. Many forces have driven growth of the real estate industry. Rapid urbanization has created booming demand for housing in China’s cities. Rising incomes have given more Chinese the resources to buy homes.

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Those who have done especially well can afford luxury homes and the household accoutrements and amenities to go with them. Developers have responded by embarking on massive building campaigns. Governments at various levels have encouraged the process as a way of bolstering GDP. The scale and speed of this expansion has been formidable. Even though urban areas grew by 36.22% in 2000, they still increased their growth rate another five points to 41.76% by 2004. (See Figure 12.4.) The growth rate at which individuals purchased homes nearly doubled every year from 2001 to 2004. B. Household Income and Its Impact on Real Estate Demand Between 2000 and 2004, urban per capita disposable income increased from 6,280 Yuan to 9,422 yuan. With the increase of urban dwellers’ incomes, per capita living space rose to almost 25 square meters, an increase of 4.63 square meters over the 2000 average. With GDP expected to more than double between 2000 and 2010—exceeding 14 trillion yuan—such trends in urban housing markets can be expected to continue until at least the end of the 11th Five-Year Plan. (See Figure 12.5.) C. Real Estate Expansion and Economic Structure Based on economic history and the experience of more developed nations, real estate development tends to create conditions that lead to a broader economic transformation. Given this, we expect aggregate investment, employment, and tax revenues in highly developed cities like Shanghai, Beijing, Guangzhou and Shenzhen to make a quantum leap in the near future. Investment will increase as growing numbers of households demand more domiciles. Demands for higher quality housing will develop alongside the increase in the quantity of living spaces. All of the products and services needed to supply these residences and the goods within them will generate a panoply of jobs. This, in turn, will expand tax revenues—in this case, business income, personal income, and retail sales taxes—flowing into local coffers. There is also a multiplier effect at work: as housing demand increases, it produces an increase in employment, which increases aggregate income, which produces more spending, which then circulates through the local economy.

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100 million RMB

160000

GDP (100 million RMB)

Urbanization Rate (%)

120000 100000 80000 60000 40000 20000 0

43.00 42.00 41.00 40.00 39.00 38.00 37.00 36.00 35.00

140000

2000

2001

2002

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2004 (Year)

%

34.00 33.00

Figure 12.4: GDP growth and urbanization in 2000–2004. Urban per capita disposable income (RMB) Urban per capita dwelling areas (in square meters)

10000

25 square meters

RMB

8000

20

6000

15

4000

10

2000 0

30

5 2000

2001

2002

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Figure 12.5: Urban per capita disposable income; urban per capita living space, 2000–2004.

IV. Trends in the Real Estate Market A. Broadening the Market Reform Process From 2000–2005, the years of the Tenth Five-Year Plan, the Chinese economy moved more quickly toward a market-based economy. These reforms fundamentally affected the real estate industry, the impacts of which have grown more widespread. Even though new housing starts have a broader impact on the economy, the secondary market for housing plays an important role in overall development as well. At present, a series of policies and mea-

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sures have been developed and implemented throughout the country to encourage and develop this segment of the housing market. For instance, housing contracts and transactions have been simplified, loans and mortgages have become more widely available to finance such purchases, and real estate agencies and brokerages have become savvier about finding such properties, making suitable buyers aware of them and then closing sales on these properties. These measures have helped make this market segment more robust: more lived-in homes have come on the market; more kinds of these homes in terms of size, style, quality, location, and price have been offered and sold; a more complete infrastructure has grown up to support this market segment; information on such properties is more readily available; and most of all, more money has changed hands. B. Improving Branding and Quality Rapid growth and opportunity in leading urban real estate markets has given rise to cutthroat competition. Successful firms will need to become stronger in several dimensions: capitalization and financial strength, operational savvy, and overall improvements in management. In response to government interventions designed to refine macroeconomic management, some developers and real estate agencies have become more aggressive in promoting sales. They have slashed prices; included bonus incentives, such as giving cars to home buyers, to encourage sales; contributed to down payments; covered the first month’s mortgage payment; and provided cash rebates. In essence, they have offered a variety of discounts to boost sales. However, changing market conditions will move the action away from price competition toward competition based on product differentiation. Competition on quality—including such features as design, decorations, setting, security, energy efficiency, and neighborhood amenities and services—will decisively affect more and more home buyers. As developers and real estate agents focus on these characteristics, reputation effects—in essence, brands—will become more important in driving sales, especially of new properties. The rapid evolution of markets and the increasing intensity of competition will promote those firms that can successfully manage financing, information processing, marketing, innovation management, and other key skills. Those that cannot will fall by the wayside. While the latter group will feel the sting of market discipline, in the long run this

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process will benefit consumers, strengthen producers, and contribute to national economic health and social development. C. Intermediary and Supporting Organizations and Agencies As the real estate market has grown and developed, so have the intermediary and supporting organizations and agencies that work within it. To date, this process remains in development; the infrastructure of the real estate industry has a long way to go. For instance, many of the individuals and organizations working in this market niche have precious little expertise and experience. Obviously this will change over time, but during the development process, the market remains vulnerable to the kinds of mistakes made by the inexperienced. Another problem is the relatively small scale of these operations; lacking resources may not allow them to serve the already-massive and still-growing demand. Perhaps most importantly, this market segment remains undercapitalized and has limited access to the capital needed to develop. However, with so much money circulating through the industry, the cleverest and hardest working firms should succeed and grow. As they do, they can better serve home buyers and developers more effectively. V. Real Estate Policy Trends A. Market Reform and Bringing More Buyers to the Market The government stated its intention and methods for supporting an expansion in the numbers of consumers purchasing homes in Document Number 18 released in 2003. In particular, this document linked the need to keep housing affordable to the success of such an effort. Market reforms introduced since have expanded home purchasing opportunities in many ways, but as prices have increased, many individuals have been squeezed out of the market or onto the market’s margins. However, recent adjustments in economic policy and management of real estate markets have cooled overheated levels of investment and price increases. Even though there have been bumps in the road, the market liberalization process should be more widely and deeply implemented.

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B. Chinese Housing Goes Green Even though environmentalism has not gained widespread attention in China, it seems clear that housing development will become greener in coming years. This change depends on a shift in attitudes, but its most tangible expression may be through greater emphasis on conservation and resource preservation, especially in energy usage and management. Clearly China must use energy more efficiently in order to maintain its economic momentum and to improve living standards and overall social development. Reducing energy demands has become a keystone of the most innovative Chinese architecture, design, and building methods. Bringing these buildings online will dramatically ease China’s currently voracious appetite for energy. Conservation extends beyond energy resources and uses. The Ministry of Construction has advanced a broad mission regarding resource use, which it codified in the document entitled “The Four Precious Resources and Environmental Protection.” These four resources—energy, water, land, and basic raw materials—must be more efficiently used in real estate development. Therefore, this document calls for more efficient resource usage, better monitoring of resource usage, and more rigorous enforcement of these standards. The Ministry sees this document as producing a variety of benefits: reducing energy costs, even into the long run; encouraging innovation in design and building methods; reducing waste; improving construction quality; and providing China a new area of expertise that will put it on the forefront of building technology. These changes can also bring economic benefits, social demands, and environmental needs into harmony with one another. C. Stabilizing Prices and Preventing Price Gouging From 2001 to 2004 the growth of investment in urban real estate developments settled in around 22%. However, certain cities vastly outpaced this rate. For instance, in 2005 the rate peaked at 63.15% in Shanghai and 41.06% in Beijing. (See Figure 12.6.) While investment has its advantages, such breakneck rates can be difficult to manage. Maintaining an orderly system of real estate development is crucial to fulfilling the broader goals of achieving stable and predictable economic growth and development. If real estate development advances pell-mell toward more rapid building and infusions of funds, several negative outcomes could come to pass: price spikes, poor land usage,

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policy research center All China

% 70.00 55.21

58.42

40.00 30.00 20.00

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60.13

37.22

40.14

21.95

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41.06

22.45

10.00 0.00

2001

2002

2003

2004 (Year)

Figure 12.6: Growth in real estate development investment and urban fixed assets investment, 2001–2004.

and various kinds of market disequilibria. This could hurt real estate markets, and through the vast network of connections tying the real estate industry to other industries, the finance, construction, and other industries as well. Therefore prudent management of the market remains the paramount goal of policymakers, regulators, business leaders, entrepreneurs, and even consumers. Prices and real estate supplies must be carefully managed. Regulators must also mindfully manage the real estate industry’s financial support system, regulations governing transactions, and taxation.

BUSINESS CYCLES AND THE GROWTH OF CHINA’S REAL ESTATE INDUSTRY Qin Wanshun, Jin Yunhui, and Bu Yongxiang I. Introduction: A Brief History of China’s Real Estate Industry since Liberalization The real estate industry has boomed in recent years. This boom has depended on a few key interdependent forces: urbanization of unprecedented scale and scope; reform of home ownership laws and related reforms in the public housing system; and government intervention in financial markets and contracts related to real estate. A variety of metrics confirm the impact of these changes. By the end of 2004, 80% of urbanites lived in their own domiciles rather than state-controlled housing. This allowed the home to become the most valued asset for many individuals and families. During 2004, the real estate industry’s share of GDP approached 10% and seems poised to break into double digits during 2005. And because real estate requires inputs from so many other industries—construction, mining, lumber, design and architecture, transportation, public works, finance, legal services, and so on—its rapid growth has helped fuel economic growth generally. This recent upward trend follows more than thirty years of ups and downs in the industry. This rollercoaster ride goes back to 1978, when the economic liberalization and reform process began. The government put into place the first measures allowing for commercialization of land and real property that year. By September 1980, Beijing’s Housing Construction Office helped to organize the Beijing City Development Company, which took a leading role in buying and developing land in the capital city. During 1982 the State Council further opened the housing ownership process by organizing experimental private housing markets in four cities. In 1984, government imposed land usage fees in Guangdong and Chongqing, which launched an entirely new way of regulating housing markets and accumulating government revenue from real estate trading. On November 26, 1987, the Shenzhen government accepted the first bids from private parties on land used for housing. This step marked the beginning of the end of the government’s

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monopoly on land ownership and control. By 1990 Shanghai built on these earlier moves by issuing a full-blown housing reform plan and simultaneously creating an office to accept bids on land transfers out of government hands. Since 1991, the State Council has approved 24 general plans for housing reform. This marks the close of the first phase of housing market reform. The second phase of the reform process started in 1992. Privatization produced conditions ripe for speculation, poor judgment, and volatile fluctuations that affected both real estate prices and investment flows. For instance, one month-to-month jump saw investment climb by more than 145%. Given the scarcity of knowledge about real estate markets, such confusion could be expected to some degree. Beginning in 1992, the government took steps to combat these problems. Systems for collecting funds on sales of land relinquished by the government became widespread. While this did not directly address the new difficulties in the real estate market, it did provide funds that would be used to monitor and enforce rules made later. 1993 saw two key changes. The first involved the launch of affordable housing programs in cities. The second arose in response to the new macroeconomic control policies and strategies designed to finetune government economic management. A key short term aim was to rein in runaway markets like real estate. Unfortunately, these measures produced a precipitous drop of 17.2% in investment by early 1995. The real estate industry entered a third developmental phase in 1995 when the economy began growing steadily again. Government implemented a variety of policy and regulatory reforms in order to keep the economy on this path. One key reform stands out: canceling the government-controlled housing allocation system and allowing markets to allocate housing stocks as well as the development of future projects. This set into motion a crucial subsidiary change: the organization of mortgage contracts to finance the private purchase of real estate. With the market system handling basic allocation, pricing, and investment issues, real estate markets began operating with greater efficiency. This allowed the industry to move onto a faster growth track. Parallel to these developments, personal incomes started increasing rapidly. Taken together, these factors revitalized real estate markets and began to move the industry into a pivotal role in China’s future economic development. The real estate industry’s fourth phase of development started in 2003. Because of renewed growth and interest in the industry, money

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% 160 140 120 100

Real estate investment growth rate Fixed asset investment growth rate

80 60 40 20

–20 –40

02/1992 07/1992 12/1992 06/1993 11/1993 05/1994 10/1994 04/1995 09/1995 03/1996 08/1996 02/1997 07/1997 12/1997 06/1998 11/1998 05/1999 10/1999 04/2000 09/2000 03/2001 08/2001 02/2002 07/2002 12/2002 06/2003 11/2003 05/2004 10/2004

0

Data source: The China Economic Statistics Data Bank, China Economic Information Network.

Figure 13.1: Investment Growth Rates in the Chinese Real Estate Industry

poured into real estate. Investment has grown by about 30% per annum since. This activity has generated growth, but it also generated volatility and uncertainty. The government intervened in the market to ameliorate these problems and this set into motion a tug-o-war between government controls and market momentum. This process is still in effect. Figure 13.1 summarizes this history. Research on the connection between fluctuations in real estate markets and macroeconomic business cycles provides insight into the ebb and flow of real estate markets in China described immediately above. Key findings show that housing markets experience greater volatility than the general economy and that the fluctuations in housing markets typically anticipate general economic trends. Davis and Heathcote (2001) formalized these notions by finding that the standard deviation1 in US housing investment was twice that of non-housing investment, and that changes in housing investment predicted the direction, and to some degree, the magnitude of changes in GDP. Ortalo-Magne and Rady (1998) added that housing prices fluctuate more widely than GDP. 1 The standard deviation of a variable measures the variable’s spread or distribution around some central value. The standard deviation is the square root of the variance.

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qin wanshun, jin yunhui, and bu yongxiang II. The Relationship between Real Estate Investment and Fixed Asset Investment

A. The Real Estate Market’s Current Condition Real estate transactions totaled to 1,315.825 billion yuan in 2004. This sum exceeded the 2003 total by 28.1%, which in turn had exceeded the 2002 total by 25.8%. Real estate investment in urban areas rose from 12.7% of total fixed asset investment to 18.8% in 2004. 1998 marks the sea-change in real estate investment. Before 1998, real estate had not been fully integrated into market processes, especially regarding financing and investment. Because of this, real estate did not function as an investment or an asset. After 1998 real estate funding moved toward a market-based system, financial contracts evolved to handle this change, markets handled the allocation of land and real estate assets, and prices began to surge upward, producing investor interest. Even private individuals began to think of property as a key asset and form or wealth-holding. B. Drawing the Relationship between the Growth in Real Estate Investment and GDP Growth Below we examine the relationship between GDP growth and all private and public spending on housing for the years 1982–2004. 1) Fluctuations in Housing Investment Exceeded GDP Growth Rates As predicted by the findings of David and Heathcote, the variability in housing investment exceeded that of GDP growth. All private and public spending on housing rose by an average of 18.75% per annum, with a standard deviation (sd) of 13.53% during the years 1982 to 2004. GDP increased 9.76% per year on average in the same period, with an sd of 2.89%. Given these measurements of variance, it is safe to conclude that housing investment rose more rapidly than GDP in good times, and fell more precipitously in downturns. 2) When Growth in Housing Investment Diverged from GDP Growth Between 1983 and 2004, housing investment diverged from GDP growth for ten years. That is, when housing investment went up at an increasing rate, growth went up at a decreasing rate. Or when growth accelerated, housing investment decelerated. However, in 12 of the 22 years, the two measures increased and accelerated together.

business cycles and the growth of china 70

175

Private and public housing investment growth (%) GDP growth (%)

60

16 14

2002 2003 2004

2001

2000

1999

1998

1997

1995 1996

10

1994

2 1993

0 1992

4

1991

10

1990

6

1989

20

1988

8

1987

30

1986

10

1985

40

1984

12

1982 1983

50

0

( Year)

Data source: China Statistical Abstract in 2005, National Bureau of Statistics.

Figure 13.2: Comparing annual growth rates in housing investment and GDP in China

From 1978, when economic liberalization and reform started, through the mid-eighties, housing investment had a relatively minor impact on the economy. Through the late eighties and into the nineties, the fate of the general economy and real estate markets continued to be loosely connected. For instance, when inflationary pressures mounted in 1987 and 1992, and when regulatory measures produced a subsequent steadying of the economy in 1988 and 1993, such changes barely registered in real estate markets. In fact, real estate investment growth peaked in 1993, rather than simply gaining renewed strength as in the general economy. In 1998, when consumer spending softened and GDP growth slowed, housing investment surged. When the government took an active role in regulating the economy and exerting greater control over inflationary pressures in 2003, the economy settled into a more stable and steady growth pattern. However, real estate investment took off like a shot, with markets becoming far more active and volatile in 2004 than they had been in 2003. Figure 13.2 summarizes some of these motions. Note that since 1998, the ratio of housing investment to total fixed asset investment has declined (See Figure 13.3.) At the same time,

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16000

35

14000

30

12000

25

10000 20 8000 6000 4000

Total private and public investment in housing (100 million yuan) The ratio of housing investment to total fixed asset investment (%)

15 10 5

0

0

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

2000

( Year) Data source: China Statistical Abstract in 2005, National Bureau of Statistics

Figure 13.3: The ratio of housing investment to total fixed asset investment

housing investment has become increasingly important in stimulating economic growth. In fact, economic policies and strategies have been quick to stimulate real estate markets, but once set into motion, real estate activity has been difficult to control. III. The Relationship between Real Estate Sales and Consumer Spending The relationship between housing sales and household consumption is weak and negative. The coefficient on the independent variable related to the dependent variable is –0.11. Estimates for a one-month lag show the coefficient rising to –0.22, but then fluctuating in the following three months as the estimated value goes from –0.13 to –0.16 and then back to –0.10. In short, as households spend more on homes, they spend less on other goods and services, provided that incomes do not rise. The second six months of the year mapped out an equally unstable set of estimates for the variable’s coefficient: –0.12, –0.15, –0.19, –0.17, –0.24, and –0.12. The time-lag on sales lasts about one month. The coefficient on the sales growth rate with a one-year time lag is –0.23. (See Figure 13.5.)

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Monthly growth rate in housing sales (%) Monthly growth rate in consumer spending (%)

120

20 18

100

16 14

80

12 60

10 8

40

6 4

20

2 0

07/2005

01/2005 04/2005

07/2004 10/2004

01/2003 04/2003 07/2003 10/2003 01/2004 04/2004

10/2002

07/2002

01/2002 04/2002

10/2001

04/2001 07/2001

10/2000 01/2001

01/2000 04/2000 07/2000

0

Data source: Economic Statistics Data Bank for China, China Economic Information Network.

Figure 13.4: Comparing real estate sales to growth in consumer spending –13 –12 –11 –10 –9 –8 –7 –6 –5 –4 –3 0

–2 –1 0

1

2

3

4

5

6

7

8

–0.05

–0.1

–0.15 –0.2

–0.25 –0.3

Data source: Economic Statistics Data Bank for China, China Economic Information Network.

Figure 13.5: Estimated coefficients for commercial housing sales and consumer spending

qin wanshun, jin yunhui, and bu yongxiang

4

4 20

04

Q

4

Q

20

03

Q

4 20

02

Q

4 20

01

Q

4 20

00

Q

4 Q

99 19

98

97

Q

4

The pricing index for homes (By quarter) 130 125 123.98 120 115 112.40 110 103.33 105 100.00 106.85 100.40 100 101.60 100.00 95 90 19

19

97 19 Q4 98 19 Q4 99 20 Q4 00 20 Q4 01 20 Q4 02 20 Q4 03 20 Q4 04 Q 4

135 The pricing index for national commercial 130 128.65 housing (By quarter) 125 120 115.80 115 110 104.46 105 108.22 100.00 100.70 102.51 100 100.10 95 90

19

178

Data sources: Economic Statistics Data Bank for China, China Economic Information Network.

Figure 13.6: Building an index for changes in housing prices (Q4 1997 = 100)

Data collection methods used in China separate housing sales from consumer spending. However, by adding these two figures together, we can generate a picture of the total amount that consumers spend on various goods and services including housing. This sum shows a strong upward trend in recent years. In 2000, this sum increased 7.5% over the previous year’s total. Total spending basically stayed on this pace for the next year, with 2001 finishing the year with 7.4% growth. However, the pace picked up in 2002, when spending growth leapt to 10.0%. In 2003, total spending rose another 11.8% and in 2004 spurted to 14.2%. Estimates for the first six months of 2005 put growth in total spending at 18.1%. IV. Real Estate Price Fluctuations and Inflation Housing prices have increased rapidly and continuously since 2004. Based on fourth quarter (Q4) 1997 prices,2 we calculate real prices through Q4 2004. Data in Figure 13.6 clearly show the increase in prices and the acceleration in this increase.

2 In other words, Q4 1997 prices = 100 in our indexing system; prices in all other years will be adjusted based on this scale.

business cycles and the growth of china 115

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Housing prices Consumer spending Housing leasing prices

110

105

100

5

4

00 /2

00

03

4

/2 09

3

00 /2

00

03

3 00

/2 09

2

/2

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/2 09

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/2

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0 00

/2 03

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03

9

/1 09

8

99 /1

99

03

/1 09

03

/1

99

8

95

Data source: Economic Statistics Data Bank of China, China Economic Information Network.

Figure 13.7: Quarterly housing prices and sales (basis: 2004 = 100)

In Q1 2005 average housing prices rose 12.5%. The growth rate in housing prices climbed 5.8%. Price data collected by the National Bureau of Statistics covering 35 large and midsized Chinese cities in Q1 2005 provides deeper insight into housing price trends. In general, prices went up by double-digit rates. Eight cities showed especially strong increases, with Shanghai leading the way with a 19.9% increase. Xiamen followed behind with a 16.5% rise, Chengdu at 14.7%, Qingdao at 13.7%, 12.4% at Hangzhou, 11.9% at Jinan, 11.4% at Ningbo and 11.2% in Nanjing. Increases in housing prices have consistently outpaced household spending increases and increases in residential leasing rates. (See Figure 13.7.) Several points in Figure 13.7 deserve more careful analysis. First, note that inflation has remained under 5%, and that consumer spending has been steady, rising by 2–3%. Note that consumer spending only included the portion spending directed toward leased housing. Also, certain classes of real estate included in the data here have a limited influence on consumer spending. In other words, because only a small percentage

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of the total population bought houses, housing price increases did not drive consumer spending. Also, rising input prices that contributed to rising prices for housing were not fully reflected in the prices consumers paid. Technical innovations in organizing all factors of production have contained a substantial portion of input price increases. Increased building has swelled housing supplies, which put additional downward pressure on prices. All of these factors have contributed to keeping price increases, and therefore inflation, to a modest level. In summary, real estate investment and fixed asset investment have moved together since 1998. This should come as no surprise since real estate makes up such a large component of new investment. Note as well that growth in real estate investment and consumer spending have a weak inverse relationship with each other, even as the percentage of consumer spending directed toward housing increases. Surprisingly, price increases in real estate did not result in rapid run-ups for input prices or inflation.

GROWING SUPPLY AND DEMAND IN THE AUTOMOTIVE INDUSTRY Fu Yuwu I. Growth in Productive Capacity China’s automobile industry has grown by leaps and bounds in recent years. (See Table 14.1.) In 2004 production equaled 5,010,500 units with sales at 5,071,100; these figures represent growth rates of 14.11% and 15.50% over 2003’s output and sales figures. Passenger cars represented about 45% of both figures: 2,316,300 cars built and 2,326,500 cars sold. Approximately 1.25 million secondhand autos changed hands. Taken together, the total sales figure placed China in the number three spot in total auto sales and fourth in total output. The rapid expansion of China’s automobile market has attracted more than 11 billion Renminbi (RMB) of investment from transnational automobile companies, spurring growth in production capacity. Daimler-Chrysler, Volkswagen, Toyota and Hyundai led this process by Table 14.1: Automobile production and sales in China, 2002–2004 (Thousands) Categories Total Sedans Freight vehicles

Passenger vehicles

Subtotal Heavy-load Medium-load Light-load Micro Subtotal Large Medium Small Micro

2002 Output Sales 3251 1091 1096 253 164 531 148 1064 17 65 328 654

3248 1164 1077 245 165 520 983 1046 17 65 333 631

Source: China Automobile Industry Association.

2003 Output Sales 4444 2019 1230 262 136 689 143 1195 20 54 443 679

4391 1972 1211 255 136 682 137 1201 19 53 440 695

2004 Output Sales 5070.5 2316.3 1455 369 173 806 167 1240 26 53 403 758

5071.1 2326.5 1525.9 370.8 175.6 808 171.5 1218.6 26.1 52.7 397.7 742.1

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establishing new production lines in China. Cooperation and capacity in procurement and production now goes beyond manufacturing and assembly, having moved into component manufacturing, design, sales, and various segments of the after-market. By the end of the 10th Five-Year Plan in 2005, China produced 8 million cars annually. About 2.75 million of these cars are sold in the domestic market. Growth in the automotive industry continues at a rapid pace. No other country’s automobile industry comes close. Even the fast growing Chinese economy grows at only half the rate of China’s auto industry. However, the industry’s growth rate decelerated by more than 20% in 2004 from 2003’s rate. Intense competition continues to shape and reshape the industry. Mergers and acquisitions (M&As) have become fairly common and widespread, as stronger players seek to expand their capacity, while absorbing or overwhelming weaker companies. Because of this process, automobile manufacturing has grown more centralized. One manufacturer produces more than one million cars, four produce between 500,000 and a million vehicles, and two more produce between 200,000 and 500,000. (See Table 14.2.) Table 14.2: Sales, market shares and production capacities of the top 13 auto groups in 2004 Ranking

Company/Group

1 2 3 4 5 6 7 8 9 10 11 12 13 Company totals Market total

一汽 FAW 上汽 SAIC 长安 Chang’an 北汽 Beiqi 东风 Dongfeng 广汽 Guangqi 哈飞 Hafei 江淮 Jianghuai 昌河 Changhe 金杯 Jinbei 南汽 NAC 奇瑞 Qirui 江玲 Jiangling

Sales (in 1000s)

Source: Annual Report for China’s Automobile Industry 2005.

1007.5 848.5 579.5 531 523.3 209.6 205.1 130.8 104.6 99.6 95.3 86.6 74.6 575.1 5071.1

Market share (%) 19.87 16.73 11.43 10.47 10.32 4.13 4.04 2.58 2.06 1.96 10.88 1.70 1.476 11.34 100.00

growing supply and demand in the automotive industry 183 A. Characteristics of Consumption in the Automobile Market Automobile manufacturing in China moderated its growth rate between 2002 and 2004. Even as the growth rate has slowed, market share for domestic brands has grown, such that 70% of cars sold in China come from domestic companies. Consumers with increasing disposable income are buying more personal and family cars. Since 2003, private automobiles have accounted for over 50% of the cars on China’s roadways. Increasing demand for cars, especially “micro-cars” (engine displacement between 1.0 and 1.6 liters) has driven this trend. (See Tables 14.3 and 14.4 and Figure 14.1.) The data confirm that growth is brisk as established foreign brands make inroads into the Chinese market. Domestic brands dominate the downscale market segment by offering lower-priced new products and deep discounts on older models. (See Table 14.4 and Figure 14.1.) At the end of 2004, almost 27.5 million vehicles were on China’s roads. Just over half of these are privately owned. Cars number 9.2 million; 6.0 million of these are privately owned. The trend toward private ownership suggests the scaled will tip further in that direction. Table 14.3: Market segmentation for micro-cars (1–1.6L) in 2002–04 Categories Foreign brands

1.3–1.6L New brands Old brands

GOL, Saloon (飞度), Yueda (悦达), Palio (派力奥), Siena (西耶那), BORA (宝莱), Kia Qianlima (千里马), Fiesta (嘉年华), VIOS (威驰), Elantra (伊兰特), Vela (威乐), Kaiyue (凯越) Domestic Vela (威乐) brands VIOS (威姿), Haifei Saima (赛马), Qirui Fengyun (风云), Family (福美来) Lioncel (菱帅)

Less than 1.3L New brands Old brands

POLO, Palio (派力奥) SAIL (赛欧), SRV, Lingyang (羚羊), ELYSEE (爱丽舍), Fukang (富康) Palio (派力奥)

Hongqi (红旗), Geely (吉利), Xiali (夏利), Huapu (华普)

ULION (优利欧), FLYER (福莱尔), QQ , Hafei Lubao (路宝), IDEAL 爱迪尔, Xinyatu (新雅图)

Xiali (夏利), Geely Haoqing (豪情), Changhe Beidouxing (北斗星), MR (美日), ATTA (奥拓 )

Source: Market Forecast for China’s Automobile Industry compiled by the State Information Center.

184

fu yuwu Table 14.4: Market shares for micro-cars (displacement 1.0–1.6L) in 2002–04

Categories

2002 Sales Market volume share (%)

2003 Sales Market volume share (%)

2004 Sales Market volume share (%)

Low-end High-end

130713 161964

174322 305497

162184 313312

44.7 55.3

36.3 63.7

34.4 65.9

Source: “Market Forecast for China’s Automobile Industry” compiled by the State Information Center.

Lower limit (1.0–1.3L)

(%) 70 60

Upper limit (1.3–1.6L) 63.7

65.9

55.3

50 40

44.7

30 20

2002

36.3

34.4

2003

2004 (Year)

Figure 14.1: Market shares for micro-cars (engine displacement 1.0–1.6L) in 2002–04

From 2000 to 2004, individual purchases made up 48%, 53%, 66%, 74% and 77% of total sales. Some brands have enjoyed even faster rates of growth in sales. For instance, Xiali sold fewer than 10% of its cars to individuals before 2001. By the end of 2005, individual purchases made up 80% of the company’s total sales. Not all brands have done as well. Sonata sold 63.6% of its cars to individuals in 2000; individual sales now make up 70.0% of its volume. B. Potential Excess Capacity It is estimated that market demand for automobiles in China will be 12.5–14.0 million cars in 2020. (See Table 14.5.) Looking at the existing production capacity and the capacity under construction allows one to see capacity will expand from 8.5 million units per annum to about 12.5 million by 2010. This output exceeds

growing supply and demand in the automotive industry 185 Table 14.5: Forecasts of demand and ownership of automobiles in China over the next 15 years (Thousands) Year 2010 2015 2020

Demand Total Vehicles Personal Cars 9370 13,520 18,900

Ownership Total Vehicles Personal Cars

5890 10,300 17,270

63,510 103,510 156,920

29,600 57,860 104,010

Source: The State Council Development Research Center.

estimated market demand by three million units. This places domestic auto makers in an especially difficult situation since they focus on the downscale market segment, and buyers in this price range will increasingly find suitable products through the second-hand market. This segment is expected to exceed 1.5 million cars by 2010. China will have to find new markets for its vehicles via trade in order to absorb its potential output. II. Current Production Capacity Conditions Excess productive capacity will place multiple pressures on the automobile industry. Surplus output will tend to drive down prices, cutting margins and reducing profits. Funding and investment will likely become more difficult to acquire as some risk-averse investors pass up potentially profitable opportunities until the market stabilizes and moves closer to a sustainable equilibrium. The reductions in capital flowing into the industry will also hamper the transition to higher-skill, higher-margin segments of the value chain, such as design. Furthermore, by remaining in basic manufacturing, China will continue to shoulder more than its share of the global economy’s burden in energy consumption and emissions produced. A. Developing Environmentally-friendly Micro-autos Micro-autos command a 30% market share in the Chinese automobile market. However, as incomes have boomed, this share has fallen as more consumers buy upscale vehicles. Even though market share is declining, analysts expect overall growth to continue. With many of these vehicles developed through joint

186

fu yuwu Table 14.6: Car sales by segment, 2000–04 (Thousands, %)

Total micro-cars Freight vehicles Passenger vehicles Personal Cars Market shares

2000

2001

2002

2003

2004

683.8 137.8 408.3 127.7 33.06

701.1 130.5 491.7 78.9 29.94

947 148 653.9 145.1 29.11

1100.9 142.6 678.5 287.9 24.78

1232 167.3 757.8 306.9 24.29

Source: Yearbook of China’s Automobile Industry and Annual Report for the Development of China’s Automobile Industry.

ventures or strategic alliances, China has emerged as a major player in this market segment. These cars now lead the market in the performance-price ratio vis-à-vis their competitors. The Chinese possess first-rank technical expertise in the field. Not only do these cars offer great value to consumers, they offer various environmental advantages, particularly low emissions and low fuel consumption. Because these vehicles offer substantial consumer and social benefits, and because Chinese firms dominate this market segment, we believe that policymakers should extend preferential treatment—e.g., through reduced taxes—to manufacturers and their subcontractors as a way of expanding this market and ensuring its success. (See Table 14.6 and Figure 14.2.) B. Export Strategies Worldwide automobile sales topped 63 million units in 2004. China’s market share equals just over 8%. However, China’s share of global auto exports is a meager 2.7%. Clearly China must grow its export market in order to maintain growth and profitability in its automotive industry and the overall economy.1 Domestic brands with suitable technology and products should be supported in their efforts to penetrate foreign markets. (See Figures 14.3 and 14.4.) Export growth is advancing on two fronts: domestically developed commercial vehicles and passenger cars. Vans, trucks, long-haul freightbearing vehicles, and passenger cars have all found success in markets

1 Policymakers and economic strategists see the automobile industry, as well as housing and real estate, as the two industries driving growth in China during the 11th Five-Year Plan, 2006–2010.

growing supply and demand in the automotive industry 187 140

Total micro-cars Passenger micro-cars

120

Freight micro-cars Personal micro-cars

100 80 60 40 20 0

2000

2001

2002

2003

2004 (Year)

Figure 14.2: Growth in micro-car sales 2000–04 150000 Total autos exported

136258 100000

50000

39327

45777

26073 28645

0

2000

2001

2002

2003

2004 (Year)

Figure 14.3: China’s auto exports, by segment 2000–04 6

10,000 vehicles

5 4

10 or more seat passenger vehicles Personal sedans SUVs, 9 or fewer seat passenger vehicles Freight vehicles Specialty vehicles, pull carts

3 2 1 0 2000

2001

2002

2003

2004 (Year)

Figure 14.4: China’s auto exports, by segment 2000–04

188

fu yuwu

Table 14.7: 2000–2004 Changes and trends in freight vehicle production Unit: 1000 vehicles

Total freight vehicles Heavy-load Medium-load Light-load Micro

2000

2001

764 82 154 391 138

806 157 156 362 131

2002 1096 253 164 531 148

2003 1230 262 136 689 143

2004 1455 369 173 806 167

outside of China, especially in less developed countries. China’s relatively strong research and development (R&D) capabilities and high product quality have emerged as key competitive advantages. Moreover, China readily adapts its vehicles to the needs of its customers abroad. This foundation of success poises China’s automobile manufacturers to take the next step: moving into high-margin mainstream automobile markets. Current estimates state that within fifteen years, 20% of China’s domestic automobile output will find its way into these markets. Fulfilling this estimate depends on delivering more high-margin cars to foreign customers. C. Developing the Market for Commercial Vehicles The demand for commercial transportation services, and therefore vehicles, depends on several factors. For instance, the uneven distribution of resources produces the need for shipping resources and goods produced from them. Growth in economies around the world—including China’s—as well as the growing importance of globalization, also drives transportation demand. For these reasons, the market for freight-bearing vehicles has grown rapidly, becoming an increasingly important niche in the overall growth pattern in transportation markets. So while commercial vehicles with a weight capacity of 15 tons or less still dominate sales, they lost 2% of their market share between 2003 and 2005 to large-capacity vehicles. This segment will also benefit from improvements in infrastructure and logistics made in China and elsewhere. Estimates show that 600,000 new large-load, long-haul vehicles will hit the roads by the end of the decade. Eventually, the mix of vehicles in China will resemble that seen in developed countries. (See Table 14.7.)

growing supply and demand in the automotive industry 189 D. Expanding the Automobile Market in Outlying Areas The automobile market in rural areas faces significant changes as well. Regulations demanding greater fuel efficiency, lower emissions, and improved vehicle safety will drive many vehicles, including used vehicles already in service, out of operation. Demand for new vehicles in rural areas seems poised to increase as a result. Since vehicles used in outlying areas perform varied tasks, this growth will affect producers serving many different niches. In anticipation of this demand, producers should now bolster R&D efforts in the field of low-displacement diesel engines as well as vehicles that can readily serve the more highly containerized logistics and shipping systems coming on line around the world.

ANALYSIS AND GROWTH FORECAST FOR THE SERVICE SECTOR, 2005–2006 Shi Zhuxian, Wang Liyong, Mou Xiaoyun, and Liu Junsheng I. Introduction Since starting on the path of economic reform and liberalization, China’s service sector has grown by leaps and bounds. In 1978 services brought in 86.1 billion RMB; by 2004 the sum had grown to 4.3384 trillion RMB. In other words, real growth of service sector spending averaged over 10% for more than 25 years. The sector’s contribution to GDP rose from 23.7% to 31.8% over the period. In recent years, China’s service sector has become more labor intensive and now enjoys a faster rate of employment growth than either agriculture or heavy industry.1 It now has the largest number of new employees and has proven to be the most easily stimulated job market of the three main economic sectors. This has placed it at the center of economic strategy and policy regarding employment and improvements in living standards. According to foreign researchers, the service sector’s increasing contribution to GDP has changed business cycle behavior in China. Because service expenditures remain relatively stable over time, growth in the sector has reduced the volatility of business cycles. Even though economic performance has been strong, China’s service sector lags behind the growth rates and scale of service sectors in developed economies. It also lags behind developed countries’ service sectors in terms of total employment and growth rate. In short, the service sector in China has a long way to go before fulfilling its potential. Of most immediate concern is correcting idiosyncratic growth tendencies within some particular industries in the sector.

1 Translators’ note: The three economic sectors included in this paper are agriculture, industry, and services. Note that this paper does not include the government sector in its analysis.

192 shi zhuxian, wang liyong, mou xiaoyun, and liu junsheng This essay uses conditions and trends at work in the service sector to forecast values for a variety of key indicators of the sector’s performance in 2005–2006. These forecasts are used in a larger analysis of economic growth, particularly the impact of the service sector on employment. The essay concludes with policy suggestions on how to foster growth in the service sector based on empirical findings. II. The Stabilizing Effect of Service Sector Growth on Macroeconomic Growth Growth of consumption contributes over 50% to GDP growth. Therefore, stabilizing consumption growth plays an important role in stabilizing overall growth. And as expenditures on consumer services increase, the service sector plays a more important role in achieving stable macroeconomic growth. A. A Review of Expenditures on Services Table 15.1 presents growth rates of expenditures on services against all expenditures. Percentage contributions of each spending category to GDP are recorded for the years 1996–2004. In recent years, consumer spending on services been on the rise. Food and other basics take up a smaller percentage of overall household and personal spending; at the same time a greater percentage of income goes toward a wider range of goods, higher quality goods, and a wider array of services. Table 15.1 shows that consumer spending on services has outpaced general consumer spending growth. The one anomaly is 2003 when the growth rate in expenditures dipped to 6.7%, 1.5% less than overall growth in consumer spending. The timing of this drop Table 15.1: Growth rates of consumer expenditures on services, 1996–2004 (%) Year Growth rate of spending on services Growth rate of consumer spending Percentage of consumer spending going to services

1996

1997 1998 1999 2000 2001 2002 2003 2004

19.8

16.4

14.7

9.1

4.7

4.6

16.8

19.9

20.5

17.8 22.3

12.5

25.3

6.7

14.4

9.6

7.3

9.1

8.2

10.3

22.4 25.0

26.3

27.4

27

28

7.56

analysis and growth forecast for the service sector

193

coincides with the SARS epidemic. During the epidemic certain hightech expenditures continued to grow—e.g., spending on mobile phones and internet equipment—while a variety of service expenditures like tourism and transportation services suffered. The sector recovered on rapid growth in spending for medical services and insurance, as well as education. As incomes have grown, a larger percentage of spending has gone toward services. In 1996, 16.7% of income was spent on services; by 2004 the proportion has jumped to 28%. Although this number still lags rates seen in developed countries, it clearly shows that the structure of the market in China has changed dramatically. B. Analyzing the Stabilizing Effect of Consumer Spending on Services To analyze the stabilizing effect that consumer spending on services has on economic growth we apply a special case of coordination theory in defining estimators used in formulating a statement of total consumer spending and consumer spending on services. Equations (1) and (2) state these definitions. lnCt = β0 + β1lnYt + β2lnSt-1 + β3lnπte + e1t lnSCt = β0 + β1lnYt + β2lnSt-1 + β3lnπte + e2t

(1) (2)

In the equations above, Ct is total real consumer spending in period t, SCt is total real consumer spending on services in period t, Yt is real GDP in period t, St–1 is the real total of savings deposits in the previous period, πte is the expected inflation rate, with average of changes in money supply M2 in the current and previous years serving as a proxy for inflation.2 The analysis uses data from the first quarter (Q1) of 1994 to Q4 2004. These data are used to test the logarithmic unit roots of the variables Ct, SCt, Yt, St–1, and πte. Results are expressed in terms of 95% confidence intervals for Ct, SCt, Yt, and πet, and a 90% confidence interval for St–1. By testing over the time series we can determine the long-term trends of consumer spending.

M2 is a widely used definition of money supply. It is defined as the total of all currency, including holdings at the central bank that can be converted to currency, plus the total of all demand accounts (“checking” accounts), plus most savings account and time deposits. 2

194 shi zhuxian, wang liyong, mou xiaoyun, and liu junsheng Table 15.2: Results of augmented Dickey-Fuller testing Time series e 1t e 2t

ADF statistics –3.56**–2.63 –1.99*

1% critical value –1.95 –2.63

5% critical value –1.95

The results presented here are based on an augmented Dickey-Fuller (ADF) test.3 Table 15.2 presents the results of ADF testing conducted on the logarithms of Ct, SCt, Yt, St–1, and πet. The results show that Equation (1) and Equation (2) can be estimated with 99% and 95% confidence. This clearly shows the existence of a relationship between Ct, and the SCt, Yt, St–1, and πte. Estimations using the two equations yield the following results: lnCt = 0.295127 + 0.328874lnYt + 0.372752lnSt-1 + 0.369867lnπte (0.711043) (2.237667) (4.127939) (0.260271) lnSCt = 4.477253 + 0.017963lnYt + 1.130078lnSt-1 + 5.858058lnπt (–4.903661) (0.055561) (5.689107) (1.873941)

(3) e

(4)

Note that t statistics are stated in the parentheses below parameter values. A comparison of the parameters β2 in equations (3) and (4) clearly shows that β2 in the overall consumer spending equation is much larger than in the service consumer spending equation. This indicates that the range of fluctuations in overall consumer spending exceeds that of spending on services, given changes in GDP. This allows us to conclude that spending on services can lessen fluctuations in GDP to a certain extent. C. Projections Based on the Stabilizing Effect of Spending on Services The remainder of this essay will use what we know regarding the stabilizing effect of growth in the service sector on overall economic growth to project how the sector will impact GDP in the future. Figure 15.1 shows the growth rates of the three economic sectors under analysis here. This graph clearly shows that in the early days of reform and liberalization, agriculture occupied a more prominent role

3 The Augmented Dickey-Fuller specification (ADF) tests for a unit root in a time series. The “augmentation” allows for the test to be conducted reliably in the presence of certain forms of serial correlation.

analysis and growth forecast for the service sector

195

in the economy. During this period, its proportion of GNP peaked at 12.9% before slipping below 5% in later years. Growth rates over the period fluctuated around 4% per year. 2004 marks a turning point in agricultural production as a result of changes in economic policy. This transition came in response to five consecutive years of falling grain yields and farm incomes. However, prescriptive measures brought about the fastest income growth rates in agriculture since 1997. Since beginning economic reform and liberalization, the economy has leaned most heavily on the burgeoning industrial sector to drive economic growth. Growth in the sector has been prodigious, even as it has been marked by significant fluctuations caused by changes in state policies. Since industry makes up such a large percentage of GNP, these policy changes produced profound changes in overall economic conditions. In contrast, the service sector has experienced relatively mild fluctuations in growth. Two primary forces drive this outcome: the steady demand for services and the nearly simultaneous production and consumption of services. That is, delivery and “fulfillment” in the service sector does not rely upon vast, capital-intensive investments or accumulations of inventories. Nor does it require considerable resource inputs that vary wildly in price. Shipping is not an issue. In short, it does not suffer from the sorts of difficulties that have sometimes plagued China’s industrial sector. As China’s service sector becomes a larger proportion of GNP, its steadier growth profile should help to ease business cycle volatility. Based on recent observations, summarized in Graph 1, growth of the service sector has remained high and stable even as the industrial sector varied more widely. Note that in 1981 growth in the industrial sector slowed to a paltry 1.9% in response to government policy intervention. By the following year, growth rebounded to 5.6%, but both figures fall far shy of the Chinese economy’s overall growth trend. However, the service sector grew by 10.4% and 13% in spite of these policy changes. GDP growth for 1981 and 1982 worked out to 5.2% and 9.1%, which fell into midrange between the growth rates in the two sectors. By the early 1990s the roles reversed. Growth in the industrial sector zoomed to 21.2%, 19.9% and 18.4% during the years 1992, 1993 and 1994. However, growth in the service sector continued at or near its 10% rate. Because the service sector moves on such an even keel, it tends to moderate GDP growth over time.

196 shi zhuxian, wang liyong, mou xiaoyun, and liu junsheng Agriculture Industry Services

(%) 0.24 0.20 0.16 0.12 0.08 0.04

2004

2002

2000

1990

1998

1996

1994

1992

1988

1986

1984

1982

1980

1978

0.00 (Year)

Figure 15.1: Growth rate curves for the agricultural, industrial, and service sectors Table 15.3: Growth rate standard deviations for agriculture, industry, and services Five-year plan

GDP

Agriculture

Industry

Services

Sixth Five-year Plan Seventh Five-year Plan Eighth Five-year Plan Ninth Five-year Plan

3.74 3.63 4.29 1.36

5.63 1.08 1.77 1.02

5.37 5.55 7.31 2.36

5.07 4.69 3.86 0.54

Examining the standard deviations of growth rates within the three sectors over four five-year plans—in particular the Sixth through the Ninth Plans—formalizes the intuition. These results are shown in Table 15.3. Note that for all four periods, the standard deviations of growth figures in industry best those in the other two sectors, as well as for the national economy. This result holds during the Ninth Five-Year Plan when the economy went through a significant contraction. Simply put, volatility in industry drove business cycles and the stability in the service sector blunted this effect. Business cycles have become less severe as the service sector has grown. Figure 15.2 shows the curves of business cycles in the industrial and service sectors after smoothing them with a Hodrick-Prescott (HP) filter.4

4

The Hodrick-Prescott filter is one of many ways to analyze business cycles. The

analysis and growth forecast for the service sector 2000

Services

197

Industry

1500 1000 500

2004

2002

2000

1990

1998

1996

1994

1992

1988

1986

1984

1980

–1000

1982

–500

(Year)

Figure 15.2: Business cycles in the industrial and service sectors

The graph reveals that the industrial sector experienced considerable business cycle volatility since the late 1980s as a response to regulatory interventions introduced between 1989 and 1991. The sector hit a trough in the early 1990s, only to recover in dramatic fashion by middecade. The graph also reveals that the service sector experienced no such volatility, growing quite predictably over the whole period. II. Generating Employment in the Service Sector A. A Brief Review of Employment Conditions by Sector Since beginning the reform and liberalization process in 1978, the structure of employment across sectors has experienced considerable change. These changes mirror structural changes at work in each sector and across sectors, as shown in Figures 15.3 and 15.4. Over this period, the percentage of persons employed in the agricultural sector declined by 23.6% from 1978 to 2004. Note, however, that total employment increased from 283.18 million to 352.69 million in 2004 HP filter minimizes the sum of squared deviations between the trend and the actual time series, and uses a special parameter λ to adjust for short term fluctuations in the time series in a way that changes the slope of the trend to change less than the slope of the actual time series. This has the result of making long-term trends in the actual time series clearer.

198 shi zhuxian, wang liyong, mou xiaoyun, and liu junsheng Agriculture

(%) 80

Services

Industry

70 60 50 40 30 20 2004

2002

2000

1990

1998

1996

1994

1992

1988

1986

1984

1982

1980

1978

10 (Year)

Figure 15.3: Changes in employment rates for the agricultural, industrial, and service sectors, 1978–2004

2004

2002

2000

1990

1998

Services

1996

1994

1992

Industry

1988

1986

1982

1980

1978

1984

Agriculture

40000 36000 32000 28000 24000 20000 16000 12000 8000 4000

(Year)

Figure 15.4: Changes in total employment for the agricultural, industrial, and service sectors, 1978–2004

over the period. Unsurprisingly, industrial employment exploded, rising from 69.45 million to 169.20 million in 2004, moving its share of total employment form 17.3% to 22.5%. Most of the percentage gain happened soon after 1978; since the mid-1980s the share has stabilized around 22%. In contrast, employment in the service sector has grown by leaps and bounds since 1978 and this momentum shows no signs of abating. Employment in the sector has gone up from 48.90 million in 1978 to 230.11 million in 2004. This surge boosted the sector’s share of total employment from 12.2% to 30.6% over the period.

analysis and growth forecast for the service sector

199

Table 15.4: Elasticity of demand for labor in the agricultural, industrial, and service sectors Year 1980–1989 1990–1999 2000–2004 1980–2004

Industry

Agriculture

Industry

Services

0.092 –0.098 –0.087 0.075

0.380 0.114 0.078 0.205

0.357 0.335 0.409 0.359

Even though the structure of employment has changed dramatically in the past quarter century, China’s employment structure by sector still differs from what we observe in developed countries. First, China still employs a far greater percentage of its people in agriculture. Secondly, even though employment in the service sector has grown dramatically, its share of employment still falls well short of the 50% figure typically observed in developed countries. B. Analyzing the Elasticity of Demand for Labor in the Service Sector Calculating elasticities of demand for labor provides another way to gain insight into the changing role of the service sector in the Chinese economy. Table 15.4 summarizes these results. According to Table 15.4, the elasticities of labor demand in agriculture, industry, and services are 0.075, 0.205 and 0.359 over the period 1980–2004. Note that the service sector enjoys a much larger elasticity, meaning that as the sector grows it will continue to add jobs at a faster rate. Limiting the data to the first three periods dramatically alters the results. As expected, labor demand elasticity for agriculture changes sign from positive to negative, while the figure for industry falls off from 0.38 to 0.078. However, the elasticity for the service sector standards apart from this pattern, with a figure of 0.335. Since then it has climbed even higher, reaching 0.409 over recent years. The reader should note, though, that the sheer size and growth in the industrial sector means that it still adds jobs in absolute terms, as does the service sector. Even though the service sector has by far the highest elasticity of labor demand in general, individual industries within the sector vary widely owing to the heterogeneous character of the sector. A closer examination of industrial “clusters” inside the sector provides a more granular view of where we can expect employment numbers to grow

200 shi zhuxian, wang liyong, mou xiaoyun, and liu junsheng Table 15.5: Elasticity of labor demand for various industrial clusters within the service sector, 1990–2003 Sectors

Elasticity

Sectors

Transportation, logistics and storage, posts and telecom Wholesale, retail, catering

0.177

Social services

0.356

Finance and insurance

0.248

Real estate

0.505

Public health, sports and social welfare Education, culture, art, radio and television broadcasting Scientific research and comprehensive technological services

Elasticity 0.238 –0.056 0.054 –0.02

over time. A summary of these findings, based on data collected from 1990 to 2003 are shown in Table 15.5. The results show that the real estate, wholesale and retail, and catering clusters have the highest elasticities. The transportation, logistics and storage, post and telecoms, finance and insurance, and social services clusters have relatively high elasticities of around 0.2. These six clusters will play the largest role in adding jobs to the economy in the coming years, provided that structural conditions remain more or less the same.5 III. Forecasts of Main Indicators in China’s Service Sector, 2005–2006 On the basis of the above analyses, this essay presents forecasts of the service sector’s impact on employment. Specifically, the share of total employment and the percentage contribution to employment growth for 2005 and 2006 are calculated. Estimates are made using an ARMA

5 Note that these figures only track the number of jobs. Information regarding job quality, productivity, and wages is omitted from this analysis. Clearly, those clusters where wages remain low can add more employees because each individual worker costs less to employ. Furthermore, low-wage, low-skill workers tend to cost less to find, hire, and train, further increasing the quantities demand of such labor. The long term impact of these trends on economic conditions remains mixed.

analysis and growth forecast for the service sector

201

Table 15.6: Forecasting the value of economic indicators in the service sector, 2005–06 (%) Contribution to gross Contribution to growth Proportion

Volume 31.8

Transportation, logistics and storage, post and telecom Wholesale, retail, catering Finance and insurance Real estate Social services Public health, sports and social welfare Education, culture, art, radio and television broadcasting Scientific research and comprehensive technological services Others

2004

2005

2006

29.10

26.65

28.28

2.8

2.5

2.6

Total Volume Employment 30.6 31.4

Total Employment 31.5

Volume 31.6

Total Employment 32.6

5.6

3.4

5.6

3.4

5.5

3.4

7.4

7.5

7.3

7.5

7.2

7.4

5.6

0.98

5.5

0.99

5.6

0.99

1.9 4.4 0.9

0.2 2.06 0.88

1.9 4.6 0.9

0.2 2.13 0.88

1.9 4.8 0.8

0.2 2.2 0.89

3.2

2.7

3.3

2.6

3.4

2.6

0.8

0.41

0.9

0.4

0.9

0.39

2

12.5

1.4

13.4

1.5

14.5

model6 and transitions in a time series based on Malkoff ’s work.7 Forecasts are then integrated through averaging (See Table 15.6.) A. Slowing Growth in the Service Sector, 2005–2006 The service sector seems poised to stay on its steady growth track during 2005 and 2006. The sector will essentially remain unchanged 6 Autoregressive moving average (ARMA) models are often used to understand trends and to make estimates of future economic values based on time series data. The model is made up of two parts: an autoregressive (AR) part which captures the ongoing effect of changes in earlier periods and a moving average (MA) part, which captures the decreasing impact of changes in earlier periods. 7 Malkoff, D. B., “A framework for real-time fault detection and diagnosis using temporal data,” in Artificial Intelligence in Engineering, Vol. 2, no. 2: 97–111.

202 shi zhuxian, wang liyong, mou xiaoyun, and liu junsheng terms of employment share, falling from 31.8% in 2004 to 31.4% in 2005. Estimates show a 0.2% rise to 31.6% in 2006, but accounting for statistical error makes these figures virtually equal. The service sector’s contribution to employment growth moves a bit more, but no large change appears here. Starting from the known contribution to employment growth in 2004 of 29.1%, the figure falls to 26.65% in 2005, before recovering to 28.28% in 2006. B. Changes in the Internal Structure of the Service Sector The internal structure of the service sector will essentially remain the same during 2005 and 2006. Long-time employment leaders like the wholesale and retail trade, catering, transportation, logistics and storage industries will account for 40.2% of service sector turnover in 2006, and 41.1% in 2005. Note that these figures move around the 2004 percentage of 40.9%. Employment figures follow the same pattern. These industries will account for 33% of jobs in the service sector in 2006 and 34.6% in 2005. The estimates show that younger industries in the sector, such as finance, insurance and social services, will enjoy much higher employment growth during 2005 and 2006. In response to structural fine-tuning, the service sector will continue to add jobs in general, but that current employment leaders in the sector like retail will make up a smaller proportion of the total over time.8 As noted immediately above, the finance, insurance and social service industries will add jobs and outpace other areas of the service sector in job growth. Moreover, these clusters have grown large enough that the growth percentages reflect large absolute numbers of jobs, whereas other emerging sectors play only minor roles in adding jobs. Note, however, that as the sector grows and adds more jobs, its rate of growth will typically slow.

8 Part of this shift away from traditional leaders is simply the result of mathematics: as the base grows larger, growth tends to slow. There is also a purely economic effect here: as these industries mature, their growth rates will level off. Above and beyond these factors, however, policy effects will shift job growth in the sector to other areas.

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IV. Policy Suggestions Maintaining momentum in employment growth will require business leaders and policymakers to avoid an array of problems that could slow or undermine employment growth in the service sector. The first concern to note is the relatively small scale of the service sector. Note, though that structural adjustments in the Chinese economy will probably correct this shortcoming in the next two or three Five-Year Plans. The second issue also arises from current conditions: the dominant role played by certain traditional industries (e.g., retail) in the service sector. Again, as described above, emerging sectors seem poised to outpace growth in retail during the near future, although it seems likely that retail and other traditional service industries will continue to be major players for quite some time. Current conditions also play a role in the geographical distribution of jobs. Currently, urban areas continue to play a dominant role in service sector employment and employment growth. However, policy moves aimed at directing resources to rural areas will help to develop the service base in outlying areas.9 Other challenges confronting development of the service sector arise from current and ongoing economic forces. First among these is the growing problem of market disequilibrium. That is, pent-up demand exists for a variety of services, but the number of service providers remains inadequate to meet demand and/or service providers and their potential customers cannot readily engage in transactions. Growth in the service sector will resolve much this problem; proliferation of service providers will meet some of the pent-up demand and will make service providers more available in more places, and at generally lower prices. The second issue, lack of management and operational acumen, may prove to be a thornier problem. Growth will attract more talented managers to the field, but continued sloppy performance as a result of inexperience and other such problems will delay growth and the development of a richer offering of services. The generally low skill level of employees plays a central role in driving these problems. That is, while managers are not up-to-speed, neither are their subordinates. Increasing urbanization and familiarity with markets will help in this

9 A number of chapters in this volume delve into policy changes aimed at generating economic growth in the countryside.

204 shi zhuxian, wang liyong, mou xiaoyun, and liu junsheng regard, but this may prove to be the most complicated shortcoming standing between the service sector and its potential in job creation. This essay recommends taking the following measures to address these problems: A. Growing the Service Sector Efforts should be taken to expand the sector, especially by more effectively integrating the provision of services into agricultural and production. Note that as the least developed of the three major sectors, it has the greatest growth potential. B. Improving Coordination with and Cooperation Between the Three Major Sectors Service providers can play key roles in increasing the productivity of the agricultural and industrial sectors. By working with these other sectors, management systems can be improved, workflow optimized, and strategy enhanced. Working with the industrial sector is especially important since it continues to play a central role in economic growth and activity. Doing this can help to grow the service sector, especially in those industries where overall employment, worker productivity and wages are high. C. Growing the Job Base in the Service Sector Not only does the job base in the service sector need to grow acrossthe-board, but particular industries within the service sector need to be bolstered in order to generate job growth. These industries include knowledge intensive sectors like consulting, information technology and management, finance, insurance, and real estate. These sectors offer the further advantage of improving operational efficiency in other services industries and economic sectors. D. Improving the Educational and Skill Level of Employees in the Service Sector Finding educated and skilled workers continues to be an impediment to growth of the service sector. To address this problem, the state and firms should increase investment in worker education and training.

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In particular, such investments should be comprehensive; multi-level, multi-form and multi-channel mechanisms can build a base of workers with specialized skills. This will raise productivity, and with it, wages. Business and government leaders should redouble efforts in emerging sectors with the greatest employment growth potential. E. Promotion of Urbanization Urbanization goes hand-in-hand with growth and development of the service sector. Coordination of various productive and planning processes associated with urbanization relies on various service providers. Moreover, as urban areas grow and become denser and more complex, this demand increases. F. Pushing Through Market Reforms The service sector has reaped substantial benefits from the economic reform and liberalization process. Given this, broadening and deepening market reforms should help the sector to grow even more. In particular, market reforms should help to rationalize business processes, and this process of adjustment will require input from high-skill service providers like consultants. More traditional service industries10 can benefit from an expansion of market reform as well. Competition will improve overall market function as well as firm-by-firm operations, structure, and management. The same argument follows for those service industries that are farther along in the reform process.11 Even those industries currently held by monopolies12 can benefit from a gradual opening to competitive forces.

10 Examples of traditional services industries would include commerce, wholesale and retail, catering, tourism and public service. 11 Examples of those industries that are farther along in the reform process would include public services, public health, education, tourism, and culture. 12 Examples of monopoly industries in the service sector include telecommunications, finance, and insurance.

CONSUMER SPENDING SLOWS, INFLATIONARY PRESSURES DISSIPATE: ANALYZING THE CURRENT PRODUCTION SYSTEM AND ITS PROSPECTS FOR 2006 Chen Kexin and Chen Zongqun I. The Means of Production in 2005 The means of production in China display three major characteristics as of 2005: slowing growth, increases in consumer spending, and falling prices for many consumer goods. We explore these phenomena in turn below. A. The National Economy Slows In 2004 some industries in China showed signs of overheating, as seen in ballooning resource demand and, with it, skyrocketing input prices. This precipitated state intervention. The leadership introduced changes regarding investment in capital projects and fixed assets, and canceled the export tax rebate program, among other changes. These moves produced measurable, and welcome, impacts in early 2005. According to statistics from relevant departments, new investment in productive capacity amounted to almost 7.75 trillion yuan from January to July of 2005, up 16% from the same period in the previous year (adjusted for inflation). However, the growth rate in investment fell by 6% compared to the previous year’s rate. Economic regulations and policy adjustments eventually slowed the rate of economic expansion, but growth continues to be strong. Gross domestic product (GDP) grew at a brisk 8% clip during 2005’s first three quarters. Consumer spending grew at a double-digit pace. If trends for 2005 carry forward through the fourth quarter (Q4), consumer spending should exceed 13 trillion yuan. This is a 12% improvement over 2004’s total. Even with the slowdown, the economy still has vast input demands. The economy will require 350 million tons of steel during 2005, a

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10% increase from the previous year’s total.1 Coal inputs will exceed 1.6 billion tons, up by more than 8%. Crude oil consumption will come to 300 million tons.2 Nearly four million tons of copper and 7.5 million tons of aluminum will be used in production; the growth rate for copper consumption is 12% and growth for aluminum demands exceeds 7%. Over a billion tons of cement will go into production, an 8% hike over 2004’s total. B. Strong Consumer Spending and Good Margins Economic expansion continues to feed growth in capacity. Even with the increase in supply, prices remained stable, helping many firms to take in heftier margins. Strong margins helped to attract investment and to reduce the time needed for these investments to pay returns because well financed facilities come online more quickly. New resources entering the market3 increased by 14.3% during the first half of 2005 compared to Q1 and Q2 in 2004. New coal resources exceeded a billion tons, a 10% rise. Petroleum resources expanded by almost 18 million tons, a 5% increase. Over 219 million tons more steel came onto the market, a 20% increase over the same period in 2004. Copper resources increased by more than 2.25 million tons, up 13% and available aluminum resources grew by 4.42 million tons, an 8.8% hike. Over 545 million tons cement came onto the market, an 8.8% year-on-year increase. Overall, resource inputs will grow by 12% as strong domestic production continues to expand the resource base. Steel production increased by 26.2% through the first eight months of the year. Steel imports declined by 21%. Domestic production of copper grew by 18.3%, while imports contracted by 11%. C. Increasing Output Quashes Inflation Given the expansion in production and resource availability, inflationary pressures have eased. Prices for many consumer products have fallen. As well, the rate of growth in consumer spending has slowed. This total takes into consideration the problem of double counting that can arise when finished products made in China include foreign-produced steel. 2 One ton of oil equals roughly eight barrels. 3 “New resources” means all domestic inputs plus imported inputs. 1

consumer spending slows, inflationary pressures dissipate 209 Table 16.1: Input Price Changes, January to August of 2005 (%)4 Indexes Changing rates of month-by-month price changes month-to-month price changes Total

January February March April May

June

July August

–0.1

0.73

1.68

0.84

–0.1

–1.45 –0.42 0.58

7.5

5.1

5.66

5.67

6.2

4.88 3.43 2.87

7.5

6.2

6.05

5.84

5.83

5.58 5.22 4.84

The gap between supply and demand moved from –0.61 in Q1 to +1.68 by the beginning of Q3. Surpluses are expected to grow through the remainder of the year. These surpluses exert downward pressure on inflation and input prices as well. Input prices have moved into a downward trend, but they are coming down off of steep increases from a few years ago. Nationally, input prices increased 4.84% between January and August of this year, which is 9% lower than last year’s growth rate over the same period. This trend has accelerated in 2005: input prices rose 7.5% in January, but only 2.9% in August. The only break in this trend came in August when a spike in petroleum and nonferrous metal prices caused input prices to surge unexpectedly. (See Table 16.1.) A variety of other input prices declined according to China’s Ministry of Commerce. After increasing at the beginning of the year, steel prices have slowly declined. Coal supplies have been expanded substantially, leading to a precipitous reduction in prices. Cement prices have also declined steeply. Price increases also extend to a variety of finished goods used in production. Automotive, mechanical, and electronic products prices fell. Petroleum and nonferrous metals continue to be the exceptions to the rule. Note, however, that supplies of these inputs depend on imports, where the government has limited control over supplies, and therefore, prices. We expect prices to continue on a downward path through Q4. Consumer demand typically drops off at year’s end, but this year the impact of this cyclical effect will be compounded by new capacity coming online, a reduction in export demand, and an increase in the value

4 For those familiar with calculus, the rows in Table 1 track acceleration/second derivative (second row) and the rate of change in prices or velocity/first derivative (third row).

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of the yuan as a result of exchange rate reform. Again, petroleum and nonferrous metal prices are the wildcards here. Steep price increases and market volatility could play havoc with international supplies and Chinese production projections. Taken together, we estimate that national input prices will show a 4.5% year-on-year decline in September. If trends hold out until the end of the year, 2005 should finish with about a 5% increase in input prices, which is about 8% lower than the 2004 rate. II. Continuing Problems Regarding Input Prices Even though price pressures have eased, various unresolved issues require continued treatment. A. Overcapacity As noted, overcapacity has grown through 2005. As new productive capacity comes online in 2006, surpluses will continue to grow. For instance, tens of millions tons of steel production capacity will come online between Q4 2005 and Q4 2006. We expect that this will lead to a substantial overcapacity problem in steel products. We expect similar trends to afflict other building materials like aluminum and cement. Some finished products used in production may well enter into a stage of surplus as well, most notably automobiles, certain types of machinery, and electrical products. To head off the development of large surpluses, output should be reduced and demand for finished products increased. A key element of demand is consumer income; rising wages will certainly increase demand, which will help to absorb the glut of consumer goods. Moving into higher margin goods should further enhance wages in China. However, policy changes can accelerate this process. We recommend raising the minimum wage, pensions, and various social safety-net payments. B. The Exceptions: Tightening Oil and Raw Materials Supplies Even though overall trends show an easing of input shortages, oil supplies remain tight. Shortages have been especially acute in eastern and southern China in Q3 and Q4 2005. Seasonal shortages cropped up in coal, copper, and rubber supplies as well.

consumer spending slows, inflationary pressures dissipate 211 C. Managing Resource Exports Although departments involved in managing exports have tried to slow the rate at which various inputs are exported, market pressures have overwhelmed their efforts since international prices remain higher than domestic prices. For instance, through the first eight months of the year China exported 10.45 million tons of refined oil, up 42.3% over the same period in 2004. Produces shipped out 14.44 million tons of steel products, up 97.2%, and 1.4 million tons of aluminum products, up 19.6%. Exporting brings in revenue, expands the job base, and helps to expand demand to meet supply. However, it can also aggravate shortages. Moreover, by producing for both the domestic and global market, China takes on a greater share of the various externalities, such as pollution, generated through heavy industrial production. D. Increasing Price Volatility for Some Inputs Although the rate of increase for prices continues to slow in general, some inputs have hit record-high prices. Demand and speculation have driven oil, copper, and rubber prices upward. In August and September, global petroleum prices 70 USD per barrel. Copper prices exceeded 3,500 USD per ton. Rubber prices climbed to more than 17,000 yuan per ton. These high prices—especially petroleum prices—may undermine the currently strong economic growth trends around the globe. Other effects add unpredictability to the picture. China’s decline in economic growth may well increase product surpluses and overcapacity, at least in the short run. Export volume may also decline as the yuan gains value against various currencies, especially the US dollar. This, taken together with the overall falling trend in input prices, paints a complicated picture. We expect overall input prices levels to fall sharply for as much as two years. However, oil price fluctuations maybe offset a substantial portion of these declines. Furthermore, the widespread impact of oil price increases introduces a large component of uncertainty into various economic measures, from overall growth, to inflation, and interest rates. III. The Outlook for Input Prices in 2006 China’s economy will grow rapidly in 2006. Even with slowing in the rate of growth, GDP is expected to grow by more than 8%, with 7%

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growth considered a worst-case growth estimate. To maintain this rate of growth, input demands will remain high. However, China’s fortunes also depend on international conditions. The declining growth rate in the global economy through 2006 will soften demand for Chinese products, exacerbating output surpluses. Increasing trade restrictions and barriers will further reduce demands for Chinese goods. In response, domestic demand will become more important. Thus demand for China’s production materials will rely more on domestic market, but it seems unlikely to make up for lost sales in global markets. With productive capacity still growing, inventories will accumulate. The downward pressure on retail prices will reduce margins, eventually putting downward pressure on supplies and input prices. When all is said and done total spending on inputs will come to about 15 trillion yuan, up about 10%. Spending on key inputs, such as oil, coal, steel products, nonferrous metals will climb at double-digit rates. If input and retail prices fall in the long term, and if China remains committed to producing in lower-margin parts of the value chain, inflation will remain manageable. Regulators and policy makers need to make sure that this process does not gain strength. Although the overall growth rate militates against deflation, the experience of Japan weighs heavily on many minds in China. These conditions frame our analysis of the evolving conditions affecting Chinese production systems and capacities, especially the key inputs examined below. A. Petroleum and Petroleum Products When global oil prices shot up to more than 70 USD per barrel in 2005, shockwaves reverberated through Chinese energy markets. Petroleum refined in China saw its price increase steeply, given producers a strong incentive to sell these goods on world markets. August’s year-on-year price increase exceeded 21% for oil; diesel prices increased by more than 23%. Note that high prices cut into petroleum imports. For various reasons, the price of refined oil products produced in China is about 1/3 lower than the global prices for similar goods. As China opens itself to market reforms, this gap will decline, but while this adjustment takes place, domestic producers have a strong incentive to sell products internationally.

consumer spending slows, inflationary pressures dissipate 213 B. Coal Input-output adjustments produced a significant decline in coal prices, a key input in China’s economy. Total output through August 2005 fell just shy of 1,145 million tons, up 9.9% over the January through August amount in 2004. Projections for the year’s output equals 1,700 million tons, about a 10% increase over 2004’s output. Coal stockpiles have increased with output growth. During August coal stores at the Port of Qinhuangdao reached 4.7 million tons, 1 million tons more than usual. About the same time per ton coal prices had declined between 20–50 yuan since the beginning of the year. This expansion in capacity, and the commensurate price decreases, had eased shortages and bottlenecks that plagued the Chinese economy in the first years of the century. Total coal demand in 2006 will be at least 1,800 million tons, up 10% over that in last year. China has more than enough capacity to meet this demand, which should keep prices under control. However, some transient price shocks and seasonal effects will introduce some passing prices increases. C. Steel Products Since 2002 domestic demand for steel products has been strong, even as price has increased. Because of its central role in industrial and infrastructural development, its price and output has been closely watched—and when necessary, regulated—by relevant department. By 2005 these interventions had moderated demand and price increases. Total steel consumption in 2005 equaled about 350 million tons, about a 10% increase over 2004’s total. Note that the growth rate slowed by about 5%. Exports shot up for the year, reaching almost 14.5 million tons between January and August, and 120% increase over 2004 exports. Productive capacity is expected to reach 360 million tons, up about 20% from the previous year. About 26 million tons of imports bring total steel available in the Chinese market to more than 385 million tons. Total demand for steel products is expected to reach 380 million tons, up about 10%. Because this exceeds demand, we can expect price increases to be controllable.

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D. Copper Copper supplies are expected to tighten in 2005. Total resources will not reach four million tons, which does not meet demand. Storage reserves will make up the difference, but clearly, these stocks will be stressed. As a result, copper prices have soared to record highs. E. Cement With adjustments in financial markets, investment in building projects has declined, and with it, the demand for concrete. Total concrete output in 2005 equaled about 900 million tons, just shy of a 10% increase over total output in 2004. More important, output exceeds demand, which keeps downward pressure on prices. In August, building material prices declined 3.29% and the cement price declined by 8.34%. F. Rubber Drought conditions in spring cut into rubber production and total output will fall just shy of 600 thousand tons, just off last year’s output. The poor harvest in areas outside of China drove prices up. Stockpiles leftover from 2004 further softened demand for imported rubber. However, synthetic rubber output grew 8.6% through August. Total rubber and rubber synthetics available comes to about 2.96 million tons, up only 3% as compared to last year’s January to August figures. Projections put total output for 2005 as just shy of 5% over 2004’s total. Stocks-onhand do not correct the overall supply condition: only about 200,000 tons are stored in China. Although output remains stagnant, demand shows strong growth. Demand for tires, which absorbs more than 50% of the rubber output, rose 28.9% for the year. Furthermore, a key input in synthetic rubber, petroleum, has risen steeply in price. Clearly, this market will experience steady and substantial price increases in coming quarters. G. Automobiles Between January and August 2005 nearly four million automobiles rolled off of Chinese assembly lines, a 9.7% year-on-year increase. Total output for the year is expected to reach 6 million, up about 10% over 2004. With the economic growth rate slowing, demand will soften.

consumer spending slows, inflationary pressures dissipate 215 Output will exceed demand, putting downward pressure on retail and input prices. Input prices in the automotive industry are projected to fall by 7% through August. Low inflation will certainly benefit many parts of the Chinese economy. However, fatter margins, realized through price increases brought about through improved product quality or efficiency gains, must be realized in the long run for China to continue its overall growth trend and to further its economic and social development.

CONSUMPTION IN CHINA IN 2005 AND 2006 Guo Shouzhong I. The Basics of Consumption in China A. National Income Data National Day Golden Week, which starts on October 1st, marks the beginning of the year’s fourth quarter (Q4). Q4 this year promises to be eventful, even turbulent, regarding economic policy and trends. Surging input prices, especially oil, threatened to increase input and retail prices throughout the economy and dampen economic growth. Trade frictions between China, Europe and the United States regarding exports and prices, especially for textiles, will place impediments on growth. On the home front, new policies aimed at curtailing speculation, particularly in real estate and investment, will reshape economic decision making throughout the country. Better monitoring of local government decision making will produce greater tensions between the private incentives of local leaders and the policy goals of national leadership. Increasing incomes and wealth disparity challenges basic Chinese notions of egalitarianism. This problem spills over into other concerns regarding rural areas, including agricultural production and distribution and food security. Clearly economist will have much to study and governmental and business leaders much to work on in the coming months. According to data from the National Statistics Bureau, GDP grew by 9.5% during Q1 and Q2 of 2005. The industrial sector, led by manufacturing, made up more than 60% of output. This sector grew by 11.2% during the year. Through August, capital investments were up 27.4% compared to the total attained in the first eight-months of 2004. However, the growth rate slowed by 2.9%. Real estate investment, a key component of total investment, grew by 22.3%, with a 3.3% slowdown. Trade exceeded 891 billion US dollars (USD) through August, growing by more than 23.5% over the same period in the previous year. Trade for all of 2005 is estimated to reach 1.4 trillion USD. Agricultural output promises to be bountiful even with the loss

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of 430,000 tons of rice as a result of bad weather. The overall macroeconomic indicators continue strong. B. Market Reform, Economic Adjustments, and Their Effects on Consumption Changes to the economy will affect income, income distribution, and with it, consumption. For instance, various fiscal and monetary policies have been implemented that are changing economic structure and performance. Of interest here is financial system reform, which has entered its early stages. In late July 2005, China announced that its currency, the yuan, would move off of a strictly pegged exchange rate based on the USD and on to a managed float.1 However, its value would fluctuate by only ±2% vis-à-vis its position against the US dollar. Because of this constraint, the impact of the change remains limited to trade; domestic markets remain largely unaffected, at least in the near-term. However, exchange rate reform will help prices of traded goods reflect global market conditions, while limiting the variance in the yuan’s value will blunt the effects of exogenous volatility. Chinese establishments and consumers will enjoy a more stable and predictable situation because of this. Changes in the exchange rate will produce some adjustments in the financial industry. However, a broader package of reforms in the industry will bring widespread changes to the real estate market. Its booming growth has papered over various inefficiencies and weaknesses that these reforms address head-on. Pricing remains a deeply problematic point. Not all individuals have true access to the bidding process since land availability is often unannounced, allowing transfers to take place through insider connections. Speculation has run up prices in particular localities. Oversight of improvements of properties and construction standards remain shaky and poorly enforced. The industry is rife with corruption. To combat these and related problems, central authorities have introduced and implemented regulatory measures aimed at better managing real estate financing and investment. Early evidence provides some indication that the growth rate of real estate investments has cooled somewhat and along with price increases.

1 This policy change and its implications are examined in chapters throughout this volume.

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C. Market Reforms Regarding Quality Control and Consumer Protection As the market system continues to evolve in China, it is crucial that new institutions, legal and regulatory frameworks, and social norms take root that support efficient and robust economic and social development. Various events that occurred in 2005 underscore the need to do more in this regard: • Carcinogenic compounds were found in food supplies soon after the 2005 Spring Festival;2 • Garlic containing poisons appeared in Hebei Province in May 2005; • Iodine had been found in Nestle brand milk powder in June 2006. These lapses in food safety raise broader concerns. Obviously, they demonstrate that the food safety has clear deficiencies. They raise questions regarding ethical conduct. They also raise questions about quality control in food and non-food production in China. These problems must be addressed on multiple fronts. First, a “people first” policy must become the foundation and cornerstone of quality control systems for all manner of production and distribution systems. Once this value is moved to the central role in decision making, other changes, like developing logistical processes and legal and regulatory systems that improve product quality, will fall into place. These changes will affect everything from licensing manufacturers and distributors, to testing goods headed to market, as well as addressing the way regulators and producers respond to crises and quality control system failures. Once all consumers have basic assurances regarding product safety, production and distribution of products in the market system can be refined further. D. Market Adjustments: Inflation Large harvests have reversed increases in the consumer price index (CPI) that shot up between January and March on the back of agricultural price increases. Still food prices rose by 3.7% in August, vastly outpacing 2 The “Spring Festival” is typically called “Chinese (or Lunar) New Year” in the West.

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overall inflation for the month which equaled 2.1%. Other industries saw steep price hikes as well. Housing prices rose 5.7%. Reform to the medical and educational industries produced price hikes in these markets. These industry-specific inflationary pressures exerted distinct effects on various segments and individuals, but the effects were broad enough to unsettle consumer confidence. II. Consumer Behavior: Personal Income and Income Distribution The National Statistics Bureau’s Group for Urban and Rural Surveys’ data on personal income and income distribution help to distill these broad economic conditions down to a human scale. Median income averaged just over 878 yuan per month over the first eight months of the year for urbanites. Rural residents’ income averaged 264 yuan per month, or about 30% of that enjoyed by urban dwellers. Based on this and other data, the China’s Gini coefficient3 equals 44%. While this indicates that income inequality is greater than in the most egalitarian societies, China comes in well ahead of those countries that have dangerously unequal income distributions.4 However, poverty reduction efforts have declined in recent years and new pockets of poverty have grown in some urban areas. Migrant workers have been especially hard hit as the job market has tightened. Statistics can help to illuminate the size of different market niches as well as their distinctions. Currently, just under 12% of China’s urban population can be described as upwardly mobile or nouveau riche. Even though they make up only 1/8 of the population, they control a disproportionate share of income and influence in the market. Increasingly firms and retailers see them as trendsetters in fashion and taste-making. Not only do they exert this influence as individuals but also as family members and workers, transmitting their beliefs and influencing others through their actions. Lower income consumers who have little contact with them often follow their lead.

3 The Gini coefficient measures income inequality in an economy. The statistic ranges from zero to one, where zero indicates perfect income equality and one indicates perfect inequality. Actual values range from 24.7 (Denmark) to 74.3 (Namibia). 4 Other countries with Gini coefficients in the 40% range include less developed countries like Cameroon and Cambodia, developing states like Costa Rica and Malaysia, and developed economies like Hong Kong and the United States.

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These low income consumers make up about 30% of the population. Their limited disposable income makes their purchasing patterns highly sensitive to price and income changes. By many reports, though, there is considerable pent-up demand in this market segment. Serving it effectively could be very lucrative. At the top of the income pyramid are the truly well-to-do, accounting for about 10% of the population. These persons and families go beyond having things; they want the best things. Comfort has given way to luxury, acquisition to refinement, income to wealth accumulation. Because of their small numbers, they cannot impose their will through political means; therefore, they express themselves through conspicuous consumption; that is, purchasing specialized goods and services that underscore their exclusive social positions. This manner of high powered spending has put China on track to be the world’s number three market for luxury goods within ten years. Income distribution trends strongly suggest what products will enjoy higher demand in coming years. These include rental housing, automobiles, and electronic products, among others. All of these products depend on growth in disposable income, and with China having surpassed the 1000 USD per capita GDP threshold in 2000, more Chinese have this kind of buying power. Even as consumer confidence wobbled, consumer spending forged ahead. Retail sales fell just shy of four trillion yuan for the first eight months of 2005, up 13% over 2004’s eight-month tally. Sales in urban areas amounted to 2.66 trillion yuan, a 14.0% hike, while sales in counties and rural areas equaled 1.30 trillion yuan, up 10.6% from 2004’s January through August total. Overall consumer spending is well up in China, but urbanites have been the engine pulling the train. Rural incomes lag far behind, and therefore, consumer spending is only a fraction of the national average and continues to fall behind national figures since urban development vastly outpaces rural development. In short, much remains to be done regarding rural development. III. The Evolving Consumer Market A. The Leading Edge of Consumer Spending Growth in the Chinese economy and consumer spending depends on the further development of the real estate, automobile, and consumer

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electronics industries, as well as a constellation of industries serving the luxury market. These have shown the most robust growth, while affecting the most widespread changes on general living standards. Real estate prices have shot up in recent years. More land is being converted to higher value uses in the commercial sector, while the influx of persons moving into cities has generated a boom in housing demand. Even though much of this activity takes place in cities, real estate spills over into land development policies and the construction and finance industries. Through these connections changes in the real estate industry impacts almost every part of the economy.5 Automobile manufacturing and consumption has also become a key driver of China’s economy. Demand for passenger cars in China will grow by at least 20% in the coming years. Individual demand for cars will grow even faster, approaching 33%. Income and savings data suggest that 42 million households have the means to buy a car. One in eight, about five million persons, actually makes the purchase. Still, this makes China the world’s third largest automobile market. Unfortunately, growth in the automotive market faces a major bottleneck: oil supplies. Soaring global oil prices in 2005 put the brakes on current auto sales and make future expectations more questionable. To offset some of this impact, the state will provide incentives for microautos6 by eliminating sales taxes on their purchase. At the same time, sales taxes will increase to about 27% on cars with engines larger than 2.2 liters. These taxes will weigh hardest on governments and stateowned enterprises, which has shown a strong propensity to purchase larger cars with greater fuel demands. So even though China has a much smaller total fleet of cars, its average annual consumption is much higher than rates in more industrialized countries: the Chinese average is 2.3 tons, compared to the US average of 1.8 tons, the European average of 1.5 tons, and 1.1 tons in Japan.7

5 Several chapters in this volume detail the scale, scope, and impact of changes in real estate markets. 6 Micro-autos have engine displacement of less than 1.6 liters (L). See the chapter on the automotive industry in this volume for details. 7 Since a ton of oil equals almost eight barrels, and since a barrel equals 42 US gallons or 159 liters, these annual consumption figures can be converted as 773 (PRC), 605 (US), 505 (EU), and 370 ( Japan) in US gallons; and 2926 (PRC), 2290 (US), 1908 (EU), 1399 ( Japan) in liters.

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Electronic products, including household computers, digital products, and telecommunications devices, have recently emerged as a growth segment in consumer spending. For instance, as of July 2004 there are 87 million internet users and 20 million broadband users in China. Note that this means millions of units in computers, peripherals, modems, and more. According to the Ministry of Information Technology, as of April 1, 2005, China had 674 million telephone users, including 349 million mobile phone subscribers and 325 million landline subscribers. Specialized services, like Short Message Services (SMS or text messaging) and custom ringtones have shown staggering growth. Youthful consumers have seized on these services and propelled them through many consecutive months of growth. At least two forces drive this process: the desire for novelty, which produces rapid replacement of tones or ongoing use of text messaging, and the high entertainment value inherent in these services. Items heretofore unknown in China until a few years ago, have become more common. The business for high-end and rare collectibles, jewelry, limousines and other luxury vehicles, fine accessories, and mansions has boomed. For instance, in 1990 Chinese consumers spent 250 million USD on diamonds; in 2003 the figure had ballooned to 1.24 billion USD. Diamond purchases make up the fifth largest single consumer spending category in China, and with a growth rate of 13.2%, it may move up the rankings in the future. This massive shift in the volume of jewels moving into and through China has changed global markets. By 2010, Shanghai will emerge as one of the leading trading and processing centers for diamonds. This exchange will handle between three and five billion USD in diamonds and other fine jewels, and employ over 100,000 people. B. Consumer Spending in Rural China Much of the growth and evolution in consumer markets has taken place in and around urban centers. This has left rural residents in the dust, as it were. Given current conditions and trends, this situation will persist into the foreseeable future. (See Figures 17.1, 17.2 and 17.3.) Policymakers remain concerned about how to serve the lower income market segment. Along with industrial decision makers they must expand the offerings of products that better serve rural customers and

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households. In doing so, they must consider a variety of variables that distinguish rural dwellers from urban consumers: income, culture and customs, age cohorts, and increasingly diverse tastes.

Sub-county level 22%

Cities 67%

County level 11%

Figure 17.1: Percentages of retail sales: urban, suburban/exurban, and rural, January to August 2005

(%) 16.00 Growth of total retail volume in urban areas 14.00

Growth of total retail volume in rural areas

12.00 10.00 8.00 6.00 4.00 2.00 0.00

1998

1999

2000

2001

2002

2003

Figure 17.2: Comparing urban and rural retail sales

2004 (Year)

consumption in china in 2005 and 2006 (RMB) 7000.00 6000.00 5000.00

225

Consumption expenditures of urban residents Consumption expenditures of rural residents Consumption expenditures of rural residents in Western regions

4000.00 3000.00 2000.00 1000.00 0.00 2000

2002

2003 (Year)

Figure 17.3: Comparing household spending in urban and rural areas

IV. Consumption Forecasts China’s economy will continue its strong growth in Q4 despite high global oil prices and trade frictions. Growth continues to buoy consumer confidence; the consumer confidence index for September, the last month for which data are available, remains high. Spending typically surges during Golden Week. This momentum will carry through to the year’s end, making 2005 a record-breaking year in total spending. Note that the rate of increase in spending growth will decline, but this is to be expected since the baseline starting point has become so large. The Q4 spending spree will especially benefit electronics sales. Many audiovisual products will be replaced this year, and falling prices and higher quality offerings will spur sales. Sales of flat screen televisions and computer monitors will climb for these reasons. Total Q4 retail sales estimates equal 1.67 trillion yuan, with 8.7% year-on-year growth. As expected, the lion’s share of the spending will take place in urban areas: about 1.10 trillion yuan. However, growth in spending among urbanites is almost flat, moving only 0.07%. Rural consumers will spend 591 billion yuan, but with much stronger growth of 8.09%.

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GDP growth for 2005: 9.0% to 9.3%. CPI for 2005 is estimated at 2.0%. Income figures suggest that 2006 may well bring renewed growth in urban spending. Disposable income of urban residents is 10,600 yuan per year, a 12.5% year-on-year improvement. Rural residents will bring in 3,150 yuan, with a very respectable 7.29% growth rate. V. Factors Affecting Consumption in 2006 A. Income and Manufacturing Various exogenous and endogenous factors described above will continue to affect consumption in 2006. These factors introduce uncertainty into economic performance, including consumption. Although the manufacturing side of the economy straddles the consumption, investment, and trade components of GDP, we begin by examining conditions facing manufacturers because this is where the income needed to fuel consumption originates. Oil prices will continue to be the primary exogenous factor affecting the Chinese economy, including consumption. Because of China’s huge and growing energy demands, oil price increases and fluctuations place an especially acute stress on economic performance. Domestic establishments experience disproportionately high increases in costs, while at the same time feeling more pinched on the output side of the process since final prices do not fully reflect the increase in costs. Aggravating this problem is China’s relatively energy inefficient production systems and its intensive focus on basic manufacturing with high energy demands. Domestic coal meets much of these energy needs, which helps to buffer many firms from global oil price fluctuations, but those moving into cleaner production systems will find that transition more difficult and costly given oil supply shortages. Because China depends so heavily on exporting goods, often to distant markets like the United States and the EU, fuel price increases raise shipping costs, and final product price, which cuts into the quantity demanded for Chinese-made goods. This slices deeper into margins for Chinese firms and the distributors they supply. Chinese manufactures also face a variety of homegrown challenges. China’s booming investment activity has produced a vast expansion

consumption in china in 2005 and 2006

227

in productive capacity. This has generated surpluses of many goods, which in turn has caused prices to fall for these goods. Taken together, these forces have reduced margins to razor-thin levels for many operators. Some economists and policymakers fear a deflationary spiral could take hold, such as the one that gripped Japan’s economy through the 1990s, since some aspects of the current Chinese economy mirror conditions in place in Japan 20 years ago. However, given continued strong growth projections with inflation creeping along at only 3%, this outcome seems unlikely. Firms will also need to adjust to changing investment regulations and conditions. However, investment activity promises to be strong well into the future and certainly through 2006. Much of this investment will go into the real estate and automotive industries, which continue to grow in prestige and importance in China. Real estate will enjoy the additional benefit of slowing price increases. However, global oil supply shortages will likely dampen automobile demand; even so, estimates place growth in the sales of Chinese-built autos as high as 15% in the coming year. Trade tensions, brought about by China’s near-universal trade surpluses vis-à-vis developed economies, have raised worries of increasing trade restrictions coming into existence. Because the Chinese economy depends so heavily on trade, these rumblings merit serious attention. Not only must China work for open trade, it must do more to develop its domestic market to blunt the effects of restrictions on Chinese exports. Simply put, the domestic market can be managed and controlled more successfully and broadly than individual foreign markets and the global trading system. B. Income and Economic Reform On the home front, China has instituted a wide range of policy and regulatory changes that will affect economic performance in general, and consumer spending and behavior in particular. This continues the government’s recent moves to fine-tune economic performance, with the aim of maintaining high growth while addressing various troublesome tendencies like increasing input prices. These policies build on the broader framework of the Eleventh Five-Year Plan, which is the fundamental guide for economic and social development in coming years. The Plan structures the way sustained and rapid growth will be realized given resource constraints. The document pays especially close

228

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attention to spelling out the ways in which energy needs can be better regulated and environmental damage eased and eventually reversed. The Five-Year Plan touches on a variety of subsidiary concerns as well. Given recent attention-grabbing scandals involving food safety enumerated above, guidelines regarding inspections, distribution controls, and sanctions for violations are discussed. This is the first step on a longer road toward improvement of consumer protection and quality control measures. On a related note, various measures regarding public health are also addressed in the Plan. Finally, the Plan makes adjustments in sales taxes. All of these points affect worker productivity, earnings, and disposable income, which form the building blocks of consumer spending, and therefore, the consumption component of GDP. The Plan also addresses issues of income distribution. First, it raises the minimum income level for individuals to begin paying income taxes. This allows those persons at the bottom of the income distribution ladder to hold onto their money. Second, the Plan includes various provisions for agricultural investment and development, which should help to raise incomes in rural areas, especially in the West’s least developed areas. At the same time, employment in the public sector will increase, which should raise incomes in outlying areas, and make the skills-base more diverse. All of these moves should help to close the widening income gap, or at least, to offset its acceleration. Taken together, these moves help make the economy, and consumer spending in particular, more robust and diversified. Various changes in the social service system will bolster these efforts. Social security protections are strengthened in the 11th Five-Year Plan. Education receives greater support, which should help to close income gaps over time. Various problems continue to exist in the provision of medical care, and this produces at least two kinds of difficulties: those with the least income have the hardest time paying for services and spend a higher percentages of their incomes on medical services; and two, poorer individuals forestall seeking medical treatment, which means that when they do go for help they are sicker, paying even more for care, and missing more work, all of which further carves into their already meager incomes.

consumption in china in 2005 and 2006

229

C. The Consumer Market in 2006 Consumer spending will likely settle into a steady growth pattern through 2006, based on current conditions and trends. Urbanites will spend more on housing, telecommunications devices and services, education, medical care, entertainment, cultural goods and services, leisure activities, and tourism. They will become more quality sensitive. Services regarding repairs and so forth will become more central in deciding how to spend money. The range of goods and services targeting this part of the market will grow increasingly diverse. According to forecasts, GDP will grow by 8.5% to 9.0% in 2006, with the CPI growing by 2%. Per capita disposable income for urban residents will amount to 11,713 yuan in 2006, with growth of 10.5%. Rural residents’ disposable income will equal 3,401 yuan, with growth of 8.0%. Retail sales will equal 6.82 trillion yuan, with 10.36% growth. Retails sales in urban areas will equal 4.61 trillion yuan, with 11.98% growth, and rural retail activity will total 2.21 trillion yuan, with 7.12% growth. VI. Policy Suggestions Points covered in the 11th Five-Year Plan go a long way toward spelling out policy prescriptions to improve economic performance, equity, and development. First and foremost, issues facing rural areas should be addressed. Developing and stabilizing agricultural production and prices should take precedence in this process. Secondarily, upgrading environmental and food safety conditions will dramatically improve the lot of farmers and other persons and firms working in rural areas. Problems affecting demand for farm goods typically start in rural areas, and taking preemptive measures against these potential problems can help to stabilize demand by improving consumer confidence in farm goods. Cumulatively, these moves should improve incomes in rural areas, while reducing income volatility and cyclical fluctuations. Second, measures should be taken to narrow the gap between the rich and the poor in order to make for a more equitable, balanced, and harmonious mode of economic and social development. Measures targeting rural conditions will contribute to this outcome.

230

guo shouzhong

Third, sales tax reform should be implemented to allow more consumers to enjoy the growing bounty of Chinese production, and to reduce the adverse impact sales taxes can have on Chinese producers. Fourth and finally: emphasis needs to be placed on developing the domestic market, particularly consumer spending. This will reduce China’s dependence on foreign trade and exposure to global economic conditions. Furthermore, by developing a more robust, balanced, and diverse domestic market, various problems confronting the market now, such as energy consumption, pollution, and resource depletion, can be more successfully managed.

GROWTH TRENDS IN CHINA’S THREE MAJOR ECONOMIC CENTERS Deng Lishu and Wei Shuhua Through 2005 China’s most dynamic economic regions—the Yangtze River1 Delta, the Pearl River Delta, and the Beijing, Tianjin, Hebei region2—continued to show strong growth. As of 2004, these three regions cumulatively accounted for just over 10% of the national population, but generated 41% of GDP. In short, these three areas together have emerged as mainstays of the economy and its continuing growth. All three continue to change, and these changes deserve close attention. Understanding the roots of these changes can provide insight into the future prospects of these three areas. I. Strategic Adjustments and Economic Growth A. Growth3 Growth in the three centers of economic activity builds on prevailing trends. One new wrinkle is that the capital region has eclipsed output of the Pearl River Delta region. All three centers continue to grow rapidly and add increasing shares to GDP, even though the country as a whole continues its prodigious economic growth.4

The Yangtze River is often written in Chinese pinyin Romanization as Yangtze River. 2 This region is sometimes abbreviated as “Jing-Jin-Ji.” 3 Throughout the paper we use 2004 as the focal point of our analysis. This is the most recent year for which complete data exist. In general, we have avoided the use of estimates and piecemeal recalculations of economic data. 4 Our definition of an economic region, or sphere is based on the definitions used by the National Development and Reform Commission (NDRC). This definition alters the list of key cities in Hebei province by adding Shijiazhuang to the usual list of seven cities. The full list of eight cities for the entire economic sphere includes: Beijing, Tianjin, Shijiazhuang, Langfang, Baoding, Tangshan, Qinhuangdao, Zhangjiakou, Chengde, Cangzhou. 1

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deng lishu and wei shuhua

1. Gross Product The Yangtze River Delta has emerged as the leading region of economic growth in China. Its output is 2,877.542 billion yuan, which exceeds the sum of the Beijing-Tianjin-Hebei (1,411.851 billion yuan) and the Pearl River regions (1,357.224 billion yuan). The focal point of the Yangtze River Delta is Shanghai, which generates total output of 745.027 billion yuan. This is the largest single urban economy in the country, and its dynamism, infrastructure, and other advantages will probably allow it to hold this lead for some time to come. Other cities in the area have vital and substantial economies as well: Suzhou generates 345 billion yuan; the economies of Hangzhou, Wuxi, and Ningbo all exceed 200 billion yuan, with Nanjing just under this threshold; and Changzhou, Nantong, Jiaxing, Shaoxing, and Taizhou have surpassed 100 billion yuan mark. Two of the major cities in the Pearl River Delta, Guangzhou and Shenzhen, take in over 400 and 300 billion yuan, respectively. Foshan and Dongguan have passed the 100 billion yuan mark and a clutch of other cities have economies larger than 50 billion yuan. The Beijing-Tianjin-Hebei, or “Jing-Jin-Ji,” economic sphere is centered on the capital, which generates a gross product of more than 400 billion yuan. The second-municipality in the cluster is Tianjin,5 which produces almost 300 billion yuan in economic activity. The most advanced cities in the province of Hebei—Shijiazhuang, Baoding, and Tangshan—each makes 100 billion yuan in gross product. Second-tier cities like Qinhuangdao, Zhangjiakou, and Chengde bring in less than 50 billion yuan each. In short, there is a considerable disparity between the leading cities in this economic sphere. This stands in contrast to the development of the Pearl River Delta, which is relatively balanced across its largest cities. (See Tables 18.1–18.4.) 2. Three Economic Sectors: Agriculture, Industry, and Services6 The three regions we examine here mainly rely on the industrial and service sectors for the bulk of their gross output. These two economic sectors produce higher value-added compared to agriculture. Each sector contributes about the same percentage to output in all three regions, although the

5 Tianjin is one of four “municipalities” in the People’s Republic of China (PRC). Even though it is an urbanized region, it has provincial status in governmental matters. Essentially, it is a hybrid of a city and a state. 6 Where other economic analyses may include the government sector, we omit that sector from our analysis.

growth trends in china’s three major economic centers 233 contribution from services is slightly higher in Jing-Jin-Ji area. The industrial sector plays a relatively more significant role in the Yangtze River Delta; the Pearl River Delta leans more heavily on industry than the Jing-Jin-Ji region. In essence, the strength of the industrial sector is inversely related to the strength of the service sector. But the share of the third industry is just the contrary, from high to low are Jing-Jin-Ji, Pearl River Delta, and Yangtze River Delta respectively. The relative contribution for each sector in the Yangtze River Delta is 4.6%, 55.9%, and 39.5%. Each of the 16 cities in the region relies upon industry as its largest contributor to output, with the service and agricultural sectors following behind. While agriculture typically dwindles in its contributions to gross output with economic development, the slow pace of development in the service sector is cause for some concern. Even with sustained high-rate economic growth, the service sector in major cities like Shanghai, Nanjing, Suzhou, and Hangzhou have yet to catch fire. The basic structure in the Pearl River Delta economic sphere is similar: 4.4%, 53.3%, and 42.3%. However, some cities in the region, such as Guangzhou and Zhaoqing, have services making the largest contribution to gross product. In the Jing-Jin-Ji region, industry plays a less dominant role, as seen by the percentage contributions to output: 8.5%, 47.3%, and 44.2%. Beijing and Qinhuangdao rely on services to make the largest contribution to output. (See Tables 18.1–18.4.) 3. Three Major Demands A key major economic indicator—capital investment—shows that the Yangtze River Delta has solid economic prospects in the near future. The total in the region comes to 1,363.793 billion yuan, which exceeds the sum of the other two key economic regions. The Jing-Jin-Ji region boasts higher investment than the Pearl River Delta. The largest cities in the three regions contribute a substantial sum to total fixed capital investments: Shanghai enjoys a total of 308.466 billion yuan and Beijing 252.83 billion yuan. Together these two cities generate more capital investment activity than every region in China except for the described in this paper. The primary indicator of consumer spending—gross retail purchases—places the Yangtze River Delta at the head of the pack, with Jing-Jin-Ji, and the Pearl River Delta regions following behind. This is no surprise since these gross figures tend to mirror gross product. And as with investment, the key cities in each of the three regions—Shanghai,

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Beijing, and Guangzhou—all serve as the economic engines that pull each region forward. Trade also contributes to overall economic health and development. On the export side, the economic region centered on Beijing drops into third place, with the Yangtze River Delta and Pearl River Delta far out in front. The Shanghai-centered region brings in 208.306 billion US dollars (USD) on exports and the Guangzhou-centered Pearl River Delta region sells 182.429 billion USD of exports. The Beijing region brings in the relatively modest sum of 48.792 billion USD; 85% of these products come out of Beijing and Tianjin. Clearly the capital region is not as focused on the trade sector as the two delta regions, which have long been the center of trade in China. Even so, Jing-Jin-Ji has enjoyed the greatest increase in the rate of FDI and this bodes well for the future of trade activity in the region. (See Tables 18.1–18.4.) 4. A Comparison of Leading Cities Shanghai, the leading city in the Yangtze River Delta, is the nation’s most developed city. It leads the region and the nation in numerous economic categories: gross output, total industrial output, total services output, total capital investment, aggregate retail purchases, total trade activity, and FDI. In order to stay in front and to show the way forward in the region regarding development, Shanghai needs to better develop its service sector. The city’s industrial structure needs to evolve as well, which is interrelated with the development of the service economy. Guangzhou, the Pearl River Delta’s major city, enjoys the highest gross product per capita in the country. Moreover, it has a robust and forward-looking industrial structure, with the service sector leading the way. Its income on exports leads all cities except for Shanghai. All of these factors and the total size of the local economy indicate the city’s strong competitive position. Jing-Jin-Ji’s major city, Beijing, occupies the number two position in many categories: regional gross product, total capital investments, aggregate retail purchases, and foreign direct investment. Its per capita gross product is number three in the country, behind Shanghai and Guangzhou. However, its service sector is much more developed than other cities in China. Jing-Jin-Ji’s second city, Tianjin, runs neck-andneck with Guangzhou in such performance measures as fixed capital investment, aggregate retail purchases, and FDI. However, its gross output and per capital output lag other major cities. (See Table 18.5.)

growth trends in china’s three major economic centers 235 5. The Special Status of the Three Largest Regional Economies The three major economic spheres play a very important role in China’s economy. The sum of their gross products accounted for 41% of GDP in 2004. The value-added in these three regions accounted for 41% of the nation’s value added in the industrial sector and 54% of the nation’s service sector value-added. Per capita output is 2.9 times the national average. Taken together these three cities account for one-third of the nation’s total fixed capital investments as well as the aggregate retail sales. The three regions dominate other categories: 75% of the nation’s trade moves through these regions and 80% of the FDI flows into these regional economies. Between 2003 and 2004, these three regions actually outperformed the national economy, which means they increased their show of national output and many other key economic categories. (See Table 18.6) B. Economic Development and Long-term Prospects of the Three Major Economic Regions 1. The Yangtze River Delta Almost all major economic indicators—such as regional gross product—increased in 2004 over 2003. However, some signs of slowing have appeared: fixed capital investment, total trade volume, export growth, and the growth rate of FDI all declined more than 10%. (See Table 18.7.) Data from the first half of 2005 reveal other contractions. Thirteen of the sixteen cities in the Yangtze River Delta registered a decline in the growth of gross product. Eleven experienced declines in industrial output and fixed capital investment, and nine showed slowing in the growth of retail spending. Shanghai showed signs of a general slowing in growth: gross product, industrial value-added, capital investment, retail sales, and exports all declined. While Shanghai dominates the regional economy, these indications of a slowdown could be seen elsewhere in the region. The seven cities in Zhejiang showed similar signs; fixed capital investments slowed especially quickly. (See Table 18.8.) 2. The Pearl River Delta Between 2003 and 2004 gross economic indicators—with the exception of FDI—for the Pearl River Delta all registered increases. However, growth rates for fixed capital investment, retail sales, trade volume, and exports have slowed slightly. (See Table 18.9.)

7450.27 (13.6%) 1910 (17.3%) 781.16 (14.7%) 2350 (17.4%) 1100.61 (15.5%) 3450 (17.6%) 1226.06 (15.6%) 788.13 (14.7%) 705.20 (14.7%) 2515 (15%)

Shanghai

Hangzhou

Taizhou

Yangzhou

Nantong

Suzhou

Changzhou

Wuxi

Zhenjiang

Nanjing

Output

City

96.71 (–5%) 70 (5.2%) 34.11 (6.6%) 51.80 (2.1%) 51.24 (2.7%) 77 (–0.5%) 148.89 (5.3%) 79.79 (6%) 82.70 (4.5%) 139.1 (5.1%)

1st7

3788.22 (14.9%) 1005 (20.7%) 460.56 (15.7%) 1353.50 (19.4%) 647.7 (17.6%) 2268 (20.4%) 664.16 (19.5%) 419.87 (17.3%) 380.50 (18.7%) 1332.9 (16.7%)

2nd

Value-added

3565.34 1.3 (12.9%) 835 3.7 (14.9%) 286.49 4.4 (14.2%) 944.70 2.2 (15.5%) 401.67 4.7 (14.1%) 1105 2.2 (14.5%) 413.01 12.1 (14.1%) 288.47 10.1 (13.5%) 242.00 11.7 (12.5%) 1043 5.5 (14.3%)

3rd

53

54.0

53.3

54.2

65.7

58.8

57.6

59.0

52.6

50.8

41.5

34.3

36.6

33.7

32.1

36.5

40.2

36.7

43.7

47.9

31665 (21.1%) 57992 (16.1%) 15806 (16.1%) 17359 (14.5%) 14014 (14.8%) 38858 (13.7%)

33050 (15%) 29235 (14.7%) 52825

55090

3084.66 (25.8%) 1201.88 (26%) 320.5 (35.1%) 1114.13 (24.7%) 588.6 (31.8%) 1554.80 (10.3%) 605.17 (35.0%) 330.05 (33.6%) 306.24 (32.8%) 1205.18 (19.7%)

Output by sector (%) Output Fixed per capita capital 1st 2nd 3rd (RMB) investment 2454.61 (10.5%) 711.44 (18.5%) 192.05 (14.2%) 579.21 (18.9%) 324.05 (15.5%) 625.10 (18.8%) 384.25 (16%) 228.01 (15.2%) 200.69 (15.5%) 704.34 (15.2%)

Retail sales

218.46 (51.9%) 69.05 (31.5%) 1032.01 (57.2%) 67.93 (31.5%) 24.18 (19.5%) 12.56 (42.6%) 244.96 (34.4%)

1600.26 (42.4%) 206.39 (40.3%) 34.79

Trade Volume

12.2 (50.8%) 19.48

65.41 (11.8%) 15.12

FDI

110.22 (50.5%) 47.16 5.36 (33.6%) 507.74 95 (55.6%) (39.6%) 43.49 11.04 (32.4%) 13.51 7.52 (25.4%) 9.54 4.17 (50.4%) (133.8%) 151.75 14.1 (38.6%) (39.8%)

735.2 (51.6%) 104.6 (36.5%) 15.19

Exports

Table 18.1: Key economic indicators, Yangtze River Delta, 2004 (100 million RMB; last three categories—100 million USD)

236 deng lishu and wei shuhua

123.50 (5%) 77.88 (5.4%) 64.81 (8.2%) 92.22 (3.5%) 38.21 (10.2%) 96.70 (0.1%)

1230.21 (16.6%) 635.05 (18.3%) 323.69 (18.5%) 786.73 (17.1%) 91.30 (21.9%) 686 (14.2%)

804.33 (15.8%) 337.63 (16.2%) 202.19 (12.9%) 434.91 (14.7%) 82.53 (15.5%) 391.09 (16.4%)

28775.42 1324.66 16073.39 11377.36

2158.04 (15.5%) 1050.56 (16.5%) 590.69 (15.4%) 1313.87 (15.3%) 212.04 (17.0%) 1173.79 (13.6%) 4.6

8.2

18

7

11

7.4

5.7

55.9

58.5

43.1

59.9

54.8

60.5

57.0

39.5

33.3

38.9

33.1

34.2

32.1

37.3

35040

21855 (17.5%) 21177 (13.0%)

30254

31506 (16.2%) 22966

39045

4012.56 2083.06

595.63 261.13 166.90 (14.2%) (38.8%) (38.2%) 325.34 79.25 51.06 (14.7%) (38.8%) (41.2%) 208.34 16.97 14.48 (14.3%) (39.4%) (43.2%) 335.43 86.62 66.09 (14.9%) (945.3%) (45.8%) 87.52 10.11 8.14 (16.5%) (62.9%) (50.8%) 302.92 47.89 37.99 (15.5%) (45.6%) (43.3%)

13637.93 8258.93

1095.7 (31.1%) 633.7 (20.6%) 365.47 (36.4%) 624.95 (16.8%) 127.87 (30.5%) 479.03 (24.1%) 298.245

21.03 (21.8%) 10.22 (28%) 6.11 (13.7%) 8.23 (10.9%) 0.225 (32.1%) 3.03 (40.3%)

7 In China, agriculture is called the first sector, industry the second sector, and services the third sector. These sectors will be referred to as 1st, 2nd, and 3rd respectively throughout this chapter.

Note: Data for Nanjing, Wuxi, Changzhou, and Yangzhou are the amounts of FDI, while the figures in the brackets indicate annual rates of increase; this format applies to tables below as well.

Data source: The Statistical Report on the 2004 National Economy and Social Development for each city (hereinafter referred to as Statistical Report).

Total

Taizhou

Zhoushan

Shaoxing

Huzhou

Jiaxing

Ningbo

growth trends in china’s three major economic centers 237

3rd

1st

4.4

3rd

37

30.0 39.6 38.0

65.0 57.0 61.6 42.3

41.6

49.5

53.3

30.8

57.1

55.45 42.15

44.16 53.03

58

35.64 36.82

2nd

42499

59271 (7.8%)

44005 (17.3%) 41800

23642 (13.1%) 21000

47500 (14.5%) 56300 (13.7%) 71328

13920

4522.48 (20.6%)

144.71 (26.1%) 565.40 (33.4%) 1321.96 (12.5%) 433.89 (35.9%) 297.61 (30.3%) 197.88 (22.82%) 291.29 (11.2%) 179.6 (27.3%) 1090.14 (14.9%)

Output Fixed per capita capital (RMB) investment

Data source: The Statistical Report on the 2004 National Economy and Social Development for each city.

13572.24 596.84

7233.15 5742.25

2nd

Output by sector (%)

Total

1st

Value-added

195.51 201.96 27.54 (18.6%) (13.7%) 959.15 612.24 5 (20.9%) (11.9%) 1817.71 2182.60 2.81 (17.2%) (13.8%) 640.60 487.00 2.40 (24.5%) (14.8%) 390.96 211.19 12.1 (14.2%) (21.7%) 413.15 347.44 8.9 (14.6%) (11.2%) 396.49 183.14 5.0 (22.5%) (13.8%) 311.44 216.20 3.4 (15.1%) (12.7%) 2108.14 1300.48 0.4 (21.3%) (11.3%)

Output

548.51 151.04 (13.2%) (5.7%) Foshan 1653.70 82.31 (16.3%) (3.8%) Guangzhou 4115.81 115.50 (15.0%) (5.4%) Dongguan 1155.30 27.70 (19.6%) (–9.6%) Huizhou 685.14 83.00 (15.1%) (4.5%) Jiangmen 834.56 73.97 (12.2%) (3.5%) Zhongshan 610.14 30.51 (18.7%) (1.8%) Zhuhai 546.28 18.63 (13.8%) (3.6%) Shenzhen 3422.80 14.18 (17.3%) (–19.8%)

Zhaoqing

City 19.03 (21.7%) 216.90 (31.7%) 447.96 (28.2%) 645.18 (24.0%) 166.35 (26.7%) 78.40 (33.5%) 156.21 (19.0%) 218.13 (30.0%) 1472.83 (25.5%)

Trade Volume 12.40 (12.9%) 138.30 (35.3%) 214.73 (27.1%) 351.92 (26.1%) 87.39 (22.3%) 50.74 (38.9%) 99.95 (21.1%) 90.40 (30.8%) 778.46 (23.6%)

Exports

4598.69 3420.99 1824.29 (13.6%) (26.1%) (25.7%)

193.91 (13.3%) 542.19 (14.6%) 1675.05 (9.7%) 389.04 (15.1%) 212.75 (17.1%) 311.57 (12.1%) 178.84 (16.4%) 179.89 (13%) 915.45 (14.2%)

Retail sales

121.92

5.10 (38.8%) 4.70 (23.8%) 23.50 (10.4%)

5.12

17.25 (40.8%) 24.77 (64.8%) 30.34 (18.4%) 6.32

4.82

FDI

Table 18.2: Key economic indicators, Pearl River Delta, 2004 (100 million RMB; last three categories—100 million USD)

238 deng lishu and wei shuhua

Output

1610.4 (16.7%) 1560.16 (19.8%) 4703.4 (14.8%) 794 (17.6%) 325.4 (13.8%) 544.16 (19.8%) 915.02 (18.0%) 187.43 (16.7%) 194.66 (16.6%) 151.8 (16.9%) 388.4 (16.4%)

2nd 2570 (11.6%) 1269.43 (11.7%) 2763.2 (12.5%) 609 (12.3%) 186.7 (12.5%) 388.71 (11.8%) 497.92 (14.0%) 218.58 (11.0%) 147.23 (9.0%) 96.4 (15.5%) 261.9 (13%)

3rd

14118.51 1203.64 6671.43 6245.87

102.9 (1.9%) 102.29 (5.1%) 1370.4 (6.7%) 230 (6.5%) 92.6 (8.5%) 178.01 (4.8%) 213.39 (5.8%) 47.43 (6.4%) 58.22 (13.5%) 55.0 (13%) 123.8 (17%)

1st

Value-added

53.2 48.7 54.4 49 56.7 42.5 48.8 50.6 51.8

15.5 14.1 14.8 16 13.3 8.9 14.3 17.8 14.4 47.3

53.2

3.5

8.5

37.6

2nd

2.4

1st

44.2

33.8

31.6

36.9

48.6

30.0

35

30.8

37.2

31.3

43.3

60

3rd

Output by sector (%)

20263

11395

8890 (13.1%) 8294

22965 (14.3%) 16500

10208

15566

13017 (12.2%) 17798

37058 (11.9%) 31550

6370.18 (23.4%)

2528.3 (17.2%) 1258.98 (20.3%) 3215.3 (28.8%) 716.7 (32.0%) 266.0 (18.3%) 472.1 (37.3%) 461.00 (42.1%) 141.8 (20.9%) 129.0 (33.6%) 151.0 (39.6%) 245.3 (40.5%)

Output Fixed per capita capital (RMB) investment

18.16 (76.2%) 22.05 (30.8%) 3.63 (48.4%) 2.5 (82.0%) 6.78 (58.7%)

946.6 (38.2%) 420.19 (43.2%) 135.3 (50.7%) 36.6 (30.1%) 10.1 (26.5%)

Data source: Statistics reports of 2004 Beijing, Tianjin, and Hebei, together with 2005 Hebei economic annual.

FDI

71.81 (40.6%)

205.7 30.8 (21.8%) (43%) 208.65 24.72 (45.4%) (51.4%) 93.4 19.8 (57.6%) (27.0%) 28.8 3.52 (23.5%) (33.8%) 4.4 2.2 (48.5%) (16.7%) 7.56 2.23 (57.5%) (–16.3%) 8.98 4.13 (100%) (100%) 16.09 2.0 (59.9%) (32.5%) 1.71 0.37 (44.0%) (69.7%) 1.2 1.01 (94.4%) (34.3%) 4.83 0.83 (62.2%)

Trade Exports Volume

5212.38 1502.09 487.92 (11.1%) (40.6%) (26.7%)

2191.8 (14.4%) 1052.70 (14.1%) 2522.9 (15.8%) 533.1 (16.7%) 138.3 (14.6%) 367.9 (16.3%) 359.70 (17.0%) 135.08 (14.7%) 138.69 (11.0%) 102.96 (12.3%) 192.15 (16.2%)

Total retail sales

Note: Because of the limitations of the data source the Aggregate Trade Volume is calculated as the sum of the trade volume of Hebei’s eight cities.

Total

4283.3 (13.2%) Tianjin 2931.88 (15.7%) Hebei 8836.9 (12.9%) Shijiazhuang 1633 (14.1%) Langfang 604.8 (12.5%) Baoding 1110.9 (14.5%) Tangshan 1626.33 (14.9%) Qinghuangdao 453.44 (12.8%) Zhangjiakou 400.16 (13%) Chengde 300.6 (15.8%) Cangzhou 774.1 (15.3%)

Beijing

City

Table 18.3: Key economic indicators, Jing-Jin-Ji, 2004 (100 million RMB; last three categories—100 million USD)

growth trends in china’s three major economic centers 239

56466.17 3125.14 29977.97 23365.48 5.5 136515 20744 72387 43384 15.2 (9.5%) (6.3%) (11.1%) (8.3%)

Total PRC

41.4 31.8

44.2

42.3

39.5

3rd

30732 10502

20263

42499

35040

24530.59 70073 (25.8%)

13637.93 (24.3%) 4522.48 (20.6%) 6370.18 (23.4%)

Output Fixed per capita capital (RMB) investment

18070 53950 (13.3%)

8258.93 (14.9%) 4598.69 (13.6%) 5212.38 (11.1%)

Retail sales

8935.64 11548 (35.7%)

4012.56 (44.9%) 3420.99 (26.1%) 1502.09 (40.6%)

Trade Volume

FDI

4395.27 491.975 5934 606 (35.4%) (13.3%)

2083.06 298.242 (47.4%) (15.6%) 1824.29 121.92 (25.7%) 487.92 71.81 (26.7%) (40.6%)

Exports

Tianjin

Beijing

2931.88 (15.7%)

7450.27 (13.6%) 4115.81 (15.0%) 4283.3 (13.2%)

Shanghai

Guanghzhou

Output

City

102.29 (5.1%)

96.71 (–5%) 115.50 (5.4%) 102.9 (1.9%)

1st

3rd

1st

2nd

3rd

Output by sector (%)

1560.16 1269.43 (19.8%) (11.7%)

3.5

53.2

43.3

3788.22 3565.34 1.3 50.8 47.9 (14.9%) (12.9%) 1817.71 2182.60 2.81 44.16 53.03 (17.2%) (13.8%) 1610.4 2570 2.4 37.6 60 (16.7%) (11.6%)

2nd

Value-added

31550

56300 (13.7%) 37058 (11.9%)

55090

1258.98 (20.3%)

3084.66 (25.8%) 1321.96 (12.5%) 2528.3 (17.2%)

Output Fixed per capita capital (RMB) investment

Trade Exports Volume

FDI

1052.70 (14.1%)

420.19 208.65 24.72 (43.2%) (45.4%) (51.4%)

2454.61 1600.26 735.2 65.41 (10.5%) (42.4%) (51.6%) (11.8%) 1675.05 447.96 214.73 24.77 (9.7%) (28.2%) (27.1%) 2191.8 946.6 205.7 30.8 (14.4%) (38.2%) (21.8%) (43%)

Retail sales

Table 18.5: Key economic indicators of leading cities, 2004 (100 million RMB; last three categories—100 million USD)

53.1 53

47.3

8.5

6245.87

14118.51 1203.64 6671.43

2nd

Jing-Jin-Ji

1st

53.3

3rd

4.4

2nd

Output by sector (%)

55.9

1st

Value-added

4.6

Output

Yangtze 28775.42 1324.66 16073.39 11377.36 River Pearl River 13572.24 596.84 7233.15 5742.25

Region

Table 18.4: Key economic indicators by region, 2004 (100 million RMB; last three categories—100 million USD)

240 deng lishu and wei shuhua

Output

23796.1

28775.42 1324.66

City

2003

2004

50 54

3rd 295 293

34 35

Output per capita Fixed (RMB) capital investment 33 33

Total retail sales 77 77

Trade Volume

3rd 5.1 55.9

54.6 39.5

40.3 35040

29159

10975.18 (38.9%) 13637.93 (24.3%)

Fixed Output by sector (%) Output per capita capital 1st 2nd 3rd (RMB) investment

16073.39 11377.36 4.6

12992.26 9584.39

2nd

Value-added

7186.07 (10.9%) 8258.93 (14.9%)

Retail sales

2769.88 (56.1%) 4012.56 (44.9%)

Trade Volume

Table 18.7: Key economic indicators, Yangtze River Delta, 2003 and 2004 (100 million RMB; last three categories—100 million USD)

37 41

2nd

1413.36 (50%) 2083.06 (47.4%)

Exports

73 74

Exports

257.93 (43.5%) 298.245 (15.6%)

FDI

89 81

FDI

8 In China, agriculture is called the first sector, industry the second sector, and services the third sector. These sectors will be referred to as 1st, 2nd, and 3rd respectively throughout this chapter.

1219.45

1st

14 15

38 41

2003 2004

1st8

Output

Year

Value-added

Table 18.6: Contributions to the national economy from the three key regional economies (%)

growth trends in china’s three major economic centers 241

Exports

Total Retail Sales

Fixed Capital Investment

Value-Added

Output

Growth

Gross

Growth

Gross

Growth

Gross

Growth

Gross

Growth

Gross

2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004

City 3930.64 3417.75 10.3 14.8 1977.94 1654.03 11.7 18.3 1607.59 1396.23 15.1 25.9 1409.3 1215.08 10.9 12.2 426.62 337.39 26.4 54.5

Shanghai 1140 902.81 16 18.2 454.11 395.77 23.0 21.8 618.51 478.92 29.1 23.1 418.64 350.48 19.4 19.2 66.76 44.74 49.2 31

Nanjing 1292.42 1094.92 15.6 17.6 621.28 490.47 23.4 25.1 600.59 479.73 25.2 26.3 335.00 281.59 19.0 20.0 70.47 46.34 52.1 45.4

Wuxi 603.19 507.40 15.3 16.0 289.70 237.87 23.1 23.9 337.72 256.68 31.6 28.2 184.76 158.31 16.7 16.7 27.37 21.17 29.5 35.6

1961.01 1630.36 15.7 18.0 1133.31 861.78 23.5 26.0 952.42 790.58 20.5 20.1 358.16 298.87 19.8 19.6 322.18 218.19 47.7 69.8

711.63 585.61 15.9 16.1 265.95 194.12 28.4 25.5 386.88 294.34 31.4 48.8 216.26 185.13 16.8 17.3 26.45 18.82 40.6 29.7

432.26 365.63 15.2 14.7 189.08 149.95 25.6 23.1 206.98 152.08 35.9 48.3 128.99 111.51 15.7 15.8 9.04 5.42 66.9 11.1

439.96 376.72 15.1 14.2 176.11 140.29 25.5 20.7 203.88 150.59 35.4 27.5 105.57 91.05 16.0 15.0 9.07 6.74 34.7 23.9

387.6 329.89 15.2 14.7 167.79 139.50 25.3 23.2 196.82 151.91 29.6 35 113.17 97.52 16.0 15.5 6.1 4.35 40.0 50.1

Changzhou Suzhou Nantong Yangzhou Zhenjiang Taizhou

Table 18.8: Key economic indicators, Yangtze River Delta, Q1, Q2 2005 and Q1, Q2 2004 (100 million RMB; %)

242 deng lishu and wei shuhua

Growth

Gross

Growth

Gross

Growth

Gross

Growth

Gross

Growth

2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004

1300.46 1142 11.5 16.2 2439.1 1990.95 20.4 33.2 454.81 450.67 0.9 29.5 413 343.72 14 18.3 89.8 64.6 39.1 33.3

Hangzhou

39.3 37.3

1129.2 972.3 12.5 16.1 2136.06 1582.58 25.2 30.3 548.3 469.9 16.7 56.5 327.4 285.9 14.5 14.0 103.1

Ningbo 531.65 452.85 14.2 17.6 938.68 702.33 30.2 34.3 288.94 286.83 0.7 40.3 175.51 155.42 12.9 16.8

Jiaxing 313.35 267.45 14.4 17.2 479.79 352.44 32.5 35.9 194.24 158.38 22.6 50.2 116.58 102.12 14.2 14

Huzhou 670.99 583.09 13.7 15.5 1452.45 1100.4 26.6 33.6 313.73 307.83 1.9 14.5 187.30 165.29 13.2 15.1 32.2

103.81 86.92 15.2 17.7 113.28 81.57 30.4 31 70.95 51.72 37.2 19.6 48.44 43.16 12.2 17.6 4.4 42.2

16.8

600.07 519.77 13 16.3 756.58 568.92 24.1 29.2 194.75 190.01 2.5 28.3 168.47 146.04 15.4 16

Shaoxing Zhoushan Taizhou

Data source: The Statistical Report on the 2004 National Economy and Social Development for each city.

Exports

Total Retail Sales

Fixed Capital Investment

Value-Added

Output

Gross

City

growth trends in china’s three major economic centers 243

11453.10 547.84

13572.24 596.84

2003

2004

1st

Output

City 3rd

7233.15 5742.25

5962.10 4943.16

2nd

Value-added

4.4

4.78

1st

53.3

52.0

2nd

42.3

43.16

3rd

Output by sector (%)

42499

36797

3749.44 (27.3%) 4522.48 (20.6%)

Output Fixed per capita capital (RMB) investment 4048.28 (14.1%) 4598.69 (13.6%)

Retail sales

2713.87 (28.9%) 3420.99 (26.1%)

Trade Volume

Table 18.9: Key economic indicators, Pearl River Delta, 2003 and 2004 (100 million RMB; last three categories—100 million USD)

1451.39 (28.9%) 1824.29 (25.7%)

Imports

169.34 (12.7%) 121.92

FDI

244 deng lishu and wei shuhua

Growth

Gross

Growth

Gross

Growth

Gross

Growth

Gross

Growth

Gross

Growth

2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 118.34 96.22 23.1 29.8

2103.21 1865.54 11.1 16.4 3053.55 2592.14 15.1 22.2 507.89 504.82 0.6 26.1 914.12 800.86 14.0 12.4

1894.76 1525.11 14.0 17.4 1252.9 791.3 17.0 24.5 462.67 447.14 3.5 16.7 515.90 446.97 15.4 15.9 758.25 639.65 18.7 26.8 412.71 324.4 27.6 22.0

Guangzhou Shenzhen 1024.50 741.73 19.5 16.0 568.46 399.34 29.1 20.1 337.85 253.16 33.5 52.1 301.04 259.62 16.0 14.4

Foshan

36.0 30.6 17.5 27.4

356.3 299.1 14.2 13.6 139.2 115.5 16.1 16.5 123.0 105.1 17.0 25.0 119.8 100.8 18.8 16.2

341.30 281.22 15.1 18.8 1031.8 784.25 19.4 30.0 119.4 124.32 –3.96 20.04 105.76 86.42 18.30 15.48 85.53 72.06 18.7 23.7 55.78 45.27 23.3 24.74

327.31 195.63 18.0 17.3 831.51 673.33 21.2 22.3 70.23 55.79 25.9 69.1 106.63 80.99 15.5 14.3 151.22 134.99 11.9 24.1 83.30 70.91 17.3 23.2 14.7

11.9 5.27 4.7 11.6 14.4

41.95

21.3

27.68

11.30

166.94

14.8

95.3

14.9

150.57

11.6

433.01

201.13 236.36 9.4 11.4 31.71 58.00 15.4 17.8 68.16 57.76 18.0 40.0 97.36 87.75 14.6 11.8 7.79

292.35 254.42 12.8 12.0 143.04 119.67 15.3 13.1 98.1 77.4 26.7 3.1 106.23 87.12 16.6 14.8 112.8 97.3 16.0 29.9 46.4 38.4 21.0 34.4

Huizhou Zhongshan Dongguan Zhaoqing Jiangmen Zhuhai

Data source: The Statistical Report on the 2004 National Economy and Social Development for each city.

Exports

Trade Volume

Total Retail Sales

Fixed Capital Investment

Value-Added

Output

Gross

City

Table 18.10: Key economic indicators, Pearl River Delta, Q1, Q2 2005 and Q1, Q2 2004 (100 million RMB; %)

growth trends in china’s three major economic centers 245

246

deng lishu and wei shuhua

Year-on-year growth slowed for a variety of indicators in cities throughout the Pearl River Delta between 2004 and 2005. In general, output in the various cities in the region slowed, as well as industrial production, exports, and most of all, fixed capital investment. The biggest cities, Guangzhou and Shenzhen—because of their greater starting values and more mature economic conditions—showed the largest declines in growth rates. (See Table 18.10.) 3. Jing-Jin-Ji As with the two coastal economic hubs, Jing-Jin-Ji’s gross economic indicators rose between 2003 and 2004. The indicators most strongly associated with aggregate demand—fixed capital investment, retail sales, and exports—all grew, but at declining rates. (See Table 18.11.) II. Evaluating Development and Assessing Economic Trends A. The Yangtze River Delta Continues its Leadership Position while Entering a Period of Strategic Adjustment 1. Strategic Change Since 2004 the growth rate in the Yangtze River Delta has slowed. This slowdown can be largely attributed to constraints facing economic growth and changes in economic policies regarding growth. Growth to date has largely been achieved through a combination of high and increasing investment, resource and energy consumption, and low input costs. Chinese producers have focused on low-cost, low technology, and low-value added segments of the value chain. Moreover, they have operated inefficiently. In spite of these drawbacks, the massiveness of foreign investment and the continuing cost advantages offered by Chinese-based operations have granted this economic strategy primacy in the region. However, national macroeconomic adjustments, and changing world markets, have led to a tightening resource supply for energy, raw materials, land and other key inputs. As a result, prices for all of these inputs are rising, in some cases precipitously. This has an adverse effect on economic growth. Taken together, these factors reveal the need to apply a new economic strategy. Successfully navigating this transition will depend on harnessing nascent and underutilized creative capabilities. Since the regional economy is based on manufacturing, integrating new technologies

8.5

8.5

1st

47.3

45.9

2nd

44.2

45.6

3rd

Output by sector (%)

17042 5164.16 (26.3%) 20263 6370.18 (23.4%)

Output Fixed per capita capital (RMB) investment 4691.25 (15.9%) 5212.38 (11.1%)

Total retail sales 1068.14 (28.5%) 1502.09 (40.6%)

Trade Volume

385.06 (29.7%) 487.92 (26.7%)

Exports

71.81 (40.67%)

51.07

FDI

9 In China, agriculture is called the first sector, industry the second sector, and services the third sector. These sectors will be referred to as 1st, 2nd, and 3rd respectively throughout this chapter.

5396.3

5356.08

14118.51 1203.641 6671.43 6245.87

997.3

2004

3rd

11750.07

2nd

2003

1st

9

Output

City

Value-added

Table 18.11: Key economic indicators, Jing-Jin-Ji, 2003 and 2004 (100 million RMB; last three categories—100 million USD)

growth trends in china’s three major economic centers 247

248

deng lishu and wei shuhua

into work processes is paramount. Doing so can improve the region’s competitiveness, increase value-added in output for the products currently being produced, allow a move into higher value-added segments, and bring the region closer to realizing sustainable development goals. Secondarily, producers should look to be more innovative in other ways: introducing new products, improving organizational structure and management systems, and developing original brands. Conversion from an economic development system based on growth to one based on innovation goes hand-in-hand with changes in industrial structure. A strategy of innovation will drive the economy toward specialized manufacturing and making higher quality products. These refinements will require changes in education, training, and management. Wages will rise. High wage workers will demand more services. These changes can feed off one another: high-skill industrial workers will have greater income and will demand more services; as the number and skill level of service workers—including managers, accountants, lawyers—improves, they can offer more forward-looking models and abilities to manufacturers. The dominant role of manufacturing in the region has left other sectors, particularly the service sector, in its shadow. However, because of improvements in infrastructure and income levels, and the relatively underdeveloped base of service providers, the growth potential in this sector is huge. Advanced economies have large, well developed service sectors. They serve as pillars for manufacturing—bringing innovative capacities to even the most nuts-and-bolts oriented industries. Shanghai has the opportunity to serve as the nerve center for the region, providing various high-value functions for other cities in the region such as Hangzhou and Suzhou in industrial cooperation, logistics, shipping, and database management. By playing a leading role in these functions, Shanghai can accelerate the economic conversion of the entire region. The Yangtze River Delta can reach a new level of development if its leaders correctly manage challenges, grasp opportunities, and stay on course in changing the region’s economic strategy. 2. Changes in Industrial Structure have Already Begun The change in economic strategy has already started. Concentration of capital, shortage of land, a new attitude regarding the environment, and higher operating costs have started to push production in new directions. Some of this direction is literally geographic; inland provinces, like Anhui, where

growth trends in china’s three major economic centers 249 the cost of doing business are lower, have begun to attract increasingly large flows of capital. At the same time, the changing cost structure within the Delta is pushing businesses to move into higher margin niches in order to cover their rising costs. These two trends will likely continue given economic trends. This will bring the Delta’s economy more in line with the aforementioned changes in economic strategy and structure. Such steps are necessary for the Yangtze River Delta to maintain its economic vitality and to lead the way in regional and national development. 3. The Yangtze River Delta will Continue to be the Most Developed Region in the PRC At present, the Yangtze River Delta serves as the nation’s economic foundation. It is also the most developed region in terms of infrastructural density and quality, and overall economic, social, and industrial integration. For these reasons, it will fall to the Delta’s leaders to face the challenge of being the first regional economy to go beyond a growth-based economy to one built on a more robust industrial structure and higher value-added production techniques and products. Some economists, policymakers, and business leaders have begun to see the need for making this change and to act on it. As part of the 11th Five-Year Plan, Shanghai has trimmed its targeted annual growth rate to 9%, a substantial reduction from the previous Five-Year Plan’s target of 10, and the 9th Plan’s target of 11.4%. This period of transition will be guided by two cooperating forces: the market, which will push the transition toward efficiency and rational outcomes, and the government, which will use its considerable power to organize the process and assure that it unfolds methodically. Taken together, these twin forces ensure that the Changijang Delta will continue to play the leading role in national economic development. B. The Pearl River Delta: Moving Meyond the Growth-Based Economic Strategy 1. The Pearl River Delta must Change its Overarching Economic Strategy As with the Yangtze River Delta, the Pearl River Delta region must embrace a new economic strategy. This strategy will move the region toward a new industrial structure and higher margin production, while deemphasizing the pure growth-based model employed in recent years. The underlying economic reasons for doing so are the same as in Yangtze

250

deng lishu and wei shuhua

River: decreasing growth rates, increasing costs of production, resource scarcity, and a changing political, legal, and social landscape. To date growth has been achieved based on a few, powerful factors: cost-advantages in manufacturing, especially through relatively low-cost but highly skilled labor and a large influx of foreign capital and expertise. With wages and other input prices rising, and with foreign capital finding other areas more productive, the Pearl River Delta region, like the larger but similarly structured Yangtze River Delta economy, must evolve. External economic pressures will continue to cut into economic growth in the region. Changes in world input prices, especially oil, and national macroeconomic policies, especially regarding energy usage and land allocation, have an especially acute affect on the regional economy. These factors, as well as new credit restrictions, have placed the Pearl River Delta’s economy in the same sort of bind that is described above regarding the Yangtze River Delta’s economic conditions—increased international and national competitive pressures, and increasing prices. Furthermore, both regions rely too heavily on foreign investment and initiative. Given these problems, the solutions proposed above—a change in economic strategy designed to develop a more robust and diverse economy—apply to the Pearl River Delta region as well. The strategic conversion of the Pearl River Delta economy should be conducted from the inside out. The first order of business is to balance the region’s heavy reliance on producing low-cost exports by developing initiatives aimed connecting the export economy to a more muscular and diverse set of productive capacities. These capacities would include improvements in overall innovativeness, especially domestically developed research and development (R&D) efforts; the independent development of processes and products that can be patented and trademarked, as well as the capacity to effectively protect these intellectual property rights; and to develop and promote branding of homegrown products and companies. While these initiatives can cut across all levels of industry, economist strategists, policymakers, and business leaders should redouble efforts to develop greater competitiveness in high-tech and cutting-edge technologies. Doing so will depend on changing organizational cultures, improvement worker and management training, developing cooperative ventures that encourage technological development and transfer when necessary, and a closer linkage between educational and research centers and businesses. These moves can place the region’s economy in a new position in the global industrial system. They can also bring establishments in the Delta high margins by moving production up the value chain.

growth trends in china’s three major economic centers 251 2. Developing Regional Support and Coperation can Help to Facilitate Economic Change789 The Pearl River Delta’s economy has a symbiotic relationship with the Hong Kong economy. This relationship could be characterized through the metaphor of the behind-the-scenes workshop serving the product showroom. This relationship is likely to continue since it affords both economies clear—and difficult to substitute—benefits. In essence, Hong Kong provides the high value-added, high-tech elements needed to distribute the massive industrial output of the Delta. The trick is to bring more of this capacity into the Delta; the Closer Economic Partnership Arrangement (CEPA)10 offers one mechanism for achieving this aim. Hong Kong’s more fully developed and diverse economy can provide access to new markets for Mainland goods and services, improve management, raise capital, develop intellectual property, and nurture brands. Moreover, by working together more closely, skills transfer could hasten the development of the Pearl River Delta economy, allowing it to more quickly develop a high-skill service sector and a more diverse productive base. By using the CEPA as a stepping-stone to a wider development of economic cooperation with other provinces along the Pearl River, changes already underway can be deepened, broadened, and better managed. Doing so will open up new markets, harness a wider array of productive skills and resources for future development and growth, extend the industrial chain, and divert some resources and investments from low-cost manufacturing toward other productive processes in order to diversify the regional economy and to better balance the industrial structure. Even though this process is in its early stages, it will soon become a substantial force in the region. Investment, skilled labor, infrastructural development, and industrial capacity will spread outward from the Delta for years to come. This process is as inevitable as it is necessary. And in the long run it can help to expand and more evenly distribute the benefits of growth and development.

10 The CEPA is agreement between the Hong Kong Special Administrative Region’s (SAR) government and the PRC’s Central People’s Government. The Agreement was signed on June 29, 2003. The Agreement lays down as its primary objective the “strengthening trade and investment cooperation between Mainland China and Hong Kong.” Incidentally, the CEPA also applies to the Macao SAR.

252

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3. The Pearl River Delta will Continue to be an Economic Hub As one of China’s budding innovation hubs, the Delta’s trade-oriented economy is one of China’s most dynamic regional economies. Given the trends discussed above, it is likely to continue playing this role in the national economy. C. Jing-Jin-Ji: Development Lies in Balancing Development in the North and the South 1. As the Center of Governance, Jing-Jin-Ji will Play a Crucial Role in Guiding Economic Transition As a latecomer to the process of regional economic integration, the Jing-Jin-Ji regional economy is relatively loose and unevenly developed compared to the two coastal regional economies analyzed above. Moving forward will require more research and planning. With state administrators realizing the increasing importance of regional economic development and integration in the overall national development picture, leaders have recently trained new attention on the challenge of developing the region around the national capital. This effort has been codified in the 11th Five-Year Plan led by the National Development and Reform Committee. In some sense, Jing-Jin-Ji’s condition offers an opportunity: a more advanced, rational, and carefully managed transition can be planned and implemented in the region, free from the headlong rush for economic growth that has driven the coastal economic hubs. Proper execution of this process can lead to more powerful results and thoroughgoing changes. The twin goals of high value-added output and diversified industrial structure may be more readily attained because less inertia exists to tie the economy to low-value, heavy manufacturing. With Beijing as its center, the region has a natural advantage in developing a high-skill service sector. The challenge will be to develop a culture of innovation, and to extend capacities for innovation out to the region’s industrial centers, Tianjin and Hebei. 2. The Tianjin Binhai New Area (TBNA) and Caofeidian are Key Developmental Engines in Jing-Jin-Ji National planners and economic policy strategists have pinned high hopes on exploiting opportunities in the Tianjin Binhai New Area. These hubs of economic development will not only bring benefits to Tianjin and Hebei and the provinces that surround them, but to the entirely of Jing-Jin-Ji. Rapid development of the

growth trends in china’s three major economic centers 253 TBNA opens the region to vast trade opportunities and a reorientation toward increased import-export activity. In turn, this seems likely to stimulate growth in related industries, such as logistics, transportation, storage and warehousing, shipping, and cargo distribution. To sustain growing capacities in trade, manufacturing will almost certain grow as well. In many ways, this connects Tianjin to all parts of the region as well as its neighbors; integration will spur cooperation throughout the Northeast. The Caofeidian Industrial Construction Project has become the hub of chemical and heavy industrial production in the region. In particular, metallurgical manufacturing and processing, including iron and steel smelting, has moved from the Beijing area into Caofeidian. This allows for specialization in the region, with the added benefit that these outputs are much closer to shipping and transportation infrastructure. As with the TBNA, this industrial base will energize the Jing-Jin-Ji region and a large swath of the Northeast near it. 3. Harnessing Rapid Growth The Jing-Jin-Ji economic sphere faces an historic opportunity to move directly into the innovation-oriented economy. Its major city lies at the heart of its competitive advantage. Beijing has a better developed service sector and also the most potent technical innovational capacities in the nation. Tianjin is also quite strong in the latter regard; its industrial base is quite forward-looking in that innovation permeates the various economic sectors. What remains to be seen is if local specialization and cooperation can be realized among the region’s many industrial, technical, and strategic players. If these elements come together through vigorous competition and thoughtful cooperation, Jing-Jin-Ji could leapfrog other economic regions in China, providing the nation with an alternative path to future development from the one already paved in the Yangtze River Delta and Pearl River Delta regions.

ANALYZING REGIONAL ECONOMIC ADJUSTMENTS IN THE PEOPLE’S REPUBLIC OF CHINA Jing Tihua In the Fifth Plenary Session of the Sixteenth Communist Party of China (CPC) Central Committee meetings, government representatives affirmed the achievements of the Tenth Five Year Plan. They based their approval on domestic and international conditions at work in and around the People’s Republic of China (PRC) in its continuing development. Their analysis considered overall strategic conditions. From these the CPC could formulate principles for guiding development and use these principles to craft specific development goals. These specific steps are designed to fulfill China’s long term goal of becoming a strong modern state. I. Assessing Current Conditions and Future Prospects A. Viewing the Current Point of Departure in Terms of Global Strategy On December 11, 2001 China entered the World Trade Organization (WTO). As China’s trade volume has expanded, it finds itself increasingly enmeshed in the global economy. WTO membership formally ratifies China’s new position. From 2002 to 2004, trade volume surged by 31.5% per annum, rising from 620.8 billion US dollars (USD) to 1154.8 billion USD. This growth rate far outpaces the global average. Growth on the export side of the ledger has been especially prodigious; China’s increase in exports accounts for a full one-third of the world’s growth in total exports. In 2003 trade volume surpassed Japan’s, moving China into the world’s number three position in total trade volume. In 2004, Chinese exports accounted for 22% of American imports; 28% of German imports; and 32% of Japanese imports. Import volume has also grown of late. China has imported a particularly large volume of goods from its neighbors. In 2003, China increased its imports from Korea by 22 billion USD. Imports from

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Singapore grew by 3.5 billion USD and Malaysian imports increased by 7.1 billion USD. With China importing more, business opportunities in neighboring countries will open and expand. This is especially true of developing countries in the region. To foster trade with these nations, China implemented a zero-tariff policy for goods important from the region’s least developed countries. China benefits by easing the flow of imports and its neighbors benefit by bringing more revenue from sales to China.1 Even though China has only recently entered the WTO, its twenty years of economic reform and liberalization has allowed it to become a major force in international trade. By integrating itself into the global economy, however, China has exposed itself to the forces and changes at work in this system. Between 1980—only two years after Deng Xiaoping made his “black cat, white cat” speech2—and 2001, China has become far more dependent on foreign trade since trade accounts for a large percentage of total Chinese GDP. This steep increase in trade activity accompanied a massive influx of foreign direct investment (FDI). FDI has poured into China mostly to create a manufacturing base. China’s increasingly important role in manufacturing has increased its profile in global markets and as a recipient of investment. In fact, China’s elevated economic profile has reshaped the global economy, and at the same time, China’s domestic economy. In essence, these changes are completely interdependent: without the FDI, China could not have developed the capacity to become a major trading force. If the Chinese economy had not evolved and overhauled its internal structures, the international trading system would be completely different. According to Ministry of Commerce calculations China’s contributes about 10% to global economic growth, even though China’s GDP makes up less than 4% of world output. And with only 6% of global trade volume passing through China, the country contributed over 12% to trade growth.

1 “Total trade volume surpasses 1000 billion US dollars—A new world trade record,” China Economic Daily, October 10, 2003, page 2. 2 Deng famously said: “As long as it catches mice, it does not matter whether the cat is black or white.” With this, the era of market reform, or implementation of “the socialist market economy”, had begun. For Deng, the quotation above summed-up the concept of a market economy adapted to state controls.

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In sum, we can see that China is now completely enmeshed in the world economic system. This has allowed the country’s economy to grow and for many people to prosper. In short, opening up the economy, and changing the economic development framework from one based on internal development to one that links internal development to the global system, will continue to be the basis of economic planning and growth for years to come. B. New Problems 1. The Problem of China’s Cost Leadership Position Even though China enjoys new stature, access to capital resources, and revenues from trade, it has accomplished these things by producing an enormous volume of goods at low margins and prices. For instance, in 2004 China exported 17.1 billion articles of clothing valued at only 3.51 billion USD. In some segments, China dominated the market; the country exported six billion pairs of shoes, or about 60% of the world’s total annual sales. However, with each pair of shoes fetching only 2.5 USD, Chinese manufacturers work on slim margins. Furthermore, China must bear the costs of this vast expansion in industrial capacity. Resource consumption has grown by leaps and bounds. Also, pollution has grown into a pervasive problem. China must bear these costs alone, even though much of the profit made on final sales of these items ends up in foreign countries. 2. Resource Costs will Constrain Growth A 2004 analysis conducted by affiliates of the Statistical Science Research Institute of the National Statistic Bureau reached a shocking conclusion: China has some of the highest production costs in the world. A quick examination of figures from 2001 will clarify this point. China’s energy use per unit of output is 2.3 times the United States’ rate and 5.1 times that of Japan. By using steel consumption as a proxy for overall resource consumption, we can see that China’s use of raw and processed resources is far in excess of other countries. Steel consumption per of unit production is nine times that of the US and more than two times the rate in India, Brazil, and Russia. As of 2003 the PRC’s GDP was less than 5% of world output, but the country consumed a high share of the world’s resources: 30% of the world’s coal, 13% of its electric power, 25% of its steel, and 50% of cement for the year. The high per-unit costs can

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be stated in a different way: high inefficiency, or more to the point, wastefulness. Let us step back for a moment and connect the dots. In the past 20 years GDP quadrupled. While this is certainly praiseworthy, this accomplishment it has been premised almost entirety on growth; efficiency has not been integrated into the process, and therefore, the potential for real economic benefit and development has been dissipated by poor resource and energy use. These conditions prompted Chen Dongqi, Vice President of the Macroeconomic Research Institute of the National Development & Reform Committee (NRDC), to point out that China’s annual GDP growth rate in the past two years of about 9% may be imperiled because of price and supply fluctuations of coal, oil, electricity, and transportation. The problems go beyond resource constraints. Funding the rapid development of capacity has required lax credit policies. This means that many loans currently in circulation are high risk, which in turn generates instability in finance markets. Because so much credit is easily available, inflationary pressures could mount. It is worth pointing out that China’s current status as a “great nation of manufacture and trade” is based on the manufacture and export of products that are energy-intensive, highly polluting, and low valueadded. Whether in production or trade, the methods used capitalize on scale rather than quality. Production and export sectors have sobered up to the fact that in the new global environment, they cannot continue to depend on low-end, low-price goods to expand the scale of production, nor on economies of scale to increase production and foreign commerce. This is not only due to a long list of commercial disputes. As high levels of energy consumption, pollution, and low value-added production transform China into the world’s key manufacturing and trading nation, it will inevitably become the world’s largest polluter and resource consumer as well. Obviously, this is not something we can accept if we are to build a harmonious society: Chinese citizens can neither use the resources due to future generations, nor endure the disruptive effects of pollution. On the other hand, one should consider the continual increase in China’s resource imports. China has already become one of the world’s largest oil-consuming countries. While many countries marvel at the speed of China’s economic growth, the energy constraints of the 21st century have also caused them to focus on the rapid increase in China’s energy demand. The pace of China’s economic growth is

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no longer an issue that preoccupies China alone. The adverse effects of resource constraints on economic growth are increasingly evident. Addressing the issue of how to maintain high growth rates, Premier Wen Jiabao stated: In recent years, China has imported increasing amounts of important resources such as oil and ore. The level of dependence on the external market continues to rise. Excessive imports of resources are not only costly, but also exacerbate the contradiction between supply and demand on the international market. This creates a set of economic, political and diplomatic problems.3

The attentiveness of countries worldwide will impel us to act more rationally. The 21st century is marked by global resource constraints. China has no choice but to contemplate future economic development from a long-term perspective. For the sake of economic and national security, we must control and reduce the level of dependence on external resources. 3. The Embarrassment of a “Great Manufacturing Nation” Obviously, “great manufacturing nations” cannot willingly occupy the low end of the value chain forever. Yet the fact is that the technology of developed countries has impeded the core competitiveness of China’s key industries. The technology flows of economic globalization have been cut off by high-end international competition. One example is Shanghai’s Bao Steel Company. The China Mining Paper of September 17, 2005 reports that while the company’s overall competitiveness has been acknowledged by the global steel industry, its entry into the circle of core competitors has caused it to progressively feel “the difficulty of purchasing advanced technology and equipment overseas”. Apparently, steel and technology companies abroad have begun to limit the technology available to Bao Steel. This type of technology “purchasing difficulty” could be suffered by all of China’s large enterprises as they sharpen their competitive edge. Although China has already become one of the world’s large manufacturing countries, as long as its manufactures remain low quality, and Chinese industry is unfit to compete with the world’s leading enterprises, the flow of technology

3 Wen Jiabao, “Attaching Great Importance to Strengthening Leadership to Speed the Building of Saving Society,” Economic Daily, July 4, 2005, page 4.

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transfers to China will continue at sufficient levels. However, once the product structure of Chinese enterprises is updated, and their competitive level gradually rises, the technology flow will contract, especially when it comes to core technologies. Bao Steel, which topped the Chinese Large-scale Enterprises Roll in 2005, has at present already graduated from the technology-absorption and -replication stage to become an industry front-runner. Yet if it fails to make a fundamental breakthrough in the R&D and integration of its homegrown technologies, thereby overcoming the high-end technology “purchasing difficulty”, China’s steel industry will never become world leader. This example alone does not sufficiently illustrate how the obstruction of technology flows affects China’s economy. According to a Xinhua News Agency report, nearly all pharmaceutical patents are owned by developed nations. In the DVD industry, numerous enterprises have gone bankrupt because they are unable to pay patent fees. In car manufacturing, state-manufactured cars only comprise 10% of the total. There are countless examples across different industries. Practice has proven that when it comes to strategic fields concerning national security and citizens’ livelihoods, real core technologies cannot be purchased from abroad. If China is not willing to have the “world’s factory” on its doorstep, manufacturing medium- and low-end goods, then a shift from dependence on external technologies to independent R&D and innovation is the only way forward. C. A National Strategy for a New Way Forward In June 2005, during a discussion on medium- and long-term programs for national science and technology development, the Politburo of the CPC Central Committee underlined one point: progress and innovation in science and technology are the prime catalysts for socio-economic development. As the nation develops, the enhancement of independent innovation forms the central node between economic restructuring, the alteration of economic growth patterns, and the improvement of national competitiveness. Establishing a nation shaped by innovation is a significant strategy for the future. When General Secretary Hu Jintao investigated and researched China’s capability for independent innovation in August 2005, he repeatedly emphasized this quality as the core of national competitive power, as well as the key to vitality and development in industry. It is noteworthy that “improving the capacity for independent innovation” has already been elevated by the govern-

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ment from a science and technology policy to a national development strategy significant for the future. Over the next 15 years, the guiding principle of this “national strategy” for science and technology work is: innovate independently, excel in vital areas, bolster development, and lead the way into the future. In terms of economic development, this principle comprises four pillars: sustaining long-term, stable, and fairly rapid economic development; restructuring the economy and economic growth patterns; building a resource-efficient, environmentally friendly society; and improving economic competitiveness and risk aversion capabilities. This strategic approach demonstrates that building a resourceefficient, environmentally friendly society cannot be achieved by maintaining current economic growth alone. Rather, implementation rests on minor acts of resource efficiency and environmental conservation in daily life. On the production side, inadequate organization has led to illegal, excessive and energy-intensive production that is wasteful; mistakes in investment and policy-making have led to low-quality, redundant construction. These issues have been neglected; even though it is precisely “waste” that consumes large amounts of social resources and poses the greatest obstacle to building a resource-efficient, environmentally friendly society. Clearly, in order to build such a society in economic terms, it is prerequisite to shift economic growth models from scale-oriented, inefficient approaches to ones that are quality-oriented and resource-efficient. In reality, this is a matter of restructuring the economy on a higher level. II. New Development Opportunities in the “Jing-Jin-Ji” Region The CPC Central Committee’s “Proposal to Define the Eleventh Fiveyear Plan for National Economy and Social Development” was discussed at the Fifth Session of the Sixteenth Central Committee. The Proposal’s ten important items, which included economic growth models and the restructuring of industry, attached greater importance to regional development. The “Jing-Jin-Ji” Economic Zone (Beijing, Tianjin municipality, and Hebei province) was placed higher on the central government agenda as a pilot project for regional development. During more than 20 years of the Reform and Opening Up Policy, the Pearl River and Yangtze River Deltas have ascended rapidly, building on the foundation of the Shenzhen Special Economic Zone and

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the vanguard role of the Pudong Development Zone. These regions constitute the “two foci” of China’s economic dynamism. Since Tianjin’s Binhai New District has been decreed a strategic focal point for national development, what strategic mindset will the “Jing-Jin-Ji” Economic Zone adopt in order to alter the imbalance between the backward North and advanced South? To create a new development configuration for China will not only require Tianjin shipping business, but also incisive thinking on Beijing’s behalf. Observers believe the development of Binhai New District follows on the heels of development in Shenzhen in the 1980’s and Pudong in the 1990’s. Expanding a third area is a strategic measure to propel a third wave of coastal development and market openings. It is thought that along with Pudong and Shenzhen, Binhai will form one of three major “foci” that fulfill similar functions for China’s northern, central, and southern coastal areas respectively. Just as Shenzhen was a catalyst for the Pearl River Delta and Pudong for the Yangtze River Delta, Binhai will likewise transform the “Jing-Jin-Ji” urban network into an economic growth machine that stimulates the areas around the Bohai Sea. We believe this is a valid prospect. Yet the strategic path on which Binhai New District will embark cannot retrace the steps of Shenzhen and Pudong. As Tianjin embarks on a new round of development and market opening, and provides centrifugal stimulus to the “Jing-Jin-Ji” Economic Zone, Beijing will not be a passive bystander, but an active participant and team player. Beijing will not only give support, but also seek it from Tianjin. This “giving” and “seeking” will bolster the “JingJin-Ji” Economic Zone’s rapid ascent and stimulate the economy of the areas around the Bohai Sea, as well as Beijing. III. Analysis of Difficulties in Leading Economic Regions A. Pearl River Delta In 1980, the government formally established four special economic zones in Shenzhen, Zhuhai, Shantou, and Xiamen, further adding Hainan Province in 1988. Driven by the special economic zones, the Pearl River Delta became the first area nationwide to undergo rapid development. The area’s close ties to Hong Kong, Macao, and Southeast Asia are its most striking feature, as well as its most courageous and successful experiment. While pushing export-oriented development,

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the region has also participated directly in the adjustments and cycles of international industry. Yet the downside of such a model is that it inspires short-term profit opportunism through three tendencies: 1) Foreign capital is mainly channeled into a form of manufacture that processes client-supplied materials, assigning the Pearl River Delta a role akin to “world factory” or “workshop of the world”. The capital attracted is not used to mature or fertilize local innovation, nor is any account taken of domestic demand and markets. Instead, the region has gradually entered the international industry chain with an export-oriented economy. 2) The shift to “world factory or workshop” has made the Pearl River Delta a medium- and low-end manufacturer in the value chain of foreign industry. Facilitated by China’s accelerating pace of urbanization, the reliance on a mass of cheap labor from rural areas has maintained low costs and “reaped the profits due to China’s laborers” in order to advance. 3) In production, reliance on a scale-over-quality growth model has enabled light industry to develop. Most production is in the form of labor cluster industries low in investment, technical content, and added value, and high in energy consumption and pollution emitted. An industry cluster has taken shape on the basis of low cost, preferential policies, and geographical advantage. In the early stages of the Reform and Opening Up Policy, short-term profit opportunism drove the fast growth of the Pearl River Delta. Since the country’s first three special economic zones were all in Guangdong Province, this region created rapid economic growth and industrialization that has been sustained for over 25 years; Shenzhen, once a small town on the periphery, has become a modern industrial city overnight. However, as preferential policies and geographical advantages become less decisive, resource insufficiency, pollution, rising labor costs, and friction in international trade are beginning to take their toll. The constraints prompted by these adverse conditions have become more visible, causing the Pearl River Delta to surrender its position as “leader of the pack”, and shaping a trend toward gradual retrogression in the Yangtze River Delta as well. In early 2004, news of worker shortages sent a warning signal to the low wage system and the Pearl River Delta model. The hotspots of foreign investment have shifted from the Pearl River Delta to the

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north and west of the country. As flows of labor and capital thin out, it is only a matter time before a structural shift occurs in the Pearl River Delta economy. In November 2003, Guangdong province was the first to conceptualize a “Greater Delta Economic Circle” for collaboration in and around the Pearl River Delta. In June 2004, leaders of local governments in related areas jointly signed a “Framework Agreement for Greater Pearl River Delta Cooperation”. This covers nine provinces (Fujian, Jiangxi, Hu’nan, Guangdong, Guangxi, Hainan, Sichuan, Guizhou, Yunnan) and two special administrative regions (Hong Kong and Macao), abbreviated as “9+2”. These nine provinces cover one third of China’s territory, are home to one third of its population, and produce one third of the national economic aggregate. Taken together with Hong Kong and Macao, the Greater Delta region’s importance is quite evident. Collaboration within the Greater Delta region is essential. Yet as the structure of global industry changes rapidly, the most important task for the Pearl River Delta itself is to accelerate the transformation of growth patterns, to strive towards a new form of industrialization characterized by high technology content, economic efficiency, low resource consumption, low levels of pollution, and efficient use of labor power. This would modify the region’s role in the international industry chain, allowing it to thrive once again. B. Yangtze River Delta The steady rise of the Yangtze River Delta has taken a backseat to the Pearl River Delta’s rapid progress. Yet the Yangtze River Delta’s advantages lie precisely in the areas where the Pearl River Delta suffers shortcomings. First of all, the Yangtze River Delta has not treaded the one-track path of an export-oriented economy. While widely attracting foreign capital through an open market economy, it has also amended the errant approach of “caring a lot about acquiring foreign capital, and very little about how it is used locally”. The region has been riding the momentum of domestic and foreign markets, using foreign capital to plant new seeds in the local economy. Second, in the course of becoming a “world factory or workshop”, the Yangtze River Delta has been sure to incorporate skills from the medium-level chain of foreign industry, enabling it to leave its mainstay at the lower end of the value chain.

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Third, it has further ascended the value chain by shifting its focus from light industry to equipment manufacturing. The scale-over-quality growth model—low in investment, technical content, and added value, high in energy consumption and pollution emitted—has been altered to some extent. A new industry cluster involving different levels of industry has taken shape that has proven superior to the Pearl River Delta. It has become the source of competitive edge and the backbone of development. As the center of world manufacturing has shifted to China, the Yangtze River Delta has seized the opportunity. A latecomer on the scene, the region has nevertheless faced a higher entry barrier than the Pearl River Delta. This has rendered the division of labor between the two Deltas all the more evident: in the eyes of foreign investors, if you want to manufacture shoes or toys, you will set up shop in the Pearl River Delta; if you want to produce chips or other high-end products, you will set up shop in the Yangtze River Delta. It is quite difficult to alter such an established trend. However, “Yangtze River Delta Manufacturing” has not rid itself of the scale-over-quality growth model altogether, evidencing problems such as redundant construction and surplus production capacity. Over the span of the Tenth Five-year Plan, the Yangtze River Delta has grown from nothing but a name on the map into an integrated economic zone where cities are increasingly interlinked. However, it has still been quite difficult for the region to overcome administrative hurdles in order to establish an integrated, multi-level industry chain. At present, competition within the region’s industry is growing fiercer by the day. Identical manufacturing structures pose the greatest obstacle to regional economic integration. According to statistics, the proportion of homogenous industry to the whole of industry stands at 92%, 86% and 78% for Jiangsu, Zhejiang, and Shanghai municipality respectively. In the cement, steel and chemical fiber industries, the pressure exerted by the “surplus production crisis” has led small enterprises to shut down in succession, and large ones to walk on thin ice. Thus, the Yangtze River Delta’s economic figures have evidenced overall decline. IV. A Change in Strategy for the “Jing-Jin-Ji” Region In recent years, the “Jing-Jin-Ji” region has achieved definite economic results. Yet in comparison to the Pearl River and Yangtze River Deltas,

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the market opening process has stagnated and steps toward regional cooperation have only been small. This has seriously inhibited the formation of a regional economic belt. Nevertheless, the new dynamics of economic globalization provide excellent prospects for further reform and expansion in the area. A. A Head Start for Jing-Jin-Ji The reason why the “Jing-Jin-Ji” region cannot retrace the steps of the Pearl River and Yangtze River Deltas over the past 20 years is because we now stand at the summit of global strategy: we face an environment that is more complex both internationally and domestically. In order to cope with various unprecedented challenges to development, we must diversify the content of development, create new development perspectives, and expand modes of conceptual and structural thinking. The implementation of “scientific development” should be based on a comprehensive realization of strategic concepts, systems, and mechanisms. In light of this, as the Eleventh Five-year Plan sets in, regional development in the “Jing-Jin-Ji” region must begin by condensing and transcending the market opening trajectories of the Pearl River and Yangtze River Deltas over the past twenty years. At this new point of departure, the “Jing-Jin-Ji” region will join the process of global economic integration and actively contribute to larger adjustments in the international industry structure. However, it will no longer be a place for the lower end of the “world factory” value chain to engage in energy-intensive and highly polluting production. As our efforts focus on restructuring the economy by enhancing the capacity for independent innovation, overall national competitiveness will improve tremendously. China will bid farewell to high levels of consumption and pollution, making the leap from a “great nation of manufacture and trade” to a “leading nation of manufacture and trade”. B. Using New Concepts to Drive Investment North World industry is shifting at an accelerating pace. Foreign investment in China is exhibiting a tendency to move north and west. How can foreign investment be driven north to become involved in the expansion and construction of the “Jing-Jin-Ji” region? Conceptually speaking, the following three aspects are essential:

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1) As shifts take place in the international service industry, we should seize the opportunity to promote an upgrade of this industry at home, especially in production-oriented sectors. At present, developed countries tend to transfer the low end of the service industry to China. We might have the choice of adopting preferential policies to counter this trend. 2) In view of current trends, the more established manufacturing industry has tried to expand market share through rapid entry into related production-oriented service industries. Manufacturers should sufficiently modify the core of industry by actively attracting production-oriented services. In the process, it should make great efforts to assimilate and innovate. 3) In strategic sectors crucial to the national economy and citizens’ livelihoods, core technologies should not be introduced from abroad. Homegrown and integrated innovation provides the key foundation for innovative capacity and competitive edge in science and technology. The rapid development of the science and technology revolution, coupled with the accelerated transfer of hi-tech upgrades into real productive power, has made homegrown innovation increasingly essential to improving a nation’s overall strength and competitiveness. Along with the introduction of technology, the focus should be on upgrading independent innovation, especially to maintain a favorable system for large industries with strategic, fundamental, and prospective importance for the national economy, defense, science and technology, and social development. National and regional innovation projects should be established and an efficient working environment fostered. Production, study, and research: these elements should be combined to tackle problems collectively in a transparent manner. In sectors where technical revolutions might take place—such as biotechnology—we should adopt the strategy of catching up generally and making breakthroughs partially in respective fields. Strategic industries should gradually be rid of regulatory tape. It is well-known that the “Jing-Jin-Ji” region is home to many of the country’s top science and technology research institutes and universities. It is also a fact that many of the nation’s large enterprises are located here. If the forces of production, study, and research across the region can be joined up—using independent innovation to master the

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world’s cutting-edge core technologies and founding several brand-name enterprises able to compete internationally—the “Jing-Jin-Ji” region will acquire the wings to soar, and its ascent will make an important contribution to national security and citizens’ livelihoods. The “Jing-Jin-Ji” region has the credentials to join the “national team”, to become a strong asset for homegrown innovation nationwide. It certainly will not be easy to institute the reforms and innovation of systems and mechanisms necessary to achieve this. Government support will no doubt be extremely important during the start-up phase. The “Jing-Jin-Ji” region will seize the opportunity provided by a new round of structural reforms: to shift from a resource-reliant to an innovation-driven economy, and from a reliance on foreign technology to self-dependence. If it does so by taking bigger and more forceful steps, it will no doubt propel a tide of reform in northern China. C. New Concepts: Wide Integration of Industries and the “Aviation Innovation Project” The first thing to take note of is the profound influence the new service industry is having on production methods. In new forms of service activity, service products reside in service activity itself, while technical service enhances products. This kind of product does not merely refer to manufactured products; agricultural products also require science and technology services. The modern service industry is comprehensively integrating primary, secondary, and tertiary industries. Development of integrated industry implies interpenetration between different government departments, as well as between markets. This not only breaks down the original division of labor between different sectors; interpenetration informs mutual dependence relationships and facilitates the wide application of new technology in production. This creates more effective modes and channels of operation. Integrated industry is accelerating the reform of production modes. In the course of such reform, new forms of service activity—especially the production-based service industry on the basis of rapid developments in communications technology and economic globalization—are gradually becoming a force that steers and delineates the course of economic growth. In the past, there was often no specific way to put into practice the notion of “science and technology as primary productive force”. Integrated industry steered by a production-based service

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industry, however, is a detailed elucidation of how this theory can be implemented. At present, owing to the high level of development in Beijing’s tertiary industry, the “Jing-Jin-Ji” region is the first nationwide to integrate primary, secondary, and tertiary industries. The “Jing-Jin-Ji” region should seize this advantage and diligently pursue a move to integrated industry. It will take the lead in pursuing new forms of industrialization. How can such aspirations be fulfilled? I suggest we model ourselves on the example of France’s “Competitive Foci Program” and China’s “Aviation Innovation Project”. France is a developed country whose economic strength ranks fifth in the world. The fierce pace of economic globalization has caused international competition to heat up. The French government is implementing the “Competitive Foci Program”4 in order to enhance its global competitiveness. The “Competitive Foci Program” refers to collaborative partnerships between enterprises, training centers and research institutes within a designated geographic scope. The Program allows these entities to jointly develop innovation projects that are expected to strengthen comparative advantages in core areas. This represents a new economic development strategy designed with economic crisis in mind. Judged by the specifics of its implementation, the Program has indeed identified the key to enhancing economic competitiveness today. In summer 2005, the French Ministerial Committee for Territory Management and Development designated 67 projects throughout the nation as “Competitive Foci”. For example, TLS and surrounding areas were designated as “Competitive Foci” of the aviation industry. The Committee has vouchsafed 1.5 billion Euros from the French budget to support projects over a three-year period beginning in 2006. It is to improve the competitiveness of French products on the international market. What projects are selected for the program is of the utmost importance. Leading industries are prioritized, and they rely on the innovative “foci” of the program to make themselves as competitive as possible. At the same time, areas with competitive potential and tutelage prospects

4 “Competitiveness Pillar Program Vigorously Implemented in France,” The Economic Daily, Sept. 30, 2005, page 8.

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are also taken into consideration. Enterprises, training centers, and research institutes join in a type of collaborative unity and symbiosis. This allows for thorough integration of industry. A report states that the EU has set itself the target of being the number one competitive and knowledge-based economy in the world in the first decade of this century. At an EU Committee Conference held in March 2005, the “Competitive Foci Program” implemented in France was extremely well-received. The program might set an example for innovation in the European industry as a whole, illustrating how to strengthen international competitiveness through science and technology development. The “Aviation Innovation Program” is the Chinese version of the “Competitive Foci Program”. The manned Shenzhou VI spacecraft was created with hundreds of self-dependent innovations by many research institutes throughout China and hundreds thousands of components designed and manufactured by quite a few enterprises. This has allowed China to join the world leaders of the aviation industry. Why not initiate an “Aviation Innovation Project” Program in the “Jing-Jin-Ji” region? This program would enhance international competitiveness based on the development of science and technology. Where there is no breakthrough in strategic concepts, there can be no breakthrough in strategic implementation. At the Fifth Session, our strategic brainstorming led us to put forward guideline instructions to this end. D. Cooperation between Beijing and Tianjin, Two Core Districts at Different Levels Beijing and Tianjin are the two core districts of the “Jing-Jin-Ji” region. Judged by present development trends, Beijing and Tianjin will come to form modern service and high-end manufacturing industries. Beijing will be founded on a modern service industry and will become a fulcrum that functions as an international management and control center. Based on modern manufacturing and international logistics, Tianjin will become a regional node. Characterized by different industries, there is much room for cooperation between the two cities. Therefore, it is clear that “Coordinated competition at different levels” will make these two nuclei become main orbits of the “Jing-Jin-Ji” region. A more advanced point of departure and new strategic concepts will not only incite a new wave of reform and market openings in northern

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China; the strategic pace development in the Pearl River and Yangtze River Deltas will also change significantly. It is estimated that modifications in regional strategy will not only reform the strategic makeup of the nation’s economic development, but also lay a foundation for China’s overall national power to reach a higher level.

THE YANGTZE RIVER DELTA: MANAGING SUSTAINABLE DEVELOPMENT1 Tian Boping Since entering the 21st century riding a wave of economic growth, China has begun to face ever more serious resource and environmental constraints. Tensions between growth and these constraints are especially acute in the Yangtze River Delta region since this is one of the most densely populated regions on earth. Two such constraints have grown especially acute: scarce mineral and energy resources, and overall environmental carrying capacity. New pronouncements developed during the Third and Fourth Plenums of the 16th Communist Party of China Central Committee meeting include requirements to harmonize and rationalize a comprehensive system for managing sustainable development. As China’s most economically developed region, the Delta’s leaders face an important challenge: how to stay in the forefront of China’s development efforts while more effectively balancing development with other factors— mostly environmental and social—in order to develop and implement a sustainable system of development. This is not only a domestic issue: developing and implementing these changes has to be done in an environment of increasingly fierce international competition and economic globalization. I. The Initial Achievement of Leading Development The Delta is located on the eastern coast of China, comprising the triangular-shaped territory of Shanghai, Jiangsu and Zhejiang provinces with a total area of 210.7 thousand square kilometers (of which Shanghai is 6340.5 km2, Jiangsu is 102.6 thousand km2, and Zhejiang 1 This article was written by Researcher Tian Boping. Professor Song Linfei, Professor Zhang Haohan, and Researcher Assistants Wang Zhen, Chen Wei, Yang Jianhua, and Sun Keqiang all took part in discussing the first draft. This final version reflects their input. Luo Zuchun, Zhang Chao, Zhan Zhao, and Wang Shuhua all provided useful insights as well. We respectfully extend our gratitude to these comrades.

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is 101.8 thousand km2), which accounts for 2.19% of China’s total land area. By the end of 2004, populatoin registered 133,621,100, or just over 10% of the national total.2 The Delta offers numerous natural and geographic advantages. Broad flatlands, crisscrossing waterways, fertile soil, and a warm and humid climate, support development, espcally in agriculture. The coastal locatoin and large delta provides ready access to major rivers and seaports. It the “gold coast” with “golden waterways”, a place from which people can readily connect with destinations on all parts of the globe. Road, rail, and shipping conections also connect the region to virutally any domestic destination. Since the period of the Northern and Southern Dynasties (beginning in the Fourth Century AD), the Delta has been a main cultural and economic center of China. It’s preeminence as a commercial and agricultural center earned it the nickname “the storehouse of China”. In pre-modern times, it was the seedbed for national industry and commerce and the cradle of modern urban culture. It is here that Chinese and western cultures blended to form a new, broadminded, innovative, but deeply pragmatic subculture. These factors nurtured a rich industrial base, which in turn, led to improvements in the labor pool. In 1949, when the People’s Republic of China (PRC) was founded, more than one-tenth of the total population, one-sixth of the gross economic product, and about one-fourth of the domestic industrial base existed in the delta region. Until the 1950s Jiangsu led all provinces in terms of economic output; during the 1960s Shanghai overtook this position and continues to play a leading role in national economic development. A. Rapid Economic Growth and Sustainability (See Tables 20.1 and 20.2) From 1979 to 1991, the average annual economic growth rate of Shanghai was 7.46%, yet from 1992 to 2004, it leaped to 12.42%. Meanwhile, economic growth in Jiangsu jumped from 10.92% to 14.12% and in Zhejiang from 11.70% to 14.18%, respectively. These provinces have established a remarkable track record of double-digit growth: Zhejiang has maintained at least 10% growth since 1991, while in Shanghai and Jiangsu have maintained a double-digit pace since 1992. From 1992 to 2004, economic growth in the Delta was as much as 13.6% higher

2 Shanghai contributes 13,523,900 to this total, Jiangsu another 74,325,000, and Zhejiang about 45,772,200.

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than the national average. In 1992, the total economic output in the Delta equaled 465.58 billion yuan, or about 17% of the national GDP; by 2004, output had ballooned to 3423.412 billion yuan, or just under 25% of the national output. Table 20.1: Economic growth in the Yangtze River Delta region, 1991–2004 (Billion RMB, %) Shanghai

Jiangsu

Zhejiang

Year

Output

Yearon-year growth

Output

Yearon-year growth

Output

Yearon-year growth

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

89.377 111.432 151.161 197.192 246.257 290.220 336.021 368.820 403.496 455.115 495.084 540.876 625.081 745.027

7.1 14.8 14.9 14.3 14.1 13.0 12.7 10.1 10.2 10.8 10.2 10.9 11.8 13.6

160.138 213.602 299.816 405.739 515.525 600.421 668.034 719.995 769.782 858.273 951.191 1063.175 1246.083 1551.235

8.3 25.6 19.8 16.5 15.4 12.2 12.0 11.0 10.1 10.6 10.2 11.6 13.6 14.9

108.175 136.506 190.949 266.686 352.479 414.606 463.824 498.750 536.489 603.634 674.815 779.600 939.500 1124.300

17.8 19.0 22.0 20.0 16.7 12.7 11.1 10.1 10.0 11.0 10.5 12.5 14.4 14.3

Total Delta output 359.230 465.580 645.396 872.697 1117.211 1307.767 1470.349 1589.675 1711.797 1919.162 2123.130 2385.901 2813.204 3423.412

Data source: The Shanghai Statistical Yearbook 2005, The Jiangsu Statistical Yearbook 2005, The Zhejiang Statistical Yearbook 2005.

Table 20.2: Main economic indexes for the Delta in 2004 (Billion RMB) City

Gross output

Gross Industrial Real estate Total Foreign exports valueinvestments revenue investment* (100 million added USD)

Shanghai 745.027 349.289 Jiangsu 1551.235 778.154 Zhejiang 1124.300 538.140 Delta** 3420.535 1665.583

286.30 500.82 396.96 1184.08

110.619 98.043 80.595 289.257

54.159 100.503 55.319 209.981

73.520 87.497 58.146 219.163

Data source: The Shanghai Statistical Yearbook 2005, The Jiangsu Statistical Yearbook 2005, The Zhejiang Statistical Yearbook 2005. * These totals use the average conversion rate in 2004, which was 8.28 yuan to the dollar. ** Note: there are rounding errors in the totals for the Delta region.

As noted above, the Delta region contributed almost 25% to national GDP. It also played a dominant role in other categories. It contributed 26.52% of national industrial value-added, a relatively modest 20.20%

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of real estate investment, 24.72% of total financial revenue, a whopping 41.83% of total foreign investment, and an equally impressive 36.94% of total imports. The success of the regional economy makes it “an economy within an economy.” This is true for gross figures, such as those in Table 2.2, as well as averages. For instance, per capita output for the region stands at more than 300% of the national average. Table 20.3 enumerates per capita output figures for each province in the Delta. Table 20.3: GDP per capita in 2004 (yuan) City

Output per capita (Yuan)

Shanghai Jiangsu Zhejiang The Delta Percent(%)

55307 20852 23924 33361 315.89

Data source: The Shanghai Statistical Yearbook 2005, The Jiangsu Statistical Yearbook 2005, The Zhejiang Statistical Yearbook 2005.

Through 2005 the region maintained its robust economic growth. According to preliminary statistics, regional gross output for Shanghai reached 913 billion yuan, an increase of 11.1%; Jiangsu attained an output of 1,800 billion yuan; and Zhejiang topped 1,334 billion yuan. Note that the latter two provinces growth rate exceeded 14%. Total economic output for the region supassed the 4 trillion yuan mark. 2004 GDP exceeded 2003 GDP by 1,926 billion yuan; 610 billion yuan of the increase came from the Delta. This equals almost 32% of the GDP increase. (See Table 20.4.) Table 20.4: The contribution from the Delta in national economic growth (Billion RMB, %) 2001

2002

Net Net % growth growth Added of GDP of GDP Shanghai 39.969 Jiangsu 92.918 Zhejiang 71.181 Delta 204.068 PRC 784.67

5.09 11.84 9.07 26.07 –

45.792 111.984 104.785 262.561 785.75

2003

2004

Net Net % % % growth growth Added Added Added of GDP of GDP 5.83 14.25 13.34 33.42 –

84.205 6.97 119.946 182.908 15.14 305.157 159.900 13.24 184.800 427.013 35.35 609.903 1207.96 – 1926.31

6.23 15.84 9.59 31.66 –

Data resource: Figures based on data presented in The China Statistical Yearbook 2004, 2005.

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B. Gains Through Trade Export volume from the Delta also increased rapidly from 1991 to 2004. (See Table 20.5.) For the period, the average annual growth in export volume climbed by just under 25%, or 7% more than the national average. During the end of this span, from 2000 to 2004, export growth reached a dizzying pace: 35% per annum, besting the remarkable national average by 10%. The net growth of exports equaled 155 billion dollars—or about 1,300 billion yuan—in 2004. Almost 70 billion dollars of the growth in trade came to the Delta. This is just over 45% of the national total. Betweeen 1990 and 2004 the Delta’s share of national exports exploded, moving from 16.84% and ending at 36.94%. Total trade volume in 2004 reached more than 416 billion dollars. The region’s success in meeting the challenge of globalization demonstrates its competitive savvy as well as its openness to engage the world. Table 20.5: The growth in exports from the Delta (Billion USD, %) Year

Shanghai

Jiangsu

Zhejiang

Total

Percent

1990 1995 2000 2001 2002 2003 2004

5.321 11.577 25.354 27.628 32.055 48.482 73.520

2.944 9.782 25.770 28.878 38.480 59.140 87.497

2.189 7.698 19.443 22.977 29.411 41.595 58.146

10.454 29.057 70.567 79.483 99.946 149.217 219.163

16.84 19.53 – 29.86 30.70 34.05 36.94

Data source: China Statistical Yearbooks, State Statistical Bureau, Beijing.

C. Urban and Rural Development The Delta has long been highly urbanized. Besides Shanghai, China’s largest city, other well known cities dot the Delta: Nanjing, Hangzhou, Suzhou, Wuxi, Changzhou, Zhenjiang, Yangzhou, Xuzhou, Lianyungang, Ningbo, Wenzhou, Huzhou, Jiaxing, Shaoxing, and Jinhua. No other region has a higher concentration of cities. Economic growth has accelerated the process of urbanization. From 1990 to 2004, the percentage of the Delta’s non-agricultural population jumped from 24.58% to 44.17%, or 3.4% higher than the national national average. The ratio of employees holding their first industrial job to the labor pool dropped from 46.17% to 30.38%, a full 16.5% below the national average. (See Table 20.6.)

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tian boping Table 20.6: Urbanization in the Delta (thousand persons, %)

City

Shanghai Jiangsu Zhejiang The Delta

Year

NonTotal Total Agricultural agricultural Percent Population Employees workers Population

Percent

1990 2004 1990 2004 1990 2004 1990 2004

12833.5 13523.9 67669.0 74325.0 42349.1 45772.2 122851.6 133621.1

11.08 8.04 48.89 37.40 53.17 26.12 46.17 30.38

8644.6 10976.0 14589.4 35809.8 6967.8 12240.6 30201.8 59026.4

67.36 81.16 21.56 48.18 16.45 26.74 24.58 44.17

7877.2 8368.7 35691.3 44825.2 2554.46 29919.5 69113.1 83113.4

872.5 672.9 17451.2 16764.6 13582.8 7814.9 31906.5 25252.1

Data sources: China compendium of statistics, 1949–2004; Shanghai Statistical Yearbook 2005; Jiangsu Statistical Yearbook 2005; Zhejiang Statistical Yearbook 2005.

Sixteen cities in the region contain more than one million persons; eight of these were larger than two million people. One-fourth of China’s mega-cities—those with populations of over 2 million—were located in the Delta, making the region one of the “top six megalopolis groups”3 in the world. By almost any measure economic growth and prosperity in the Delta leads the nation. (See Table 20.7.) As of 2005, in a comparison of competitiveness, Shanghai ranks first, and Hangzhou, Ningbo, Suzhou, Wuxi rank fifth, sixth, seventh, and eighth, respectively; that is, half of the ten most competitive cities in the country are located in the Delta. Both the Pearl River Delta and the Beijing-Tianjin-Tangshan regions have only two cities each on the list. Of the top fifty such cities, eleven are in the Delta, as compared to six and four in the Pearl River Delta and the Beijing-Tianjin-Tangshan region.

In 1989, the world-renowned geographer Jean Gottman pointed out that the Delta, centered on Shanghai, is the sixth megalopolis group in the world; the other five being the cluster of cities of the American northeast Atlantic Coast Megalopolis Group, the North American Great Lakes Megalopolis Group, Japan’s Pacific Coast Megalopolis Group, the European Northwestern Megalopolis Group, and the London Megalopolis Group. 3

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Table 20.7: The concentration of large cities in the Delta, by province (Unit: City) City Shanghai Jiangsu Zhejiang Total

Total

Over 4 million

2~4 million

1~2 million

0.5~1 million

Countylevel cities

1 40 33 74

1 1 1 3

– 4 1 5

– 5 3 8

– 3 6 9

– 27 22 49

Data source: Shanghai Statistical Yearbook 2005; Jiangsu Statistical Yearbook 2005; Zhejiang Statistical Yearbook 2005.

At the same time, rural and small town construction and improvement have created a thriving economy outside of the cities. Of the top 100 counties as of 2004, 46 were in the Delta, compared to only 15 and 21 in the Pearl River Delta and the Bohai Rim Region—which includes Beijing. Among the top 10 on the list, the Delta region shows its dominance by placing eight counties on the list: Kunshan, Jiangyin, Zhangjiagang, Changshu, Xiaoshan, Wujin, Shaoxing, and Taicang. In fact, Kunshan ranks first overall. The list is rounded out by two counties in the Pearl River Delta. The Delta dominates the top 20 as well: 15 of the 20 counties are in the region. D. Vastly Improved Living Standards Household income has surged on the wave of economic growth. Per capita disposable income grew from 1,859 yuan in 1990—a figure 23.1% higher than the national average—to 13,904 yuan in 2004, which outpaced the national figure by 47.6%. Per capita income for urban dwellers in Shanghai and Zhejiang reached about 16,000 yuan and 14,000 yuan, respectively. In contrast, their rural counterparts’ per capita disposable income started at 1,216 yuan in 1990—or 77.2% higher than rural dwellers nationally—reaching 6,062 yuan in 2004, or more than double that of persons living in rural areas in the rest of the country. (See Table 20.8.) During these years the Engel’s coefficient4 of urban residents decreased dramatically. (See Table 20.9.)

4 The Engels coefficient is the ratio of household expenditures on food to non-food items. It provides a measure of prosperity and expanding household consumption.

280

tian boping Table 20.8: Increases in per capita income in the Delta, 1990 to 2004 (RMB) Shanghai

Year

1990 1995 2000 2004

Jiangsu

Zhejiang

The Delta

Urban Rural Urban Rural Urban Rural Urban Rural Residents Residents Residents Residents Residents Residents Residents Residents 2182 7172 11718 16683

1665 4246 5565 7337

1464 4634 6800 10482

884 2457 3595 4754

1932 6221 9279 14546

1099 2966 4254 6096

1859 6009 9266 13904

1216 3223 4471 6062

Data Resource: Shanghai Statistical Yearbook 2005; Jiangsu Statistical Yearbook 2005; Zhejiang Statistical Yearbook 2005.

Table 20.9: Engel’s coefficients for persons living in the Yangtze River Delta region (%) Shanghai Year 1990 1995 2000 2004

Jiangsu

Zhejiang

Urban Rural Urban Rural Residents Residents Residents Residents 56.5 53.4 44.5 36.4

46.4 44.3 44.0 34.6

55.5 51.9 41.1 40.0

52.3 54.8 43.5 44.2

Urban Residents

Rural Residents

55.1 47.0 39.2 36.2

46.1 50.4 43.5 39.5

Data Resource: Shanghai Statistical Yearbook 2005; Jiangsu Statistical Yearbook 2005; Zhejiang Statistical Yearbook 2005.

Other indicators of prosperity abound. In 1990, per capita savings deposits in Shanghai, Jiangsu, Zhejiang were 1,965 yuan, 696 yuan, and 183 yuan respectively; by 2004, savings had increased to 51,472 yuan, 11,925 yuan and 16,134 yuan. In 1990, the average household in Jiangsu and Zhejiang occupied 20.5 m2 and 21.4m2 respectively; by 2004, these figures had jumped to 31.9 m2 and 37.6 m2. Shanghai’s rural residents enjoyed an even steeper increase in their living spaces, moving from 37.08 m2 in 1990 to 59.84 m2 in 2004. By the end of 2004 Delta residents owned 72.3 home telephones and 51.3 mobile phones per 100 residents. Home consumer goods soared as well: Delta residents owned 137.5 color TV sets and 48.8 computers per 100 homes. Even big ticket consumables, typically automobiles, enjoy burgeoning demand.

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281

II. The Delta Faces New Challenges A. Mounting Environmental and Resource-Constraint Pressures Economic development has two faces. On one hand, it improves people’s living standards, providing greater creature comforts and opportunities for personal development; on the other, the growth it generates requires vast resources, and can push population growth to the limits of environmental and infrastructural carrying capacity. With its high population density and lack of readily available energy resources, the Delta region has found itself caught in a dilemma over how to address these competing forces. 1. Ecological Conditions are Grim Since the 1990s, local governments in the Delta have given increasingly greater attention to environmental protection. In 1992, Shanghai invested 1.52 billion yuan in environmental protection; by 2004 the figure had soared to 22.54 billion yuan. The total amount represents an increasing share of output: 1.4% in 1992 and 3.03% in 2004. The shift in Zhejiang is even greater: in 1998 the province spent 0.713 billion yuan on environmental efforts, and in only six years the number climbed to more than 21 billion yuan, close to a 3000% increase. During these years environmental protection absorbed a greater percentage of output, moving from .14% to 1.87%. These large increases have produced substantive impacts. For example, industrial soot emissions in Zhejiang’s fell from 0.33 million tons in 1999 to 0.21 million tons in 2004. The volume of industrial dust emissions decreased from 0.69 million tons to 0.33 million tons in the same period. Meanwhile, in Shanghai the volume of industrial wastewater discharged had declined from 85,200 tons to 61,100 tons. The rate of industrial wastewater meeting environmental standards increased at the same time: from 89.9% to 94.9%. The comprehensive utilizaion radio of industrial waste residue grew to 97.2% from 91.9% during these years. In spite of these gains, the Delta region faces severe environmental problems caused by industrializatoin. Growth has come at a particularly high price in four categories: water pollution, air pollution, noise pollution, and solid waste pollution. From 1999 to 2004, Shanghai’s output of wastewater and soot remained dangerously high, sulphur dioxide emissions increased 17.4%, while other gas emissions ballooned by

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72.7%. (See Table 20.10.) Note that the volume of industrial wastewater increased 31.0%, the volume of industrial gas emissions increased 46.9%, and the volume of industrial sulphur dioxide emissions increased 32.9%. (See Table 20.10.) Table 20.10: Waste emissions in Shanghai, 1999 to 2004 (1000 tons, unless noted otherwise) Year

Wastewater discharge

1999 2000 2001 2002 2003 2004

202.8 193.7 195.0 192.1 182.2 193.3

Gas Sulphur Industrial Hazardous Soot Trash emissions dioxide solid Waste emission 3 (Billion m ) emission waste 548.0 639.8 762.0 790.2 839.1 946.6

135.7 141.2 135.2 107.4 115.4 122.7

403.1 464.9 472.6 446.6 435.4 473.1

– 13547.4 16050.9 15952.5 16593.8 18108.0

– 283.2 381.4 335.0 305.7 364.7

7670 8580 9010 7600 8000 8020

Data source: Shanghai Statistical Yearbook(s).

Table 20.11: Waste emissions in Jiangsu, 1999 to 2004 (1000 tons, unless noted otherwise) Year

Wastewater discharge

Gas emissions (Billion m3)

Soot emission

Sulphur dioxide emission

Industrial solid waste

Hazardous Waste

1999 2000 2001 2002 2003 2004

2.011 2.019 2.710 2.627 2.475 2.635

835.4 907.8 1334.4 1428.6 1463.3 1781.8

421.7 374.7 408.1 384.8 387.8 415.1

932.9 843.3 1087.6 1119.7 1240.7 1239.9

28960 30380 35530 37960 38940 46730

– – – 973.7 854.8 858.1

Data source: Jiangsu Statistical Yearbook(s).

Table 20.12: Waste emissions in Zhejiang, 1999 to 2004 (1000 tons, unless noted otherwise) Year 1999 2000 2001 2002 2003 2004

Wastewater Gas emissions Soot discharge (Billion m3) emission 1.922 2.133 2.426 2.591 2.703 2.813

541.7 650.9 853.0 853.2 1043.2 1174.9

Data source: Zhejinag Statistical Yearbook(s).

330 250 230 190 180 210

Sulphur Particulate dioxide emissions emission 610 610 560 590 710 790

690 490 460 330 280 330

Industrial solid waste 13610 13860 16030 17780 19760 23180

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283

From 1999 to 2004, wastewater discharge, gas emissions, and sulphur dioxide emissions have increased 46.4%, 116.9% and 29.5%, respectively (See Table 20.11.) Because of the large volume of gas emissions, acid rain is common. In 2003, 84.3% of the rainfalls in Jiangsu were acidic. Cities across the Delta experience moderate to severe acid rain: 14 cities experience “heavy” acid rain, another 18 fall into the middle rank, and no city in the region is relatively free of acid rain. Accounting to the World Bank, 20 Chinese cities made the list of the 30 most air polluted cities in the late 1990s. One of these was Shanghai (See Table 20.13); however, most cities in the Delta did not experience air pollution as severe as Shanghai’s.5 Table 20.13: Comparisons of atmospheric pollution between Shanghai, Beijing, and various large cities (mg/m3) Indexes5 Shanghai Beijing Paris Berlin Tokyo TSP SO2 NO2

246 53 73

377 90 122

14 14 57

50 18 26

49 18 68

Seoul

Brussels

Singapore

84 44 60

78 20 48

– 20 30

Data resource: World Bank: World Development Indicators 2002; data on Beijing comes from The China Financial Economic Publishing House.

Water pollution figures are alarming as well. The waterways around Taihu Lake, which is on the Zhejiang-Jiangsu border, had 21 monitoring points in 2004 providing data on water conditions. 57% reported SubGrade V, meaning that the water was totlaly unusable; 24% reported Grade V levels, and 19% of them reported Grade IV water quality. No stations reported water quality of Grade I, II, or III. 61.4% of the monitoring stations indicated that at least moderate eutrophication had taken hold. Among the 88 monitoring points in Taihu Lake, only 1.1% attained Grade II, 12.6% achieved Grade III, 28.4% met Grade IV, 15.9% fell into Grade V, and a frighteningly high 42% landed in the Sub-Grade V category. In 2000, 58.5% of the water in Zhejiang qualified as Grade I or II; by 2003 the figure had fallen off to 31.6%. Furthermore, the proportion of Sub-Grade V and Grade V water increased from 11.7% to 23.4%. (See Table 20.14.)

5 TSP indicates the concentration of total suspended particles; SO2 is sulfur dioxide, NO2 nitrogen dioxide.

284

tian boping Table 20.14: Main environment indexes in Zhejiang, 1996–20036

Main indexes

1996

1997

1998

1999

2000

2001

0.03 0.028 0.023 0.017 0.015 0.018 SO(mg/m3) 0.033 0.033 0.031 0.035 0.037 0.032 NO(mg/m3) 74.2 76.1 71.3 74.3 78.4 32.4 Grade I–III water, % 56.6 52.1 55.5 54.4 58.5 45.3 Grade 1–II water,% Grade V & V- water, %6 10.4 10.5 11.1 11.7 11.7 21.8 67.8 75.5 56 56 55 Acid rain frequency (%) 45 4.7 4.55 4.8 4.81 4.75 4.79 Average PH of rainfall

2002 2003 0.012 0.027 66.4 37.6 23 83.7 4.48

0.02 0.03 62.6 31.6 23.4 84.3 4.5

Data source: Association of Science and Technology in Zhejiang: Report on economic resources and the environmental system in Zhejiang during the 11th Five-Year Plan.

2. Energy Shortages and Resource Scarcity The Delta cannot meet its resource needs using local sources so it must rely on imports. Because of this, supplies cannot be guaranteed. Shanghai is acutely vulnerable since it relies on outside sources for virtually 100% of its energy needs. However, conservation efforts and improvements in achieving production efficiencies have bettered conditions to some degree. From 1992 to 2004, the energy consumption per 10,000 yuan of output decreased from 3.28 tons of coal equivalent to 1.03 tons; energy consumption per 10,000 yuan gross industrial output decreased from 1.20 tons of coal equivalent to 0.33 tons. However, gross consumption continues to increase. In 1992, total energy consumption was 36.6 billion tons of coal equivalent and by 2004 had nearly doubled to 72.7 billion tons. Onefifth of Shanghai’s total transport capacity was devoted to transport of energy resources (mostly coal). It is estimated that Shanghai’s demand for energy in 2010 will exceed 100 billion tons of coal equivalent. This will place tremendous strains on supply, energy transport systems, and the environment.7 (See Table 20.15.) Jiangsu and Zhejiang face similar situations (See Tables 20.16 and 20.17). In 2000, the energy consumption per 10,000 yuan output value was 10.03 tons of coal equivalent and declined to 8.88 tons by 2003. Nevertheless, the total consumption of energy has continued to increase.

V- Indicates Sub-Level V water quality. “To develop a world-class city—Shanghai: the 11th Five-Year developmental planning study,” edited by Wang Ronghua. Shanghai Academy of Social Sciences Publishing House. 6 7

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Table 20.15: Shanghai’s energy consumption, 1990–2004 Year

Energy consumption (Thousand tons of coal equivalent)

Industrial use

1990 1995 2000 2001 2002 2003 2004

31910.6 44658.7 54920.8 58182.8 61185.3 66509.1 72668.5

24622.1 35124.9 37791.3 39231.2 39731.5 43052.2 45151.4

Power Industrial consumption use (billions of kwh) 26.474 40.327 55.942 59.299 64.571 74.597 82.140

22.097 30.701 39.313 41.333 44.746 50.700 55.508

Data source: Shanghai Statistical Yearbook, 2005.

From 1995 to 2003, consumption of coal, crude oil and fuel oil climbed by 93%, 65.9%, and 63.4%. From 1995 to 2004 energy consumption in Zhejiang more than doubled. Even with planned conservation efforts taking hold, projected energy consumption is expected to reach 150 billion tons by 2010. Given this and similar trends in Shanhai and Jiangsu, the total for the Delta is expected to reach 430 billion tons of coal equivalent in 2010. While economic growth continues to drive this process, inefficiency is also at work, as can be seen in comparisons with developed countries. For instance, energy consumption of per unit of GDP is six times greater in Jiangsu and Zhejiang than in Japan. It is three times the rate of the UK, 1.8 times Korea’s per GDP consumption, and double Taiwan’s. Table 20.16: Jiangsu’s energy consumption, 1995–2004 Year

Coal Consumptionl (1000 tons)

Crude oil Consumption (1000 tons)

Fuel Oil Consumption (1000 tons)

Electric power consumption (billions of kwh)

1995 2000 2001 2002 2003 2004

59804.5 82439.7 89010.6 100564.4 115426.6 –

10275.2 13835.9 13127.6 14225.2 17050.2 –

1222.7 1650.3 1520.6 1735.1 1997.4 –

69.859 97.134 107.844 124.514 150.512 182.009

Data source: Jiangsu Statistical Yearbook, 2005.

286

tian boping Table 20.17: Zhejiang’s energy consumption, 1995–2004

Year

Total energy consumption (1000 tons of coal equivalent)

Electric power consumption (billion kwh)

Energy consumption per unit production value (tons/thousand yuan)

Elasticity coefficient of energy consumption

1995 2000 2001 2002 2003 2004

42315.7 58628.0 64204.0 71058.6 80858.6 92090.0

43.959 74.289 85.529 101.584 124.035 141.953

0.1201 0.0971 0.0951 0.0911 0.0861 0.0819

0.45 0.89 0.91 0.85 0.96 0.94

Data source: Zhejiang Statistical Yearbook, 2005.

Among the various resources needed for economic development, land is perhaps the most fundamental. In many ways, land constraints are the most inflexible of all resource constraints: land cannot be imported, manufactured, or readily expanded. Unfortunately the Delta’s stock of arable land has declined by 340.3 thousand hectares between 1996 to 2004, or about 5% of the Delta’s total arable land (See Table 20.18.) Counties in the Delta experienced varying degrees of decline from 1999 to 2004: 15.14% in Suzhou, 13.17% in Wuxi, 10.94% in Nanjing, and 17.09% in Changzhou. Given these substantial declines, it is clear that development and sustainability are in conflict. Table 20.18: Losses of arable land in Jiangsu, Zhejiang, Shanghai, 1996–2004 (1000 hectares) Jiangsu Year 1996 2004

Zhejiang

Arable land at Net year’s end decrease 5061.70 4795.19

– 266.51

Shanghai

Arable land at year’s end

Net decrease

1613.78 1594.92

– 18.56

Arable land Net at year’s end decrease 300.6 245.7

– 54.9

Data source: Zhejiang Statistical Yearbook, 2005; Jiangsu Statistical Yearbook, 2005; Shanghai Statistical Yearbook, 2005.

3. Environmental Impact Caused by High Population Density The rapid increase in economic growth, which included the rapid growth of laborintensive industries, attracted vast numbers of workers to the Delta region. Many new workers are part of a large and growing migrant labor pool. In 2001 there were 3,871,000 migrant laborers in Shanghai; by 2004 the number had expanded to 5,362,000. Roughly 500,000 persons join this

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migrant labor pool annually. These persons are moving into an already heavily populated area: Shanghai’s population reached 17,421,500 by 2004, ranking it fifth in the world behind Tokyo, Seoul, Mexico City, São Paulo, and New York. Population density in the central district exceeds 40,000 per km2, or twice the density found in New York’s or Paris’s central districts, and triple the density of Tokyo. Jiangsu’s southern section, the center of an international manufacturing base, also attracts a large migrant labor force. For instance, Suzhou’s population is about six million, but this does not include the three million migrant workers in the city. In Kunshan, the migrant labor force of 750,000 exceeds the local population of 600,000. Other cities in Zhejiang, such as Hangzhou, Ningbo, Wenzhou, Shaoxing, Yiwu, also have large migrant populations. The World Bank’s publication World Development Indicators 2002—which presents statistics and facts about development and the environment— points out that the main reason for environment damage is dramatic population growth. Traditional land and resource management systems lag behind changing resource demands, in particular the need to develop processes to more effectively allocate resources and to develop infrastructure in reponse to population growth. Intensifying population density heightens these challenges while sharpening environmental pressures.8 Increasing population in the Delta produces a number of related problems: reaching the constraints of environmental carrying capacity, overtaxed urban infrastructure—including dramatically worse traffic (which adds to various forms of environmental pollution), social problems, and a general erosion in the quality of life. B. Unsustainable Economic Growth Economic growth can manifest itself in various ways, generally proceeding along two dimensions: extensiveness and intensiveness. The former depends on making vast investments in production, while the latter mostly depends on achieving efficiency improvements, which are usually realized by changing production techniques and improving worker productivity and skill levels. The Fifth Plenary Session of the 14th Central Committee of the Chinese Party of China in 1995 put

8 World Bank: 1992 World Development Report: Development and Environment (Beijing: China Financial and Economic Publishing House, 1992).

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forward the theory of “two essential transformations” to address these needs. The first part of the dictum calls for a transformation from a planned or socialist economic system to a market economy; the second aspect of the program calls for the transformation from growth based on extensiveness—i.e., growth—to one which operates more intensively; that is, production which realizes substantial efficiency gains and higher value ouptuts. In the Delta, both aspects of this this transformation have begun showing measureable improvement, but intensifying growth remains unfinished. incomplete. 1. Decreasing Investments Economic growth in the Delta depends on increasing investment (See Table 20.19.) Statistics show that from 1992 to 2004 investment’s contribution to the economy equalled 46.61% in Shanghai, 50.34% in Jiangsu, and 49.60% in Zhejiang. Investment typically contributes 20–30% to an economy, with consumption playing the dominant role, usually contributing over 70% to output.9 Table 20.19: Contributions of consumption, investment, and exports to output, 1991–2004 (%) Year 1992–1995 1996–2000 2001–2004 1992–2004

Shanghai

Jiangsu

Zhejiang

C

I

X

C

I

X

C

I

X

44.36 41.30 48.94 44.59

75.33 23.22 47.13 46.61

–19.69 35.48 3.93 8.80

37.44 40.90 46.06 41.42

53.22 44.69 54.52 50.34

9.47 14.41 –0.58 8.24

34.02 50.38 43.19 43.13

60.42 37.55 54.81 49.90

5.56 12.08 2.00 6.79

Data source: Calculations based on data taken from the Zhejiang Statistical Yearbook, 2005; Jiangsu Statistical Yearbook, 2005; Shanghai Statistical Yearbook, 2005.

In recent years, the productivity of investments in the Delta has changed. From 1992 to 1995, the average input-output coefficients (IOC)—the ratio of the growth rate of fixed asset investments divided by the growth rate of gross output—in Shanghai was 1.99. In other words, for every 1% increase in gross output, fixed asset investments would grow by 1.99%. The input-output coefficients for the years 2001

9 In 2000, the average values across the world were household consumption 61 per cent of GDP, governmental consumption 17 per cent, investment 22 per cent. Refer to World Bank’s “2002 World Development Indicators” (Beijing, China Financial and Economic Publishing House, 2004).

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to 2004 averaged 2.7. Efficiency increased in both Jiangsu and Zhejiang in this period. Jiangsu improved from 1.70 to 1.51; Zhejiang moved from 2.14 to 1.90. Another important investment indicator is the incremental capitaloutput ratio (ICOR). This ratio measures the productivity of capital and is defined as 1/the marginal product of capital. From 1992 to 1995, Shanghai’s ICOR averaged 2.24; the average for 2001 to 2004 equaled 3.56; meanwhile, the indicators in Jiangsu and Zhejiang increased to 3.04 and 3.43 form 1.36 (See Table 20.20.) Table 20.20: Productivity of investment in the Delta by province, 1992–2004 Year 1992–1995 2001–2004

Shanghai

Jiangsu

Zhejiang

IOC

ICOR

IOC

ICOR

IOC

ICOR

1.99 2.70

2.24 3.56

1.70 2.14

1.36 3.04

1.51 1.90

1.36 3.43

Data source: Calculations based on data taken from the Zhejiang Statistical Yearbook; Jiangsu Statistical Yearbook; Shanghai Statistical Yearbook.

The Delta attracted a great deal of foreign direct investment (FDI). 25% went into fixed asset investments in Jiangsu; Shanghai and Jiangsu took in about 20% each. In the past ten years, information technology (IT) has been a magnet for foreign investment. However, this wave seems to have crested and broken, leaving the way clear for “the next big thing.” Governments in the region have pinned their hopes to the service industry. However, the service industries differ from manufacturing in that they depend much more on local consumption, and generally require business strategies that go beyond establishing and maintaining cost leadership, China’s competitive advantage until now. This creates serious challenges: domestic demand cannot begin to compare to foreign demand, developing new business strategies will take time, and persuading foreign investors of the potential benefits of investing in this shift will take considerable effort. Moreover, macroeconomic factors will influence foreign investors as well. Rapidly increasing housing prices, land costs, and wages could throw the whole process into question. Underscoring this is the fact that the effective utilization of foreign investment declined during 2004–2005.

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2. Inadequate Attention Paid to Innovation The general level of investment in resarch and devleopment (R&D) is lower than in developed countries. Developed economies general spend 3% of GDP on R&D. China spents a much smaller percentage in general and the Delta region is no exception. R&D expenditures equal 2.29% of output in Shanghai as of 2004, but this is a marked improvement over the previous year’s proportion of only 1.78%. Still, Shanghai vastly outpaces its neighbors in the Delta. For instance, Jiangsu spent 1.38% of output on R&D in 2004, up from only 0.97% in 2003. Total government expenditures at the county level and above amounted to 1.191 billion yuan in Jiangsu and 0.804 billion yuan in Zhejiang, or 0.68% and 0.76% of government revenues in each province (See Table 20.21). Private firms did little better. The ratio of R&D investment to total revenue for Shanghai’s large- and mediumsized enterprises was 1.24%; the ratios in Jiangsu and Zhejiang were 0.78% and 0.70%. Note that this falls well short of the 3–5% proportion spent by most multinational corporations. (See Table 20.22.) Table 20.21: Government R&D expenditures in Shanghai and Jiangsu (Billion RMB, %) 2001

2002

2003

2004

City

R&D outlays

% of revenues

R&D outlays

% of revenues

R&D outlays

% of revenues

R&D outlays

% of revenues

Shanghai Jiangsu

8.808 92.07

1.78 0.97

10.236 10.909

1.89 1.03

12.892 15.046

2.06 1.21

17.028 21.398

2.29 1.38

Data source: Shanghai Statistical Yearbook(s) and Jiangsu Statistical Yearbook(s).

Table 20.22: New products and R&D in Jiangsu, Zhejiang, and Shanghai (Billion RMB, %)

Shanghai Jiangsu Zhejiang

Year

Total revenue

2002 2004 2002 2004 2002 2004

549.008 818.047 724.707 1485.831 345.643 929.515

R&D Ratios of Gross Ratios of new Value outlays R&D outlays industrial products’ value of new on new to total output to output value products products revenue (%) value (%) 6.081 10.113 6.305 11.590 2.419 6.520

1.11 1.24 0.87 0.78 0.70 0.70

552.961 825.645 736.084 1510.193 321.32 933.083

107.033 144.217 126.354 174.513 – –

19.36 17.47 17.17 11.56 – –

Data source: 2003 Shanghai Statistical Yearbook, 2005 Shanghai Statistical Yearbook, 2003 Jiangsu Statistical Yearbook, 2005 Jiangsu Statistical Yearbook, and 2003 Zhejiang Statistical Yearbook, and 2005 Zhejiang Statistical Yearbooks.

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The reader should note that the majority of investment expenditures enumerated above were made by foreign-owned enterprises. In 2004, R&D outlays on new products among Shanghai’s medium and largesized enterprises equaled 10.114 billion yuan; foreign-held firms contributed 8.112 billion of this total, or about 80%. About 58,600 people worked in R&D; 31,200—about 53%—worked for foreign-owned establishments. Over half of the R&D expenditures made in Jiangsu went toward electronics manufacturing, including communications and computer equipment; 90% of these enterprises were foreign-owned. Clearly, the capacity of innovation among domestically controlled enterprises is in doubt. Few such enterprises control valuable independent intellectual property. Most do not have the capacity for developing it. Investments designed to introduce new manufacturing techniques and assuring their adoption amounted to about 5.5 billion yuan in Shanghai and Jiangsu, while Zhejiang lagged far beyond with well under one billion yuan being devoted to such efforts. Chinese firms invested a much smaller percentage of revenues went toward R&D and investments in process improvements than their Japanese and Korean counterparts. The Delta has become an important production base for international manufacturers, especially in the high-tech industries. Firms in the region have focused on improving production techniques in producing telecommunications equipment, computers, integrated circuit (IC) die, automobiles, and petrochemical goods. However, much of the equipment and expertise involved comes from abroad. From 2000 to 2004, 59.587 billion yuan of equipment flowed into businesses operating in the Delta; Shanghai dominated this sum with 30.871 billion yuan. Jiangsu took in 22.575 billion yuan worth of equipment and Zhejiang enjoyed 6.141 billion yuan worth of equipment inflows. Multinational corporations (MNCs) have moved much of their manufacturing capacity to the region. Operations in the Delta have largely taken on labor-intensive work, such as machining, assembly work, and other basic manufacturing functions. This kind of work has poured into developing countries, including China because MNCs want to gain access to large supplies of low-wage labor. However, capital and technology-intensive activities, such as R&D, design, and intellectual property development, remain in developed countries and closer to corporate headquarters. So even though the Delta has grown rapidly, attracted vast sums of FDI, and now plays an increasingly important role in the international industrial system, it still dominates the lowervalue part of the system. While the large, productive and inexpensive labor pool will continue to draw capital to the region, it traps workers

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and firms in production that has low value-added. High efficiency, high wage, and highly innovative work remains out of reach. 3. Economic Changes Affecting China’s Role as a Cost Leader Cost leadership has allowed the Delta to enjoy rapid economic growth in recent years. However, rising input prices are undermining this position. Global oil prices have soared as well as various raw material prices. Both raise prices of a wide range of other goods, but do not cut into China’s competitive advantage since firms in other countries must pay similar prices. However, increasing labor costs, changing controls on land ownership and development, and various macroeconomic policies have nudged costs upward in China vis-à-vis its competitors. (See Table 20.23). From 2000 to 2004, the wages of urban workers have doubled in Zhejiang; wages in Shanghai increased 58% and in Jiangsu 77%. Even with these increases, wages remain insuffient to attract enough migrant laborers to jobs in Zhejiang and South-Jiangsu; firms find themselves in a new double-bind. Such trends have some experts saying that the demand peak for Chinese labor may well be past; the labor market is moving from one based on limitless supply to a condition of “limited surplus.” Another key input, land, is becoming costlier, as supplies of the most suitable land grow tighter. Between 2002 and 2004, the land in the Delta appreciated by more than 70%; because it was already more built-out, land prices went up in Shanghai by “only” 50%. Prices for basic inputs such as raw materials, fuel, and energy increased as well. In 2004 alone, the price for these goods increased more than 15% in the region. These price increases seem likely to continue. Early indications suggest this will be the case: at the beginning of 2005 petroleum and raw materials prices rose to unprecedented levels. In only a few months during 2005, petroleum prices jumped from less than 50 dollars to 70 dollars in this period. 4. Emerging Sectoral Tensions (See Tables 20.24–20.26) Economic development generates growth and diversification of economic activity as well. Experience shows that when industrialization reaches a certain threshold, it goes beyond relying heavily on one or two leading industries and makes room for the development of a third major industry as a substantial contributor to output. In the Delta this third industry is the service sector. However, its development defies the received wisdom; in recent years it has contributed a dwindlnig percentage to output. In

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Table 20.23: Rising input prices, 2000–2004 (%) City

Project

2000

Average wage Real estate price index Shanghai Materials, fuel & power index Average wage Real estate price index Zhejiang Materials, fuel & power index Average wage Jiangsu Materials, fuel & power index

2001

2002

2003

2004

15,420 17,764 19,473 22,160 98.6 104.4 107.3 120.1

24,398 115.9

107.1

106.4

116.4

12,414 15,770 18,277 20,853 – – 111.3 112.7

23,101 115.2

107.2

105.8

113.4

10,299 11,842 13,509 15,712

18,202

107.1

116.3

98.7

99.6 99.5

97.7

97.5 98.6

106.5

Note: These calculations take the previous year’s data as 100 for price index Data resource: Shanghai Statistical Yearbook 2005, Jiangsu Statistical Yearbook 2005 and Zhejiang Statistical Yearbook 2005.

Shanghai, the service sector’s contribution to output fell from 51% to 37.9%, in Jiangsu from 37.4% to 35.0%, and in Zhejiang from 40% to 39%. Note that in the US, the service sector made up 78.24% of output in 2000; in the EU the proportion equaled 69.71%. While the small declines in China may be a statistical hiccup, these statistics underscore the continuing robustness of growth in manufacturing in the Delta. Table 20.24: Contributions to output by economic sector, 1992–2004 (%) Year 1992 1995 2000 2001 2002 2003 2004

Shanghai Industry Services 60.8 57.3 47.6 47.6 47.4 50.1 50.8

36.1 40.2 50.6 50.7 51.0 48.4 47.9

Jiangsu Industry Services 52.4 52.7 51.7 51.6 52.7 54.5 56.5

29.2 30.9 36.3 37.0 37.4 36.6 35.0

Zhejiang Industry

Services

47.9 52.0 52.7 51.7 51.1 52.6 53.8

32.9 32.1 36.3 38.4 40.0 39.7 39.0

Data source: Shanghai Statistical Yearbook 2005, Jiangsu Statistical Yearbook 2005, and Zhejiang Statistical Yearbook 2005.

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tian boping Table 20.25: Structural changes in the service sector in Shanghai, 2001–2004 (Billion RMB, %)

Year

2001 2002 2003 2004

Valueadded in services 250.981 275.583 302.711 356.534

Transport and Shipping

IT and software

Valueadded

%

Valueadded

%

Valueadded

%

Value-added

%

24.289 25.856 27.258 32.492

9.68 9.38 9.00 9.11

15.924 19.410 22.847 26.099

6.34 7.04 7.55 7.32

61.999 58.467 62.474 74.168

24.70 21.22 20.64 20.80

31.685 37.363 46.393 62.259

12.62 13.56 15.33 17.46

Finance

Real estate

Data resource: Shanghai Statistical Yearbook 2005.

Table 20.26: Structural changes in the service sector in Jiangsu, 2001–2004 (Billion RMB, %)

Year

Valueadded in ervices

2001 352.202 2004 542.665

Transport and Shipping Valueadded

%

64.487 18.31 97.382 17.95

Finance

Science, R&D, and IT

Valueadded

%

Valueadded

%

45.064 63.288

12.79 11.66

10.664 18.008

3.03 3.32

Real estate Valueadded

%

39.375 11.18 66.94 12.34

Data source: Jiangsu Statistical Yearbook 2005.

Development of a robust service sector is one of the benchmarks of economic modernization, yet growth in the sector has stalled recently. Comparing data from 2001 to that of 2004, the breadth of the decline in services’ contribution to outupt becomes clearer. The contribution to output from financial services decreased from 24.7% to 20.8% in Shanghai and from 12.9% to 11.7% in Jiangsu. During these years transportation and shipping services made a lesser contribution to output—a particularly suprising outcome given the growth in exporting activity in the Delta. The small increase in the contribution of information, scientific research, and technical services to output did little to offset losses in other services. The one service segment to show robust growth was real estate, which increased its share of output from 12.6% to 17.5% in Shanghai; given the shortage of land in Shanghai, this reflects tightening supplies and increasing prices in the sector. Even though the Delta’s economy has been integrated into the international economy, it largely operates within relatively low-skill and low-value-added parts of the value chain: mass production of component parts and parts assembly. Because of China’s huge labor

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pool, it can continue to offer price leadership in these functions, but by emphasizing this role, the development of true technical or process innovations remains out of reach. Even though the number and size of establishments in the Delta has grown rapidly in recent years, these firms continue to operate in a low-value segment of the value chain. Even as industries in the Delta have grown rapidly in recent years, value-added has grown far more slowly. (See Table 20.26.) For instnace, the electronic communications industry has been the fasted growing industrial sector. In 2003, its gross output was 259.577 billion yuan, accounting for one-eighth of industrial output in Jiangsu. This places it number one in terms of gross output; however, value-added just was 61.215 billion yuan, placing it near the bottom of all industrial sectors.10 Table 20.27: Declining industrial value-added in the Delta (Billion RMB, %) Shanghai

Jiangsu

Zhejiang

Year

Gross output

Value- Increment Gross Value- Increment Gross Value- Increment added rate output added rate output added rate

1999 2000 2001 2002 2003 2004

621.3 696.8 765.7 847.6 1126.7 1401.8

175.9 195.7 212.1 231.3 286.6 349.3

28.31 28.08 27.70 27.29 25.44 24.92

891.5 1045.3 1174.8 1386.6 1803.5 2483.7

338.8 384.9 427.1 488.1 600.5 778.2

38.00 36.82 36.35 35.20 33.30 31.33

519.2 660.4 788.3 977.9 1286.4 1872.9

263.0 288.3 313.4 358.0 438.1 538.1

50.66 43.66 39.76 36.61 34.06 28.73

Explanation: the gross industrial output value in Shanghai equals the output of all industrial enterprises, while in Jiangsu and Zhejiang only enterprises with output over-quota could be taken into consideration. However, when calculating value-added, only over-quota firms are considered. Date source: Shanghai Statistical Yearbook(s), Jiangsu Statistical Yearbook(s) and Zhejiang Statistical Yearbook(s).

C. The Pressing Need to Resolve Social Tensions Since moving away from economic policies based on achieving fundamental developmental—providing basic sustenance, shelter, clothing, and livelihood—and pursuing the relatively narrow goal of economic

10 According to the data of “the development of China manufacturing industry and the global adjustment of MNC” from 2005 China economic senior forum report, the increment rate of China’s communication equipment industry was 22 per cent, it was the lowest of all manufacturing industries.

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growth, some aspects of social development have been neglected, which has produced a number of social tensions. 1. The Widening Gap Between the Rich and Poor (See Table 20.28) In 1992, the ratio of per capita disposable income levels between Shanghai’s urban and rural dwellers was 1.35; by 2004 the ratio had increased to 2.27. During these years the ratios in Jiangsu increased from 2.02 to 2.20 and in Zhejiang from 1.93 to 2.39, respectively. In 2000, the top 20% of Shanghai’s urban residents enjoyed per capita income of 19,959 yuan, while the bottom quintile took in only 6,840 yuan. In other words, the per capita income of the top 20% was 229% of those on the opposite side of the income distribution. By 2004 the ratio ballooned to a staggering 487%. In Jiangsu the ratio moved from 220% to 262%; in Zhejiang from 239% to 261%. Based on these figures, it seems that many peasants have largely missed the benefits of economic growth. Survey data gathered in 2004 indicates that individuals who net less than 3,000 yuan annually make up a substantial percentage of the Delta’s population: 7.7% in Shanghai, a whopping 28.0% in Jiangsu, and 18.3% in Zhejiang. This net income figure corresponds to the United Nation’s (UN) definition of poverty-level existence: living on only a dollar a day. Table 20.28: Per capita income disparity between urban and rural residents, 1992–2004 (RMB, %) Shanghai

Jiangsu

Year

Urban residents

Rural residents

%

1992 1995 2000 2002 2003 2004

3,009 7,172 11,718 13,250 14,867 16,683

2,226 4,246 5,565 6,212 6,658 7,337

135 169 211 213 223 227

Urban Rural residents residents 2,138 4,634 6,800 8,178 9,263 10,482

1,061 2,457 3,595 3,996 4,239 4,754

Zhejiang %

Urban residents

Rural residents

%

202 189 189 205 219 220

2,619 6,221 9,279 11,716 13,180 14,546

1,359 2,966 4,254 4,940 5,431 6,096

193 210 218 237 243 239

Date source: Shanghai Statistical Yearbook(s), Jiangsu Statistical Yearbook(s), and Zhejiang Statistical Yearbook(s).

2. The Intensifyuing Imbalance of Development (See Tables 20.29 and 20.30) Rapid growth has centered on Shanghai and the area within 150 kilometers of its central district. Cities outside of this area have developed less quickly. This disparity can been seen in growth figures of these

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smaller cities in comparison to growth in the region. For instance, from 2000 to 2004, Suzhou’s economic output grew precipitously from 154.1 billion yuan to 345.0 billion yuan, yet its share of the Delta’s economy only increased from 7.83% to 9.88%. The monetary gain is 239%; the change in contribution to the regional economy moved just over 25%. Similar outcomes can be observed throughout the region: Wuxi’s share of the regional economy in these years increased from 6.10% to 6.73%; cities like Yancheng and Lianyungang were overtaken by regional economic growth, showing declines in their share of the economy from 2.79% to 2.49% and 1.48% to 1.19% per cent. Benefits and growth have not be equally shared in the region and this has driven income disparaties as well. Table 20.29: Contributions to the Delta economy by city, 2000–2004 (Billion RMB, %) City Nanjing Suzhou Wuxi Changzhou Hangzhou Ningbo Jiaxing Taizhou Wenzhou Xuzhou Lianyungang Yancheng

2000

2004

Output

% of Delta

Output

102.130 154.068 120.017 60.066 138.256 117.575 54.102 67.499 82.812 54.450 29.113 54.859

5.19 7.83 6.10 3.05 7.03 5.98 2.75 3.43 4.21 3.28 1.48 2.79

191.000 345.000 235.000 110.061 251.500 215.800 105.056 117.379 140.257 109.580 41.636 87.136

Changes in % of Delta, 2000 to % of Delta 2004 5.47 9.88 6.73 3.15 7.20 6.18 3.01 3.36 4.02 3.14 1.19 2.49

0.26 2.05 0.63 0.10 0.17 0.20 0.26 – 0.07 – 0.19 – 0.14 – 0.29 – 0.30

Date source: Calculations based on data from the Shanghai Statistical Yearbook(s), Jiangsu Statistical Yearbook(s), and Zhejiang Statistical Yearbook(s).

3. The Underdevelopment of Public Services (See Tables 20.31–20.33) The government should be responsible for providing essential public services, including medical care, public transit, housing, and education, to ensure the basic living standards of its citizens. However, since moving away from an emphasis on developmental fundamentals, public services in the Delta have not kept pace with general economic development. Comparing data from 1995 and 2004 reveals, to some degree, the degree of this problem. Educational expenditures in Shanghai decreased

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Table 20.30: Comparing economic development by cities in 2004 (RMB) City Suzhou Shanghai Wuxi Ningbo Hangzhou Nanjing Changzhou Jiaxing Shaoxing Zhejiang Huzhou Zhoushan Jinhua Taizhou Wenzhou Yangzhou Nantong Taizhou Xuzhou Quzhou Yancheng Lishui Huaian Lianyungang Suqian

Per capita output

Urban residents income

Rural residents income

57,992 55,307 52,825 39,174 38,858 33,050 31,665 61,506 30,254 29,235 22,966 21,855 21,703 21,177 18,846 17,359 15,806 14,014 12,005 11,570 10,928 10,582 9,597 8,891 6,462

14,451 16,683 13,588 15,882 14,565 11,602 12,868 14,693 15,642 10,858 13,487 13,747 13,910 16,113 17,727 9,851 10,937 9,695 9,840 11,477 9,362 11,892 8,209 8,872 6,378

7,503 7,337 7,115 7,018 6,382 5,533 6,235 7,021 6,970 5,306 6,380 6,232 5,018 6,008 6,202 4,677 4,929 4,574 4.021 4,414 4,451 3,321 3,701 3,501 3,474

Date source: Shanghai Statistical Yearbook 2005, Jiangsu Statistical Yearbook 2005, and Zhejiang Statistical Yearbook 2005.

from 14.72% to 11.13% of revenues, and appropriations for medical care declined from 3.59% to 2.28% per cent. Over the same period, Jiangsu’s proportions of revenue invested in these services fell from 20.87 % to 16.34% for education and from 3.80% to 2.51% for medical care. Contrarily, expenditures directed toward infrastructure increased dramatically. In 2004 outlays for medical care in Jiangsu were only 0.36% of outlays spent on fixed assets; in Zhejiang the ratio was better, but still only 0.56%. Comparing expenditures on neighborhood services to spending on fixed assets returns even tinier percentages: 0.21% in Jiangsu and 0.33% in Zhejiang.

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Table 20.31: Percentages of average output spent on medical care and education (RMB) Education

Medical care

Infrastructure

City

Year

Public Outlays

Outlays

%

Outlays

%

Outlays

%

Shanghai

1995 2004

267.89 1,395.69

39.44 155.35

14.72 11.13

9.62 31.76

3.59 2.28

42.26 310.67

15.78 22.26

Jiangsu

1995 2004

253.49 1,312.04

52.91 214.37

20.87 16.34

9.62 32.87

3.80 2.51

18.69 101.22

7.37 7.71

Data source: Shanghai Statistical Yearbook 2005, Jiangsu Statistical Yearbook 2005.

Table 20.32: Increasing medical care and educational expenses (RMB, %) Per capita Medical care sevice expenditures Expenditure %

Housing

Transportation

Education

Expenditure

%

Expenditure

%

Expenditure

%

Jiangsu 1995 2001 2004

3,772 5,533 7,332

74 297 497

1.96 5.38 6.78

275 438 761

7.29 7.92 10.37

– 67 119

– 1.21 1.62

– 420 558

7.58 7.61

Shanghai 1995 2000 2004

5,868 8,868 12,631

113 501 762

1.93 5.65 6.03

401 794 1,327

6.83 8.95 10.51

166 375 995

2.83 4.23 7.88

176 585 1,102

3.00 6.60 8.72

Zhejiang 1995 2000 2004

5,263 7,020 10,636

196 541 829

3.72 7.71 7.79

375 600 971

7.13 8.55 9.13

124 274 794

2.36 3.90 7.47

193 490 860

3.67 6.98 8.09

Date source: Calculations based on the Shanghai Statistical Yearbook(s), Jiangsu Statistical Yearbook(s), and Zhejiang Statistical Yearbook(s).

Table 20.33: Rising medical expenses faced by the Delta’s peasantry Jiangsu

Zhejiang

Shanghai

Year

Medical costs

% of income

Medical costs

% of income

Medical costs

% of income

1995 2000 2004

49.1 129.5 163.2

2.53 5.54 5.38

73 209 425

2.17 5.05 6.72

103.2 200.1 326.1

4.34 6.19 7.00

Date source: Calculations based on the Shanghai Statistical Yearbook(s), Jiangsu Statistical Yearbook(s), and Zhejiang Statistical Yearbook(s).

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With fewer resources being directed toward public services, market forces played a larger role in the provision of public goods. As a result, medical, educational, and housing costs prices soared. Survey data covering the years 1995 to 2004 show that the Delta’s urban residents’ per capita expenditures on such services increased about 100 percent, yet per capita medical expenditures exploded: Shanghai and Jiangsu residents increased expenditures six-fold, and Zhejiang’s residencts paid out 300% more. Educational outlays increased 500% in Shanghai and 300% in Jiangsu. Spending on housing and transportation increased between two and five times. Skyrocketing housing prices placed an especially heavy burden on buyers, especially in cities like Shanghai, Hangzhou, Nanjing, where the price of a typical residence equals decades of the average worker’s wages.11 This has produced palpable dissatisfaction among many citizens. Even the prices of basic goods, such as water, power, gas, and bus tickets, have increased steadily. Such increases place a proportionately heavy burden on low-income individuals and families. More worrisome is that a majority of peasants cannot afford basic medical care and education. III. Maintaining the Delta’s Economic and Developmental Leadership Through Sustainable Development A. Sustainable Growth is a Necessity The Delta development has reached a crossroads. Growth has become a more complicated issue; severe challenges regarding environmental and resource constraints, changing cost positions, and social pressures have become more prominent. To meet these challenges leaders, policymakers, and citizens must work toward realizing development based on reason and sound science, while actively exploring useful and innovative solutions to development challenges. This is the only way that the region can maintain its economic preeminence within China, while at the same

11 The reader should note that some of these increases in expenditures reflect lifestyle changes where consumers voluntarily increase the quantity of such services, as well as paying for improvements in the quality of these services. Those with rapidly rising incomes drive this process; those who earn less may well see basic services become too expensive to afford.

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time balancing economic goals against social needs and environmental realities. The Delta must lead the way in this regard and shoulder its share of responsibility as a force for positive change. 1. Sustainability Goals Sustainable growth can lead China to a higher level of development. It can promote growth, and at the same time, improve social conditions and quality of life in many dimensions. Fulfilling this aim requires a new sense of mission and marshaling of resources. a. Applying sustainability’s principles, and continuing to work toward maintaining its leading position in the Chinese economy, can help the Delta realize long-term growth. By promoting sustainability among citizens, more persons can begin to understand the essence of these ideas and their importance to the economy, environment, society, and the hamonious interaction of these elements. b. Shifting economic strategy from its emphasis on extensive growth— which depends on increasing levels of investment in capital, labor and material resources—to a strategy of intensive growth—which leans more on innovation, R&D, and improvements in laborers’ skill levels, education, and productivity—will allow the Delta, and China, to grow economically and improve developmentally. Taking the latter path can generate numerous desirable outcomes: development of a culture of innovation can be cultivated both within firms and within the society at large; economic structure will become more diverse and robust; the regional economy will operate more efficienty and this will improve its competitive position vis-à-vis other regional markets; growth can be maintained and even enhanced by moving into higher-value added segments of the value chain; and prosperity can be offered to more Chinese people, leading to a general improvement of the living standards in the Delta. c. Promoting economic and social consensus based on policies that serve human needs first-and-foremost assures that social and economic development work concomittantly. The benefits of growth and development must be shared and enrich ordinary citizens as well as the most fortunate. Achieving this aim depends on improving the infrastructure and public services. Especially important are those services that maintain and ensure human welfare, either through the social security system and/or by preparing persons to acquire gainful employment. Such efforts must extend beyond the “ordinary citizen” to those at the

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margins. The vulnerable must be protected and supported and income disparities need to be narrowed. Resources flowing to urban areas need to provide benefits to rural areas and comprehensive, regional solutions that consider the needs of rural and and urban areas in an integrated system must be implemented through the policymaking process. Efficiency and honesty must be promoted in markets as well as governmental processes. Implementing democratic decisionmaking processes in all levels of governance can help to accomplishing these things. By fulfilling these aims, the economy can be prosperous, and its citizens enriched in the broadest sense of the word. This will stablize society as it develops for many years. d. Promoting environmental improvements must be done systematically and comprehensively. As part of this effort, policymakers and decisionmakers need to elevate environmental demands to the level of economic demands. The general consensus needs to move toward a system of sustainable economic growth that relies on rational and scientific principles in determining questions of resource utilization. To meet these goals, environmental protection measures and enforcement must be pursued with vigor. Environmental values should be broadly promoted; resource conservation, recycling and zero-waste, crade-to-cradle design and production12 should be instituted. Taken together these steps can benefit society, the environment, and long term economic prospects. e. Comprehensively promoting reform of the economic system needs to be maintained. Leaders in the Delta can play a leading role in perfecting the socialist market economic system. Doing so will strengthen the market system, while at the same time ensuring that it responds to genuine human and social needs. Various elements enter into the decisionmaking calculus: ensuring resource allocation and distribution balances market and social demands; integrating the different geographical parts of the Delta into a coherent whole; successfully integrating the Delta economy into that of China, East Asia, and the World; and continuing government reform efforts, especially those

The designer William McDonough coined the term “cradle-to-cradle” to describe design and production systems whose component parts can be absorbed by the environment and/or other industrial processes in an efficient fashion. He uses the term as a way of distinguishing such systems from typical industrial product cycles that follow a “cradle-to-grave” path. 12

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aimed at improving macroeconomic management, will lead to stable, sustainable growth. 2. Realizing Sustainable Development is a Realistic Aim a. The Delta has many resources necessary for being at the vanguard of economic development while generating economic growth within a sustainable framework. Notably the region has a solid cultural and educational foundation: the region is rich in talented and skilled persons, partly due to the fact that over 30% of China’s science and technology universities exist in Shanghai, Nanjing, and Hangzhou. Shanghai placed first in a 2004 survey measuring regional capacity for innovation. (See Table 20.34), Shanghai also ranks first in knowledge acquisition and general innovativeness; Jiangsu ranks right behind Shanghai in these measures. Table 20.34: Indexes summarizing capacities for innovation by region, 2004 (U = utility) Region

Integrated ratio U

Weight Shanghai Beijing Guangdong Jiangsu Zhejiang Shandong Tianjin

Rank 1.00

57.16 54.82 49.32 48.52 41.19 39.93 39.61

Knowledge innovation U

Rank 0.15

1 2 3 4 5 6 7

45.42 83.08 25.57 26.39 23.52 24.04 32.50

Knowledge acquisition U

Rank 0.15

2 1 7 6 10 9 3

52.74 34.67 46.92 51.97 37.23 35.15 28.57

Enterprises innovation U

Rank 0.25

1 6 3 2 4 5 9

68.65 44.50 55.07 62.98 45.55 56.34 42.39

Innovation environment U

Rank 0.25

1 7 4 2 6 3 9

51.91 56.30 50.44 49.12 45.82 42.17 33.25

Innovation performance U

Rank 0.20

2 1 3 4 5 6 8

61.45 59.79 60.33 43.70 46.18 32.10 57.70

1 3 2 6 5 9 4

Data source: China’s science and technology development strategy research team: “China’s regional innovation report 2004–2005,” Beijing, Intellectual Property Rights Press, 2005.

b. Governments in the Delta have exceptional administrative acumen. They have especially strong competence in developing and implementing innovative project plans, systemic resource integration, as well as financial planning and execution. In a survey of competiveness, Shanghai’s municipal government ranked first in the nation. Other Delta cities, such as Hangzhou, Ningbo, and Nanjing, placed high as well. Even though such rankings may provide insight into development in and around a city, it is important to remember that development depends more on market conditions than government administration.

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However, government has a role to play in development, especially in those areas where markets underperform, such as in pollution control. In these cases government must take responsibility for managing onditions.13 c. Businesses and governments in the Delta have already implemented some policies necessary to realize the goal of sustainable development. In 1997 Jiangsu’s provincial government drew up the document entitled “China’s 21st century agenda—the Jiangsu implementation brief ”, which established sustainable developmental methods for meeting the twin goals of expanding prosperity while simultaneously promoting sound environmental stewardship. This document integrates a number of interrelated concerns regarding the economy, society, population, education, natural resources, as well as the carrying capacities of the environment. In 2002, Zhejiang compiled a similar document called the “Zhejiang planning brief for sustainable development—Zhejiang’s implementation plan regarding China’s 21st Century agenda.” Like the Jiangsu’s planning document, this work addressed many issues: agriculture, industry, transportation, communications, energy, population and society, urbanization and regional collaboration, protection of natural resources, responsible resource utilization, pollution abatement, environmental protection, land control, disaster prevention and response, as well as improving the province’s capacity to manage sustainable development. Shanghai’s plans focused on resource conservation, resource utilization, clean production techniques, pollution controls and reductions, and broadening recycling efforts. Taken together these plans should maintain strong economic growth, while at the same time addressing environmental and resource depletion concerns. B. Linking Economic Transformation to Innovation Supporting innovation is crucial for the Delta to continue modernizing and growing sustainably. Note that sustainable development aims to create growth and prosperity, but to do so within the limits of natural and social bounds. Generating wealth is fundamental to the Delta’s future; this wealth not only improves the quality of life for those living in the Delta, it provides income that can be invested in realizing productive

13 World Bank, 1992 World Development Report: Development and Environment (Beijing, China Financial and Economic Publishing House, 1992).

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efficiencies and using cleaner technologies necessary to implement sustainable systems. This corresponds with experience in developed markets where more efficient use of resources and the overall course of development are clearly interrelated. Because of the emphasis on extensive development in the region, the Delta cannot meet either goal. Therefore, the overall developmental mode must change and doing so requires businesses and governments to develop greater capacities for innovation independent of foreign control. 1. Changing the Developmental Mode is a Key Step in Achieving Sustainable Development Overreliance on extensive development has produced a panoply of unintended consequences: energy shortages, rapid price increases for energy, severe conflicts over land use, ecological deterioration, an undeveloped public goods sector, and social development that lags economic development. Pursuing a growth-based economic strategy has required vast resource inputs to be yoked to large-scale investments, which undermined industrial diversification, access to highvalue work in the value chain, productive efficiencies, and development of the capacities needed to innovate. This, in turn, made access to resources increasing volatile. Worse, the physical, biological, and social environment became badly damaged. Addressing these problems will require a new approach. By moving toward intensive growth—placing an emphasis on high-efficiency processes, high-tech work, and high value-added output—the economy can simultaneously reduce its resource demands, pollution output, and process inefficiencies. Product quality will improve, and Chinese goods will find new, higher-return markets in which to sell. This can make firms more profitable and that profit can be reinvested in addressing environmental and social concerns. The Delta’s economic engine will become more potent while the lifestyle in the region will improve. Choosing between developmental modes depends on numerous factors. Internal as well as exogenous conditions play roles as can be seen in studies on the subject. Some factors that pushed the Delta toward the extensive model are: government officials at all levels seeking to create easily counted benefits in the short term, free-for-all competition among domestic entrepreneurs and foreign investors, and shortsightedness regarding the consequences of the single-minded pursuit of growth. Achieving reform will require changes that address each of these problems. Administrative reform is a starting point since policymakers can implement policy and rules changes necessary to begin

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the process of transformation from extensive to intensive economic development. Moreover, government can develop the coordination and communication systems necessary to build and implement plans to guide this transition. All production depends on some kind of technique. Therefore, changing production systems depends on changing techniques, i.e., technology. Changing the role and kind of technology applied to economic production can transform the economy. By introducing sophisticated and high-tech and production techniques, productivity can be improved, and production can move toward higher margin products. This will broaden the core competence of Chinese producers and workers. Moreover, using high-tech production techniques and improving productivity will generally increase efficiency. This can reduce energy demands in the near-term, while enhanced technical capacity can lead to new ways of using energy or completely new energy sources in the long-term. The same is true for other raw materials and resource inputs. Taken as a system, technological improvements can pave the way toward improved productivity, prosperity, and environmental quality. Taking this course of actoin will lead to secondary and tertiary effects in the industrial structure of the Delta economy. Firms and industries that use obsolete technologies, use energy and other resources inefficiently, or that sully the environment must be reformed or shuttered. At the same time companies that use intensive production techniques can be supported by creating the infrastructure—both human and physical—for high tech industries. As well, efforts can be made to support cradle-to-cradle economics and systems that protect and even improve environmental quality. Because the productive part of the service sector can add large numbers of jobs quickly in highly efficient, high productivity, and high wage work, its development should be emphasized. More traditional niches in the service sector should be reformed where possible to modernize and improve their operations. Making these changes in the Delta would likely spill over into the national economy over time. 2. The Delta Must Control and Marshal its Capacity for Innovation Developed economies pass through four phases on the road to modernization: organizing basic livelihood, marshaling resources, developing the capacity for innovation, and building wealth. The Delta is obviously in the midst of the scond of these four stages: its economy depends on

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large investments, high resource consumption, low value-added work, and low-cost production. Although going through this stage is necessary, and fits into the larger process of modernization, it seems clear that its benefits have been nearly exhausted. The economy must move on to the next stage of its development: building its innovative capacities. Moreover, this capacity must be homegrown; Chinese people must build these capacities to serve its interests, and this will require a large degree of independence in organizing and using these resources. As the most developed and economically dynamic region of China, the Delta has the ability, and the responsibility, to take the lead in developing these capacities regionally and nationally. The Delta has a number of colleges, universities, and scientific research institutions that can contribute to this effort. These can be employed right now to solve technical problems that have impeded growth and development. For especially large or thorny problems, these organizations can cooperate with each other and share resources as they develop solutions to these impediments. By doing so, they can begin to develop the building-blocks of an independentally controlled capacity for innovation, and to apply findings toward developing new endeavors while improving the operations of established producers and organizations. These efforts should be redoubled in those fields with the greatest economic and strategic importance. Such efforts can help Chinese firms establish key trademarks, patents, and other intellectual property, and to do so as first-movers. This can allow Chinese firms to establish large market shares, and this dominance can lead to high profitability and future investment in technical improvements. China already has some of the elements necessary to build such capacity. Its existing industrial capacity can be a testbed for innovation. Certain industrial niches under greater domestic control can serve this purpose as well. Firms in some industries are of particular interest: information management and processing, energy and resource development, environmental technologies, and agriculture. Large-scale special projects, perhaps established with universties and research centers, can help to spur innovations and innovativeness across these organizations. In the past ten years the Delta has achieved many notable accomplishments: attracting vast sums of FDI, importing technical expertise from abroad, and gaining access to world markets. This places it at the forefront of efforts to introduce, absorb, and re-create innovation. These core competencies should be applied to the larger, strategic effort of pushing the regional economy to the next stage in its development.

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Taken in steps, business leaders, government administrators, and policymakers should recognize how to transform and integrate ideas and systems, organize domestic enterprises to study these ideas and systems, and to push for the adoption of the most relevant and successful of these. This will foster the development of Chinese-held intellectual property rights, new management systems, and more valuable core competencies. Independence is a key element needed to fulfill these interlocking goals. By managing its own resources, this system can look for new ways to push through impediments to achieving innovations, and to foster a culture of innovation in Chinese business, education, government, and society. 2. Policy Prescriptions for Achieving Sustainable Development in the Delta a. Fostering regional cooperation within the Delta To successfully fulfill the aims of sustainable development the Delta’s economy must function with greater cooperation and coordination. Engendering cooperation can produce many benefits: decreasing waste resulting from chaotic internal competition; improving productive efficiency, especially in those sectors where public goods play an important role; and cutting the cost of development by better resource allocation, especially in the use and distribution of land. The nascent systems currently in place are not sufficiently developed to meet the near-term challenges facing the Delta, much less the longer-term challenges of helping the regional economy to transform itself. By building the capacity of coordination and cooperation in various systems, such efforts can be more widely applied, more robustly operated, and more effectively executed. Planning industrial development can be done systemically and comprehensively. Zoning and urban planning can be integrated into such plans based on best practices and scientific findings, and applied to cities and rural areas within an integrated, regional template. Integration of industrial systems will be encouraged, where appropriate; in general, this can reduce redundancy in production and resource acquisition, thus improving efficiency. Government will have a role in this effort as well. Administrative divisions should be abolished since they pursue narrow, disconnected goals. This works against the broader aims of cooperation and coordination. Other kinds of administrative obstructions should be set aside as well. By building a large and integrated market in the Delta, elements of production can flow unrestricted, and products and service mar-

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kets can become more open and flexible. The goals are manifold, but interrelated: optimizing the regional resource configuration, fostering the development of regional industrial groups, focusing decisions on market responsiveness, and building the competitive capacity needed to succeed in global markets. Regional coordination will depend on improving regional infrastructure. Many elements must be addressed in this effort: improving intraregional road and rail transit systems; managing river resources—both for water and transit—more effectively; refining communications and information management systems; more vigorously managing and protecting environmental resources; and creating organizational linkages needed to integrate these and other relevant systems. The goal underlying all of these moves is to realize resource and information sharing to improve the design and utilization of infrastructure for economic and social benefit. b. Continue economic and administrative reforms while strengthening market mechanisms Close study of regional economic development shows that modernization depends fundamentally on the initial resource endowment— including raw materials, location, and any already developed technical expertise. However, it also depends on the configuration of these and other physical and human elements into an integrated system. Three factors stand out as important elements in fueling regional development: successfully managing resource, technical, and systems constraints. Resource constraints abound: the planned economy was based around the idea of coping with resource constraints, but because of its internal inefficiences, did little to overcome them. Through the past 30 or so years of economic reform, the essential elements of a socialist-market economic system have taken shape, and a key innovation of this system is to deal more effectively with resource constraints. For instance, by moving toward market mechanisms, Zhejiang has improved the efficiency of governmental functions and the effective reform of numerous enterprises. Even though resource constraints still exist, they have relaxed somewhat due to improved operational efficiencies. The point is that systemic change and coordination has improved operational effectiveness and efficiency, and with it, the overall level of development. Examination of conditions in the other provinces in the Delta— Shanghai and Jiangsu—can further illuminate this point. In these two provinces the government plays a dominant role in economic

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development. In general, this dominance is connected to government’s tendency to distort markets, which produces inefficiencies. Furthermore, this dominance weakens enterprises, especially in their commitment to becoming involved in assuring economic vitality throughout the region. With economic and administrative reforms being more widely applied and their impact more deeply felt, the overarching policy and economic system embodied in the socialist-market economic approach is driving development in the region. That is, as business flourish, government power will be blunted to some degree; at the same time, successful businesses will have more at stake in the region, and therefore, will invest more of their time, attention, and resources into its effective governance. This helps to overcome the tendency of businesses faced with a dominant government to cede a great deal of power to that government. The impact of market and administrative reforms has changed competition in the Delta from a system based on inter-local competition based on a narrow set of resource, policy, and economic advantages and interests, to one based on a more fully integrated set of systemic advantages.14 To further extend the developmental process, reforms must be more widely and deeply applied. A key element of this process is to use the market to handle more of the load in allocating and configuring resources. That is, the big question is how to let the market take over the dominant role in development from government. Government and administrative reform must be part of this process, and yet, its primary task should be to more completely refine and apply the socialist-market mechanism, integrate the regional economy into global markets, and apply rules and regulations that help to organize unified, orderly, fair, efficient, and competitive markets. Investment, exports and consumption are the elements making up gross domestic product (GDP), and therefore, they are intimately bound to national economic growth and development. For more than twenty years, the Delta has built its economy through increasing investment. This brought economic growth and prosperity, but it also generated

14 It is important to see these elements in an integrated, systemic whole. All elements mentioned here—resources, technology, rulemaking, and coordination—are interrelated and intimately connected to overall development processes. Neither resources nor infrastructure play a dominant or determining role; it is their systemic relationship that drive development.

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many economic and social problems. These have been documented elsewhere, but are worth reiterating: resource depletion, environmental damage, overproduction, and inefficient resource utilization. Because of these and other problems, this rapid growth cannot be sustained by using the well-worn approach of large-scale capita investment. Because of this, it is inevitable that the pursuit of sustainable development in the Delta move toward a focus on consumption as the driving force behind the economy. The goals here are manifold: refining consumption policies, improving the conditions necessary to expand consumption, reinforcing consumer confidence, and building consumer demands. These moves go hand-in-hand with the need to accommodate changes in the structure of consumption, while improving the structure and coordination between production, supply, and consumer demands. Finally, and perhaps most important, is to increase economic activity in service consumption. Achieving these goals depends on meeting more elemental challenges. First: increasing personal income throughout the region. This includes increasing the incomes of peasants, low, and middle-income persons and to provide them the tools to improve their economic situation in the long run. Second: promoting the demand for consumer items, including houses and cars. As well, smaller priced, but more commonly consumed items, should be promoted, especially to those individuals and families who cannot yet afford large ticket items like houses and automobiles. By increasing consumption in this way, rapid and balanced economic growth can be realized.

ANALYZING INDUSTRIAL CONDITIONS IN THE PEARL RIVER BASIN Shu Yuan The economy of the Pearl River Basin—also known as the Pan-Pearl River Delta1—fuels national economic growth. Its dynamism and central role in economic development makes it worthy of careful analysis. This article provides such an analysis. The first section of this article presents a quantitative analysis based on several key economic statistics: value-added in the three key economic sectors—agriculture, industry, and services—and the prospects for changes in value-added contributions from these sectors over time.2 This section also includes information on employment and labor productivity conditions and trends. The second section delves into an examination of economic structure, including comparisons of the contributions made to gross product by each of the three main economic sectors. Information on and analysis of capitalization and investment conditions and trends are presented here as well. The third section looks at the current state of development in the region and provides some data in disaggregated form in order to better understand economic conditions and trends by province. The fourth section focuses on the service sector, which shows the greatest promise in driving growth, development, and a establishing a more robust economic structure. Throughout, these analyses consider the regional economy on its own terms and also compare it to the broader national picture. These analyses also include details on the region’s geographical and competitive advantages.

1 This term—the Pan-Pearl River Delta—is used in the Chinese press and in some official policy documents. There is even a website for the grouping: http://www.pprd. org.cn/. However, use of the term “pan” may cause confusion among English speakers, since this prefix merely means “the entire”. The “Pan-Pearl River Delta” extends far beyond the Delta, and in fact, covers the entire length of the Pearl River as well as the provinces it flows through. To avoid confusion among our readers, we will use the terms “Pearl River Basin” and “Greater Pearl River region” throughout this chapter. 2 Translator’s note: The analysis in this paper omits the fourth key sector, government.

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shu yuan I. Industrial Structure and the State of Development in the Pearl River Basin

In 2003, Zhang Dejiang, member of the Political Bureau of the Communist Party of China’s (CPC) Central Committee and Secretary of the Guangdong Provincial Committee, put forward the notion of the “Pearl River region” as a single economic entity. Seeing this expanse as a coherent whole provided a framework for encouraging regional economic cooperation regarding development. This fit well with the national development strategy as it moved toward a focus on regionby-region growth. The Pearl River Basin spans nine provinces—Fujian, Guangdong, Guangxi, Guizhou, Hainan, Hunan, Jiangxi, Sichuan, and Yunnan— and two Special Administrative Regions (SARs), Hong Kong and Macao. This takes in an area of just over two million square kilometers,3 which is about 20% of the People’s Republic of China’s (PRC) total area. The population contained in this region is about 560 million,4 or 43% of the national total. The gross product in the region equaled 4,640 billion yuan5 in 2004, or about 34% of the GDP. The current status of the region’s economic structure can be understood through various measures. By examining the percentage of valueadded coming from the service sector, a sense of modernization and diversification in the regional economy can be determined. Comparing employment data—including total employment levels, productivity, and per capita output, and comparing these figures to national measures, a sense of the Pearl River region’s importance to national economic strength and health can be understood. A. Contributions to Output by Sector From Table 21.1 we can see that the nine provinces along the Pearl River have contributed increasing amounts to GDP. Agricultural output in the region amounted to 731.88 billion yuan, industrial output equaled 2,183.83 billion yuan, and services added another 1,724.06 billion

Extracted from http://www.pprd.org.cn/ziliao/zhengee/200603030013.htm. Calculated based on provincial population totals found in the China Statistical Yearbook 2005. 5 Calculated based on the regional gross product figures in the China Statistical Yearbook 2005. 3 4

analyzing industrial conditions in the pearl river basin 315 yuan. Value-added from industry, agriculture, and services in the region made up 35% of the national total. Even though gross amounts have increased, the proportional contribution of each sector has remained essentially unchanged over the last four years. Agriculture in the Pearl River region contributed 35% to the total value-added from agriculture for the nation. Industry in the Pearl River Basin contributed 30% of the national total in that category; the region’s contribution to total value-added in the service sector amounted to 40% of the national total. (See Figure 21.1.) Compared to almost any other region of similar size, the Pearl River region is the most economically potent. The region has an especially strong service sector; this bodes well for the region since analysts expect services to play an increasingly important role in generating regional and national economic growth. Table 21.1: Value-added by sector in the Pearl River Basin and the PRC (Billion RMB) Year

2001 2002 2003 2004

Pearl River Basin

PRC

Agriculture

Industry

Services

Agriculture

Industry

Services

545.79 566.88 601.04 731.88

1356.81 1507.80 1762.70 2183.83

1239.26 1371.84 1518.84 1724.06

1541.18 1611.73 1692.81 2076.81

4875.00 5354.07 6127.41 7238.72

3315.30 3513.26 3918.80 4372.06

Data source: China Statistical Yearbook 2002–2005.

B. Contribution to Employment Total employment in the region is about 230 million; 120 million of these jobs are in the agricultural sector, 40 million in industry, and 70 million services. The ordering and magnitude of each category roughly mirrors national figures, however, the percentage of jobs in industry is slightly higher. (See Table 21.2.) The proportion of jobs in the agricultural sector, about 35%, is higher than in the nation as a whole. About 30% of jobs are in services and about 25% are in industry.6 (See Figure 21.1: Value-added from agriculture, industry, and services in the Pearl River Basin and the PRC.)

6

The other 10% of employment is in the public sector.

316

shu yuan 2001

(%) 50

2002

2003

2004

40 30 20 10 0 Agriculture

Industry

Services

Figure 21.1: Proportion of total national value-added originating in Pearl River Basin Table 21.2: Employment in the Pearl River Basin and the PRC (Thousand persons) Year

2001 2002 2003 2004

Pearl River Basin

PRC

Agriculture

Industry

Services

Agriculture

Industry

Services

128,880 127,470 125,420 123,690

36,150 37,310 40,140 43,200

61,980 63,670 66,820 71,730

365,130 368,700 365,460 352,690

162,840 157,800 160,770 169,200

202,280 210,900 218,090 230,110

Data source: China Statistical Yearbook 2002–2005.

C. Labor Productivity Examining Tables 21.1 and 21.2 together helps to shape a picture of labor productivity. Note that employment in agriculture makes up 35% of total employment in the Pearl River region and contributes 35% of the national value-added in the sector. Industry in the Pearl River Basin makes up 25% of the national total in jobs, but the sector contributes 30% of the national value-added in the industrial sector. Services in the region make up 30% of national employment in the sector, but 40% of the sector’s value-added for the entire country. Table 21.3 summarizes these data for the years 2001 to 2004. Industrial productivity in the nine provinces around the Pearl River outpaces national industrial productivity. Industrial value-added in the region in 2004 amounted to more than 50,000 yuan per capita. Services

analyzing industrial conditions in the pearl river basin 317 2001

(%) 40

2002

2003

2004

30 20 10 0 Agriculture

Industry

Services

Figure 21.2: Proportion of national employment total based in Pearl River Basin

placed a distant second at only 24,000 yuan per capita. Unsurprisingly the agricultural sector placed an even more distant third with only 6,000 per capita. Agricultural productivity in the Pearl River region roughly equaled national levels, but the region outpaced the nation in productivity in both the industrial and service sections by 18% and 26.5%, respectively. Table 21.3: Labor productivity comparisons by economic sector (RMB per capita) Year

2001 2002 2003 2004

Pearl River Region

PRC

Industry

Agriculture

Services

Industry

Agriculture

Services

4235 4447 4792 5917

37537 40412 43919 50549

19994 21547 22729 24035

4221 4371 4632 5888

29937 33929 38113 42782

16390 16658 17969 19000

Note: Figures calculated from Tables 21.1 and 21.2.

D. Per Capita GDP The degree of economic development shows great variance across the Pearl River region. GDP per capita figures for 2004 provide a strong indication of this. Guangdong, the province at the heart of the Delta, leads the way at 19,707 yuan, with Fujian following close behind at 17,218 yuan. Note that these two provinces are the only two in the Pearl River region that exceed national per capita GDP; Guangdong’s

318

shu yuan Agriculture

Industry

6000 5000 4000 3000 2000

60000 50000 40000 30000 20000

1000 0

10000 0

2001 2002 2003 2004 Pearl River Basin PRC 25000

2001 2002 2003 2004 Pearl River Basin PRC

Services

20000 15000 10000 5000 0

2001 2002 2003 2004 Pearl River Basin PRC

Figure 21.3: Labor productivity, Pearl River Basin and the PRC

per capita GDP is 87% higher than the national figure and Fujian outpaces the national figure by 63%. The remaining seven provinces collectively lag national per capita GDP by 28%. More tellingly, the other seven provinces lag far behind the two leading provinces in the region: Hainan comes in a distant third at 9,450 yuan; Hunan follows closely with 9,117 yuan; Jiangxi takes the fifth position with 8,189 yuan; Sichuan is only a bit behind at 8,113 yuan; Guangxi fills the seventh position at 7,196 yuan; Yunnan is eighth with 6,773 yuan; and Guizhou trails far behind with only 4,215 yuan. Note that Guangxi barely clears 20% of the per capita GDP for Guangdong. If we include Hong Kong and Macao in the region the spread becomes even greater: Hong Kong’s per capita output in 2004 was 184,448 HK dollars (HKD), while Macao’s output per capita equaled 180,965 Macao dollars.7 In short,

7 Note that the Pataca is the internationally recognized currency for Macao. It trades for about 8:1 versus the US Dollar (USD), or roughly the same rate as the HKD to the USD.

analyzing industrial conditions in the pearl river basin 319 24000 21000

19707 17218

18000

RMB

15000 12000

10561

9450

9000

9117

8189

8113

7196

6000

6733 4215

3000 0 PRC Guangdong Fujian

Hainan

Hunan

Jiangxi

Sichuan Guangxi

Yunnan Guizhou

Figure 21.4: GDP per capita of Pearl River Basin by province in 2004

the per capita income in the most developed parts of the Pearl River region exceeded the level of the poorest by more than forty times.8 (See Figure 21.4.) II. Industrial Structure and Development by Province In the first section we analyzed the Pearl River region as a whole to better understand its contribution to the national economy. In this section, we look at each province individually, as well as Hong Kong and Macao, to gain a more nuanced understanding of industrial structure and development in the region. A. Industrial Structure Distinctions We start our analysis by examining 2004 value-added data by sector in each province, Hong Kong, and Macao (See Figure 21.5.) The latter two economies display a structure distinct from the Mainland provinces. The economies of Hong Kong and Macao generate 90% of their value-added within the service sector. The Mainland provinces receive

8 While similar in value, exchange rates for these three currencies varied slightly in 2004. The yuan equaled 7.2768 per dollar, the Hong Kong dollar equaled 7.788 per dollar, and the Macao dollar equaled 8.022 per dollar.

320

shu yuan Services

Industry

Agriculture

(%) 100

80

60

40

20

10

Fujian

Jiangxi

Hunan

Guang- Guangxi Hainan Sichuan Guizhou Yunnan dong

Hong Kong

Macao

Figure 21.5: Value-added by sector in the Pearl River Basin, 2004

the bulk of value-added from both industry and services. The two most developed provinces, Guangdong and Fujian, lean a bit more heavily on industrial output, and less on agriculture than the more interior parts of the Pearl River region. Hainan also generates a relatively greater proportion of value-added in the agricultural sector. We can distill these insights into a single index, the Industrial Structure Similarity Coefficient. (See Table 21.4.) From Table 21.4 we can see that industrial structures are indeed quite similar. Many provinces score over 0.9 when compared to one another. The coefficient of 0.77 for Guangdong and Hainan is one of Table 21.4: Industrial Structure Similarity Coefficients by province Type

Fujian Jiangxi Hunan Guangdong Guangxi Hainan Sichuan Guizhou Yunnan

Fujian

1.000

HK

Jiangxi

0.990

1.000

Hunan

0.982

0.990

1.000

Guangdong

0.993

0.973

0.953

Guangxi

0.971

0.990

0.997

0.938

1.000

Hainan

0.840

0.888

0.926

0.770

0.942

Sichuan

0.985

0.995

0.999

0.958

0.998

0.921

1.000

Guizhou

0.988

1.000

0.991

0.969

0.992

0.896

0.996

1.000

Yunnan

0.990

1.000

0.993

0.970

0.993

0.897

0.997

1.000

1.000

HK

0.700

0.655

0.747

0.651

0.705

0.718

0.715

0.658

0.674

1.000

Macao

0.713

0.668

0.758

0.666

0.716

0.723

0.727

0.671

0.687

1.000

Macao

1.000 1.000

1.000

analyzing industrial conditions in the pearl river basin 321 the lowest scores. The truly distinct scores can be seen in the comparisons between Mainland provinces and Hong Kong and Macao, where coefficients have an absolute value of about 0.7. B. Labor Productivity across the Provinces The industrial structure similarity coefficient is obtained by calculating the weights of three sectors in order to construct an index.9 A coefficient of nearly one would indicate perfectly identical industrial structures. The relatively high values for the coefficient in the Pearl River region indicate similar structure; however, other differences distinguish these provincial economies. Labor productivity across the three main sectors in each province uncovers one dimension of these differences. (See Figure 21.6.) Agricultural labor is more productive in Hainan than any other province in the region. Hainan’s unique climate and rich soil, among other characteristics, give it advantages that other provinces do not enjoy. This combination of labor, capital, and natural resources allows Hainan to achieve output per capita of 13,361 yuan in the agricultural sector. This puts Hainan in the unusual position of having higher per capita income in the farming sector than in the other two sectors. Fujian follows behind with 10,621 yuan. Guangdong takes the third spot with 8,081 yuan, with Jiangxi close behind at 7,275 yuan. Sichuan and Hunan run a dead-heat with 5,814 yuan; Hunan follows close with 5,814 yuan. Guangxi brings in 5,297 yuan per capita. The two poorest provinces, though, clearly show the inequality in development across the region: Yunnan only takes in 3,530 yuan per capita, while Guizhou has the lowest agriculture productivity in the Pearl River region, making only 2,583 yuan per capita. Guangdong dominates the region in labor productivity in industry, clearing 70,830 yuan per capita. Yunnan follows with 60,186 yuan per capita and Fujian places third with 55,292. Both Hainan and Guangxi follow with 48,593, with Guangxi a comfortable distance behind at

9

The expression of industrial structure similarity coefficient is: Sij = Σ xinxjn/(Σ xin2 Σxjn2 )1/2 n

n

In the formula, xin, xjn are the weights of n industry in industrial structure of i country (region) and j province. The range of the coefficient is [0,1]; when Sij = 0, provinces i and j have completely different industrial structures, but when Sij = 1, the provinces have identical industrial structures.

322

shu yuan Agriculture 13361

Hainan 10621

Fujian 8081

Guangdong

7275

Jiangxi 5860

Sichuan

5814

Hunan Guangxi

5297 3530

Yunnan Guizhou

2583 5000

10000

15000 (RMB per capita)

Industry

70830

Guangdong 60186

Yunnan

55292

Fujian 48593

Hainan

44869

Guangxi Jiangxi

38580

Hunan

38570

Sichuan

34069

Guizhou

33782 20000

40000

60000

80000 (RMB per capita)

Services Fujian

42153

Guangdong

38852 26087

Hainan Yunnan

22096 21609

Hunan Sichuan

18521

Jiangxi

18345

Guangxi Guizhou

14701 8184 10000

20000

30000

40000

50000 (RMB per capita)

Figure 21.6: Labor productivity by sector in the Pearl River Basin by province in 2004

analyzing industrial conditions in the pearl river basin 323 44,869 yuan. Jiangxi and Hunan practically tie for sixth place at 38,580 and 38,570 yuan per capita. Sichuan and Guizhou bring up the rear in a near dead-heat at 34,069 and 33,782 yuan per capita. The labor productivity in the service sector has Fujian leading the pack with 42,153 yuan per capita. Guangdong places a strong second with 38,852 yuan per capita. Hainan comes in a somewhat distant third with 26,087 yuan per capita. Yunnan and Hunan finish in a near tie with 22,096 and 21,609 yuan per capita. Sichuan and Jiangxi finish with an even narrower margin separating them for the sixth and seventh positions: 18,521 and 18,345 yuan per capita. Guangxi takes the eighth position with 14,701 yuan per capita. Guizhou once again places last with only 8,184 yuan per capita in service output, or just under one-fifth the per capita sum made in Fujian. These figures point up the disparity in development in the Pearl River region as well as the urgent need to implement more balanced development across the region. An examination of the industrial and service sector will reveal more distinctions across the region as well as some underlying conditions that point toward the means for resolving some inequities affecting the region. III. Analyzing the Current State of Development In this section we analyze the present condition of the industrial sector in the nine provinces surrounding the Pearl River. Here we pay particularly close attention to competitive advantages afforded by particular locations within the Pearl River Basin. These data come from various 2004 Statistical Yearbooks. Constructing an index called the “value-added location quotient” allows for more straightforward comparison on locational advantages.10 The value-added location quotient is an indicator of relative scale; it 10

The value-added location quotient is defined as: xij /Σxij i LSEij = ––––––––––––– xij/ Σ Σ Σxij j

i

j

In the expression, LSEij is the location quotient of the relative concentration ratio of i industry in j region; xij is the value-added of sector i in location j; Σ xij is the i cumulative value-added in location j, Σ xij is the value-added of sector i in the nation; i j Σ Σ xij is the value-added for all sectors in the nation. j

i

324

shu yuan

measures the contribution of a given province’s economic sectors to economic productivity in the country. Sectors with location quotients greater than 1 are regarded as having relative advantages; these attract and accumulate specialized production resources in a given region. As the quotient rises in value, it indicates a stronger attraction and the resulting output in a particular place. Calculating the quotients for each province along the Pearl River, we can identify those sectors which enjoy a locational advantage in a particular province. (See Table 21.5.) A number of industries enjoy strong locational advantages in the Pearl River region: ferrous metal mining and processing; non-metal mineral products processing; non-ferrous metal smelting and processing; agricultural and food manufacturing; tobacco processing; timber harvesting and processing; printing and electronic media duplication; synthetic cloth manufacturing; transportation equipment manufacturing; electricity and power generation; and water storage and distribution. A number of other industries enjoy locational advantages limited to Guangdong: electrical equipment and instrument manufacturing; telecommunication equipment manufacturing; computer and electronic equipment manufacturing; instrumentation and metering device manufacturing; office machinery manufacturing; and cultural production. Table 21.5: Enumerating locational advantage by industry and province Province

Industries with locational advantages

Fujian

Art production; Synthetic cloth manufacturing; Leather, fur, and feather products Cultural production, education, sports products; Electronics equipment manufacturing (including telecommunications and computer equipment); office machinery Agricultural products processing; Nonferrous metal mining and processing Coal mining and refining; Non-metal mining; Nonferrous metal processing Ferrous metal mining and processing; Gas production and supply; Medical equipment manufacturing Coal mining and refining; Energy products manufacturing, including petroleum and nuclear fuel processing; Nonferrous metal mining Coal mining and refining; Nonferrous metal mining and processing; Nonferrous metal processing Soft drinks manufacturing; Gas production and distribution; Oil and natural gas extraction Tobacco processing; Nonferrous metal mining and processing

Guangdong Guangxi Guizhou Hainan Hunan Jiangxi Sichuan Yunnan

analyzing industrial conditions in the pearl river basin 325 B. Labor Productivity Comparisons Labor productivity figures capture much of the overall productive efficiencies within an industry. Moreover, higher labor productivity generally implies greater value-added, and higher wages. Table 21.6 highlights the best and worst performers. Table 21.6: Comparing labor productivity across different industries by province Province

Industries with higher labor productivity

Industries with lower labor productivity

Fujian

Tobacco processing; Electronics equipment manufacturing (including telecommunications and computer equipment)

Coal mining and refining; Water storage and distribution

Guangdong Oil and natural gas extraction; Tobacco processing; Oil refining; Nuclear fuel processing

Coal mining and refining; Leather, fur, and feather products

Guangxi

Tobacco processing; Oil refining; Nuclear fuel processing; Energy production and distribution

Synthetic cloth manufacturing; Gas production and distribution; Rubber manufacturing

Guizhou

Tobacco processing; Energy production and distribution; Soft drink manufacturing

Leather, fur, and feather products; Textile manufacturing; Equipment manufacturing

Hainan

Oil and natural gas extraction; Tobacco processing; Oil refining; Nuclear fuel processing

Coal mining and refining; Rubber manufacturing; Specialized equipment manufacturing

Hunan

Electronics equipment manufacturing (including telecommunications and computer equipment); Tobacco processing; Waste recycling and disposal

Water storage and distribution; Coal extraction and refining; Gas production and distribution

Jiangxi

Tobacco processing; Oil refining; Furniture manufacturing; Gas Nuclear fuel processing; Ferrous metal production and distribution; smelting and pressing Cultural products creation

Yunnan

Tobacco processing; Energy production and distribution; Medical equipment manufacturing

Leather, fur, and feather products; Textile manufacturing; Apparel manufacturing

326

shu yuan

In general, tobacco processing, oil and natural gas extraction and refining, and nuclear fuel processing all yield high labor productivity. Coal mining and refining, rubber production, and textile and apparel manufacturing, have relatively low labor productivity. C. Comparing the Rate of Increase in Value-Added across Provinces By calculating the rate of increase in industrial production in all nine provinces from 2003 to 200411 we gain insight into future growth, job expansion, and wage increases. These findings are distilled in Table 21.7. Table 21.7: Comparison of growth in industrial value-added by province Province

Industries with high growth

Industries with low growth

Fujian

Ferrous metal mining and processing; Waste recycling and disposal; Rubber manufacturing

Synthetic cloth manufacturing; Gas production and distribution; Transportation equipment manufacturing

Guangdong Oil and natural gas extraction; Coal mining and refining; Ferrous metal mining and processing

Instrumentation, measurement, and machinery manufacturing; Medical equipment manufacturing

Guangxi

Gas production and distribution; Ferrous metal mining and processing

Synthetic cloth manufacturing; Rubber manufacturing; Nonferrous metal mining

Guizhou

Oil refining; Nuclear fuel processing; General equipment manufacturing; Nonferrous mining and processing

Leather, fur, and feather products; Nonmetal mining and processing; Gas production and distribution

Hunan

Ferrous metal processing; Plastic products manufacturing

Gas production and distribution; Synthetic cloth manufacturing

Jiangxi

Ferrous metal mining and processing; Textile and apparel manufacturing; Waste recycling and disposal

Timber harvesting and processing; Water storage and distribution

Sichuan

Cultural and educational products manufacturing; Oil refining; Nuclear fuel processing; Furniture manufacturing

Instrumentation, measurement, and machinery manufacturing; Waste recycling and disposal recovery and processing; Nonmetal mining

11 2004 data for Hainan and Yunnan are incomplete or unavailable, so the analysis does not cover these two provinces.

analyzing industrial conditions in the pearl river basin 327 In general, mining and ore refining, metallurgical work, and many parts of the energy industry show the greatest increases; manufacturing synthetics and various types of light equipment manufacturing show slowing rates of growth. D. Industry Leads the Way in the Pearl River Region Agglomeration can be self-perpetuating; once some threshold value is met, firms in a particular industry or in a particular cluster of complementary industries may concentrate in an area in order to realize various locational advantages concentrated in a particular place. Two aspects of this process are noteworthy: agglomeration may lower marginal costs, which helps firms achieve minimum efficient scale; second, explicit and implicit types of cooperation and coordination may arise between and among firms, suppliers—including workers, and even policymakers. The analysis of grouping and locational concentration will proceed by computing the degree of industrial concentration both by industry and across industries within a given province. 1. Industrial Concentration The concentration ratio, denoted as CR3, measures the degree of industrial concentration inside a given industry. We define the ratio as CR3 = (x1 + x2 + x3)/x

where x1, x2, and x3 refer to the firms generating the highest value-added within a particular industry in each of the nine provinces in the Pearl River region, while x is the total value-added generated throughout the entire Pearl River region. The higher the concentration ratio, the more heavily concentrated that industry is in a given location; for our analysis we will look at groups of three provinces out of the total nine in the region. Table 21.8 lists the clusters of provinces with the highest concentration ratios by industry.

328

shu yuan

Table 21.8: The industrial concentration ratios in three provinces with the highest value-added Industry

Main provinces

CR3 (%)

Value-added (100 million RMB)

Oil and natural gas extraction

Guangdong, Hainan, Sichuan

99.99

378.77

Cultural and educational products manufacturing

Fujian, Guangdong, Jiangxi

99.26

124.83

Electronics equipment manufacturing (including telecommunications and computer equipment)

Fujian, Guangdong, Sichuan

97.69

1794.92

Textile, apparel, and accessory manufacturing

Fujian, Guangdong, Jiangxi

96.65

368.00

Waste recycling and disposal

Fujian, Guangdong, Hunan

94.83

6.35

Leather, fur, and feather products

Fujian, Guangdong, Sichuan

93.55

274.30

Furniture manufacturing

Fujian, Guangdong, Sichuan

92.84

93.83

Instrumentation, measurement, and machinery manufacturing

Fujian, Guangdong, Sichuan

92.43

175.39

Electrical machinery and equipment manufacturing

Fujian, Guangdong, Sichuan

91.60

823.47

Plastic products

Fujian, Guangdong, Sichuan

91.34

294.28

Metal products

Fujian, Guangdong, Sichuan

89.77

341.16

Gas production and distribution

Guangdong, Sichuan, Yunnan

89.24

25.15

Textile manufacturing

Fujian, Guangdong, Sichuan

86.19

376.22

Rubber products manufacturing

Fujian, Guangdong, Guizhou

81.17

69.38

Oil and nuclear fuel processing

Guangdong, Hunan, Jiangxi

80.00

208.66

Synthetic cloth manufacturing

Fujian, Guangdong, Sichuan

78.87

34.56

General equipment manufacturing

Fujian, Guangdong, Sichuan

78.42

233.96

Food processing

Fujian, Guangdong, Hunan

76.87

170.43

analyzing industrial conditions in the pearl river basin 329 Table 21.8 (cont.) Industry

Main provinces

CR3 (%)

Value-added (100 million RMB)

Tobacco processing

Guangdong, Hunan, Yunnan

75.63

741.28

Paper manufacturing

Fujian, Guangdong, Sichuan

75.44

177.01

Soft drink processing

Guangdong, Guizhou, Sichuan

75.26

247.47

Printing and recorded media duplication

Fujian, Guangdong, Yunnan

74.74

118.95

Chemical processing

Guangdong, Hunan, Sichuan

74.45

721.91

Water storage and distribution

Fujian, Guangdong, Hunan

73.94

68.12

Nonmetal products

Fujian, Guangdong, Sichuan

73.39

482.39

Timber harvesting and processing

Fujian, Guangdong, Hunan

72.09

72.35

Specialized equipment manufacturing

Fujian, Guangdong, Hunan

70.79

175.77

Ferrous metal mining and processing

Fujian, Guangdong, Sichuan

68.10

28.34

Transportation equipment manufacturing

Fujian, Guangdong, Sichuan

67.95

451.9

Energy production and distribution

Fujian, Guangdong, Sichuan

66.36

911.03

Nonmetal mining and processing

Fujian, Guangdong, Hunan

63.89

40.97

Coal mining and refining

Guizhou, Hunan, Sichuan

63.82

99.63

Food processing

Guangdong, Guangxi, Sichuan

61.87

284

Medical equipment manufacturing

Guangdong, Jiangxi, Sichuan

60.40

184.52

Nonferrous metal mining and processing

Hunan, Jiangxi, Yunnan

58.81

39.93

Ferrous metal processing

Guangdong, Hunan, Sichuan

56.84

366.79

Nonferrous metal processing

Guangdong, Hunan, Yunnan

50.73

214.27

330

shu yuan

Unsurprisingly the industrial powerhouses of the region, Fujian and Guangdong, have a number of industries concentrated within their borders. Note that concentration ratios for eleven of the industries listed here approach or surpass 90%. Each of these industries posts value-added well in excess of 10 billion yuan per annum.12 Note that electronics equipment manufacturing, which includes telecommunications and computing equipment, generated a whopping 180 billion yuan across the nine provinces in the region. The analysis also reveals distinctions between industries where concentration is high, but productive value is low and vice-versa. For instance, waste recycling and disposal is highly concentrated, but has low production value; concentration may lower costs and improve profitability. Chemical processing, and various parts of the energy sector show low concentration (CR3 is less than 75% for each), but relatively high industrial production value, with each exceeding 69 billion yuan.13 Medical equipment manufacturing, and metallurgical industries exhibit even lower concentration ratios—about 60% or less—but each makes brings in over 15 billion yuan in the best performing provinces. 2. The analysis of provincial industrial concentration ratio Basing the analysis on CR2—the industrial concentration ratio for the two leading industries in terms of value-added—we can better assess the distinctive structure of each province’s economy. The-two industry concentration ratio is defined as CR2 = (X1 + X2)/X

where X1 and X2 represent the two industries within a certain province that generate the greatest value-added of all industries in that province, while X is the aggregate value-added within a given province. By this measure, Yunnan has the highest industrial concentration ratio, and is the only province in the region with a concentration ratio of more than 50%. The leading value-added industries in the province are tobacco processing and products manufacturing, and electricity

12 Value-added in furniture manufacturing is 9.38 billion yuan; even though it falls short of the 10 billion yuan threshold, we include it within this analysis. 13 The low concentration of the chemical and energy sector runs counter to experience in other countries, where scale economies and/or specialized expertise encourages consolidation and limits entry.

analyzing industrial conditions in the pearl river basin 331 and energy production and distribution. These two industries generate 56.768 billion yuan. Note, however, that this is hardly a sign of overall economic health. Guangdong has a much larger and more diverse economy than Yunnan. Therefore, the two-industry concentration ratio is much lower: only 31% of the value-added comes from the two top performers. This is actually a middling value in the Pearl River region, where other provinces have concentration ratios as low as 20% and most score between 30% and 50%. However, the typical value-added shows a much broader range: Guangdong leads the way at more than 210 billion yuan; Guangxi pulls up the rear at 12.5 billion yuan and the remaining provinces are spread out between 20 and 50 billion yuan. (See Table 21.9.) Table 21.9: Two-industry concentration ratios by province Province

Two industries with the largest valueadded

CR2 (%)

Value-added value (100 million RMB)

Yunnan

Electronics equipment manufacturing (including telecommunications and computer equipment); Energy production and distribution

62.57

567.68

Hainan

Electrical machinery and equipment manufacturing; Electronics equipment manufacturing (including telecommunications and computer equipment)

36.70

125.81

Guizhou

Food processing; Energy production and distribution

33.55

147.06

Guangdong

Tobacco processing; Ferrous metal processing

30.72

2169.96

Guangxi

Transportation equipment manufacturing; Energy production and distribution

25.54

151.14

Hunan

Tobacco processing, Ferrous metal processing

23.91

286.16

Sichuan

Ferrous metal processing; Energy production and distribution

22.19

307.08

Fujian

Ferrous metal processing; Energy production and distribution

21.18

406.18

Jiangxi

Tobacco processing; Energy production and distribution

20.77

130.24

332

shu yuan IV. Service Sector Analysis

In economically advanced countries the service sector typically accounts for more than 60% of output. These economies have completed two fundamental transitions in economic structure, going from economies based on agriculture to those focused on industry, and then moving from an industrial to a post-industrial stage based around services. Now that China has established a strong industrial base, it must look to the next step in its evolution: developing a more robust service sector. Given the level of development in the nine provinces in the Pearl River Basin, this seems to be the most promising place to glimpse the beginnings of this transition. A. Employment in the Service Sector The service sector can be organized into four sub-sectors: • Transportation, distribution, shipping, and storage; • Real estate sales and financing; • Wholesale and retail; • Hospitality, including the accommodation and restaurant industries. Each sector employs roughly the same number of people. Wholesale and retail employs the most, with the Transportation/Logistics sector following close behind. Hospitality takes the third position, and real estate employs the smallest number. Table 21.10: Employment in service sub-sectors of services (10 thousand jobs) Type Fujian Jiangxi Guangdong Guangxi Hainan Sichuan Yunnan

Transportation/ logistics

Real estate

22.67 22.45 58.97 21.71 4.55 40.68 15.54

11.20 7.55 88.53 7.61 3.34 17.08 5.41

Wholesale/ Hospitality retail 35.41 20.93 119.02 28.66 6.76 31.49 24.59

11.37 7.88 56.56 9.73 4.85 17.26 9.19

Other 156.93 137.34 445.89 166.78 27.53 229.84 149.31

analyzing industrial conditions in the pearl river basin 333

(%) 18.00

Transportation/logistics

Real estate

Wholesale/retail

Hospitality

16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 Fujian

Jiangxi

Guangdong

Guangxi

Hainan

Sichuan

Yunnan

Figure 21.7: Total employment within service sub-sectors

Unsurprisingly, different industries play relatively large roles in the region. For instance, Sichuan’s transportation and logistics sub-sector is relatively larger than in the rest of the Pearl River region. Hainan, because of its dependence on tourism, employs a relatively large number of people in the hospitality sub-sector. Table 21.10 and Figure 21.7 provide a more complete picture of employment in the service sector by province. B. Capitalization in the Service Sector14 Capitalization of the service sector in the Pearl River region is relatively low. (See Table 21.11 and Figure 21.8.)

14 All of the data in this section come from Primary Data Announcement, No. 3 of the First National Economic Census in each province, unless otherwise noted. Note that data for Guizhou and Hunan were not available from this source; therefore, they are omitted from the analysis below.

334

shu yuan Table 21.11: Total capitalization by sub-sector (100 million RMB)

Type

Transportation/ logistics

Fujian

962.15

Jiangxi Guangdong

Real estate Wholesale/ retail 2228.92

1683.26

Hospitality

Other

170.73

9548.81

763.75

724.54

593.23

94.22

4249.38

4732.01

10547.00

7236.64

889.76

53727.72

Guangxi

682.12

894.63

766.61

122.96

5250.12

Hainan

492.91

643.85

319.03

143.52

1636.61

Sichuan

2194.59

1811.20

1577.47

239.24

1994.82

Yunnan

518.14

645.11

1004.75

200.66

6679.44

(%) 30.00

Transportation/logistics

Real estate

Wholesale/retail

Hospitality

25.00

20.00

15.00

10.00

5.00

0.00 Fujian

Jiangxi

Guangdong

Guangxi

Hainan

Sichuan

Yunnan

Figure 21.8: Weighted total capital, by sub-sector

III. Business Income per Capita in the Service Sector Observing business income per capita in the service sector provides another view of the impact of value-added on the Pearl River region’s economy. Once again, the retail and wholesale sub-sector leads the way, largely on the back of high transaction volume. However, real

analyzing industrial conditions in the pearl river basin 335 estate moves up to the second position, largely because of the rapid growth in this sub-sector and the relatively high prices for individual transactions. Transportation and logistics, as well as the hospitality and accommodations sub-sectors are well behind. This is unsurprising given that these sectors include many low-skill jobs. A more detailed view reveals the per capita income leaders in each sub-sector. The largest sub-sector in the nine provinces, retail and wholesale, takes the top spot in Guangdong with nearly 1,100,000 yuan per capita. Hainan’s transportation and logistics is its leading sub-sector, bringing in 330,000 yuan per capita. Hospitality and accommodations takes in about 100,000 yuan per capita, placing it at the top of the rankings in that province. Fujian’s real estate industry leads the way among the four key sub-sectors there, clearing over 420,000 yuan per capita. (See Table 21.12 and Figure 21.9.) Table 21.12: Business income per capita by sub-sector (10 thousand RMB) Type

Transportation/ logistics

Real estate

Wholesale/ Hospitality retail

Other

Fujian Jiangxi Guangdong Guangxi Hainan

15.80 8.91 22.56 8.56 33.66

42.16 23.98 24.08 23.35 18.34

90.35 4.17 109.14 43.30 59.44

7.27 5.02 7.97 4.75 5.34

6.29 3.62 12.11 3.29 4.82

Sichuan Yunnan

11.83 9.70

31.52 32.72

79.56 65.98

5.52 10.65

1.25 4.08

V. Summary The above data analysis yields the follow conclusions: (1) In recent years value-added and employment proportions of the three main economic sectors—agriculture, industry, and services—have held even with the overall national economy. Given the diversity and size of the Pearl River region, and its large contribution to the national economy, this is unsurprising. Specific figures reveal the importance of the region to the overall national economic picture, though. The Pearl River region contributes

336

shu yuan Transportation/logistics Wholesale/retail

(%) 120

Real estate Hospitality

100 80 60 40

20 0 Fujian

Jiangxi

Guangdong

Guangxi

Hainan

Sichuan

Yunnan

Figure 21.9: Business income by sub-sector

35% of the national total value-added in the agricultural sector, 30% of industrial value-added, and 40% of the service sector. The region’s contribution to employment in China is somewhat less in percentage terms: 35% of the total in agriculture, 25% of the industrial jobs, and 30% of service-sector positions. Overall the region makes a large contribution to the national economy, especially in services, which China’s leaders look to as the engine propelling China into the next phase of economic growth. (2) Unlike overall economic contributions, labor productivity in the Pearl River region sometimes varies far from national averages. While it is roughly at parity in the agricultural sector, labor productivity in the industrial and service sectors far outstrips national averages; the region leads the nation by 18% in industry and 26.5% in services. Clearly the latter two sectors enjoy advantages by operating in the region as compared to their counterparts in other parts of the country. (3) Gross product per capita figures for the nine provinces located along the Pearl River also diverge from national averages. Guangdong exceeds the national mark by 87%. Fujian’s output per capita is 63% higher than the nation’s. However, some provinces in the region do not meet the national mark; Guizhou’s per capita output is only 28% of national GDP per capita.

analyzing industrial conditions in the pearl river basin 337 (4) The provinces situated along the Pearl River have similar industrial structure. Industry and services generate most of the economic activity. However, Hong Kong and Macao stand apart from the Mainland provinces in that they generate more value within the service sector. Even though structure is similar across the region’s provinces, labor productivity varies across the three main sectors, indicating that the level and course of development is different in each province. As noted above, Hainan has the highest labor productivity in agriculture. Guangdong is the leader in industry, and Fujian tops the list in the service sector. (5) Locational advantages vary widely by industry and province. Guangdong exhibits an advantage in the high tech and information technology (IT) industries. Fujian’s advantages lie in industrial products and apparel. Guizhou, Hunan, and Jiangxi, display advantages in natural resource exploitation, especially mining. (6) The Pearl River region has strong labor productivity in tobacco processing, oil refining, nuclear fuel processing, oil and natural gas extraction, but relatively low productivity in coal mining and refining, gas production and distribution, rubber manufacturing, and textile and apparel manufacturing. (7) Industrial value-added varies by industry, with some far exceeding the national average and others falling well shy of national standards. Value-added is relatively high in ferrous metal mining and processing, oil refining, and nuclear fuel processing. Other local industries, such as gas production and distribution, synthetic cloth manufacturing, instrumentation manufacturing, and office machinery, lag value-added measures typical of operations across the PRC. (8) Industrial concentration tends to be high in the nine provinces along the Pearl River. Three-industry concentration ratios all break the 50% mark. Agglomeration, possibly driven by a foreign direct investment pouring into certain firms in specific industries in particular areas, with labor following the jobs these investments create, is a crucial element in the provincial economies in the region. Yunnan is the region’s most concentrated, being the only one with a two two-industry score above 50%. This probably indicates that a high degree of focus in investment and strategy exists in the province, and as well, a certain degree of “follow-the-leader” thinking. (9) The service sector manifests a variety of distinctions across the region. Hong Kong and Macao have developed large, varied, and high-value service sectors. In many ways their economic development points the way forward for provinces like Guangdong and Fujian. In

338

shu yuan

the meantime, though, the region must generate jobs, and doing so in the service sector can provide potentially well-paying jobs without strictly binding environmental or resource constraints. Guangdong leads the way in service sector employment. It also produces the most jobs in the largest sub-sector, retail and wholesale. Furthermore, it generates the most work in the best paying sub-sector, real estate, largely owing to the much higher level of development in the province. The nine provinces along the Pearl River play a central role in the economic well being of China. They contribute vast amounts of wealth and jobs. The economic diversity underscores the breadth of Chinese economic development, as well as the daunting challenges that remain to be tackled. The success of the coastal provinces blazes a trail that inland provinces could follow; the even more advanced economies of Hong Kong and Macao provide a target for planners, policymakers, and leaders to shoot for in Guangdong and Fujian. By drawing more closely together and building social and economic ties that foster cooperation, coordination, and true development—not just growth, but smart growth—the process of economic modernization can be hastened and made more efficient. This would benefit the people of the region, as well as business operators, and communities.

analyzing industrial conditions in the pearl river basin 339 Appendix Table 21.a: Value-added locational quotients, by province Industry

Fujian

Jiangxi

Hunan

Guangdong

Guangxi

Hainan Sichuan Guizhou

Yunnan

Coal mining/ refining

0.80

2.99

3.22

0.02

0.81

0.01

2.40

4.46

1.49

Oil and natural gas extraction

0.00

0.00

0.00

1.43

0.00

0.94

2.60

0.00

0.00

Ferrous metal mining

1.18

0.63

0.92

0.42

2.05

15.86

2.24

0.63

1.42

Nonferrous metal mining

0.45

2.92

2.99

0.23

3.46

1.31

1.14

0.59

2.92

Nonmetal mining

0.94

1.42

1.93

0.50

1.25

1.49

1.62

4.30

0.90

Food processing

0.97

1.13

1.25

0.63

4.19

2.51

1.63

0.43

0.73

Food manufacture

1.10

1.03

1.06

1.07

0.60

2.76

1.09

0.66

0.24

Soft drink manufacturing

0.73

0.80

0.71

0.58

0.75

1.58

3.70

2.66

0.33

Tobacco processing

0.52

0.96

2.09

0.20

0.74

0.52

0.53

2.20

7.29

Textile manufacturing

1.64

1.38

0.76

1.12

0.49

0.59

0.75

0.08

0.07

Clothing accessories

2.13

0.27

0.20

1.35

0.03

0.79

0.07

0.07

0.02

Leather, fur, and feather products

2.99

0.43

0.35

1.04

0.32

0.14

0.29

0.00

0.00

Timber processing

1.51

2.15

1.44

0.82

2.18

1.51

0.50

0.18

0.57

Furniture manufacturing

1.35

0.10

0.53

1.41

0.07

2.10

0.42

0.03

0.03

Paper manufacturing

1.25

0.55

1.35

1.06

1.06

0.19

0.82

0.16

0.62

Printing and media

0.64

1.73

0.96

1.09

0.53

1.00

0.88

0.38

1.39

Oil and nuclear fuel processing

0.58

2.55

3.00

0.97

0.79

0.82

0.43

0.19

0.14

Synthetic cloth

0.62

0.82

1.25

1.04

1.10

1.41

1.12

1.28

0.84

Medical equipment

0.54

2.48

0.94

0.65

2.06

4.56

1.66

2.55

0.97

Rubber manufacturing

2.23

1.01

0.89

0.81

0.42

0.21

0.76

2.90

0.11

Plastic products

1.54

0.19

0.33

1.36

0.37

0.39

0.39

0.17

0.20

Nonmetal products

1.39

1.56

1.21

0.78

1.35

0.62

1.39

0.76

0.69

Ferrous metal processing

0.80

2.60

1.90

0.33

1.56

0.50

2.52

2.02

1.33

Nonferrous metal processing

0.44

2.74

1.98

0.46

2.51

0.12

0.95

3.32

2.27

Metal finished products

0.64

0.40

0.55

1.51

0.27

0.81

0.52

0.55

0.08

General equipment manufacturing

1.02

1.09

1.40

0.82

1.16

0.18

2.19

0.31

0.26

340

shu yuan

Table 21.a (cont.) Industry

Fujian

Jiangxi

Hunan

Guangdong

Guangxi

Hainan Sichuan Guizhou

Yunnan

Specialized equipment manufacturing

1.08

0.76

2.92

0.62

1.73

0.19

1.57

0.47

0.63

Traffic equipment manufacturing

1.08

1.76

1.11

0.85

2.27

4.27

1.01

0.99

0.28

Electrical equipment manufacturing

0.71

0.46

0.42

1.53

0.39

0.36

0.47

0.22

0.10

Electronic equipment manufacturing (telecom/ computer)

0.90

0.14

0.12

1.62

0.08

0.03

0.40

0.14

0.02

Instrumentation and office machinery

0.81

0.31

0.20

1.59

0.27

0.00

0.36

0.08

0.14

Miscellaneous manufacturing

3.16

0.46

0.19

1.07

0.00

0.00

0.08

0.29

0.01

Waste recycling and disposal recovery

0.16

0.27

2.85

1.42

0.00

0.00

0.09

0.53

0.00

Energy production and distribution

1.00

1.02

0.98

0.87

1.50

1.06

1.15

1.93

1.07

Gas production and distribution

0.29

0.23

0.41

0.97

0.01

4.87

2.88

1.29

0.84

Water storage and distribution

0.83

1.33

1.42

1.01

1.62

1.98

0.57

0.72

0.90

Table 21.b: Industrial labor productivity, by province (RMB per capita) Industry

Fujian

Guangdong

Guangxi

Guizhou

Hainan

Hunan

Jiangxi

Yunnan

Coal mining/ refining

16467

11322

17878

15941

3136

27395

18225

28334

Oil and natural gas extraction

34455424

4527500

37609

Ferrous metal mining

40547

68828

26904

32590

23832

70233

39239

38199

Nonferrous metal mining

72239

57735

23440

18497

72368

82821

20692

29777

Nonmetal mining

39871

44613

37330

52627

18109

80464

23950

36407

Food manufacture

66456

109324

68052

42155

226214

61656

39565

Soft drink manufacturing

49219

91705

24248

42177

51848

101927

38340

32954

Tobacco processing

92513

188658

70563

106431

118328

149903

59130

53202

Textile manufacturing

476334

955397

547778

282818

693532

554882

414823

1331348

Food processing

11470

77804

analyzing industrial conditions in the pearl river basin 341 Table 21.b (cont.) Industry

Fujian

Guangdong

Guangxi

Guizhou

Hainan

Hunan

Jiangxi

Yunnan

Clothing accessories

43959

48010

17536

8015

62160

72907

22316

7677

Leather, fur, and feather products

25435

27055

12325

23623

33499

78291

20312

13949

Timber processing

26576

22677

40940

-6026

24870

132500

27070

6324

Furniture manufacturing

43617

58588

37326

12311

30502

101653

34468

33194

Paper manufacturing

38330

35278

21635

14917

32659

133500

14867

Printing and media

57155

78160

32857

19091

39647

146033

32927

74076

Oil and nuclear fuel processing

50973

52348

31068

21469

31787

166341

81944

81249

Synthetic cloth

130503

523379

275936

38409

652402

396202

259104

76323

Medical equipment

106580

190526

45909

45371

141707

104354

39260

46480

Rubber manufacturing

132466

118303

68931

101943

167640

229766

57431

117447

Plastic products

96715

44622

12297

45858

12846

105739

57826

15873

Nonmetal products

43075

47564

39489

27220

36630

135474

31221

42380

Ferrous metal processing

54313

52291

21494

18686

39204

61776

30397

38000

Nonferrous metal processing

109805

167174

76365

41250

125719

157855

83306

72676

Metal finished products

120788

119127

81583

75652

108630

204085

78641

62593

General equipment manufacturing

55997

54887

44565

31513

103879

132845

36788

23318

Specialized equipment manufacturing

62678

63453

31050

11382

35442

111472

30067

22795

Traffic equipment manufacturing

67691

56507

46137

17942

17530

146600

30815

27571

Electrical equipment manufacturing

156180

132376

96643

31568

205807

227721

54268

59679

Electronic equipment manufacturing (telecom/ computer)

77831

65986

55647

38563

85455

146429

56293

37330

Instrumentation and office machinery

210366

118053

61596

54421

34222

782682

37654

78856

Miscellaneous manufacturing

56730

75627

37130

15583

95699

19235

28830

Waste recycling and disposal recovery

26516

30942

16315

23645

54653

16607

342

shu yuan

Table 21.b (cont.) Industry

Fujian

Guangdong

Energy production and distribution

131379

76577

Gas production and distribution

67593

371711

Water storage and distribution

29832 23404

Guangxi

Guizhou

Hainan

Hunan

Jiangxi

Yunnan

65564

63168

482000

82250

105030

149523

102733

73435

52745

136439

178200

1198

29070

118698

51935

16076

41140

94663

34239

14748

21284

23302

27369

63569

Table 21.c: Industrial value-added growth, by province (%) Industry Coal mining/refining

Fujian

Guangdong

Guangxi

89.7

105.4

–0.5

Oil and natural gas extraction Ferrous metal mining

Guizhou 66.0

Hunan

Jiangxi

32.6

65.9

137.4

Sichuan 73.9 22.9

500.0

81.4

96.8

68.8

64.2

863.6

81.5

45.9

31.3

–10.0

75.8

37.7

106.4

28.4

Nonmetal mining

71.7

26.0

26.2

–70.7

34.0

28.6

–8.3

Food processing

54.1

3.1

24.7

6.7

39.3

55.9

57.3

Food manufacture

49.5

16.2

43.6

70.6

67.7

37.9

14.1

Soft drink manufacturing

13.7

5.2

28.4

34.4

19.5

32.3

24.4

Tobacco processing

13.9

32.3

31.6

20.6

26.4

6.4

4.3

Textile manufacturing

48.6

28.0

9.4

31.0

31.7

28.1

43.0

Nonferrous metal mining

Clothing accessories

45.3

24.6

24.4

17.5

21.7

471.9

84.6

Leather, fur, and feather products

30.6

16.8

11.9

–750.0

36.9

55.8

71.2

Timber processing

30.6

19.3

41.5

31.8

44.2

–1.2

60.9

Furniture manufacturing

70.7

25.0

32.1

14.3

36.3

297.4

90.4

Paper manufacturing

40.0

10.2

62.0

16.7

27.8

71.1

17.2

Printing and media

39.7

23.5

26.1

–2.6

23.4

0.4

8.8

Oil and nuclear fuel processing

30.3

46.8

0.3

460.7

0.1

18.0

100.5

Synthetic cloth

64.5

46.4

34.6

52.7

57.4

53.7

55.2

6.6

–0.3

7.2

16.0

20.8

30.1

40.3

Rubber manufacturing

91.4

17.3

–10.8

26.9

2.8

52.8

34.0

Plastic products

13.9

15.0

35.3

15.9

70.4

74.8

70.1

Nonmetal products

67.4

35.3

32.6

18.2

27.1

40.0

21.4

Ferrous metal processing

28.3

9.3

122.5

52.4

71.5

20.6

33.0

Nonferrous metal processing

60.1

42.7

80.8

24.6

60.9

74.5

59.0

Metal finished products

24.2

40.5

30.2

6.0

42.2

116.0

21.1

Medical equipment

analyzing industrial conditions in the pearl river basin 343 Table 21.c (cont.) Industry

Fujian

Guangdong

Guangxi

General equipment manufacturing

48.6

57.1

28.9

Specialized equipment manufacturing

64.1

56.0

Traffic equipment manufacturing

–18.0

Electrical equipment manufacturing

Guizhou

Hunan

Jiangxi

Sichuan

107.9

44.4

54.1

50.7

26.5

–6.6

13.1

38.6

29.7

24.3

26.9

–3.8

12.0

7.3

40.4

49.5

31.9

17.2

45.3

31.0

65.8

42.7

Electronic equipment manufacturing (telecom/computer)

29.1

10.6

31.4

–3.4

21.2

–12.6

–0.4

Instrumentation and office machinery

18.2

–13.8

7.4

70.4

55.5

42.0

–30.5

Miscellaneous manufacturing

3.2

28.4

0.0

30.9

252.7

24.2

45.4

Waste recycling and disposal recovery

323.2

46.8

0.0

14.3

47.4

412.6

–25.0

Energy production and distribution

9.0

6.1

14.2

18.4

32.3

54.1

50.8

Gas production and distribution

–9.4

43.2

1072.2

–18.1

–30.9

7.4

42.2

Water storage and distribution

24.6

24.5

2.8

7.6

6.6

–0.2

38.3

ANALYSIS OF FINANCIAL MARKETS AND THEIR PROSPECTS IN 2005 Wang Yi and Chen Hao Since the beginning of 2005 macroeconomic controls have been improved and enhanced. Evidence of this can be seen in both broad and specific perspectives. GDP continues to grow quickly and steadily: in the first three quarters of the year output increased 9.4% year-on-year. Unsurprisingly, industrial production and consumption also increased without notable fluctuations. The increase in the trade surplus grew surprisingly fast. Many commodity and consumer good prices declined. Monetary trends mirrored overall economic conditions; bank loans and currency supply grew along established trends. The national economy continues to meet expectations. Nevertheless, some problems continue to linger and cause concern in spite of the overall positive picture. On the production side, enterprises continue to churn out a glut of goods. To some degree this has produced large trade surpluses. Investment in productive capacity also gallops forward, in some cases created excess capacity. On the input side of the system, the steep increase in petroleum and energy prices beginning in 2005 presents a serious threat to sustained economic growth. Conditions in financial markets suggest the need for attentiveness as well: easy bank loans have pumped up the money supply. Carefully analyzing these problems is crucial for conscientiously judging the nation’s economic status and further refining macroeconomic controls. I. The Basics of Credit in China Currently credits markets show improving strength, stability, and flexibility. In general, the money supply continues to expand apace, but without notable danger signs. The structure of outstanding loans has improved recently. Exchange between banks is active, which helps to rationalize overall financial markets. Interest rates remain stable. These elements set the stage for a smooth introduction of currency exchange reform.

346

wang yi and chen hao

A. Total Money Supply (M2) Growth1 At the end of September, the surplus of M2 climbed to 28,740 billion yuan, a 17.9% year-on-year increase, although August saw only a 0.6% increase. M1 ran a surplus of 1,010 billion yuan for the same period, up 11.6% year-on-year. The monthly increase was only 0.1%. Money mobility, or M1/M2, was 35%, a 2% year-on-year decline. The structure of these broad changes deserves deeper analysis. The growth of M1 has been relatively slow, mainly due to the slow increase of M0 over the same annual period and the contraction in the current business deposits. At the end of September the surplus of M0 reached 2,230 billion yuan, an 8.5% year-on-year increase. However, M0 declined 0.9% since August. M2 outpaced M0 and M1 in the period because of a large increase in enterprise and household savings deposits. In the first three quarters of this year, deposits increased by 3,660 billion yuan, which means an increase of 962 billion yuan year-on-year. Savings deposits increased 573.5 billion yuan year-on-year; while savings deposits made by businesses increased 358.3 billion yuan over the same period (See Figure 22.1.) B. The Rapid Influx of Foreign Currency At the end of September the surplus in M1 had reached 6,080 billion yuan, a 14.3% year-on-year increase. A huge influx of foreign currency produced this increase. September saw the general excess deposit rate of all financial institutions move to 3.96%, an increase of only 0.15% over the previous month. C. Increases in Household Savings At September’s end total household and foreign currency deposits equaled 29,260 billion yuan, an 18% year-on-year increase. Total RMB deposits reached 27,990 billion yuan, a 19.1% year-on-year increase; excluding seasonal factors the month-to-year increase is 16.2%. Household savings balances equaled 13,630 billion yuan, an 18.1% 1 Money supply, abbreviated as M, is broken into the following categories: M0 = total currency + accounts and contracts that can be exchanged for currency; M1 = M0 + checking account deposits; M2 = M1 + savings deposits + time deposits and certificate of deposit accounts (CDs) under $100,000.

analysis of financial markets and their prospects in 2005 (%) 23

347

M1 M2

21 19 17 15 13 11 9 7

07/2005

04/2005

01/2005

10/2004

07/2004

04/2004

01/2004

10/2003

07/2003

04/2003

01/2003

10/2002

07/2002

04/2002

01/2002

10/2001

07/2001

04/2001

01/2001

5

Figure 22.1: Recently M2 increases faster than M1

year-on-year increase; excluding seasonal factors the month-to-year increase is 19.2%. This indicates a rapid increase in household savings (See Figure 22.2.) The first three quarters of this year witnessed an influx of 3,660 billion RMB in deposits, which is an increase of 962 billion yuan yearon-year. A key component of this sum is household savings deposits, which increased 573.5 billion yuan year-on-year. However, demand deposits2 contracted 80.6 billion yuan from the previous September. Business savings deposits increased 358.3 billion yuan year-on-year, while total demand deposits declined 272.4 billion yuan. Foreign currency deposits declined after July in response to reforms in the exchange rate system. July’s deposits showed a 4.8 billion USD decrease from the previous month; August’s decline was 3.3 billion, and the monthly decline in September was 3.6 billion USD. Total foreign currency deposits at the end of September equaled 157.5 billion USD.

2 “Demand deposits”, also known as “current deposits,” are deposits in checking accounts available for immediate or on-demand withdrawals or payments.

348

wang yi and chen hao

(%) 23

70 (%)

Year-on-year Month-on-month

21

60 50

19

40

17

30

155

20 10

13

0

11 09/2005

07/2005

05/2005

03/2005

01/2005

11/2004

09/2004

07/2004

05/2004

03/2004

01/2004

11/2003

09/2003

07/2003

05/2003

03/2003

01/2003

11/2002

09/2002

–10

Figure 22.2: Household deposits in—year-on-year rate (left axis); month on month (right axis)

D. Increasing the Pool of Loans within a New Regulatory Framework The surplus of loans held in local and foreign currencies by all financial institutions equals 20,310 billion yuan, a 13.5% year-on-year increase. Growth in loans remains relatively stable because consumer credit, especially for housing loans, declined in the period. Changes in real estate policies precipitated this decline, which made housing loans much less attractive than in the previous year.3 In order to impel financial institutions to improve their capital structure, the central bank cut certain interest rates with the hope that banks would have greater flexibility in offering short term loans for business. However, the central bank rolled out policies designed to rein in long and middle term loans, including mortgage loans. Such moves had the desired effect; in the first nine months this year, the middle and long term loan balance grew by 19.8% year-on-year, off 5.5% from the previous year’s growth rate. Short term loan balances increased by 10.5% year-on-year, 2.6% climb from the previous year’s rate. Translated into monetary terms we see that in the first nine months of the year, short term loans and financing increased by 254.3 billion yuan over the previous year, while the long and medium loans contracted by 91.3 billion yuan year-on-year. (See Figure 22.3.)

3

This and other financial market reforms are described elsewhere in this volume.

analysis of financial markets and their prospects in 2005 (%) 39

349

Short-term loans Medium- and long-term loans

34 29

09/2005

07/2005

05/2005

03/2005

01/2005

11/2004

09/2004

07/2004

05/2004

03/2004

01/2004

11/2003

4

09/2003

24 19 14 9

Figure 22.3: Interest rate changes and their impact on short-term and mediumand long-term loans

E. The Increase of Inter-Bank Trade Volume From January to September, the inter-bank market in China totaled 16.86 trillion yuan. The daily average was 89.7 billion yuan, amounting to a 36 billion yuan year-on-year increase. When the People’s Bank of China cut interest rates on March 17 on excess deposit reserves, foreign exchange raced into the country. This set off a chain of related effects across the banking system. In particular, the inter-bank seven-day repurchase weighted average interest rate, after having declined in the precious four months, approached the over-quota loan reserve interest rate of 0.99%. But after June the interest rate stabilized. The weighted average interest rates for inter-bank borrowing for September, as well as the rates fetched by repurchased pledge bonds and simple repurchased bonds, came to 1.51%, 1.15%, and 1.47% (See Figure 22.4.) The decline of interest rates in the money market produced positive effects. For instance, the structure of credit improved. However, declining interest rates produced problems as well, especially in the structure of interest rates. Specifically, commercial banks faced greater pressures in raising operating capital. A questionnaire circulated by the Investigation and Statistics Administration of People’s Bank of China showed that 81% of bankers considered the current interest rate “moderate”. F. Stability is the Goal in Reforming the Exchange Rate Mechanism On July 21, the exchange rate system entered a process of reform. For the first time the exchange rate between the RMB and the US dollar

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(USD) would respond to market forces. Since entering the period of this managed float, exchange rates have fluctuated between 8.1128:1 and 8.0869:1. The largest single-day fluctuation was 0.09%. II. Lingering Areas of Concern in Financial Operations Those of us in the financial trade should pay close attention to changes in economic operations following the implementation of policies affecting financial markets. Careful observation is needed to judge current conditions and future trends produced by these policy moves. Further, by measuring the impacts of these changes, we can more effectively implement future control measures. A. The Growing Gap between Money Supply and Outstanding Loans Beginning in 2006 M2 and the total amount of outstanding loans diverged, eventually reaching a margin of 4.16% in September. (See Figure 22.5.) At present, the adverse effects produced by the increasing gap between money supply and loans are becoming more obvious. First, with a relatively stable loan pool and rapidly increasing deposits, inter-bank mobility has surged. Mobility received yet another boost when the central bank lowered the excess deposit reserve interest rate. Second, the average interest rate on loans rose slightly, while the money market

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Figure 22.5: M2 outpaces loan growth (RMB)

interest rate continued falling. Note that demand for loans pushed up these interest rates. In the second quarter of 2005 the one-year fixed interest rate for loans from financial institutions was set at the weightedaverage interest rate of 7.46%, which was 0.71% higher than the rate in the fourth quarter (Q4) of 2004. Note that the high mobility of bank capital continued to put downward pressure on money market interest rates.4 Third, structural differences exists in the capital supply by region and type of investment. The bank system is rich in capital, while some economic entities lack financial support; loans are directed toward advanced regions and large enterprises, while the underdeveloped regions, small and midsized enterprises, and private farmers lack funding. It must be pointed out that the increase in M1 is relatively small, and the small but steady increase in loans does not necessarily mean that enterprises typically lack funding. From January to September of 2005, enterprise deposits increased 838.2 billion yuan, or 85.9 billion yuan more year-on-year. Savings deposits increased 358.3 billion yuan year-on-year, while demand deposits decreased 272.4 billion yuan yearon-year. Moving demand deposits into savings deposits indicates that many enterprises believed that meeting near-term expenses would not be an issue; furthermore, it proves that enterprise funds remain healthy. 4 Of course, there are other reasons for the decline of money market interest rates. For example, on March 17, 2005, the People’s Bank of China reduced the excess deposit reserve interest rate.

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There are a few key causes behind the widening gap between money supply and loans. First, foreign exchange holdings increased rapidly, which in turn caused total basic currency and even the broad currency supply (M2) to increase rapidly. Second, reform of stock ownership of the four major state-owned commercial banks obstructed other stock ownership reform moves. This actually increased regulatory control over the sector and brought about greater scrutiny of loan applications. In general, loan operations have gone forward based on more transparent and rational analysis.5 The need for strict supervision over capital also prodded these banks to adjust their capital structure by reining in the scale of risk capital. Furthermore, since instituting new macroeconomic regulations and strategies in 2004, economic growth and the distribution of economic benefits have contracted slightly. In response, these banks have become more careful in managing loan operations. Third, given the aforementioned slowing of GDP growth, and the concomitant contraction in expected profits, most enterprises have retooled systems to look for long term gains rather than investing in projects paying a quick return. Some enterprises have even reduced their investment and output in response to excess productive capacity in some sectors. Obviously, this has cut into the demand for new productive capital. Fourth, the diversification of capital channels enables enterprises to obtain capital in forms other than loans.6 In the first half of 2005, the commercial remittance bills issued by enterprises totaled 208.2 billion yuan, bonds issued by enterprises (including short term financing securities) amounted to 30.3 billion yuan, and the capital collected through stock sales at home and abroad was about 90 billion yuan. Research done by the People’s Bank of China also shows that until the end of 2004, Chinese enterprises had financed approximately 950 billion yuan through various financial instruments, accounting for 5.92% of the enterprise loan balance in home or foreign currency, with 37% of the enterprises surveyed receiving civil financing.

5 In the first three quarters of 2005, loans from the four major state-owned commercial banks reached almost 580 billion yuan, about 250 billion yuan less than 2004’s total. In the same period, loans issued by all financial institutions increased to 1,960 billion yuan, which is about 164 billion yuan more than at the same time last year. 6 Many enterprises, especially those having income from foreign exchange, can increase their domestic capital holdings through exchange settlement. Other forms of payment and transfers can also replace loans as a capital source: bill settlement, internal enterprise financing, deficit financing, stock issues at home and abroad, capital borrowing in overseas markets, export rebates, and civil financing, among others.

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B. Complications in Currency Policies Since the middle of last year, our country’s trade surplus has been increasing. With direct investment by foreign business interests increasing on a stable path and expectations for increases in the value of the RMB, the foreign exchange reserve has increased steadily. From January to September this year, foreign exchange holdings increased 1,400 billion yuan, a 581 billion yuan increase since the same time last year. By the end of September, foreign exchange holdings reached 6,387.040 billion yuan, a 7.7% year-on-year increase. The rapid increase in foreign exchange holdings has produced clear effects. First, both M1 and M2 have grown sharply. By September, the ratio between the balance of foreign exchange holding and M1 equaled 63%. To blunt the impact of rapidly increasing foreign exchange holdings, the central bank issued a substantial amount of currency. Second, capital is concentrated in export-oriented markets; parts of the economy less oriented towards trade often lack access to capital. C. Capital and Construction Loans Up, Consumer Loans Down Since June notable changes have occurred in the mix of loans being made. In particular, the increase in capital and construction loans and the large obvious decrease in consumer loans merit further inspection. Capital and construction loans have increased for four consecutive months. Between the beginning of June and the end of September, new capital and construction loans totaled 493.8 billion yuan, 79.2 billion yuan more than the same period last year. During the previous five months, capital and construction loans increased 236.4 billion yuan, 21.4 billion yuan less than the same period last year. From June to September, the monthly increases in civic fixed capital investment equaled 28.8%, 27.7%, 28.5%, and 29.4%, respectively. From January to September, the capital construction investment in cities increased 27.7%, 0.1% higher than the total increase of the previous last year. Although the increase in investments by foreign investors and local government sources has slowed, investment by state capital holders has steeply increased. This booming trend needs to be carefully monitored to prevent overheating or excess capacity from being built. (See Figure 22.6.) In contrast, consumer loans—especially short term loans—have decline. During Q1–Q3 of 2005, personal short term consumer loans declined by 3.3 billion yuan. This means that small, day-to-day purchases, may be contracting as well. (See Figure 22.7.)

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III. Prospects for Loan Operations Since January 2005 the world economy has growth steadily. According to IMF projections made in September, global GDP is expected to increase by 4.3% in 2005. However, this strong figure came with predictions of greater potential volatility as well: rising oil price rises, interest rates, and trade barriers cloud the horizon. In spite of this, China’s macroeconomic policies and strategies continue to effectively guide the economy, as evidenced by continued rapid, but stable economic growth. Annual GDP growth is estimated to be about 9.4%, while the CPI7 is only about 1.8%. Growth in M2 is estimated at 17.4%, which overshoots the beginning-of-year target of 15% growth. The increase in outstanding loans stands between 2,400 to 2,500 billion yuan, which more-or-less hits the 2,500 billion yuan target amount. Given current trends and condition—and barring a major policy change or exogenous shock—China’s GDP should increase at about 9% in 2006, with an inflation rate of about 2%. M2 should grow by about 16%, with the loan pool increasing by about 2,600 billion yuan. Based on its success in guiding the economy on a stable growth path, the current macroeconomic regulatory framework remains in place. This framework includes financial, fiscal, and monetary policies aimed at promoting stability; capital ownership reforms intended to improve business performance, efficiency, and transparency; and currency conversion adjustments designed to bring trade and prices more in line with market outcomes. A. Monetary Policy and Stability Given the relative size of money supply (M2/GDP) and the oversupply of most consumer products, moderate surges in money supply will not cause much change in the CPI. However, it could produce inflation in asset prices (e.g., real estate prices). Close attention should be paid to the influence that money supply growth can have on middle-term price increases (e.g., asset prices). Money supply also depends upon currency flows, and therefore, the reformation of the currency exchange system should continue. However,

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policy moves must adjust to the effects of reform. In general, the capacity for clearing transactions by domestic financial institutions must be considered. Furthermore, the Chinese, especially the People’s Bank, must become more acquainted in reading fluctuations due to market forces. Finally, maintaining the desired mix of trade and financial instruments must be monitored in the international balance-of-payments scheme. B. The Interest Rate’s Effects on Money Markets Effective monetary policy requires that a stable interest rate in currency markets be maintained. This provides the foundation needed to ensure smooth interactions between financial institutions. The central bank can also consider issuing longer term bonds as a way of preempting volatility. If economic growth slows, appropriate steps should be taken in monetary policy operations to keep near-term monetary policies on target. C. Broaden Financing Options Currently, capital is widely available, and currency markets show little sign of strain. Given these strong fundamentals, policymakers should move to develop direct financing instruments such as short term business financing bonds. This can facilitate new uses of capital by financial institutions. This should help banks and other financial institutions to grow more robust. When joined with government financing, this new influx of commercial financing should provide a range of financing options such that underserved market segments should soon have reliable access to capital. D. Using Markets to Allocate Resources (1) Intervention in oil markets, especially price fixing, must be set ended. The relevant departments and policymaking bodies should actively reform this system to steer clear of the problems it produces. The reasons for doing so have been thoroughly described elsewhere. Except for oil, commodity prices have been on a declining path, moving toward a market-based pricing will rationalize procurement and allocation, especially for large scale infrastructure projects (2) Consumer spending should be encouraged. For many years China has tended to have low consumption and high investment. A few piv-

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otal steps can be taken to combat this problem. First, personal income taxation should be made more progressive, thus reining in income disparity. Second, a social insurance system should be formulated and implemented, which will stabilize household consumption over the lifecycle. Third, payments to rural and underdeveloped regions must be enhanced, with an emphasis on developing infrastructure in these regions.

REFORMING THE CURRENCY EXCHANGE SYSTEM Li Yang and Yu Weibin I. Introduction The People’s Bank of China made the following announcement on July 21, 2005: “Beginning today China will adopt a managed float exchange rate system. That is, currency value will depend on supply and demand of a basket of currencies being exchanged in the marketplace.” This pronouncement initiated the process of current exchange reform. This paper examines the consequences and implications of this reform process. This announcement came at a moment of openness, cooperation, and opportunity. First, after years of preparation and discussion, decision makers directly and indirectly affected by this policy change have developed a working understanding of what reform entails. This includes knowing the conditions giving rise to the need for reform, the goals of reform, as well as the mechanisms of currency exchange. Second, China has entered into discussions regarding ongoing trade imbalances with its trade partners in order to calm frictions. Currency exchange plays a central role in this process. Third, macroeconomic conditions and indicators point toward continuing strong growth, which should provide the economy sufficient momentum and stability to move through temporary difficulties produced during the currency adjustment process. Taken together, these conditions reduce confusion and inspire confidence in reform. The type of exchange rate reform also deserves closer attention. Note that moving toward a managed float moves China’s economy and economic policies toward market mechanisms. While a managed float is not a completely liberalized system, as would be the case with a free float, it still demonstrates China’s commitment to relying on markets to determine prices and to allow the rationalizing force of the market mechanism to shape economic decision making. Given the complexity of the reform process, difficulties are bound to manifest themselves. Taking preemptive measures where possible, and developing ameliorative strategies where prevention fails, can dampen

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the negative effects of these difficulties. As this process unfolds, the reform process can be refined. Reform should develop apace, and over time, expand to address the exchange rate system comprehensively. II. The Features of a Managed Float System Thus far exchange reform in China has pivoted on three key features: moving to the managed float, organizing the basket of currencies used to evaluate the renminbi, and setting the starting value for exchange rates. The managed float can be better understood in the context of various exchange rate mechanisms. The International Monetary Fund (IMF) identifies a number of currency exchange mechanisms and breaks these into three categories: hard pegs, soft pegs, and floats. Hard pegs include systems that offer no separate legal tender or currency values set by a currency board; currency values are fixed. Soft pegs include setting the value of a currency to a single currency or a composite of currencies. Soft pegs including crawling pegs, that is, pegs that move by limited degrees, or “corridors”, which limit fluctuations to a certain range. Floating systems include managed floats and free floats; values are largely determined by the supply and demand for various currencies.1 The system now employed in China, falls somewhere between a “corridor” or banded peg and a managed float. At any rate, adopting this system moves China a great distance toward using a market-driven exchange rate system. The system adopted by China offers flexibility and more complete integration into global markets, but still affords Chinese regulators and monetary authorities some control to avoid the kind of currency value collapses that have hurt currencies like the Mexican peso and Thai baht. Moving to a managed float—with the value of the renminbi (RMB) tied to a basket of currencies—frees the central bank from reactively adjusting currency values since market mechanisms adjust exchange rates. Moreover, relying on the market allows economic observers and other interested parties to get a more accurate picture of currency values

1 Demand for a given currency tends to be driven by the demand for goods from the country associated with that currency. Currency supplies tend to be determined by various monetary policies.

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and how these will affect the price of various goods and services on world markets. However, any kind of float system comes with a major risk: exposure to exogenous forces that can generate wide fluctuations in currency values. This includes instability brought on by speculation and/or capital migration. However, a managed float can blunt the most extreme fluctuations by allowing central banks to intervene in currency markets. Limiting variance in exchange rates helps to prevent “stampede” behavior that can fundamentally undermine currency value. As a result currency markets enjoy greater stability and predictability. China has taken this course to avoid the kind of currency fluctuations and economic instability that gripped the Thai economy in 1997 during the “Asian Flu.” Note as well that this kind of managed float will not allow a currency to maintain a low value while demand for goods from that economy increases. In China’s case, this almost certainly means that the RMB will appreciate in value. While this means that China’s goods and services will go up in price vis-à-vis foreign substitutes, some advantages come about through currency appreciation as well. First, this will ease trade imbalances to some degree. Second, a stronger currency will attract capital to the country, and encourage more investors to hold the RMB. Taken together, these effects can help the Chinese economy to become more robust, diverse, and less vulnerable to trade shocks. As with virtually any large economy, macroeconomic conditions depend on adjustments in monetary policy. My moving to a currency exchange system based on exchange with other currencies, China’s economy risks exposure (and enjoys benefits) from global economic changes and conditions. Note however, that China’s conditions affect other markets as well. In short, national markets have grown more interdependent. Figures 23.1–23.4 illustrate the variations in exchange rates for the RMB against the US dollar (USD), the Euro, the Yen, and the Hong Kong dollar (HKD). These currencies are important for two reasons: these are the currencies of some of China’s largest trading partners and these are some of the most important currencies used in global and regional trade. Note the comparisons in the RMB’s value against these currencies, and how fluctuations remain within a certain range. The new exchange rate regime puts China on an entirely new footing in this regard. Before beginning the reform process, the RMB remained pegged to the USD; as the USD has fallen in value in recent years, so did the value of the RMB vis-à-vis other currencies.

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Figure 23.4: The RMB/HKD exchange rate

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As with any change, especially one that will likely play out over a very long period, we can anticipate various problems manifesting themselves. While long term problems are important, we will focus on four issues that are likely to require our more immediate attention. To begin, a sector-by-sector, or industry-by-industry analysis should reveal the most likely immediate impacts of reforms. Building a body of analysis and making it widely available can help business leaders and policymakers adjust to changing conditions in markets brought on by currency exchange reform. Current research suggests that a number of industries benefit from these changes: tourism and air travel, retail, food and beverage sales, Chinese traditional medicine, paper manufacturing, banking, real estate, and electrical power generation and distribution. Several industries also seem relatively insulated from exchange rate reform: coal mining, building material manufacturing, national defense, and railway construction, among others. Those most negatively impacted include oil and natural gas; chemical manufacturing, metallurgy; electronic equipment manufacturing, including appliances and metering devices; mechanical equipment manufacturing; automobile manufacturing; garment and textile manufacturing; and information technology, on both the hardware and software sides. Second, the managed float should be relaxed over time in order to dismantle the last vestiges of the pegging system. For instance, some observers believe that the renminbi will only appreciate in value, claming that the currency’s value had been artificially depressed under the old pegging regime. Further, given the power of the Chinese economy and demand for the goods it produces, it seems likely that appreciation of the RMB will eventually exceed the 2% variance allowed under the current managed float regime. While a stronger currency will adversely affect Chinese exports, it will increase the spending power of Chinese residents and make the currency more attractive to investors. Third, looking at foreign currency deposits can reveal a great deal about the demand for currency, and therefore, upward pressure on its value. Deposits have declined since early 2003 into early 2005. (See Figure 23.5.) This trend ran counter to experience; when a country enjoys brisk demand for its products, it typically has a correspondingly high demand for its currency. In this same period Japan attacked China, claiming that the renminbi was undervalued. This claims started in 2002, and by 2003, the Japanese

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called on the Chinese to increase the value of the RMB. This set off a ripple effect through world currency markets and expectations of an increase in the value of the renminbi have grown more common and widespread. Once the reform process had begun, all manner of entities found themselves exposed to greater financial risks posed by fluctuating exchange rates including governments, financial institutions, industrial and commercial enterprises, and even individuals. Various hedge and derivative products would be needed to brace these entities from the worst of the potential problems brought on by varying currency values. Introduction of these financial instruments started before July 2005 and continued after initiating the reform process. Specific policies include opening up the currency spot market; starting and expanding inter-bank futures trading, settlement, and sales; and increasing the renminbi’s range of values against non-USD currencies. With time and experience, other measures designed to decrease the worst aspects of exchange rate risks will be developed and implemented. Fourth, to better allow the aforementioned entities to adjust to exchange rate fluctuations, an entire financial information support system needs to develop. This includes data collection on economic conditions related to price, trade, and exchange rate fluctuations. Relevant data from accounting, taxation, and financial firms and bureaus should be gathered, analyzed, and circulated to interested parties. Having this information and analysis at hand will allow firms, governments, and 7600 7400 7200 7000 6800 6600 6400

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individual to respond more rationally to the direct and indirect impacts of exchange rate fluctuations. By better understanding the impact of these changes, monetary system managers can more effectively manage the float. This helps maintain stability in the RMB’s value and maintain smoother economic operation. IV. Potential Long Term Problems Empirical research shows that when developing countries move to a floating exchange rate system, they tend to remain actively engaged in managing currency values. Calvo and Reinhart (2000) indicates that the level of intervention pushes the bounds of a floating system, and shares many characteristics with a pegging system. Because of this, Calvo (2000) regards such currency reforms as subterfuge. Central banks becoming overly involved in managing currency value when net equity or net income (or both) is very sensitive to exchange rate fluctuations. Internal and external forces work in concert to create this condition, which is known as a “currency mismatch.”2 These external pressures began to form with the collapse of Bretton Woods.3 Bretton Woods established the primacy of the USD in international markets. Later in the century, the Euro would be established and would eventually play an increasingly central role in international transactions. Some economists call this aspect of Bretton Woods the “original sin.” These moves relegated other currencies to secondary or marginal roles in international exchange. Furthermore, markets other than the United States and the European Union had to work in multiple currencies. Therefore, these countries faced various risks brought on by fluctuations in their domestic currency against internationally recognized currencies. Note that this burden fell disproportionately on developing countries. Note also that because developing countries lack well developed capital markets, gaining access to the foreign capital needed to complete inter-

2 In their 2004 book Controlling Currency Mismatches in Emerging Markets, Morris Goldstein and Philip Turner refer to this conditional as a “currency mismatch.” 3 The Bretton Woods Conference took place in 1944 and gave rise to a regime for international monetary exchange, which included establishing the International Monetary Fund (IMF) and the World Bank (originally called the International bank for Reconstruction and Development or IRBD).

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national transactions placed firms and economies in a kind of “double jeopardy”: product markets and capital markets compounded the risks faced by firms, banks, and individuals.4 In the face of such exchange rate fluctuation and their aftereffects, the governments of developing countries have only two choices. First, they can use their foreign currency reserves to intervene on foreign exchange markets to influence currency values. Asian central banks applied this strategy in the 1997 Asian financial crisis, albeit only have enormous damage had been done. Alternatively, nations can cover losses incurred by those establishments as a result of currency mismatches. Brazil’s government issued bonds denominated in US dollars as a way of financing losses sustained during their own monetary crisis in the late 20th Century. Both forms of intervention produce problems, but the first form of intervention brought on particularly acute difficulties for Asia’s economies. First, shoring up currency values nearly exhausted foreign reserves. While intervention softened the impact, this turned out to be a one-time-only move; with foreign currency holdings nearly depleted, central banks could not intervene a second time and had to give in to floating rates. Moreover, the underlying problem has remained largely untouched: the concentration of large currency holdings in private hands hat can move out of the market or currency on a moment’s notice. The latter form of intervention also has its shortcomings. First, it requires central banks to accumulate vast foreign reserves and to maintain them for long periods in case mismatches generate substantial losses at some point. Second, it creates a “moral hazard” problem; that is, firms may behave recklessly knowing that they will be bailed out in spite of their mismanagement of exchange rate fluctuations. Research into currency mismatches provides a new analytical framework through which to better understand currency exchange reform. In particular, it focuses on assuring that transitions lead to macroeconomic stability, a key goal in assuring smoothly trade function. And as a developing country, China is exposed to the difficulties of currency mismatch. Policymakers must remain vigilant regarding problems that can arise from this sort of disequilibrium. To better understand the degree of exposure to currency mismatch, we can briefly examine China’s holdings and liabilities on international currency markets.

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At the end of 2004 Chinese individuals and enterprises held 153 billion USD and another 80 billion dollars worth of other currencies. State reserves reached about 610 billion USD. Using an estimate for M2 in the amount of 25,320 billion yuan, the ratio of Chinese foreign currency against M2 is about 1:30. Examining foreign currency liabilities helps to flesh out the picture. By the end of June 2005 the Chinese foreign loan balance equaled 266.176 billion USD. Just under half of this, or 124.829 billion USD, was medium and long term debt; short term debts amounted to 141.347 billion USD at the time. Since 2000, total liabilities increased by less than 120 billion USD. However, the structure of debt changed, with medium and long term debt declining by 7.7 billion USD and short term foreign debt increasing by 109.4 billion USD. Revenues are needed to service this debt. Fortunately, China’s trade sector has grown rapidly, which provides the funds to service this debt. Income from trade in goods and services in 2000 amounted to 279.6 billion USD; by 2004 it had jumped to 655.8 billion USD. Foreign exchange expenditures rose commensurately: imports rose to 606.5 billion USD, from 250.7 billion USD. Foreign debt payments peaked in 2004 at 190.2 billion USD in 2004, up about 150 billion USD over the amount posted in 2000. In sum, Chinese income and payments are nearly equivalent. When adding in income on foreign exchange holdings, income slightly overshadows expenditures. When looking at the balance sheet—that is, foreign currency assets against foreign currency liabilities—we see that foreign currency assets are slightly larger than foreign debts. This underscores part of the strength of China’s position. In short, China’s economy faces a relatively low risk from currency mismatch risks. Countries running the risk of financial crisis typically face foreign debts that dominate foreign assets; this exposes the domestic currency to devaluation. With conditions reversed, the renminbi may well face upward pressures on its value. The managed float seems to be working well and the risks associated with floating have been largely preempted, which puts the economy onto a stable footing. In fact, China’s condition more closely resembles Japan’s regarding foreign assets and debts. An examination of Japan’s experience in currency markets in recent decades can illuminate conditions that China now faces.

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V. Lessons Drawn from the Japanese Yen’s Rising Value For a variety of reasons many observers expect the RMB to rise in value. There are clear parallels between the upward pressure on the renminbi now and the situation facing the Japanese yen before ratification of the Plaza Accords of 1985. We consider and compare these similarities below in order to better understand how policymakers might handle the intensifying upward pressure on the RMB’s value. Ronald McKinnon and Kenichi Ohno provide one of the earliest and most thorough investigations of the yen and currency markets in their book Dollar and Yen: Resolving Economic Conflict between the United States and Japan. In this book the authors explain how the yen’s rise in value following the passage of the Plaza Accords brought on the Japanese bubble economy and subsequent currency deflation and economic stagnation. While the linkage between the Plaza Accords and the bubble economy is not completely straightforward, the former definitely set in motion a chain of events that led to the latter. In particular, the sustained high value of the yen encouraged the Bank of Japan, the nation’s central bank, to loosen the money supply. This allowed large sums of money to be directed to speculative ventures, and this in turn, drove up prices in the sectors and industries attracting speculative money. Eventually prices became unsustainable, and collapsed. The book’s authors take a contrarian’s view of causes for the collapse of the bubble economy and the long-running stagnation that has plagued Japan’s economy since. In essence they reverse the lines of causation typically linking stagnation and currency values. In particular, a high-value yen caused trade to stall. Moreover, with interest rates in Japan lower than those to be found abroad—especially in the US—capital rushed out of the country. American pressure on the Japanese to increase the value of the yen precipitated these effects. While this research broadens the field of exchange rate dynamics and its connection to macroeconomic performance, the analysis has its shortcomings as well. Examining the performance of the yen helps to compensate for these oversights. After the collapse of Bretton Woods until the end of 20th century, behavior of the yen’s value can be broken into two phases. During the first phase, from 1974 to 1988, the yen’s value appreciated substantially. At the beginning of this period the yen traded at 357.65 to 1 USD; by

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1988 the yen’s value versus the dollar had nearly trebled to 125.83 to 1. In the second phase, however, the yen’s value fluctuated even as it continued to climb. From 1989 to 1999 the yen’s value dipped as low as 143.45:1 and rose as high as 99.74:1. These two periods accompanied various macroeconomic effects that aggravated the situation. In the first phase, the Japanese economy grew steadily; the current account mirrored this trend. In the second phase, the Japanese economy famously came to a standstill. In 1998 the economy actually contracted by about 1.0%, while the surplus in the current account fluctuated unpredictably.5 These facts call McKinnon and Ohno’s analysis into question. In particular their theory does not account for the change from steadily increasing yen values to fluctuating values. Yen appreciation and its negative economic effects exposed fundamental defects in the Japanese economy and financial system. That is, the explosive growth in the yen’s value, and the resulting stagnation, are only symptoms of deeper distress. First, in the quarter-century following World War II (1946–1971) Japanese technical proficiency had not reached a level that allowed it to significantly break into the largest foreign markets, in particular the United States. Second, the banking and deposit system has a long history of being protected from competitive pressures, which allows it to operate very inefficiently. Third—and perhaps most significantly for what China can learn from the Japanese example—Japan liberalized many parts of its financial system quickly and aggressively. Without taking these characteristics into consideration, the five leading economies in the world at the time—the United States, the United Kingdom, West Germany, France, and Japan—signed the Plaza Accords in September 1985. The appreciation in the yen outlined in the Accords encouraged The Bank of Japan, Japan’s central bank, to move to a more liberal monetary policy beginning January 1986. To accommodate the Accords, the Bank reduced its discount rate from 5% to 3%; in February 1987 it further cut the rate to 2.5%. This did not produce a hoped-for surge in investment that would change productive capacity; rather additional funds went into paper investments, such as stocks, bonds, and real estate. Demand for speculative “investments” increased,

5 Data on exchange rates, current account balances, and GDP growth are taken from various issues of The International Statistical Yearbook.

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pushing prices higher. This growth in non-bank funding adversely affected banks. In response, banks, under competitive pressure, began to sink large sums into real estate and non-bank financial institutions. More and more money began to chase real estate, and certain stocks, producing a speculative bubble. In an attempt to preempt the bursting of this bubble, the Bank of Japan adjusted its monetary policy in May 1989, raising interest rates from 2.5% to 4.25%. In August 1990 the Bank raised interest rates another 1.75% to 6.0%. This violent and sudden tightening of money supply sent stocks and real estate into a tailspin. Investors in stocks and real estate suddenly found themselves holding unprofitable and/or high-risk portfolios. The shockwave of bursting bubbles in stocks and real estate bankrupted many small and middle-tier financial institutions, negatively affecting a variety of investors. Consumption contracted in response. Japan’s currency experienced rapid deflation and the economy lapsed into stagnation. In order to maintain economic activity and stave off greater deflation, Japanese administrators moved interest rates close to zero; rates hovered around 0.25% for much of the 1990s. This analysis of the yen’s fluctuation in value, and the macroeconomic effects that currency values produced, shows that in an open economy real growth remains intimately linked to trade, innovation, and sound financial management. If any of these elements—least of all two or more—becomes unstable then the economy can become vulnerable to various economic problems. Returning to conditions in China, we see clear parallels. For instance, domestic demand remains soft in China, even since the middle 1990s when the economy has grown at unprecedented rates. Another condition that has plagued Japan, a poorly structured banking market riddled with suspect loan portfolios, exists in China as well. It is imperative that the banking and the finance system undergo long delayed reform. Not only is this necessary in order to assure that domestic businesses dependent on these banks continue to have access to financing, it is crucial for the banks themselves as they face stiffening competition from foreign banks. These conditions could be exacerbated if the RMB’s value began to fluctuate wildly. Therefore the managed float, which keeps the RMB’s value within a targeted range of variation against various currencies, should be continued in the near term. This policy is only a means to an end: maintaining overall financial and economic health. Results thus far have been encouraging.

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In order to achieve greater financial health and to maintain its impressive macroeconomic performance, the exchange rate reform should follow recommendations described below. As discussed above, many emerging economies in Asia have employed a hybrid strategy of increasing foreign currency reserves and managing currency values to realize macroeconomic and financial market stability (Yang and Weibin, 2005). Even though these nations publicly adhere to a floating exchange system, they still intervene in currency markets in order to maintain exchange rate stability, or at least, to avoid wide fluctuations in currency value. This allows central banks to effectively guard against the rapid influx or withdrawal of speculative capital; this, in turn, buffers economies and financial markets from the sort of instability that damaged Asian markets in 1997. The lynchpin of this multi-pronged approach is holding large sums of foreign currency. Such reserves produce an expectation of stability because the reserves can be readily applied in shoring up currency values. This expectation can help preempt speculative moves; in the event that speculators do pour funds into a market or rapidly withdraw it, these large reserves can be used to stabilize currency value such that the gains or losses to speculators will decline. In short, both directly and indirectly, currency values operate in a more stable and predictable pattern. Furthermore, holding large reserves defuses currency mismatch risks. This happens at the central bank level as described immediately above; however, such policies put pressure on microeconomic agents to shore up their financial holdings, particularly loans held in foreign currencies. This further buffers the economy from currency mismatch risks. By paying close attention to exchange rate management and improving financial fundamentals, China’s financial markets should become healthier and avoid the pitfalls that have plagued financial markets in other Asian nations. References Calvo, Guillermo A. and Carmen M. Reihart. “Fear of Floating.” NBER Working paper, No. 7993. 2000. Goldstein, Morris. Control of national currency mismatches in emerging markets. Social Science Academic Press, 2005.

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Li Yang and Yu Weibin. Economic Globalization and International Reserve Management in Developing Countries.” Economics Trends 8. McKinnon, Ronald, and Kenichi Ohno. Dollar and Yen: Resolving Economic Conflict between the United States and Japan. Shanghai Far East Publishers, 1999. Shilling, Gary. Deflation. Economic Science Press, 1999.

REVIEWING THE 2005 SHANGHAI SECURITIES MARKET AND ITS PROSPECTS FOR 2006 Wu Qian, Zhang Xiaozhong, and Zhu Pingfang I. A Review of the Securities Market in 2005 2005 can be regarded as a milestone in the development of Chinese capital markets. It marked the end of a severe bear market that had lasted for several years. During this time, many investors experienced heavy losses. At the same time various structural and internal conflicts in the stock market became more acute. To address these problems, market managers initiated a process of stock ownership reform, placing emphasis on updating the categorization of shareholders and overhauling dividend payment systems.1 This process aimed to achieve several interrelated goals: putting stockbrokers on a more solid financial footing, protecting investors, promoting the quality of listed companies, improving the quality of company reports, and bringing greater innovation to the investment system. A second wave of measures aimed at developing a healthy capital market over the long term has been developed as well. These steps include exchange rate reform, interest rate increases on home loans, deposit reserve interest rate reductions, capital gains tax reductions, establishment of an investor protection fund, and creation of derivative products. These innovations and reforms give capital markets a new look and greater sophistication. A. Analysis of Economic and Policy Elements Affecting Securities Market 1. As Economic Growth Slows so does the Growth of Listed Companies The national economy settled into a stable and relatively rapid growth rate of about 9.5% during the first quarter (Q1) of 2005. However, the

In China the term Equity Division Reform is used to describe efforts aimed at changing stock categorization, dividend payments, and other financial and contractual details related to corporate ownership. This bit of jargon is almost completely unknown in the West, but enjoys wide circulation in the People’s Republic of China (PRC). 1

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central bank’s research bureau points out that slowdown is in effect in the September 2005 report Current Prices and Trend Analysis, which estimates that GDP growth for all of 2005 will slow to 9.2%. The report goes on to project that growth through the first half of 2006 will be 8.7%. As growth slows, net exports have surpassed investment as the driving force behind economic expansion. In the first quarter (Q1) of 2004 exports made up 1.7% of GDP. A year later exports contributed 5.9% to output. While a more than threefold increase is a strong indicator of good times ahead for the sector, various factors, including upward pressure on the renminbi (RMB) and intensifying trade disputes, may undermine export growth. Macroeconomic adjustments initiated in the first half of 2004 have begun to have more pronounced effects. For instance, the growth in profit margins declined by 22.5% between the first half of 2004 and 2005. A key factor in this slowdown is an increase in input prices, especially energy inputs and raw materials. With input prices on the rise, margins have narrowed. Profit per share has fallen to 0.1376 yuan (about .02 USD), a slide of over 3% compared with the first half of 2004. Numerous companies now operate in the red. 219 of the blue chip companies,2 or 15.80%, failed to turn a profit in Q1 and Q2 2005. 2. Growing Support for Security Market Reform When management supports the reform process, the impact of reform deepens and broadens. We can now see evidence of this in various general economic indicators, as well as in particular industries, and most of all in the securities market. The State Council’s Decision to Deepen Economic Reform in 2005 provides a solid overview of reform’s impact on general economic conditions. This report focuses on three specific aims of the reform process: deepening the reform of management systems in state owned enterprises and national assets; advancing financial system reform; and further developing a modern capital market. Obviously, these reforms depend on reforms in capital markets. Reforms impacting industry fell hardest on those providing key inputs to industrial production, especially real estate, steel, and coal. Shortages and price fluctuations have caused the State Council to become keenly concerned about operations in these industries. One especially

2

Most Chinese texts use the term “Stock A” rather than “blue chip.”

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important move put restrictions on speculative purchases of commercial properties in order to reduce real estate demand and to relieve upward pressure on land and real property prices. Policy reform affected securities markets at the most fundamental level, by addressing the means and terms for categorizing and dividing shares. Since this goes to the heart of property rights, the aim here is to bring capital market functions more in tune with market forces. The problem of share categorization and dividend payments underscores the problem of reforming management and financial markets. These reforms will make management more accountable to shareholders as well as causing financial backers to respond more quickly and rationally to market pressure. For instance, some large shareholders have embezzled and/or appropriated the assets of listed companies. Furthermore, various unfair or rigged transactions have taken place without widespread shareholder knowledge or approval. Such abuses cannot be allowed to continue. Giving more shareholders a voice in management’s decisions seems the most direct route to steer firms away from this kind of malfeasance. Reform of ownership rules will also place greater pressure on managers to run firms with greater efficiency. For instance, well informed shareholders will demand a high return on investment. To meet these demands, management will have to effectively market products and services. This will take firms beyond the insider deals, kickbacks, and “sweetheart” contracts that continue to undermine industry function. Seeking a high return will also require firm managers to innovate and cut production inefficiencies. Currently, so much emphasis is placed on growth that waste is often tolerated. Empowered and informed shareholders will not long tolerate such conditions. Transparent and thorough discussions between those holding both trading and nontrading shares with management prod managers to respond to the demands of owners. Regulators have moved resolutely in advancing ownership reforms. For instance, firms can now buy back shares, which can bring more value to shareholders. Regulators have also banned companies from issuing stocks until they are in compliance with reforms. To summarize their progress, relevant ministries released The Key Opinions on Ownership and Dividends Affecting Listed Companies (22 articles) on August 23, 2005. Soon thereafter they issued The Administrative Measures on Ownership and Dividend Reform among Listed Companies (55 articles) and A Guide to Business Operations Regarding Ownership and Dividend Reform of Listed Companies (30

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articles). These documents concentrate on one goal; namely, market stability. This reveals the orientation of regulators: using stock reforms in the service of achieving market stability, and using market stability as the key metric for assessing the success of reforms. A pilot reform process focusing on 45 companies concluded on September 12, 2005. Following this the Shanghai and Shenzhen stock markets entered a process of thorough reformation. By September 30, 138 listed companies announced their stock reform plans. Soon thereafter 68 companies in Shanghai’s stock market had initiated their own reforms. The total market value of these firms amounts to about 390 billion yuan, or 17% of the Shanghai market’s value. B. Financing Conditions for Blue Chip Stocks Most forms of financing went on hold during Q1 and Q2 of 2005 while firms implemented of reforms. Blue chip firms attracted just over 33 billion yuan of new financing in Q1 and Q2 in 2005, about 40% of the total capital attracted in all of 2004. (See Figure 23.1 for monthly financing totals.) Initial offerings amounted to 5.807 billion yuan. About 27 billion yuan went to firms in later funding rounds. In the first half of 2005, 15 companies issued 1,392 shares of stock, which raised just over 5.75 billion yuan. These figures represent steep year-on-year deadlines: 72.29% decreases in shares issued and a 76.63% contraction in funds raised. 12 of the 15 companies issuing shares did so in April and May, that is, during Q2 in anticipation of financial markets

300

274.05

250 200 150 100 38.68

50

2.86

0 1

2

14.46 3

0.00 4

5

0.00

0.00

0.00

6

7

8

0.00 9 (Month)

Data source: Juyuan Data.

Figure 24.1: Blue chip financing Q1–Q3 2005 (100 million yuan)

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reopening. The Shanghai market only saw three new offerings in the first six months of the year. In this period, issues on the Shanghai and Shenzhen markets pulled in about 2.9 billion yuan each. The amount of capital attracted is a function of initial public offering (IPO) issue prices. These prices are negotiated between three parties: the issuing firm, the guarantor, and the institute with enquiry rights. The average per share issuing price fell from 8.55 yuan in 2004 to 6.65 yuan in 2005. In the first half of 2005 the average price-earnings ratio of IPO shares declined to just under 14:1 from almost 18:1 in 2004. Post-IPO financing turned in a mixed performance. Six companies raised over three billion yuan, most of it through reissuing shares. These moves accounted for over 99% of total refinancing, a new record. Most of this activity came through the Baogang Group, whose total stock reissues amounted to 25.6 billion yuan, divided among 3 billion shares moved from state control to Baogang and another 2 billion public shares made available to the society at large. C. Summarizing Blue Chip Stock Activity Although regulatory moves have helped investors, the economic slowdown has begun having an effect on investor enthusiasm. With more investors taking a wait-and-see approach, demand for securities and stocks have continued to slide, and therefore, prices have declined. Overall market value hit an eight-year low in 2005. On April 29th the China Securities Regulatory Commission (CSRC) issued a notice to begin the trial process of stock reclassification and dividend reform. On May 10 the CSRC announced the names of the first four companies to undergo this process. On June 20 forty-two companies began the reform process. By August 30 the test period had concluded. Following this, the Commission compiled The Regulatory Measures for Share Classification and Dividend Reform Affecting Listed Companies (inspection draft). With the test phase concluded, the reform process began in earnest during September. This process started amid violent market fluctuations and a backdrop of confusion and doubt. On May 10, after the announcement of the first list, the market lost value at an increasing rate; by June 6 it closed at 998.23. On strong trading demand markets recovered some value by the middle of the month. By June 20, when the second wave of companies entered the trial, Shanghai’s Stock Index dropped again, and hovered just above 1000 points. When markets closed at 1004 a

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full month later, on July 19, it was clear that markets had stagnated. In response, the State Council authorized the CSRC and other relevant departments to make changes aimed at improving the climate for securities. Notably about six billion USD rushed into the market. To protect these funds, the Commission announced a series of related measures, some of them mentioned above: halting new stock issues and blocking those companies in the midst of reform from refinancing debts. This led to a recovery in non-blue chip stocks: prices increased by 19%. D. Developments in the Bond Market 1. Booming Initial Bond Offerings Through 2005 the bond market continued to expand. Through September 2005, bond issues reached 1,019.8 billion yuan, or about 79% of the 2004 total. Stock exchanges issued 349.01 billion yuan of this total. In other words, at the close of Q3, stock exchanges had already issued shares equaling 97% of the total value of shares issued in 2004. If Q4 maintains this pace, this segment of the market would show more than 20% growth. (See Tables 24.1 and 24.2). Corporate bonds contributed another 126.4 billion yuan, which tops totals for the last few years. A new type of financing—short term financing certificates—played an important role in expanding the bond market. We expect these certificates to finish strong for three reasons: they face relatively lax regulations, they are relatively simple to issue and manage, and demand through Q3 seems undiminished. A more diverse group of firms have issued bonds in 2005, which further expands the market. For instance, the Agricultural Development Bank of China (ADBC), one of the policy-led banks, has begun issuing bonds in the inter-bank bond market. The ADBC has expanded its activities, expanding both the volume of issues and the number of issues made in each quarter, and it recently surpassed the ExportImport Bank of China on both of these metrics. In general, banks have increased activity in bond markets, issuing more bonds in order to assure adequate capitalization for their operations. Two types of bonds have emerged as favorites in the industry: long term option-embedded bonds and short term financing bonds. Returns—determined by interest rates—directly impact bond issues. When returns climb, firms issue more short-term bonds; on the other hand, when returns decline more long-term bonds enter the market. Since the beginning of 2005 interest rates have been falling—to

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Table 24.1: Bond market activity 2002–2005 (Billion RMB, %) Year 2002 2003 2004 2005 Q1–Q3 Total

State spot bonds Total Growth 614.80 637.88 716.39 396.05

62.07 55.07 55.84 38.84

Finance bonds Corporate bonds Convertible bonds Total Growth Total Growth Total Growth

Total

307.50 432.00 500.87 497.30

31.05 37.3 39.04 48.77

64.00 69.80 44.70 126.40

6.46 6.03 3.48 12.4

4.15 18.55 20.90 *

0.42 1.6 1.63 *

990.45 1158.20 1282.90 10919.80

2365.12 53.13 1737.67

39.04

304.9

6.85

436.03

0.98

14351.35

* Convertible bond issues were excluded during the introduction of capital market reforms.

Table 24.2: Bond issues through stock markets (Billion RMB) Year

Total

2001 2002 2003 2004 2005 Q1–Q3

108.50 151.55 223.03 359.87 349.01

Issues State bonds 9 21 31 29 21

96.00 120.40 179.38 324.07 326.11

Issues 5 5 5 8 10

Enterprise Bonds 12.50 27.00 25.50 14.50 22.90

Issues Convertible Issues bonds 4 11 11 8 11

0 41.5 181.5 213.03 0

0 5 15 13 0

Data source: Juyuan Data.

3.45% at the time of this writing—so the mix has shifted to long-term bonds. 2. Increasing Demand for State and Corporate Bonds With changes in economic policy leading to a gradual slowdown, inflationary pressures have been eased and interest rates have remained stable. The central bank, the People’s Bank of China, further relaxed monetary control when, on March 3, 2005, it lowered the prime lending rate from 1.62% to 0.99%. This led to a reduction in currency market interest rates and higher returns on bonds. These moves helped to offset the effects of upward pressure on the value of the RMB. This set up an environment of low risks and rather high returns, which helped to drive trade volume for bonds sharply higher. In response, bond prices in secondary markets rose considerably. For instance, the state debt index in Shanghai’s security market rose from 95.69 at the beginning of the year to 108.73 at the end of September. Returns on seven-year bonds dropped from 5.05% on January 1,

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2005 to 2.947% at the end of Q3, or a loss of 210.3 BP.3 Figure 24.2 provides a graphical summary of these trends. Corporate bonds outperformed state debt during the first three quarters of 2005. On the Shanghai market the corporate bond index rose 21.65%, while the state debt index rose 13.54%. However, both compare favorably to the comprehensive security market index, which fell 7%. 3. Stock Reform Adds Variations to the Convertible Bond Market 2005 marked the first slowdown in the convertible bond market since the market launched in 2002. Because the reform process put refinancing on hold during 2005 Q1 through Q3, the primary market for convertible bonds disappeared. As of this writing, only two companies received authorization from the CSRC to issue convertible bonds: Merchant Real Estate and Shaogang Songshan. However, they must first complete the share classification and dividend reform process. After doing so these two firms will likely enjoy a short-lived duopoly. Over fifty companies intend to issue convertible bonds, which gives some indication of the interest in these financial instruments.

5.5 5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 0.5

1.619BP

0.484BP (2005–9–30) (2005–1–4)

2

4

6

8

(2005–6–30)

10

12

14

16

18

Figure 24.2: The Shanghai security market state debt return rate curve

3

BP stands for “basis point.” One basis point is equal to 1/100 of 1%.

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Convertible bonds enjoy an advantage over stocks: returns do not go as high, but losses are not as dramatic. However, reform and its consequences have produced new challenges for the market. Fluctuations in prices remain a key sticking point; ownership and dividend reforms, as well as international pressures, have placed increased demands on prices to move toward “true” market values. A leading concern is the continued sluggishness of the convertible bond market. Bondholders can receive some relief by converting holdings into stocks, but whether this will cover all losses remains to be seen. 4. Innovation in Securities Markets A number of noteworthy innovations have been introduced to Chinese security markets recently. A brief overview of these can provide insight into the increasing dynamism of these markets. On May 20th 2004, the inter-bank bond market introduced buyout repurchase contracts. In essence these are futures contracts; as with any futures contract they help to smooth market transactions over time and protect both seller and purchaser from risk. In this case, when a bondholder sells off bonds, it agrees with the buyer that it will buy the sold bonds back on an agreed upon day and at an agreed upon price. By the end of August 2005, 1,842 transactions had been completed worth a total of 250.122 billion yuan. Contracts typically fixed repurchase terms between four and fourteen days. State banks issued the greatest number of these contracts, covering about 52% of total value. On June 15, 2005, the inter-bank bond market introduced futures trading. By the end of August 53 such transactions had been concluded, totaling 7.588 billion yuan. This did not represent a huge expansion of the market; however, the lack of professional expertise to finance and support such transactions may well have a dampening effect on growth of this segment. As more expertise comes to bear on facilitating transactions, much greater growth could happen. On September 28, 2005, the Ministry of Finance, with the approval of the State Council, announced that the International Finance Corporation and the Asian Development Bank will for the first time issue RMB bonds in China. This opens the Chinese bond market to international traders. These so-called “Panda Bonds” announce the beginning of broader changes in the bond market: opening China to international investors and further internationalizing the Chinese economy; bringing a new influx of investment into China, especially for infrastructural development; improving the status of Chinese capital and currency

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markets while raising the status of the RMB as an international currency; and providing another tool to convert reserves of various types into working investments. Furthermore, using Panda bonds reduces China’s reliance on US dollars (USD) and bonds. E. Developing the Funds Market 1. Open Funds Start Weak, but Currency Markets Continue to Thrive Stock market trends strongly influence fund market issues. The downward trends of stocks depressed the number and scale of fund issues. Thorough Q3 48 funds opened; nine are Listed Open-ended Funds (LOF);4 eighteen are currency funds; eleven are mixed funds; three are bond funds; and seven are stock funds. The total volume of these funds comes to 95.214 billion shares, a sharp drop-off from 2004. Only 6 of the 48 funds offered more than 4 billion shares through initial issues. Four funds offered between 3 and 4 billion, and six offered fewer than 500 million shares. The average initial offering included 1.984 billion shares, an 80% decline from the 2004. Currency market funds face new opportunities and challenges because of changes brought about by economic policy adjustments and financial market reforms. During the first three quarters of 2005, the 18 officially sanctioned currency market funds raised 38.778 billion yuan. This figure represents a slight decline from mid-2004, when currency market funds reached a peak both the number of new issues and their total value. Currency markets have remained relatively strong because of continued activity and innovation in the bond market. With stocks sliding, currency funds offer a relatively more attractive return. Other factors have buoyed the market: new entry in the currency funds market during 2004 stoked demand in the sector; gaining approval for entry remained simple; markets become more rich and robust as more products came into effect; customer resources improved; and markets became more stable. These trends are expected to continue, leading to a favorable outlook for the sector.

4 Listed Open-ended Funds (LOF) are a special class of open fund: they are listed and traded on a stock exchange.

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2. New Trends in Limited Participation Funds5 Of the 54 limited-participation funds selling in secondary markets, 23 rose in value and 31 fell through Q3. Declining funds lost an average of about 3%. Limited participation funds responded to price corrections more favorably in general. By the end of Q3 2005, the entire group of 54 limited participation funds had an average discount rate of 30.15%, up slightly from the end of 2004. The market reform process should bring prices in line with net values. During this process many funds will expire. For example, 26 funds will expire at the end of 2008. These funds yielded an average annual return of 10%, better than the 6% return brought in by the typical fund. Expiring funds tend to be smaller; their closings will limit access for new investors or funds interested in migrating from closed to open funds. For this and other reasons, insurers and trust managers still favor limited participation funds. Semi-annual financial statements for these funds show that the market shifted fundamentally during the year’s first half. The Qualified Foreign Institutional Investor (QFII) pool grew by 221.36%, making it the third largest investor in limited participation funds. By June 30, 2005, QFII investments totaled 1.71 billion shares, a more than 30-fold increase in only 18 months. Performance from Q1 and Q2 of 2005 may provide insight on what lies ahead for these funds. Of the 26 funds that concluded their contracts in the first half of 2005, 26 experienced a price increase of just under 5%, but the remaining 28 dropped by 16.32%. The average discount rate for the 26 expiring funds dropped from 21.66% at the end of 2004 to 17.11% on June 30. The average discount rate of the other 28 funds rose from 34.94% to 44.32% in the same period. II. Forecasting Performance in Shanghai’s Security Markets in 2006 Systemic reform will continue to take center stage in securities markets during 2006. Regulators will continue to expand the scope and variety of reform, moving on to adjustments in tax and exchange rates. Alongside Limited participation funds are called “closed”, “closed-type”, or “closed-ended” funds in China. Often these are trust funds. Their shares have less liquidity than other types of funds, which are usually called “open”, “open-type”, or “open-ended” funds in China. 5

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these changes, micro and macroeconomic forces will continue to play a role, especially the overall macroeconomic condition and performance of listed companies. Now that share categorization and dividend payment changes have been made, Chinese markets seem poised to move forward vigorously. In spite of this good news, we see three major areas of uncertainty in markets: new challenges in implementing reforms; management of the transitional phase of reform, especially regarding ownership and shareholder oversight; and finally, the timing, degree, and type of expansion in securities markets. We expect the reform process to encounter various snags as it affects more firms, investors, and securities. For instance, listed companies with non-blue chip stocks will experience reform quite differently than the blue chip firms that have already undertaken reforms. Many of these firms carry enormous debts, operate in the red, and have market capitalization below total asset value. As the number of variety of firms entering the reform process grows, we expect firms will implement reform steps in parallel; some firms will be nearly through the reform process while others struggle through the basics. For instance, non-trading shares that enjoy circulation rights will likely be priced differently than shares in circulation. Thus prices diverge from market equilibrium in some cases. Prices do not accurately reflect asset value or expected returns; they become a function of regulatory changes. Companies with large stock reform difficulties, particularly share price issues, will be marginalized. Note that the timing issue affects financing as well. For instance, listed companies that have finished the reform process will be the first to refinance debts. These firms include: Guotou Energy Conservation Company, Hengtong Electric, Hong Sheng Technology Company, Kainuo Technology, Wolong Technology, Zhongfu Industry Company, Shen Neng Stocks, and Fengshen Stock. Of course, these problems are connected to market expansion. The large scale listing of non-circulating shares will occur between June 2009 and June 2010. And as more players offer shares, the market will become more heterogeneous. We expect the full impact of the adjustment to a broader market to be felt in the future, but these changes introduce new uncertainties into markets. The real benefit of reform can be measured in two ways. First, the management of listed companies that have completed reforms should become more “rational”, that is, based on sound economic analysis.

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Shareholder demands should be reflected in management’s actions, and management should work to maximize shareholder value. As part of this process, we expect well managed marketing operations to evolve in such firms. We also expect decision making to become more transparent, and for various forms of corruption, malfeasance, and incompetence to be better controlled. Second, we expect to see those firms that use reform to their advantage to seize the assets of underperforming establishments. This will bring greater value to the shareholders of firms that underperform and allow aggressive firms to acquire assets at a discount. A. Prospects for Blue Chip Stocks in the Fourth Quarter of 2005 and 2006 We suspect that the market will bottom out during the fourth quarter (Q4) of 2005 or early 2006 as the impact of reforms takes hold. We expect the bottoming-out to be gradual; the probability of a steep drop in value seems unlikely. This begs the question: what will follow? Of course, we hope for a bull market, but realizing this outcome will require a great deal of work and preparation. To begin with, economic growth has mixed effects on short term performance of listed companies. Even though growth generally implies good returns, the economy is also undergoing structural transformation, so the benefits of growth will not be shared equally. Two insights are worth keeping in mind. The first is that declines in total investment in some sectors will impact long term growth, especially in industries vulnerable to business cycle fluctuations. 60% of blue chip enterprises operate in such industries. Secondly, structural adjustment has begun bidding up wages in some sectors, which has started whittling away at margins. Investors generally invest in firms with fatter margins; with returns to capital declining (or increasing more slowly), investors seem likely to become more cautious. On a related point, pricing needs to move toward a market-based system. At present, the Chinese stock market is not yet completely market oriented or fully open and transparent. Because of this, priceto-earnings ratios (P/E) do not carry the same information as they do for stocks in other markets. For instance, American firms typically have a market capitalization of about 15:1; in contrast, Korean firms trade at a ratio closer to 10:1. In general, pricing of total assets and expected returns on assets for Chinese firms varies widely from these benchmarks. However, P/E for Chinese firms are moving toward

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international standards. The current P/E of the Shanghai-Shenzhen 300 Index is around 13:1; with various adjustments inherent in this market, the ratio falls to 10:1, but this still compares favorably to the Korean standard. As well, dividend payments have yet to correspond to international standards. While the distribution of dividends has moved forward, the size of dividends, as well as their relationship to earnings, has not become consistent. Because growth continues to be robust while reforms are taking hold, we do not expect a sharp contraction in market value. Even though economic growth has slowed, it still remains quite brisk. Returns will continue to expand for many Chinese firms, and this will attract new capital to the market. Furthermore, as economy-wide reforms bring the economy more in line with market processes, stock markets will move towards more rationalized, market-driven outcomes. Windfall profits seem unlikely, but so do large losses. Returns will probably be modest, but consistent. In the post-reform era, pricing of non-blue chip stocks will change fundamentally. Stocks that have been given the rights to circulate will come onto the market in succession over a two-year period. Note, though, that the change in status will not affect evaluation. Over time, the primary and secondary markets will integrate; prices will converge based on sound investor analysis. B. The Next Phase of the Bond Market Given present conditions, we expect to see restructuring of markets, but without dramatic growth or contraction. Short term returns will remain modest in light of uncertainty over exchange rate changes. Middle term bonds are expected to offer stable returns. We expect prices to fall in the mid-to-long term bond market as supply will likely outstrip demand. Long term bonds will likely be the best performers. This situation does not address the vast need for capital in the Chinese economy. Gaining access to capital is an especially acute problem in the near term since bond markets need more time to develop, stocks need more time to recover from their slide, and commercial banks are not yet strong enough to shoulder the remaining financial load.6

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Delivery versus payment, or DVP, is a procedure in which a buyer’s payment

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C. New Financial Products We expect Chinese fund products to experience a renaissance. We feel especially hopeful about major innovations affecting bonds, warrants, and foreign exchange. 1. Innovations in the Bond Market While reform moves ahead, and economic growth attracts funding to the Chinese market, new means for harnessing these funds productively are emerging. Since 2004, the central bank has approved open repurchase, delivery versus payment (DVP) contracting, and systematic evaluation of enterprise performance. To provide a better understanding of these changes for security brokers and non-financial enterprises, the People’s Bank released Regulations on Short Term Financing Bonds, Regulations on Long Term Bond Trading, and Regulations on Asset Security. These actions reveal the government’s efforts in developing and invigorating the bond market. In developed economies bonds play a central role in investment. In the United States, for instance, the bond makes up 20%–30% of the fund market. Here in China, it makes up less than 1% of the market. However, some companies have taken steps to grow the market. These firms have introduced innovations in bond contracts, especially for short and middle-term bonds. They have also segmented the market in new ways; given distinct credit ranks for different classes of bonds, such as corporate bonds and asset converted securities. Finally, they have developed new futures contracts for bonds. 2. Innovations in the Derivatives Market The introduction of warrants7 into Chinese capital markets expands and enriches the market for derivative products. This process kicked off when the China Security Regulatory Commission, issued The Notice on Questions of Security Investment Funds: Investment Warrants on August 16, 2005. Making warrants available will help to decrease risks and uncertainty that has entered the market because of the uneven impact of financial market reform. At present, Baogang Group warrants have been listed on the market for trade. Changdian, Xingangfan, Wugang warrants and Shanghai security for securities is due at delivery. In other words, security delivery and payment occur simultaneously. 7 A warrant is a kind of derivative security that gives the holder the right to purchase securities at a specific price within a certain time frame; typically this time frame is over a year.

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market ETF50 index warrants will also soon be put on the market. However, funds face limitations on investing in indexed warrants for the time being. We hope that these limits will be removed in the future. Introduction of the warrant derivative is linked to other instruments. These include funds linked to a portfolio of diverse stocks; cost-capped funds that link targeted returns to warrants; and linked warrant funds. 3. Innovations in Foreign Exchange Markets The key innovation in foreign exchange products is the centered fund. Given its breakthrough nature, and the aggressive marketing aimed at bringing it to international investors, these instruments seems likely to meet with success. With regulators stepping up the pace of policy changes in the foreign exchange market, Qualified Domestic Institutional Investors (QDII) seem poised to make bold moves. To clarify the conditions in these markets, the People’s Bank produced a series of announcements: A Notice on Questions Regarding the Expansion of the Role of Foreign Exchange Banks to Conduct Futures and Currency Trading and Settlement, and A Notice on Questions of Quickly Developing Foreign Exchange Markets. The two documents have served to promote the development of the inter-bank foreign exchange market. Furthermore, fund companies took the unprecedented step of entering the inter-bank foreign exchange market. This regulatory change opens the door to the foreign exchange fund business to general fund companies. In a statement given on August 10, 2005 at the Asian Derivative Product Conference, Shang Fulin, President of the CSRC, described the Commission’s activities in conducting research on derivative products, stock options and futures contracts. He noted that this research will allow the Commission to better assess what instruments to promote and when to introduce these innovations. All of the steps support the fundamental efforts in ownership and capital reform regarding share classification and dividend payments. All of these steps will help Chinese capital markets to mesh with international markets in structure, variety of instruments offered, rules of governance, and overall function. Taken together, we anticipate that these steps will strengthen capital markets, and therefore, the overall health of the Chinese economy in the near and long term.

REVIEWING CAPITAL MARKET PERFORMANCE IN 2004 AND 2005 AND PROJECTIONS FOR 2006 Huang Ruifen, Yin Kedong, Zhao Xin, and Li Li I. A Brief Review of International Capital Market Conditions in 2004–2005 The global economic recovery in 2004–2005 drove the growth of capital markets generally. As a result, activity in stock markets increased. This higher level of activity developed alongside increasing volatility. Oil prices rose sharply, spurring some inflationary fears and generating huge shifts in profits from some firms and industries (e.g., transportation and logistics) to others, like oil extraction and refining. Currency reserves also experienced wide fluctuations; along with the eroding value of the dollar, this made capital markets riskier and more unpredictable. International trade frictions, which often developed hand-in-hand with broader political and regional tensions, all added to the complexity and uncertainty of investing in capital markets. A. Stocks Have Moved Upward Since the First Quarter of 2004 Various measures provide evidence of the upswing in stock markets. The New York Stock Exchange’s (NYSE) Dow Jones Industrial Average rose from 10452.74 at the beginning of 2004 to 10783.01 at end of the year. The 3.16% rise in value is modest, but clearly showed that the NYSE had recovered from the collapse of the Dot.com Bubble of 2000. The performance of other NYSE indexes moved higher as well. The Standard and Poor’s 500 (S&P 500) stock index rose 8.77 points, closing 2004 at 1244.12. The NASDAQ composite index rose 22.77 points, closing the year at 2218.15 points. These two indexes closed the year at their highest levels in four year. Macroeconomic data show that stock values were riding a broader wave of economic activity and consumer confidence. Data issued by US Department of Commerce in June 2005, indicate that Americans increased personal consumption expenditures by 0.8% for the month. At the same time, shipping order to factories increased 1% after a 3.6% increase in May 2005. Taken together, these data suggest that

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some of the economic fundamentals needed to support a bull market were in place. Like American exchanges, the London markets showed strong results for 2004 and 2005. Fluctuations in indexes were relatively mild and infrequent and the market finished the year higher. The Financial Times-Stock Exchange 100 Index rose from 4500 points at the beginning of 2004 to about 5500 points by September 2005, an increase of over 20%. The terror attacks of July 7 caused a slight downturn in the markets—the index immediately 1.36%, closing at 5158.3 that day—but the market rebounded quickly and continued on its upward trend. Japanese stock markets have not experienced the same sort of growth, largely because the underlying economic fundamentals in Japan have not recovered from the economic recession of the 1990s. The Nikkei Index remained stagnant in 2004; the index ended the year essentially unchanged. Even without positive returns, the market fluctuated often and widely. For instance, in May 2004, after rising to a high of about 12,000 points, the index quickly lost value, falling to about 10,500 points, or about 12% of its value. Through early 2005 the index staged a rally, but in May 2005 it shed over 1000 points. Through the first half of 2005 the market is up slightly. The Hong Kong stock market, the Hang Seng Index, climbed gradually from 12,000 points at the beginning of 2004, reaching a high of 15,500 points in September 2005. Unfortunately, this increase set up large fluctuations and an overall slide in value: By March 2004 the index had dropped to 14,000 points and by May it spiraled downward to only 11,000 points. This seemed to mark the bottom of the market and it has gained back some ground since. B. Currency Market Changes Stimulated the Bond Market On September 20, 2005, the US Federal Reserve raised the federal fund interest from 3.5% to 3.75%, the eleventh consecutive increase in the interest rate since June 2004. The Fed made this move in the hope that this would blunt inflationary pressures building in the American economy because of petroleum supply and delivery disruptions caused by Hurricane Katrina and the expected ripple effect that an increase in oil prices would have on input prices as well as consumer spending. In response, bond prices fell, but interest rates on bonds increased. As the economy strengthened, and inflation stayed low, bond prices rebounded.

reviewing capital market performance in 2004 and 2005 393 Because of adjustments in bond returns, and liberal borrowing policies, market interest rates continued to fall in spite of the Fed’s attempts to tighten the money supply. Then-Chairman of the U.S. Federal Reserve, Alan Greenspan, puzzled over this strange phenomenon at length. About two months before this, on July 21, 2005, the Chinese currency, the renminbi, or RMB, began floating against the US dollar (USD) as part of a broader reform of the exchange rate system in the People’s Republic of China (PRC). In fact, the float was managed; the value would only fluctuate by plus or minus 2% relative to the dollar. However, this move signaled a significant step forward in China’s decades-long process of economic liberalization. At the same time bond values and interest rates shifted. As the American debt swelled, the interest rate on Ten-Year Treasury notes reached 4.28%, indicating that incentives needed to be increased to encourage bond holders to cover the American government’s debts. Currently China has enormous US bonds holdings—191.1 billion USD as of November 2004. Given the broadening of Chinese trade and the decline of the dollar’s value, China is likely to shed some of its dollar holdings and tie the RMB’s value to a basket of currencies. Note that the difference in interest rates between US and Germany bonds has fluctuated by plus or minus 1% over the past five years, which represents a substantial fluctuation. A tenth of a point can lead The People’s Bank of China to move between bonds. In this case, the incentives seem likely to move the bank to take on greater holdings of German debt (and Euros) vis-à-vis its dollar holdings. C. Multinational Investments in Emerging Economies Multinationals continued to invest aggressively in Asian and Eastern European emerging markets in 2004. These investments increased by 48%, from 173 billion USD in 2003 to 255 billion USD in 2004. For the first time in history multinationals put more money into emerging markets rather than into the well established EU countries. Foreign Direct Investment (FDI) into Asian-Pacific developing countries increased a staggering 55%, to 166 billion US dollars. Simultaneously, multinationals slashed FDI moving toward developed countries from 380 billion USD to 321 billion USD. FDI moving into the EU continued its pattern of decline: 374 billion USD in 2002, 308 billion in 2003, and precipitous drop in 2004 to only 169 billion. The countries

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hit hardest by these cutbacks were France, Luxemburg, Belgium, and Spain. However, FDI moving into the UK offset some losses in Europe by enjoying an amazing 150% increase, to 53 billion USD. In recent years capital has become more mobile; as part of this trend capital has flowed out of the US in unprecedented volume. Moving capital to emerging markets allowed American firms to invest in markets where growth is greater, and with it, expected returns. Simultaneously, many investors have cooled on the American market: its maturity means growth in many sectors will remain steady, but modest, and as important, its geopolitical policies have caused economic problems and taken the luster off of investments in the States. To stem the outflow of capital, the US Congress passed legislation providing incentives to bring foreign profits and investments back to the US. Specifically: firms that redirect income earned outside of the US toward investments in fixed assets, debt reduction, stock buybacks, and/or training of workers will see tax rates on this income drop from a high of 35% to as low as 5.25%. J. P. Morgan Chase Bank estimated that of the 650 billion USD American firms earned outside of the US, 400 billion of it could qualify for special tax consideration under this program. II. Review of Chinese Capital Markets, 2004–2005 A. Chinese Stock Markets On February 2, 2004 the State Council released the report Opinions on Advancing Capital Market Reform: Opening and Stabilizing Development. By May small-to-midsized enterprises were listed on the Shenzhen stock market, putting into effect the policy of multi-tiered capital markets. This has widened financing channels for small-to-midsized enterprises. Overall, though, stock markets fell short of expectations in 2004. However, prospects may well improve. Innovations introduced in early 2005, such as an IPO enquiry system, and release of new stocks after a four-month hiatus in new issues, held the promise of energizing markets. (1) By October 10, 2005, the Shanghai composite index closed at 1138.95. A diagram of closing values over time shows that the market tended downward. (See Figure 25.1.) In July 2005 it nearly dipped below the 1000 point line. The Shenzhen Stock A Market Index declined as well (See Figure 25.2.)

reviewing capital market performance in 2004 and 2005 395 1500 1400 1300 1200 1100 1000

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Figure 25.1: Closing values, in points, of the Shanghai market index, October 2004 to October 2005

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Figure 25.2: Closing values, in points, of the Shenzhen Stock A market index, October 2004 to October 2005

Although the number of listed domestic companies (Stock A and B) increased from 1314 in April 2004 to 1389 by August 2005, their total market value actually decreased by 1235.935 billion yuan after reaching a peak at 4580.496 billion yuan in April 2004. This decline of over 25% hurt many investors, but worse, badly damaged confidence in nascent markets. With less value to work with and dwindling confidence to attract new traders, trade volume suffered through 2004 and 2005. Trade volume peaked in April 2004 at 521.563 billion yuan, but had nosedived to only 145.774 billion yuan by May 2005. Value and volume clearly declined

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and both variables experienced bouts of large fluctuations in the period. Investing in Chinese stock markets was not for the faint of heart. (2) By April 2005 180 funds had been established, controlling 446.541 billion shares. The rapid growth of the fund industry revitalized the stock market; funds also began to invest in currencies. The size, credibility, and acumen of institutional investors played an important role in stabilizing the stock market. As well, these investors could demand more from listed companies regarding data reporting and transparency. Moving from 2004 into 2005, these effects had not been fully felt in stock markets; currency markets responded sooner. Funds invested in stocks increased slowly through the period: 132 were involved in early 2004 and by mid-2005 147 funds had entered stock trading; their holdings declined over the period from 239.883 billion yuan to 227.235 billion. However, the number of funds moving into currency markets jumped from 9 to 23, and their holdings shot up from 63.327 billion yuan to 180.298 billion, a 42.30% increase. This imbalance may be temporary. Various reforms are developing in stock markets and company operations that should help to shore up company fundamentals, indebtedness, and access to capital for investment. Given the potential for growth in many Chinese firms, stock values should rebound. (3) Equity reforms continue to move forward in an orderly fashion. This is good news for investors and markets since the current state of equity structure has become an obstacle to rapid and broad development of Chinese stock markets. Under the current regime, the state and large private investors hold about 2/3 of total stock value; for the most part these shares do not circulate, which means that only about 1/3 of the market is in play. This skews governance towards the interests of these very large stock holders and away from small and medium sized shareholders. Some of these large shareholders have used their stock as an asset for raising money first and foremost; raising share value or market capitalization for the firms is a secondary consideration. Reform has not been widespread to date, but it is taking concrete form. In May 2005, Sanyi Heavy Industry Company, Limited; Shanghai Zijiang Enterprises Group Company, Ltd.; Qinghua Tongfang, and Hebei Jinniu Energy Resources Company, Ltd. were the first firms to enter the process of equity holding reform. Securities regulators hope that reform will achieve a new balance between actively traded shares versus long term holdings, and that regulators will consider opening trading to a broader range of shareholders. Interestingly the attempt at reform failed with Qinghua Tongfang when those shareholders possess-

reviewing capital market performance in 2004 and 2005 397 ing traded shares rejected the proposed reform. For them, the issue was not one of governance, it was of returns: after share value had fallen from a high of over 50 yuan, shareholders used their vote on reform as more of a no-confidence vote on company management. That is, shareholders opposed any move planned by the company’s managers after suffering such losses. By October 2005, 159 companies listed on the Shanghai or Shenzhen markets entered the stock reform process. This placed 11.66% of the Stock A companies of both markets into the reform process. B. Chinese Bond Markets (1) While the bond market has grown and values have increased, it has done so in fits and starts. This process can be seen through a combination of data on new bond issues. 166 new bonds were issued in the first six months of 2005 worth a total of 1839.3 billion yuan (nominal value), or 67.39% of the 2004 total. At the end of 2004 the bond index stood at 102.135; by June 2005 it had climbed to 108.850. (See Figure 25.3). Meanwhile, the inter-bank bond index rose 5.155 points, closing at 109.879 points; the state debt index rose 7.794 points, to 108.117; and commercial bonds went up 4.747 points, to 111.477 points. However, returns on state debt moved down by an average of 110 basis points (BP).1 Returns on one-year bonds dropped about 120BP, while ten-year bonds dropped around 90BP. That is, short-to-middle term bond returns declined at a much greater rate than returns on middle-to-long term bonds. (2) Bonds having a term of one year or less account for 63.17% of the total bonds issued. These short term bonds, mainly issued by the central bank, have a total value of 1019 billion yuan and account for 72.5% of the total bonds issued by the central bank. Even though it makes up a relatively small percentage of the total market, the private bond market developed rapidly in 2005. Private firms issued more than 40 billion yuan in bonds. Short term bond issues from June and July amounted to more than 25 billion yuan. Clearly the short term bond has become a popular financing tool, and holds the promise of opening up and diversifying private financial markets.

1 “Basis Points” are used in measuring bond yields. One basis point equals one one-hundredth of a percent.

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109.326 107.784 106.242 104.700 103.157 101.615

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Figure 25.3: Chinese bond index trends

By offering a new tool and one that diversifies financing options, risk can be spread out over a portfolio of financing options. Furthermore, this new tool has helped a new market to grow up around it, complete with new players, new experts, and new organizations needed to manage operations. III. Analyzing the Market Context and Prospects for 2006 A. The Context Surrounding Capital Market Development (1) The national economy continued to grow rapidly and stably, largely as a result of solid macroeconomic policies. Notably the economy did not become overheated, even with outside investment pouring into the country. Even some of the weak links in the economy—bottlenecks in energy supplies, transport difficulties, and price and supply variations in agriculture—were better handled than in the recent past. This can be seen in the outstanding overall performance of the economy: 2004 GDP reached 13,651.5 billion yuan, a 9.5% year-on-year increase. In the first half of 2005, the national economy continued this pace and the midyear GDP amounted to 6,742.2 billion yuan. Robust growth, and the profitability that comes with it, will keep money flowing into capital markets. (2) The potential pool of capital is huge and increasing. The Chinese people save a substantial percentage of their income; because of this and the large population total national saving deposits are 12,900 billion yuan. Adding to this is a large flow of private investment from

reviewing capital market performance in 2004 and 2005 399 private firms and foreign sources. By the end of March 2005, business deposits in commercial banks had reached 8,500 billion yuan. This large savings pool can be drawn upon for investment. Furthermore, such a large supply of funds tends to lower interest rates, which can also spur investment. Funds from other are available to investors. Insurance capital, social security funds, qualified foreign institutional investors (QFII), and other institutional sources can be drawn upon by investors. As reforms take hold in stock markets, and bad debts are written off and performance measures become more transparent, a substantial portion of these funds will likely go into securities. (3) Even though markets have trended downward in the last two years, some industrial stocks have gone against the tide. In particular stocks in electricity generation and distribution, steel, coal, and oil have outperformed the market averages and have been classified as blue chip stocks. In general, however, weak market performance has hurt many stocks. Some have fallen below their initial public offering (IPO) price and others have a cumulative share value that falls short of the corporation’s asset value. This would indicate that a market correction could take big board value upward. Total market capitalization of the national stock markets in the PRC amounts to 3,159.002 billion yuan, which is only 23.14% of GDP. Note that in more developed economies, such as the US, UK, and Japan, total market capitalization exceeds GDP. This further underscores the potential for growth in the Chinese stock markets. B. Prospect of Chinese Capital Market in 2006 (1) Policy changes, notably the move to keep a larger percentage of stocks in circulation, altered the structure of capital markets. With greater liquidity, capital markets may well be poised for an expansion in 2006. As noted above, 159 listed companies have begun the ownership reform process; another 1000 are expected to begin the process in coming months. This process should be complete in five years, with the effect being that more shares will be in circulation. This should attract more investors to markets. Other factors will feed the growth of markets as well, including improvements in financing, risk spreading, and diversification in the types of securities. (2) Regulatory changes affecting IPOs will have an impact on share prices. Regulations put into effect by the China Security Regulatory

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Commission directly addressed IPO pricing. Specifically these are known as the Notice on Questions of Initial Public Offerings and the Number 18 Memo on stock issue inspections, also known as the Regulation on Conditions and Behavior of Initial Public Offerings. The first IPOs affected by this regulation, those made in the first quarter of 2005, included the release of shares by Huadian International, Qianyuan Power, Nanjing Port, and Zhongcai International. Even though early trading has moved market capitalization away from true corporate value, many long term projections suggest that regulatory reform will draw these two variables toward convergence. The challenge remains of how to structure markets so that prices reflect real market value. (3) Securities markets—and security companies—will revive after market reforms take hold. The slide in market values, the wide fluctuations in prices, and the overall erosion in investor confidence have worked together to make it clear that that conditions in recent years required reform. Reforms have addressed some key problems: bankers manipulating the market, company managers who expose share holders to unnecessary risks through systematic mismanagement, companies illegally repurchasing national debt bonds, corporate executives and board members embezzling funds, and so forth. These conditions had reached a head in 2004, which forced the China Security Regulatory Commission (CSRC) to tighten regulations and enforcement and to sharpen the sting of punishments. Some especially notable violators were singled out. For instance, in 2004 the South Security Company was restricted from trading by executive orders issued by the CSRC and the Shenzhen municipal government. Others faced less draconian sanctions. Subsidiaries of the Delong Group, such as Deheng Securities, Hengxin Securities, and Zhongfu Securities were put under supervision. Hantang Securities came under the supervision of Xinda Capital Management Company. Even one of China’s oldest securities firms, Minfa Security Company, came under supervision during October of the same year. Other firms faced the summary judgment of markets, such as the Hongyi Group, which collapsed at the year’s end. Through 2005, though, things seemed to settle down. The CSRC took this pause to further reduce undue risk in securities markets, strengthen supervision over investor and securities firms, and mete out certain and severe punishments to violators of rules. These moves will improve market operation and restore trader and investor confidence, which should in turn bring a new surge of money into markets.

reviewing capital market performance in 2004 and 2005 401 (4) The rapid pace of new entry and resulting intensification of competition in the fund industry increased uncertainty in the securities market. Entry has been propelled by the volume of money that investors have placed into funds believing that the funds’ investment acumen would increase returns. With markets looking more reliable and organized in 2006, the promise of solid returns and the capacity to invest have come together. However, with so many funds competing to invest in high-return stocks, many investors, and securities firms with them, may well find disappointment rather than success. (5) New types of securities will likely attract different kinds of investors and more total investors to markets. In particular, short-term securities can attract a more diverse set of investors who have different assets, needs, and incentives from large institutional or governmental investors who dominate many markets currently. Another key need is for futures markets to become more developed. On August 12, 2005, while attending a conference of the Futures Industry Association (FIA) on derivative products in Asia, the Director of Futures Investments with the CSRC stated that recent reforms had improved the environment in China for developing futures markets. By having more kinds of investors, more trading volume, and financial contracts that smooth transactions over time, some volatility can be ironed out of markets. (6) Insurance capital may enter the stock markets on a large scale. A number of insurance firms have capital management companies geared up to enter the market: China Life, The People’s Insurance Company of China Group (PICC), the Chinese Reinsurance Company, and the Huatai Insurance Company. These companies plan to enter markets gradually, developing expertise, insight, and experience over time. Because of the nature of the insurance business, these firms will likely select low-risk securities that provide steady returns, such as convertible bonds, blue-chips stocks and the like. Such an investment strategy, and the sheer volume of funds that insurance companies can bring to bear, should have a stabilizing effect on markets. At any rate, the impact on markets will be broad and deep. By the end of May 2005 insurance capital had surpassed 1213.5 billion yuan. (7) Improvements in currency exchange rules and mechanisms will likely have far-reaching influence on capital markets. This process started on July 21, 2005, when China first allowed its currency to move from a value pegged to the USD to a managed float tied to a number of currencies. This newfound flexibility allows market forces to influence the yuan’s value. In response, the RMB’s value crept up, from 8.26:1

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to 8.11:1. Before this rise in value, an enormous wave of speculative capital poured into China from abroad with the expectation that the RMB would appreciate. However, the modest increase in the value of the currency has dampened profit expectations. Far worse, such large infusions of capital, and subsequent withdrawals, tend to destabilize capital markets in the China. The “Asian Flu” that afflicted Southeast Asian markets in 1997 attests to the unpredictable and problematic impact such fluctuations can have on an economy. Still, the economy in the PRC must remain open to the world; foreign trade makes up 70% of GDP through 2004 and has increased to 79% for the first half of 2005. China cannot—nor would it want to—shut its economy to the outside world. We have become integrated into global markets, and thus far, this has been fundamental in driving economic growth and social development for a variety of economic entities, whether they are directly focused on trade or not. References Chen Xuerong. “Seven major bodies and one market—Chinese capital markets.” Economic Theory and Economic Management 3 (2005). Li Xiaomin. “Research on the demands for information regarding national capital markets.” Modern Management Science 4 (2005). Wang Qianqian. “Analyzing the opening of Chinese capital markets in view of QFII.” Commercial Research 2 (2005). Zhang Chenghui. “China needs a multilayered capital market.” China Reform 6 (2005). China bond information net: http://www.chinabond.com.cn. The official Web site of the Chinese Security Regulatory Commission: http://www. csrc.gov.cn/. Financial channels of http://www.xinhua.org, http://www.china.com, http://www. people.com.cn, http://www.sina.com, http://www.sohu.com, http://www.yahoo. com.cn, http://dycj.ynet.com.

ANALYSIS OF CURRENT CONDITIONS AND FUTURE PROSPECTS OF THE TAIWANESE ECONOMY Zhang Guanhua After enjoying rapid growth in 2004—about 5.71%—the Taiwanese economy’s growth rate once again slowed through 2005, finishing the year about 4% growth. Two especially important and interrelated factors led to this outcome: a decline in exports and a surge in oil prices. Given that oil prices change exogenously, and that the structure of the Taiwanese economy has not fully adjusted to this and other challenges, the economy is expected to grow slowly, but steadily, in coming years. I. Analysis of Recent Economic Conditions A. Slowing Economic Growth The Taiwanese economy grew briskly in the first half of 2004, but by the fourth quarter had settled into a slower growth pattern that continued into the middle of 2005. Looked at quarter-by-quarter, an upward trend can be seen: the GDP had an annual growth rate of 2.5% in the first quarter (Q1), 3% in Q2, and 4.3% through Q3. Even though growth improved through the first three quarters, these figures fail to equal growth figures from 2004. Individual consumption grew by about 3% in the first half of 2005, keeping pace with consumer spending growth during 2004. However, the economy may be stuck at this rate for the foreseeable future because high oil prices and other exogenous factors will act as a drag on growth. In a July 2005 study produced by MasterCard on consumer confidence indexes for 13 Asian-Pacific countries and regions, Taiwanese respondents lagged those of other countries. The Taiwanese expressed especially acute reservations regarding overall economic prospects, employment opportunities, and stock market performance. Taiwan’s index equaled 38.6, well short of the 61.4 average score of the other 12 countries and special administrative regions examined.

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Investment, another telltale measure of future economic prospects, showed signs of weakness through the first half of 2005. Investment in fixed assets grew by only 11.9% and 8.3% in Q1 and Q2. Both figures are substantially lower than fixed asset investment growth in Q1 and Q2 during 2004. Even though the rate of investment has slowed, substantial sums are being directed toward long term investment. A number of key industries continue to lead the way: high tech plastics, in particular the fourth phase of the Taiwan Plastics launch; high speed rail; and aerospace. Overall investment in the first two quarters of 2005 increased nearly 10%. While this would be a solid figure in most economies, it represents a steep drop-off from the first two quarters of 2004 when investment grew by 28.2%. In order to develop a better picture of investment on the island, the Taiwanese government collected data on 765 large investment projects worth close to 650 billion yuan. A whopping 409 billion yuan of this sum went into semiconductors and LCD research, development and manufacturing, well over 60% of the half-year total. In contrast, investment in public enterprises contracted through the period, declining by 3.45% and 3.63% in Q1 and Q2. A few large public enterprises, such as Taiwan Power’s Number 4 nuclear power plant, reduced the size of this contraction. Foreign Direct Investment (FDI) amounted to 1.7 billion USD spread over 590 projects. Q1 2005 investment fell 12% short of Q1 2004’s total; Q2’s figure represented more than a 17% year-on-year decline. B. Slowing Foreign Trade and Declining Trade Surpluses Taiwan’s trade sector took hits from several sides. Increasing competitive pressure from other exporters, including China’s mainland provinces, appreciation of the Taiwan Dollar, fluctuations in the demand for imports, and a steep rise in oil prices all cut into the typically-large trade surplus. These difficulties produced secondary impacts on a wide range of sectors simply because so much of Taiwan’s economy depends on trade. Not only did the trade surplus decline, but trade volume declined as well. From January to August 2005, exports grew by 6.7%, while import volume increased 11.2%. Clearly this represents a bite out of the trade surplus. But these figures represent steep declines from the corresponding figures from January to August 2004 when exports had been growing by 20.7% and imports shot up by 31.9%. The slowdown

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can be seen in the contraction in bilateral trade with Taiwan’s largest trading partners. 37.2%, or just over 45 billion USD, of Taiwanese exports went to Hong Kong in 2005. On the other hand, Taiwan imports about 14 billion USD from Hong Kong, about 11.8% of total imports. Export to the US almost reached 19 billion USD, about 15.4% of total exports. Shipments to the US grew by 2.7% during the period. On the flip side, the Taiwanese imported about 14.5 billion USD worth of goods, or about 12.0% of total imports. Import volume with the US increased less than 5% for the period. Exports to Europe actually declined by about 0.8%, amounting to about 15 billion USD, or about 12.4% of total exports. Although trade with its major partners cooled, trade in Asia, especially to ASEAN1 nations, generally expanded. Exports to ASEAN nations exceeded 16.5 billion USD or 13.7% of total exports. This marks a 12.5% increase over the same period in the previous year. Imports from Southeast Asia fell just shy of 13.5 billion USD, or about 11.2% of Taiwan’s total. The increase in imports is relatively modest; only about 0.6%. Even though Japan is a smaller trading partner, trade expanded relatively quickly: about 7.9% in the export column and about 11% on the import side. In absolutely terms, exports exceeded 9.25 billion USD, or 7.7% of the total; imports equaled 31 billion USD, or 25.9% of total imports. The trade surplus with Japan amounted to just over 21.5 billion USD for the period. Across the board we can observe the demand for Taiwanese exports slowing. While exogenous factors have played a role in this slowdown, something else must be at work because other East Asian economies have not experienced the same degree of impact on their exports. Taiwan’s import growth outpaces Japan’s, but lags Korea’s, Singapore’s, and Hong Kong’s, which all saw double-digit increases in exports. Furthermore, export growth to Mainland China and Japan is far less than the increase in imports from these countries. Taken as a whole, these conditions point to a broader change in the Taiwanese trade environment. First of all, Taiwan’s productive capacity is beginning to move off of the island. This means that Taiwanese firms continue to draw profits ASEAN stands for the Association of Southeast Asian Nations, which is an economic cooperation group consisting of the following nations: Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam. 1

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on international trade, but that the products made by Taiwanese firms are shipped from others sources. For instance, between January 2004 and July 2005, the proportion of Taiwan information and telecommunication (IT) products manufactured overseas rose from 52.7% to 73.0%. Other electronic and mechanical products followed a similar trend: electronics moved from 23.8% to 37.8% in the same period; electric machinery rose from 31.2% to 48.5%, machinery shot up from 9.0% to 29.1%. Overall 20% of the manufacturing capacity in these industries moved out of Taiwan in only eighteen months. Note that even though these industries enjoyed a 16% increase in orders, the total volume of exports from Taiwan actually dropped because capacity had moved off of the island. In some sense, this relocation of capacity is not so much of a trouble spot in the Taiwanese economy as it is a readjustment in its structure. The second factor driving the decline in imports is far more worrisome. With the exception of semiconductor and LCD industries, Taiwanese firms have generally failed to upgrade their technical capacity, leaving them vulnerable to newer, technically adept competitors. And even in semiconductors and LCDs, Taiwan’s competitive position has eroded. All of these factors have cut into Taiwan’s trade surplus, which shed 1.17 billion USD between January and August in 2005. The trade surplus stands at a near quarter-century low point. This has the impact of constraining overall GDP growth, among other effects. C. Industrial Output Flattens While Services Surpass 70% of GDP For the aforementioned reasons industrial output did not grow in the first half of 2005 registering only a 0.6% year-on-year growth rate. Manufacturing increased by a feeble 0.14%. Two of the four major manufacturing sub-sectors registered positive growth: heavy machinery manufacturing, which grew by 1.1%, and information and electronics, which limped forward with only 0.1% growth. Chemical manufacturing contracted by 0.82%, largely due to increasing oil prices; and the consumer goods sub-sector tumbled by 4.73%, largely in response to the lifting of textile quotas by the World Trade Organization (WTO). While manufacturing languished, services continued their slow-butsure expansion. Output in the service sector grew by 2.72% in Q1 and 3.83% in Q2, a substantial drop-off from 2004’s growth rate of 5.81% in Q1 and 6.46% in Q2. Even with relatively modest growth rates, services

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outperformed manufacturing. This allowed the service sector to grow relative to manufacturing, and for the first time, services contributed more than 70% to GDP. Industry’s contribution slipped to 28.1% and agriculture added 1.7%. From January to June 2005 the wholesale, retail, and food and drink industries grew 6.3%, a considerable lower rate than the 10% growth rate during the same period in 2004. This shows that Taiwan is evolving into a post-industrial society. D. Stocks Down, Deficits Up The Taiwanese stock market remains shaky in 2005. In October, the index stalled at about 6000 points, only about 100 points higher, or about 1.7%, than at the start of the year. The high point for the year came in July when the market topped 6400 points, but in successive weeks it slowly lost value. Trade volume has also varied, rising to a peak of about 80 billion yuan in July, but falling into the 50 billion yuan range when the market languished under 6000 points during April and May. Momentum has been hard to maintain. Even with a substantial sum of foreign capital entering the market, expectations regarding currency appreciation and general pessimism about future economic conditions undermined whatever potential existed. By September, foreign investors began dumping stocks, taking a short position in the amount of 12.4 billion New Taiwanese Yuan (NTY).2 This is the eighth largest single-day short sale in history. Taiwan’s stock market index responded predictably, dropping 100 points by the closing bell on September 22nd. While capital markets wobbled, Taiwan’s fiscal condition worsened. Based on rough calculations using department-level budget data, 2005 revenues equaled 1,366 billion new Taiwan yuan. With total expenditures of 1,600 billion NTY, the administration runs a fiscal deficit of 235 billion NTY. To cover deficits, Taiwan’s government continues to issue public bonds. The total amount of outstanding bonds is somewhere in the neighborhood of 3,700 billion NTY, or about 35.9% of GNP averaged over the last three years. Even if expenditures do not increase, the current debt and its interest will increase to 39.1% of This nomenclature is rarely used outside of the People’s Republic of China (PRC). Most markets recognize the Taiwanese Dollar as the currency; however, the PRC does not recognize this currency and calculates economic activity and prices in terms of the New Taiwanese Yuan. 2

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GNP by 2009. Regulations prohibit the debt from exceeding 40% of GNP, so the debt situation is coming to a head. Currency markets paint a more mixed picture. Money supply—M1, M2, and M33—grew by 7.03%, 7.68%, and 6.51%, respectively; each figure is lower than 2004’s increase. With money supply becoming relatively more constrained, upward pressure was placed on Taiwan’s currency, but the ongoing debt situation offset this. Against the US dollar, the NTY appreciated by 6.12% year-on-year in the first half of the year. In June, the average exchange rate was 1 USD to 31.37 NTY. However, by July the value fell to 31.92; by August it stood at 32.11.4 Foreign exchange reserves at the end of August reached 254.09 billion USD, an all-time high. Interest rates followed a similar path of appreciation and depreciation. After a slight rise in the first half of the year, July the inter-bank overnight call loan rate was 1.324%, an increase of 0.059% over the June figure of 1.265%. The growth rate of commercial paper was 1.28%, an increase of 0.04% over June’s rate of 1.24%. E. Rising Commodity Prices and Unemployment From January to June 2005, commodity prices in Taiwan have been rising at a moderate rate. The consumer price index (CPI) on wholesale prices rose moderately: from 1.43% and 1.84%. However, beginning in May the CPI began to pick up momentum, exceeding 2% through July and jumping to 3.56% in August. The CPI through August equaled 2.13%. Prices for various goods and services drove this increase: rising health insurance and health care costs, oil and natural gas prices, as well as a 6.94% increase in food prices (largely in response to typhoon damage). In general, commodity prices rose 3.52%. Inflation overtook the rise in wages, causing a decrease in real wages, and with it, spending power.

3 Money supply—that is, the total amount of funds available within an economy that can be used to purchase goods, services, and securities—is made up of three components. First is M1, which includes all physical currency and demand deposits; second, M2, which includes M1 plus most savings, money market, and certificate of deposit accounts; and M3, which includes M2 plus other types of deposits, Eurodollars, and repurchase agreements. 4 Bear in mind, however, that the USD has lost value vis-à-vis other currencies, in particular the Euro, through the period described in this essay.

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Other price changes compensated for the decrease in real wages. The appreciation of currency values in the period as well as a decline in the price of electronic products cut the increase in the wholesale price index from January to August about 0.62% compared to the same period in the previous year. After a promising start, unemployment numbers have gotten worse through 2005. February’s jobless rate of 4.28% slid to a low of 4.04% in April. Since then, the percentage has climbed, reaching 4.36% in August. As with many economies, the number of persons without jobs is higher than officially reported unemployment figures. When these persons who have left the labor pool are added in, the percentage of persons without jobs rises to 6.28%. While this represents an improvement from the highest jobless rates of 2001, it is much higher than the unemployment rates observed in the 1990s, when percentages dropped close to 2%. To many Westerners, especially Europeans, all of these figures may be more-than-acceptable; however, these unemployment rates tend to be rather high compared to other developed economies in East Asia. F. Stronger Mainland Connections Promote Growth Cross-strait investment and trade continued to grow in the first half of 2005, but at a slowing rate. According to statistics gathered from Mainland sources, trade volume was 41.08 billion US dollars from January through June. This marks a 12.5% year-on-year increase from 2004, which is a substantial decline form the 20% growth figure attained between 2003 and 2004. Note that these figures differ from those gathered from Taiwanese sources, which calculate trade volume as 33.54 billion USD for the same period. More detailed examination of these figures proves useful insights. According to Mainland figures, exports from Taiwan to the Mainland equaled 33.33 billion USD, a 9.3% year-on-year increase, making up 26.6% of the island’s total exports. Imports from the Mainland came to 7.75 billion USD, a 28.8% year-on-year increase. The trade surplus for the year amounted to 25.58 billion USD, but with imports growing more rapidly than exports, the gap is closing.5

5 While figures gathered from Mainland and Taiwanese sources typically diverge, the difference is especially wide regarding trade data. According to the Taiwanese, from

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A number of products that had been driving trade volume have lost their primacy in the bilateral trade relationship between the island and the Mainland. Integrated circuits and parts, liquid crystal display panels, information products, and automobile components, all mainstays of Taiwan’s export efforts, have been cut back. This happened while the Mainland increased its volume of imports from all of these sources. In short, Taiwan is being outmaneuvered by other players. Note, for instance, that Korea overtook Taiwan in the rankings of leading importers serving the Mainland market. While products often take center stage in trade relationships, trade in financial instruments and investments plays a large role in the balance of trade. With the Mainland government pursuing macroeconomic policies aimed at cooling growth, and with producers facing energy shortages, and increasing prices for energy, labor, and land, many Taiwanese investors showed less enthusiasm for the Mainland market, slowing investment flows. According to the Ministry of Commerce, from January to June 2005, the Mainland approved a total of 1,840 Taiwan investment projects, an increase of 9.76% from the previous year. Capital under contract from Taiwan amounted to 4.77 billion USD, a 3.76% increase from the previous year. However, actually capital investments fell well short of this figure: only 1.18 billion USD, 22.31% year-on-year decline. Taiwan ranked sixth among sources of capital arriving on the Mainland, after Hong Kong, the Virgin Islands, Japan, Korea, and the United States. Once again, Taiwanese figures diverge from data collected from Mainland sources. According to the relevant departments on the island, from January to July of 2005, the Taiwanese invested 3 billion USD in 747 projects. The average project amounted to just over four million USD. Even though flows from Taiwan to the Mainland had slowed, the Mainland remained a hugely important market for Taiwanese investors, accounting to more than 65% of the total external investment from Taiwan.

January to June 2005, cross-strait trade volume totaled 33.54 billion USD. Exports from to the Mainland equaled 23.98 billion USD, which indicated an 11.8% year-onyear increase. Exports to the Mainland made up 26.6% of its Taiwan’s total exports. Imports to the island from the Mainland equaled 9.56 billion USD for the period, a 25.5% increase. Imports from the Mainland amounted to 10.7% of Taiwan’s total imports. The bilateral trade surplus was 14.42 billion USD, for a relatively modest 4.2% year-on-year increase.

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From 1991 to July 2005, the Taiwanese poured 44.26 billion USD into 33,902 prospects on the Mainland. Unsurprisingly, the Taiwanese focused on provinces with proximity to Taiwan. From January to July 2005, 53.2% of Taiwanese capital went into Jiangsu, 21.8% was directed to Guangdong, and 8.7% landed in Zhejiang.6 The largest slice of the money, about 43.0%, went into electric motor and appliance manufacture, with basic metallurgical manufacturing attracting 10.5% of the capital. Chemical manufacturing took in 6.9% of the total, with specialized instrumentation manufacturing absorbing 5.9%, and services garnering 4.1%. II. Prospects for Taiwan’s Economy The leading economic indicators show that after a relatively strong 2004, economic performance sputtered through the first half in 2005. Signs of recovery, especially in the industrial and trade sectors, should help to salvage year-end numbers. Even with this late surge, it seems clear that growth will fall short of the government’s 4% target. Official estimates put growth in the range around 3.5%: the low end figure, 3.1%, comes from the Taiwan Economic Research Institute, with the China Economy Research Institute providing the high-end estimate of 3.8%. This puts the growth rate as slightly higher than that of the still-sluggish Japanese economy and much slower than the “Little Dragons” in ASEAN. Prospects for late 2005 and early 2006 give little cause for increased optimism. Two pillars of Taiwan’s economy—consumer demand and investment—are not expected to break out of their doldrums. Other factors militate against strong growth, particularly listless stock and capital markets and rising inflation. When the market dropped below 6000 points in September, it definitely dampened consumer confidence. An investigation by the Taiwan Economic Research Center of Central University in September 2005 shows that the consumer confidence score fell to 71.42, its lowest point since December 2002. More tellingly, consumer spending grew by only 3% during the second half of the year. Industrial investments are hardly sufficient to offset this. In fact, with consumer spending slowing down, investors have responded

6

These provinces surround Shanghai.

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by decreasing or postponing investments. Estimates place the increase in capital investment at 7.59% for the year, less than half the rate in 2004. The softening investment climate directly impacts the industrial sector; the scope of this contraction is substantial. From 2001 to 2004, new investments in the Taiwanese industrial sector have declined by a total of 1,400 billion NTY (based on year 2000 currency values). Looked at another way, it is as if new investments had fallen to zero for one of these four years. FDI has done little to offset this slide: FDI in 2003 is half of the 2000 total. The decline in investment constrains Taiwan’s ability to upgrade processes, performance, and products, and this hurts its competitiveness. Pressures on industrial producers go beyond the worsening investment picture. Prices for many goods continue to fall while input prices rise. For instance, in August 2005, energy and mineral prices rose 26.5%, oil and coal prices rose 17.6%, but the prices for computer, telecommunication, and electronic components fell steeply. Declining profits erode the investment position of firms in the sector, setting a vicious cycle in motion. Cumulative losses among the seven largest LCD manufacturers in Taiwan exceeded 30 billion NTY. High tech products have lost ground to other forms of output. In 2000, the high tech sector made up 55.8% of industrial production, but by 2005 its share had fallen to 50.6%. Products requiring middle-to-high energy input intensity jumped from 46.0% of industrial output to 63.8% over the same period. Clearly this shift may be of concern. First, with energy prices increasing such a surge may not be sustainable. Secondly, energy-intensive industrial processes will come under heavier scrutiny for their environmental side effects, further raising costs of production. The economy will not find relief through trade. IMF forecasts do not paint a rosy picture for Taiwan’s trade sector. Rising energy prices, increasing protectionism, deteriorating economic conditions, especially in the US, and a slowdown in Mainland China’s GDP growth rate all conspire to cool down the growth rate of global trade. Trade to and from Taiwan typically increases in the second half of the year. This will help to offset soft performance through June 2005. However, trade growth is expected to finish the year in the single-digits. Moreover, with imports growing more quickly than exports, the trade surplus continues to erode. Estimates have it barely exceeding three billion USD, which is less than half of the trade surplus last year.

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Taken together, these factors bode ill for the island’s economic growth prospects. Taking a comprehensive viewing of Taiwan’s economic prospects for 2006 suggests that the malaise of 2005 will continue. Global markets do not inspire great optimism according to the IMF and Global Insight. The two main drivers of the demand-side of the economy, consumer spending and investment, are not poised to surge ahead. Since 2003, household income has increased only 1% per annum on average, while expenditures have increased by twice that amount. In other words, consumers are borrowing just to keep up. This leaves consumers, and the entire economy, in an increasingly vulnerable position. With interest rates expected to stay high, and with fuel prices expected to increase in price and volatility, consumer spending is not likely to grow at more than 3%. Without internal or external factors working to drive growth, we can look for modest, and slowing, growth in the economy. The IMF estimates that the economy will grow at 4.3% in 2006. Global Insight puts the figure slightly lower at 3.6%. The Swiss Bank Corporation paints a more pessimistic picture, revising their September 2005 estimate downward from 3.8% down to 2.9%. Table 26.1: Major economic indicators (2003–2005)

Economy

Indicator

2003

2004

2005

GNP growth (%)

3.31

5.71

13156 100.00 1.80 30.57 67.63

14032 100.00 1.74 29.54 68.72

3.65 (estimated) — 100.00 (Q2) 2.03 27.25 70.72

–0.3

1.62

GNP per capita (USD) GDP by sector (%) Agricultural output/GDP Industrial output/GDP Service sector output/GDP

Commodity prices

Inflation rate (CPI) Inflation (wholesale prices) (%)

2.5

7.03

Industrial production

Growth of industrial output (%) Growth of manufacturing output (%) Growth of heavy industry output (%) Growth of light industry output (%)

7.2

9.85

7.4

10.55

9.7

13.04

0.3

1.80

2.13 ( Jan-Aug) 0.62 ( Jan-Aug) –0.1 ( Jan-Aug) –0.53 ( Jan-Aug) 1.03 ( Jan-Aug) –3.32 ( Jan-Aug)

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Table (cont.) Indicator Consumption Growth in consumer and spending (%) investment Growth in fixed capital investments (%) Growth in consumer investments (%) Trade

Finance

Labor force

2004

2005

0.7

3.13

–2.0

15.4

–1.5

28.20

Growth in imports (billions USD) (%) Growth in exports (billions USD) (%) Trade surplus/deficit (billions USD) Exchange rate as of 12/31/05 (NTD/USD)

127.25 13.1

167.89 31.9

144.18 10.4

174.01 20.7

16.93

6.12

34.0

32.23 (year avg.)

Foreign exchange reserves (billions USD) Past due loans (%)

206.6

226.523

5.00

3.28

Stock market weighted index (average)

5162

6034

Employment (1,000 people)

9570

9780

503

454

4.99

4.44

58.37

78.32

30.7

34.2

9

13.55

36.7

50.4

49.37

64.78

29.7

31.2

33.33 (thru Q2) 9.3

40.37

51.23

25.58

Unemployment (1,000 people) Unemployment rate (%) Crossstrait trade (Statistics from Chinese customs)

2003

Cross-strait trade (billions USD) Growth rate of cross-strait trade (%) Exports to Taiwan (billions USD) Growth rate of exports to Taiwan (%) Imports from Taiwan (billions USD) Growth rate of imports to Taiwan (%) Mainland/Taiwan trade deficit (billions USD)

3.14 (estimated) 7.84 (estimated) 9.94 (estimated) 119.78 11.2 ( Jan-Aug) 120.95 6.7 ( Jan-Aug) 1.17 ( Jan-Aug) 32.11 ( Jan-Aug avg.) 254.09 ( Jan-Aug) 2.90 (thru Q2) 6243 (thru Q2) 9904 ( Jan-Aug) 431 ( Jan-Aug) 4.17 ( Jan-Aug) 41.08 (thru Q2) 12.5 7.75 (thru Q2) 28.8

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Table (cont.)

Investment in the Mainland from Taiwan (statistics from Ministry of Commerce)

Indicator

2003

2004

Number of Taiwanese projects on the Mainland Growth rate in investment projects (%) Contracted capital to the Mainland (billions USD) Growth rate in contracted capital to the Mainland (%) Actual capital to the Mainland (billions USD) Growth rate in actual capital to the Mainland (%)

4495

4002

–7.38

–11.0

8.558

9.31

26.96

8.7

3.377

3.12

–14.94

–7.7

2005 1840 (thru Q2) –9.76 4.77 (thru Q2) 3.76 1.18 (thru Q2) –22.31

HONG KONG’S ECONOMY ENTERS A NEW PHASE: IMPROVEMENTS IN HONG KONG’S ECONOMY AND CHANGES IN ITS RELATIONSHIP WITH THE MAINLAND Guo Guoquan Economists will look back at 2004 and see it as a turning point in Hong Kong’s economic development for two key reasons. First, the Hong Kong (HK) economy finally shook off the lingering adverse effects of the 1997 Asian financial crisis. Second, the Closer Economic Partnership Arrangement (CEPA) finally took effect, signaling the beginning of a new economic relationship between Hong Kong and the Mainland. I. The Economic Recovery Achieves Maturity Once the 2003 SARS1 Crisis passed, Hong Kong’s economy entered a period of vigorous growth. Annual gross regional product grew by 8.2% in 2004 and by 6.5% during the first half of 2005. These figures represent huge gains over 2003’s more modest 3.1% growth rate. Moreover, recent growth rates vastly exceeded those typically observed in mature economies. With SARS under control, tourism and trade picked up, and with them, consumer and investor confidence. Policy changes on the Mainland aimed at encouraging tourism helped to boost HK’s tourism industry. 2004 saw 21.8 million visits to Hong Kong from the Mainland, a 40% increase over 2003’s total. This strong showing has continued into the first nine months of 2005; total visits are up 7.6% over 2004’s strong showing. Tourism growth not only results in direct spending for tickets and lodging, but on a wide variety of other forms of spending as well. Therefore, large businesses like airlines and chain hotels and small businesses like restaurants and boutique stores enjoy the benefits of increased tourism.

1

SARS stands for severe acute respiratory syndrome.

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Trade has shown impressive growth in 2004 and 2005. Trade volume grew by 16.0% in 2004 over 2003. This momentum continued into the first nine months of 2005 as trade climbed an additional 12.0% over 2004’s nine-month mark. Continued robust growth of the Mainland economy and the increasing intensity of global trade have driven the expansion of Hong Kong’s trade sector. The strength of this economic recovery is also reflected in rising capital and asset prices. The stock and housing markets both surged starting in mid-2003. The Hang Seng Index rose from 12,576 points at the end of 2003 to 14,230 by the end of 2004. At the end of August 2005 it had soared to 15,466, its highest point in four years. Real estate enjoyed an even more potent increase in value. Prices of apartments, office buildings, and retail properties rose by 27%, 66%, and 44% in 2004. During the first eight months of 2005 the market cooled but still continued to grow impressively, racking up increases of 11%, 22%, and 3% in these same categories. The improvement in consumer confidence helped to drive the economy on all of the aforementioned fronts. Note, however, that there is significance interdependence between consumer confidence and macroeconomic performance. Tourism helped to jumpstart the entire process, causing a surge in demand. Labor markets responded by opening up new job opportunities, driving down unemployment. In the middle of 2003 the jobless rate stood at 8.6%; by the end of 2004 it had fallen to 6.6%, and by the end 2005’s third quarter had dipped to 5.5%, its lowest point in four years. With incomes growing the demand for assets picked up, driving prices upward. Consumption grew 6.8% in 2004, a formidable rebound from the 1% contraction in consumer spending during 2003. While consumer spending has eased off, it still grew by 3.5% in the first half of 2005. Given these trends and conditions, the HK economy is expected to grow 4.5%–5.5% for the whole of 2005. Even there is an abundance of good tidings for the economy, some dangers signs should be watched, especially the possibilities of increasing inflation and rising business costs. II. Fiscal Conditions Exceed Expectations The rebound of the Hong Kong economy has bolstered government revenues. For instance, property taxes from 2004–2005 brought in 32

hong kong’s economy enters a new phase

419

16 14 12

Percentage

10 8

Year-on-year growth rates, by quarter

6 4 2 0 –2

Year-on-year growth rates adjusted for seasonal effects, by quarter

–4

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

–6

2000

2001

2002

2003

2004

2005

250

6000

200

5000

150

4000

100

3000

50

2000

0

1000

–50

0

100 2000

2001

2002

2003

2004

Figure 27.2: Tourist visits to Hong Kong, 2000–2005

2005

Year-on-year growth rates

7000

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Figure 27.8: Fiscal surplus and deficit

billion yuan, more than two-and-a-half times the amount predicted. Income and corporate taxes outperformed expectations by 9% and 40%. During Fiscal Year (FY) 2004, the government ran a surplus of 21 billion yuan, its first year in the black since 2000. This sum equals 1.7% of Hong Kong’s gross product. However, bond commitments of 25.4 billion yuan put total government expenditures 4.4 billion yuan in the red. Note, however, that this again beat expectations. III. Connecting More Deeply with the Mainland Economic changes in Hong Kong go beyond cyclical growth. Its increasingly close economic relationship with the Mainland has the potential to reshape the regional economy for years to come. This relationship has been codified in the Closer Economic Partnership Arrangement. One component of the CEPA has encouraged travel from the mainland to Hong Kong and this helped to revitalized tourism, which in turn helped to energize the economy on multiple fronts. The CEPA is a free trade agreement signed between the Mainland and the two Special Administrative Regions, Hong Kong and Macao.

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Because the People’s Republic of China (PRC) is a full member of the World Trade Organization (WTO) this agreement has wider regional and global implications. The CEPA has been implemented in stages. The first agreement— usually called the first phase of CEPA—was signed in mid-2003. The second phase was agreed upon in mid-2004 and the third agreement came into being in October 2005. Each phase spelled out the scope and means for opening and deepening trade relations. The CEPA emphasizes three points: (a) Allowing many goods manufactured in Hong Kong to the Mainland duty free; (b) Lowering various restrictions faced by HK-based service providers seeking to enter the Mainland market; (c) Providing a framework for promoting trade and investment. In the early months of 2005 the government observed substantial changes in tourism, trade, and investment in those areas affected by the CEPA: (a) Exports to the Mainland qualifying for special duty-free treatment equaled 1.15 billion yuan; exports are expected to more than double in 2005, reaching 2.35 billion yuan. (b) Mainlanders made 2.4 million trips to Hong Kong in 2004. This figure was expected to increase in 2005. The increase in tourism helped to create 16,600 new jobs, which in turn added 4.5 billion yuan to output in the Hong Kong special administrative region (SAR). (c) During the rollout of the CEPA’s first phase in 2004, eighteen service companies made use of the agreement’s provisions regarding market entry. This injected a billion yuan into the Mainland economy for the year. Estimates peg the 2005 total at 4.5 billion yuan. Industry estimates expect that 10,000 jobs will be added to the Mainland service sector by the end of 2005. These changes only capture part of the change underway. To understand the CEPA’s significance, we must examine the broader context of how the Mainland and Hong Kong will do business after CEPA’s comprehensive implementation.

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Since initiating internal economic reforms in 1978 and emphasizing trade in its economic development strategy since then, the Mainland economy has grown at breakneck rates. After more than 25 of rapid growth, the economy has taken on a new structure, becoming more diversified and modernized. Industrial development is the pulsing heart of the economy. Productive capacity in heavy industry and manufacturing, flexibility in light industry, and a solid record in chemical manufacturing have driven growth through much of the last three decades. Recent strong growth in the information technology sector has diversified the Chinese economy. To build on this foundation and extend growth in coming years the Chinese economy needs to establish more efficient commercial and financial foundations. Finding and implementing processes to improve economic efficiency and to ensure ongoing improvements is crucial. In essence, this is a shift from a single-minded emphasis on increasing output to a more balanced economic system that considers quality—i.e., how things are done—alongside growth-oriented strategies and policies. The central government repeatedly claims that it seeks to further develop the national economy; to fulfill this aim it must take a more balanced and robust approach to economic development. However, economic change goes beyond policy-setting; trade has allowed many firms to grow quite large and they not only compete over export opportunities, but increasingly, over key parts of the domestic market. On both fronts, competition has become quite fierce. Fortunately, this has caused firms to become more driven, innovative, better organized, and in general, stronger competitors. As the manufacturing base has grown on the Mainland, so has personal income. Given growth trends in income, and the size of the Chinese population, consumer spending has massive potential. To effectively exploit the domestic market, firms must develop innovative technologies, new marketing concepts, management systems, and labor skills. Traditionally HK has served this process—and benefited from it—by providing Mainland operators with capital, management expertise, technical capacity, and access to world markets. This has connected Mainland firms and industries to Hong Kong and global markets. While these functions will continue to play a key role in the

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Figure 27.9: Increasingly close ties between Hong Kong and the Mainland 46

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interregional relationship, economic, business, and social changes on the Mainland offer new opportunities for Hong Kong-based firms and entrepreneurs. V. Hong Kong’s New Roles and Their Importance Changes in the relationship between Hong Kong and the Mainland cannot be overlooked. Take, for instance, the seminal role of tourism and business visits. The increasing numbers of Mainlanders going to Hong Kong puts pressure on Hong Kong business and governmental leaders to reach out to Mainlanders. As this happens, other commercial ties strengthen. In fact, travel fundamentally reshapes the market by vastly increasing the number of people and the amount of money circulating in the Hong Kong economy. Hong Kong receives 21.8 million visits annually; this means that the relatively large Hong Kong economy gets a boost from outsiders. 56% of these visits start on the Mainland; the typical traveler has relatively high income and seeks accommodations, experiences, and goods in line with their upscale income profile.

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In well known parts of Hong Kong like Causeway Bay, Tsim Sha Tsui, and the Central Ring2 we can see countless posters and advertisements hung on building walls, buses terminals, buses, billboards, and on the metro advertising consumer goods. Well known brands have to rollout new campaigns frequently. New brands enter the market, competing for ad space, shelf space, and most important, the attention of consumers and travelers. The market has become very lucrative, as evidenced by the exceptionally high rents for retail space in Hong Kong. Some Hong Kong brands that have a strong local but limited international reputation have become quite well known on the Mainland. This not only demonstrates the increasingly close linkage between the two markets, but the potential benefits from investing in marketing, advertising, and branding aimed at Mainlanders. Hong Kong services, firms, and products enter the Mainland market with an advantage; having a good reputation. Mainlanders consider goods from Hong Kong to be of high quality; firms from Hong Kong have a reputation as savvy and vigorous. As Mainland incomes rise, so too will their taste for goods and services from Hong Kong. VI. New Commercial and Financial Opportunities for Hong Kong Economic growth and structural evolution increases the demand for business and financial services. For instance, in order to have ready access to markets aboard, over 2,000 Mainland firms have established offices in Hong Kong since it is far more connected to the rest of the world through port, air, and electronic means. Various provisions in the CEPA and the changing and liberalizing economic and political climate will expand this market. Hong Kong has a longstanding role as a global financial center. With the growth of the Mainland economy, its expertise has allowed it to take the lead role in financial and capital management in the Chinese sphere. The benefits of this can be seen in local stock market performance. From 1993 to 2004, the Hong Kong stock market raised more than 900 billion yuan for 304 inland enterprises. Markets have been especially active in recent years. For example, at the beginning

2 Central Ring is the literal translation of Chung Wan, which is part of Victoria City.

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of 2004 only 44 Mainland companies were listed on the Hong Kong stock market; the total capital raised for them amounted to 75.4 billion yuan. However, by the end of the year, Mainland enterprises accounted for 30% of the total value of Hong Kong stock market and half of its transaction volume. This precipitous increase in transactions and business activity generates a commensurate demand for various professional services, especially in the high value-added end of the labor market. Of course, the financial ties between Hong Kong and the Mainland go beyond the stock market. For years Hong Kong has provided financial services to firms and individuals interested in investing on the Mainland. Because of these moves, Hong Kong investment banks actively participated in and promoted various Mainland financial transactions. However, this is not a one-way process. As wealth increases and capital accumulates on the Mainland, the demand for finding overseas investments grows. Given the close geographic, economic, and cultural ties, a significant portion of this capital will flow into Hong Kong. As important, a much larger percentage of it will flow through Hong Kong, given this role as a regional financial services hub. For instance, Mainland agencies with oversight of social security funds and insurance companies have been examining investment and financial management options in Hong Kong. This could represent a substantial influx of new capital to the HK SAR. In order to encourage such moves, the Hong Kong government has begun considering cancellation of estate duties. As of February 2004 Hong Kong banks have begun offering financial services in renminbi (RMB), which is a major breakthrough. This change facilitates making deposits to and from the Mainland, currency exchange, and remittances between Hong Kong and the Mainland. Banks have even issued credit cards denominated in RMB, which has met with unexpected popularity. By the end of August 2005 RMB deposits in Hong Kong banks exceeded 22 billion RMB. While this accounts for only 1.2% of the foreign currency deposits in approved institutions, the rapid growth of deposits shows that this could become a more significant percentage of foreign currency holdings. Moreover, this move can help smooth settlements and clearing between Hong Kong and Mainland banks. By lowering transactions costs and strengthening ties and systems of exchange, this may be the first step in a much larger constellation of financial market activities linking the SAR to the PRC. President Hu Jintao’s policy address covering economic conditions and trends in 2005 and 2006 touched on the HK SAR. His comments

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Figure 27.10: Year-end market value of Mainland enterprises listed on the Hong Kong stock market, 2004 Mainland enterprise values

indicated government support for expanding such financial services and transactions, and the administration’s desire to more fully develop financial connections between Hong Kong and the Mainland. VII. Hong Kong Faces Increasingly Intense Competition Economic and technical change continues to accelerate and touch more people and parts of the planet. Hong Kong has long been at the center of these changes; these changes now reach more deeply into China’s Mainland. While recent technological and structural changes have introduced considerable flux and competitive pressure into markets, they have also opened up tremendous business opportunities. For instance, many Hong Kong-based firms have moved low value-added industrial processing work to the Mainland. This lowers the firms’ costs, fattens margins, and provides a cornucopia of new jobs on the Mainland. However, these changes have set in motion secondary and tertiary changes. As job tenure has increased for Mainlanders, so has experience and skill level. As skills improve, productivity improves. This attracts more businesses to the Mainland; it also means a broader variety of businesses can find suitable labor on the Mainland. As this

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happens, the Mainland economy strengthens and diversifies. In turn, this means that it can begin to compete more robustly and aggressively. For instance, the port in Shenzhen has begun to carve into the market share of Hong Kong’s port in container transportation.3 Competition arises from development, and development depends on competition. Markets simply do not function properly without robust competition. Competitive pressure will prod Hong Kong to reorganize its economic structure. However, cooperation will have a role to play as well. Hong Kong’s ties with the Mainland depend as much on one as the other. While Hong Kong will have to shoulder aside other suitors, it has numerous advantages in building and deepening ties to the Mainland’s provinces. By the same token, many Mainland provinces and cities face stiffer competition, both from each other and from emerging global players. They will need strong relationships and alliances in reaching markets and at the same time improving their productive capacities. VIII. Consolidating and Promoting Growth while Confronting Challenges As noted at the beginning of this essay, Hong Kong’s economy has shown marked improvement since mid-2003. As the “Asian Flu” becomes a more distant memory, business leaders and policy makers can set their sights firmly on the future. Early indications are that the future looks bright; global markets have been strong and regional conditions, especially the connection between Hong Kong and the Mainland, show considerable promise. Growth figures for the first three quarters of 2005 have exceeded estimates and conditions are right for a continued expansion. However, challenges remain. Rapidly rising oil prices, high interest rates, protectionist rumblings, and geopolitical tensions all threaten to undo, or at least severely complicate, the currently strong economic conditions in the region. To meet these challenges Hong Kong’s leaders will need to step up the rate of change in economic transformations that have already begun.

3 However, these effects also produce wage increases, which produce mixed effects. Higher wages raise production costs on the Mainland, but at the same time, increase consumer spending.

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Zeng Yinquan, the SAR’s Chief Executive, gave a policy address on October 2005 that laid out the basic vision for Hong Kong’s economic future. He noted the need to make several moves in concert: emphasizing economic growth, enhancing Hong Kong’s comparative advantages, and consolidating the strength of its cornerstone industries. He also noted the need to respond quickly and effectively to changing market conditions, in particular, moving aggressively into growth industries and niches. He underscored the role of government in supporting such moves through thoughtful policymaking, sound regulatory intervention and rulemaking, and ongoing infrastructural development. Taken together these steps will enhance competitiveness and economic prospects. These aims build on the China’s process of economic and political liberalization, but with a particular focus on reinforcing regional connections and strengths. A key aspect of facing the world involves working more effectively and comprehensively with Mainlanders. In essence, becoming more competitive depends on becoming more cooperative. This will build on Hong Kong’s strength as a global—and Asian—financial center and metropolis. From this base, the SAR, and the wider Chinese market, can lead the way in finance, as well as trade, communications, information, and manufacturing.

ANALYSIS OF CURRENT AND FUTURE ECONOMIC CONDITIONS IN MACAO1 The Macao Macroeconomic Workgroup, Huaqiao University I. Basic Economic Conditions Because of its small territory and resource base, the economy of Macao faces a variety of constraints. To cope with these, it has developed a trade-oriented economy, making it a miniature version of some other East Asian economies.2 This strategy has worked well: Macao is in the upper tier of the world’s “micro” economies in terms of income per capita and growth. Economic revitalization of the Macao special administrative region (SAR) began shorting after the 1999 handover of the region from Portugal to China. After languishing under the Portuguese, the economy quickly righted itself, and now is among the fasted growing in the world. From 2000–2002 economic growth equaled 5.1%; the following year it soared to a stunningly strong 15.6%. In 2004 it reached absolutely stratospheric heights: 28%. Gross local product for Macao reached 82.69 billion Macao yuan,3 putting it in the same class as Singapore and South Korea, but still behind Japan. Part of this increase can be attributed to a vastly improved job market. Unemployment was at 7.1% at the time of the takeover; it dropped to only 4.1% by the second quarter of 2005. While job growth certainly adds to per capita income, it also indicates that many residents of Macao have enjoyed rising wages as well.

1 The Special Administrative Region (SAR) known as Macao is also known as “Macau”. The spelling here conforms to Romanization conventions used in the People’s Republic of China (PRC). 2 Note that “trade” goes beyond goods shipped back and forth; trade in Macao’s case includes tourism and entertainment services. 3 The Macao Yuan is a currency used in trade between the SAR and the PRC. However, the internationally recognized currency for Macao is the Macao Pataca. Its value is about equal to the Hong Kong Dollar (HKD), which is in turn, pegged to the US Dollar (USD) at the rate of about 8 HKD to 1 USD.

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Several factors came together to produce this phenomenal outcome. Growth in the region, especially in China-proper, reached a doubledigit pace. Microeconomic factors played a pivotal role as well. Macao’s unusual legal structure allowed gambling and tourist money to flood the region in a relatively short amount of time. Gambling, hotel, and other entertainment and hospitality businesses, flush with cash, found a welcome and wide-open market in Macao. A. Economic Growth After the economy grew at more than 20% for six consecutive quarters, it stetted down into a more reasonable, but still brisk growth rate of about 8.5% after the first quarter of 2005. The gaming industry continues to be the driving force within the economy. Revenues in the sector increased by 11.7% in the first quarter (Q1) of 2004 and an additional 17.2% in Q2. Economic growth in the SAR over these two quarters was 8.2%. Since the mid-1990s gaming has contributed about 30% of total output in Macao. After the handover, the People’s Republic noted this and began building the economy around the economic base of gaming and tourism. Since the handover, gaming has actually increased its share of the economy to about 33.3% of output. Turnover from gaming reached almost 11 billion yuan (1.370 billion USD), making Macao one of the major players in the gaming industry. By comparison, Las Vegas brought in 1.864 billion USD; that is, Macao’s gaming revenues are slightly less than 75% of Las Vegas’. These revenues have paid off handsomely for the SAR, which has collected almost four billion yuan (or about 500 million USD) from gaming operators in taxes and fees. Many large projects have recently been developed and more are in development. As usual, the gaming industry is at the epicenter of new building and investment. Even though investment has cooled down, vast sums continue to flow into the SAR, mainly for large projects directly or indirectly tied to gaming. In the first half of 2005 construction investment increased by a dizzying 105%. This unprecedented rate of investment laid down a solid foundation for future economic growth. The gaming industry shares very close links to tourism. However, separating non-gaming tourism shows that growth extends beyond gambling. Tourist expenditures rose 3.6% year-on-year in 2004; total private consumption expenditures increased 8.9% year-on-year.

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Even though the gaming continues to be the lynchpin of the economy, diversification is increasing: tourism and hospitality have growth steadily and those serving these industries, have seen incomes rise. With consumer spending increasing, and with investment continuing to grow at a rapid clip, Macao can look forward to continuing strong growth through 2006. In the first half of 2005 over 48 million visits were made to Macao, a 12% increase over 2004. The Chinese Mainland dominates other sources of tourists, accounting for 54% of total visits. Neighboring nonMainland locales make-up a substantial percentage of the remaining visits: 31.7% of visits start in Hong Kong and 8.47% begin in Taiwan. Note, however, that the average stay is brief: only a shade over a full day. Visitors spend 1,490 yuan on average (about 185 USD). Mainlanders far outspend other visitors, doling out 2,816 yuan per visit (about 350 USD). The total number of hotel rooms had swelled to 10,585 by the end of July 2005. From January to March 2005, the occupancy rate averaged 64.9%. During the peak season, occupancy climbs to over 80%. However, occupancy dropped in Q3, largely due to the opening of Hong Kong Disneyland in September and new prohibitions on gambling for those arriving from the Mainland. Predictably, hotel room rates have declined, but by a modest 2.1%. In general, though, the tourism and hospitality industries have continued to thrive. In 2004 expenditures on accommodations are up 6.95%, payments to amusements and cultural activities have increased by 6.51%, and outlays on food and drink are up 3.47%. B. Developing the Export Sector Although the goods trade contributes a substantial percentage to output and employment, its performance has been mixed recently. Total exports for the period January to July 2005 equaled 9.22 billion yuan, a 26.2% decline from the previous year. Locally produced goods contracted 34.0% and re-exported goods dropped 0.7%. From January to July 2005, total imports rose 5.4% year-on-year. The major components of import volume were petroleum products, capital goods, and consumer goods. These three categories increased by 34.8%, 24.6%, 3.2%, respectively. Imports of raw materials and goods declined 5.8%.

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The trade deficit rose to 7.06 billion yuan. Examining the exportimport ratio throws the contraction of exports in sharp relief. In 2004 the export-to-import ratio equaled 80.9%; the following year it had tumbled to 56.6%. Garments and textiles made up almost three-fourths of total exports. The value of clothing exports declined 31.6% for the January to July 2005 period as compared to the same span of months in 2004. However, shoes gained 90.8% in total export value between 2004 and 2005. Non-textile products lost 4.9% in value, but because of the relatively small percentage of export value coming from these products, this had a negligible impact on total export volume. Although revenues from the textile and garment industry have declined, the sector still plays an important role in Macao’s economy. Because production is labor-intensive, the sector employs many persons. Also, these products form an important link to the largest markets in the world, including the US and European Union (EU). Textile and garment exports bound for these two markets make up 59.0% of total goods exports; exports to the US make up the lion’s share of export volume, about 48%. However, textile and garment exports to the US declined in value by almost 25% year-on-year; exports to the EU suffered an even steeper decline: 62.8%. Even though changes in World Trade Organization (WTO) agreements have generally opened markets, some large markets, like those of the EU and US, have recently erected obstacles aimed at Chinese-made products. This may be one of the factors behind such steep declines. Textile and garment exports to the Chinese Mainland and Hong Kong, which made up 29.5% of total exports, decreased by more than 5.0% year-on-year. Lifting the global textile trade quota system has placed unprecedented pressure on Macao’s textile and garment exports. However, passage of the Closer Economic Partnership Arrangement (CEPA), which encourages trade and investment between the Chinese Mainland and the two special administrative regions (Hong Kong and Macao), has resulted in the construction of a cross-border processing zone for imports and exports. This will strengthen trade links between China and the SARs, while stemming the flow of exports through low-cost markets elsewhere in Asia. As a bonus, more kinds of products will pass through this zone, which will help to facilitate the growth of a variety of industries. As diversification broadens, the economic structure of trading partners becomes more robust.

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Two years after its introduction, the CEPA’s powers and impact will expand. This change will help producers in Macao gain access to rapidly growing and potentially large Mainland markets. Imports from Asia make up the bulk of total import volume. Imports from the Chinese Mainland and Hong Kong account for slightly more than half of total imports: about 51.2%. Imports from the Mainland declined 1.1% in the first seven months of 2005 compared to 2004; imports from Hong Kong held about even, losing 0.6% year-on-year. Imports from the EU account for 13.7% of total import and imports from the US account for only 4.4% of the total. However, imports from these markets increased substantially in total value: 16.0% for the EU and 8.4% for the US. This indicates that specialized and bigticket products from these markets are penetrating Macao’s market more effectively.4 Trade in intangibles—generally speaking, services—has continued to climb, largely due to the growth of the gaming industry. Year-on-year growth reached 11.6%. Non-gaming consumer spending by visitors rose a modest 3.6% year-on-year largely as a result of the relatively short stays of the average visitor. In general, intangible exports increased 10.9%. The star performer, however, was transportation services, which shot up by an eye-popping 54.1% over the pervious year’s performance. C. Steady Growth in the Construction and Real Estate Industries The momentum in the construction and development industries developed in 2004 will carry over into 2005, with numerous building projects slated for completion. Much of this development will revitalize abandoned or underutilized sections. This effort will largely fulfill government redevelopment plans. Foreign investment has helped to drive the latest building push. A number of Hong Kong developers made bold forays into Macao’s real estate market. Many of these developments have a direct or indirect link to the gaming industry. However, development and construction has a broad-based impact on an economy and its people; in many

4 Given Macao’s reliance on oil imports, it can be assumed that a substantial portion of the remaining 30% of total import volume comes from the Middle East and Africa. However, reliable figures could not be found regarding imports from these locations.

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markets construction starts serve as a bellwether indicator for future economic conditions. Although gaming is still front-and-center in Macao’s economic development plans, construction has emerged as a more and more important component of the economy. During the first quarter of 2005, gaming in Macao grew by 11.7%. However, construction investments grew by a staggering 75.7%. Clearly construction starts from a smaller base and therefore it can achieve much higher growth rates. Even so, this fast pace and the multiyear nature of construction projects shows that construction will make up a larger share of total output in the coming years. Notably, private investment has emerged as the engine powering construction investment. The government’s share of construction investment fell by more than 50% year-on-year in Q1 2005. Major publicly-funded construction projects—like the East Asian Games and the West Bay Bridge—have been completed, so a drop in government construction is expected. However, with a 75% increase in a year, private investors have clearly moved aggressively. Much of this private capital comes from owners of gaming operations, so in some sense, gaming remains at the center of economic changes in the SAR. D. Consumer and Investor Confidence on the Rise Improvements in Macao’s economy have attracted the attention of many investors. For instance, 838 new companies were launched in the second quarter of 2005, nearly 50% more than in 2004 Q2. Total investment increased to 227 billion yuan, a phenomenal 126% yearon-year expansion. 224 of these companies have opened wholesale and retail businesses. A whopping 185 construction companies entered the market along with 156 real estate firms. 132 operations offering services to the industrial sector got underway in the quarter. Capital to fund these news businesses comes from sources with close ties to Macao. For instance, while Portugal ceded administrative control of Macao in 1999, it is Macao’s number one investor, putting over 60 million yuan into the economy. Macao itself comes in a close second, putting 58 million yuan into the economy. The Chinese Mainland follows close behind at about 57 million yuan. About 20% of Mainland investment comes from the provinces surrounding the Pearl River, which ends in Guangdong, the province closest to Macao.

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Other data reveal that investment growth will likely remain strong. Fixed asset investment grew by more than 60%, with private sector investment increasing at close to 67%. Building investment shot up 133.2%. Investment in equipment rose by 10%. Government, while pulling back in terms of building investment, still saw its expenditures for construction rise almost 20% and its overall investments increase by more than 25%. Total public and private construction investments rose over 100% in Q1 2005. Growth in gaming, tourism, and construction helped to stimulate demand. Consumption and investment have steadily grown, overtaking government consumption and investment as a share of aggregate demand. In Q1 2005 consumer spending rose 8.3% after increasing 7.9% in Q4 of 2004. Retail sales, which is clearly related to consumer spending, has exploded. In Q2 of 2005, retail sales increased 17% on volume of 1.8 billion yuan. Retail sales volume in the first half year of 2005 is 4.25 billion yuan, a 19% year-on-year increase. Government spending rose 5.9% in Q1 2005 following a 2.9% increase in Q4 2004. Through it all inflation has remained largely under control, but has begun to show signs of increasing. In July 2005 the consumer price index (CPI) rose 4.75% more than in July 2004. Annual price increases have increased by about 3%. II. Forecasts Based on Leading Economic Indicators Based on available statistics and trends, this section presents forecasts for 2005 and 2006. We also include policy prescriptions and the likely outcomes of implementing them. A. Predictions Regarding Growth Since 2005, natural and human disasters have shaken the world, including the Indian Ocean Earthquake and Tsunami, Hurricane Katrina in the US, the 07/07 terrorist attack on the London Underground, Middle Eastern violence, and steeply increasing oil prices. All of these events, and many others, have produced adverse effects on the global economy. The Chinese economy has staved off the worst of these effects through economic reform and regulator changes. These steps include making improvements in corporate ownership, reforming financial markets,

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and increasing employment and wages, among others.5 These benefits have spilled over to the Macao economy since the SAR and the PRC share such close and wide-ranging economic ties. Given current conditions and trends, a few basic outcomes seem clear: the PRC’s economy will continue growing, but at a slowing rate; consumer spending will grow rapidly; export volume will continue growing, but at a slowing pace; import volume will increase; and inflation should stay under control. These conditions and trends will have direct and indirect impacts on Macao’s economy. First, the national economy will grow steadily, but the growth rate will decelerate. Expenditures will follow the same basic pattern: outlays will increases 2.4% in 2005, off 7.3% from 2004’s pace. To some degree, this trend is offset by government expenditures, which increased 5.6%, 1.7% year-on-year increase. In 2006, government will vastly expand its outlays, with spending up 9.5%. The investment component of gross product produces a mixed picture. Driven by building projects, especially in the gaming industry, overall investment continues to rise steeply. Fixed asset investments increased by 29.9% in 2005, about 18% less than the 2004 rate. Note, however, that this may be because 2004’s investment rate may well have been an anomaly. In 2006, fixed asset investment is estimated to grow by 19.1%, which supports the notion that 2004 represents an extraordinary year in investment. Slowing economic growth does not point to economic problems. Rather, it means that growth is settling into a more reasonable pace from exceptionally high growth rates. As Macao’s economy matures, and as operations funded with investments made in recent years come online in 2006, the possibility for a new period of sustained growth is close at hand. Macao may be able to transform itself from a regional gambling town into an international entertainment hub. Second, we regard the trade sector. In 2004, goods cargo exports from Macao increased almost 9%, while all exports increased 27%. Note that service exports increased almost 45%. At the same time, import increased by 18%. The trade sector has grown mainly through growth in tourism and gaming.

5 These reform and regulatory efforts are described in greater detail throughout this volume.

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However, tourism and gaming now face new challenges. For instance, Hong Kong Disneyland opens in 2005. As well, competition between various operators, while good for the industry in general, will place unprecedented pressures on individual operators. Even with such changes taking place, the prospects for Macao’s tourism and gaming industries look bright. We estimate that in 2005 and 2006, goods cargo exports from Macao will grow by 8.4% and 6.2% respectively. Import volume will increase by 14.2% and 16.8%. We expect service imports to grow by 22.7% and 19.8%. Service imports should grow by 23.2% and 15.9%, respectively. Third, commodity prices will rise, and financial markets will stabilize. Macao enjoys a special status, along with Hong Kong, as an international crossroads. Goods, services, labor, capital, and foreign exchange move freely in and out of the SAR. This provides a supportive context for economic development based on “trade” in the broadest sense of the word. We look for the SAR’s government to build on this special position and the advantages it offers to strengthen its position with foreign businesses and governments, and at the same time, the SAR’s connection to the Mainland, especially the Pearl River Delta region. For historical, cultural, geographic, and economic reasons, Macao has especially deep bonds to the Asian-Pacific region, the EU, and Latin countries, especially former Portuguese colonies. The SAR’s leadership can make use of these relationships to connect these places to the Mainland and vice-versa. Various economic indicators show that this process is well underway. The process starts in Macao. Because the gaming industry generates high margins, the economy has become quite large given the small population. In 2004 per capita GDP in Macao exceeded 180,000 yuan. Because of high personal and business income, Macao’s government is flush: the budget has operated in the black for four 4 successive years, building a surplus of over 18 billion yuan. The trade surplus stands 42.8 billion yuan, an increase of 26% over the year. Personal bank deposits are more than 108 billion yuan. And with building and development booming, the real estate market has never been healthier. Because of rapid growth and high margins, we expect investment markets to be active. We predict that in 2005 and 2006 the composite index will increase 4.7% and 4.5%, respectively. Blue chip stocks will increase in value a bit less, about 3.4% and 3.7% in these two years.

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We estimate that returns on investments in 2005 and 2006 will grow by 10.2% and 9.6%. While spectacular in almost any other context, these figures denote a slowdown of over 20% from 2003 and 2004’s numbers. Monetary continues mirror these basic trends. In 2005 and 2006 we expect “narrow” money supply, M1, to grow by 31.9% and 33.1%, respectively. We estimate that general money supply, M2, will grow by 12.1% and 8.3%. M1 growth is slowing; M2 remains stable over these years.6 Fourth, as already touched upon, personal incomes have boomed. Even as this trend continues, unemployment will move up significantly. Estimates for 2005 and 2006 show personal income growing by 4.8% and 2.0%, down from 2003 and 2004 figures of 2.8% and 7.6%. Estimates for 2005 and 2006 place unemployment at 5.2% and 7.2%, a substantial increase over 2003 and 2004’s figures of 6.0% and 4.8%. Taken together with income trends, it seems clear that some will do quite well while others will struggle. Clearly business and economic leaders have work to do on this front. Increases in income will rise especially quickly in the high-skill segment of the labor market. For instance, with the investment market booming, the demand for financial experts increases. Given the relatively small population and the steep rate of growth in the industry, wages have risen precipitously. We observe a similar pattern in the gaming, high-tech, architecture, and design industries. We expect the pattern to work its way down through the labor pool as growth continues. That is, the highest skill jobs now experience the worst supply shortages; however, with economic growth outstripping labor supply growth or population growth, we expect wages for a variety of jobs to increase. Tables 28.1 and 28.2 summarize the key variables related to these effects and trends.

6 Economists categorize money supply, M, as follows: M0 = total currency + accounts and contracts that can be exchanged for currency; M1 = M0 + demand or current account deposits; M2 = M1 + savings deposits + time deposits and/or certificate of deposit accounts (CDs) under $100,000.

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Table 28.1: Projecting key economic indicators for 2005 and 2006 (Growth rate in %) Endogenous variables

2005

2006

Consumer spending Government spending Fixed assets investments Goods exports Goods imports Service exports Service imports Personal income Fiscal revenues M1 M2 Total labor pool Unemployment rate

2.4 5.6 29.9 8.4 14.2 22.7 23.2 4.8 10.2 31.9 12.1 50.9 5.2

4.1 9.5 19.1 6.2 16.8 19.8 15.9 2.0 9.6 33.1 8.3 52.5 7.2

Table 28.2: Estimated growth rates of key exogenous variables Exogenous variables Interest rate on consumer deposits (3 months) Inter-bank interest rate (3 months) Government spending Exchange rate: Macao yuan to USD World trade

2005

2006

0.67

0.67

2.2 5% 802.26 5%

2.2 5% 802.26 5%

B. Likely Outcomes of these Policies We estimate that interest rate hikes will have a substantial impact on economic growth. If key interest rates go up 10% before or during 2005, we estimate, other things being equal, that gross product will contract by 0.2% in 2005 and by 0.1% in 2006. Fixed asset investment will fall by 0.8% and 2.2% for the same two years. Given that Macao’s economy is driven by new investment, it should be unsurprising that growth and other key variables would be especially sensitive to interest rate increases. Macao’s economy also depends crucially on trade. Therefore, the exchange rate between the Macao yuan and the US dollar, as well as changes in aggregate global trade volume, have a large effect on Macao’s

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trade sector. If the Macao’s currency appreciates by 0.5%, effects will be widespread. Goods exports would increase by 3.4% in 2005 and .8% in 2006, goods imports would increase by 2.6% and 0.8%, and service imports would rise by 7.4% and 0.4%. A 5% increase in global trade volume produces similar effects. The volume of exported goods goes up by 4.3% and 0.4% in the two years following this rise in global trade value, other things being equal. Imports increase as well, by 4.6% and 1.7%. (See Table 28.3) Unsurprisingly, government expenditures give the economy a demand-side push. Among other effects, this tends to reduce unemployment rate. If government expenditures increased by 5% at the beginning of 2005, and increased by the same amount in 2006, the unemployment rate decline by 2.3% and 4.9%. Table 28.3: Estimating hypothetical economic policy changes Variable If nominal interest rates rise 10% Change in gross product Change in capital investment Change in M1 If the exchange rate vs. the USD increases by 0.5% Change in goods exported Change in goods imported Change in services exported Change in services imported If world trade volume rises 5% Change in goods exported Change in goods imported

2005

2006

0.2 0.8 0.4

0.1 2.2 0.4

3.4 2.6 2.4 7.4

0.2 0.8 0.6 0.4

4.3 4.6

0.4 1.7

The general outlook for Macao’s economy looks good. Development will continue moving forward, and growth will be brisk. The strong investment climate will drive growth. Strong growth and diversifying investments will help the economy to change its overall structure and become more robust. Unemployment needs to be brought to heel, and given strong growth prospects, should decline. All of these factors should help to drive personal incomes up, and with them, consumer and investor confidence.

APPENDIX: GENERAL STATISTICAL DATA Unit (unless otherwise specified): % Table A.1 Year

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

GDP Value-added Value-added growth growth in growth in agriculture industry 11.7 7.6 7.8 5.3 9.0 10.9 15.2 13.5 8.9 11.6 11.3 4.1 3.8 9.2 14.2 13.5 12.7 10.5 9.6 8.8 7.8 7.1 8.0 7.5 8.3 9.5 9.5 9.4 8.9

4.1 6.1 –1.4 7.0 11.5 8.3 13.0 1.8 3.3 4.7 2.5 3.1 7.4 2.4 4.7 4.7 4.0 5.0 5.1 3.5 3.5 2.8 2.4 2.8 2.9 2.5 6.3 5.3 4.9

15.0 8.2 13.6 1.9 5.5 10.4 14.5 18.6 10.3 13.7 14.5 3.8 3.2 13.9 21.1 19.9 18.4 13.9 12.1 10.5 8.9 8.1 9.4 8.4 9.8 12.7 11.1 11.0 10.2

Value-added Value-added growth in growth in heavy industry light industry 18.4 8.6 7.9 –5.2 7.4 11.4 15.9 15.7 7.5 12.5 13.0 4.9 2.8 13.6 23.2 21.2 17.5 11.9 12.2 10.7 8.6 9.0 11.4 9.5 10.4 14.1 12.0 11.9 11.0

13.1 8.8 20.6 12.2 3.8 7.5 13.5 21.7 12.6 14.1 18.1 5.2 4.0 15.4 18.8 18.8 20.6 16.6 12.8 12.0 9.2 8.0 8.0 7.7 9.6 11.2 10.9 10.7 9.9

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appendix: general statistical data Table A.2

Year Value-added growth in services

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

13.7 7.8 5.9 10.5 13.0 15.2 19.4 18.3 12.1 14.4 13.2 5.4 2.3 8.8 12.4 10.7 9.6 8.4 7.9 9.2 8.3 7.7 8.1 8.4 8.7 7.8 8.3 7.4 7.5

Value-added Value-added growth in growth in transportation, commercial shipping, and services telecommunication 9.8 7.7 5.7 1.9 11.6 10.0 14.9 13.5 12.8 10.0 13.4 4.7 8.5 11.2 10.5 12.4 9.5 12.0 11.5 10.7 10.6 11.3 11.5 9.5 7.9 6.3 14.9 9.8 10.2

23.1 8.8 –1.3 30.0 3.9 21.8 21.5 28.9 10.6 13.5 14.3 –8.3 –4.8 4.5 13.1 6.6 7.7 5.9 5.4 8.5 7.7 7.2 8.2 7.5 8.1 9.1 6.3 6.9 7.0

Aggregate government investment (100 million RMB) 899.0 977.0 910.9 961.0 1230.4 1430.1 1832.9 2543.2 3120.7 3791.2 4746.8 4410.3 4517.6 5594.6 8080.4 13072.3 17042.9 20019.3 22974.0 24941.1 28406.2 29854.7 32917.7 37213.5 43499.9 55566.6 70072.7 86102.5 103056.1

Nominal growth of government investment 19.9 8.7 –6.8 5.5 28.0 16.2 28.2 38.8 22.7 21.5 25.2 –7.1 2.4 23.8 44.4 61.8 30.4 17.5 14.8 8.6 13.9 5.1 10.3 13.0 16.9 27.7 26.1 22.9 19.7

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Table A.3 Year

Real growth of government investment

Aggregate government investment / GDP

Growth rate of stock and bond prices

Inflation

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

19.5 4.7 –8.5 2.9 25.1 13.3 23.9 30.1 15.8 14.1 10.0 –12.9 –3.0 15.0 25.3 27.8 18.1 10.9 10.3 6.7 14.1 5.5 9.1 12.6 16.7 25.0 19.4 21.0 17.4

24.8 24.2 20.2 19.8 23.2 24.1 25.6 28.4 30.6 31.7 31.8 26.1 24.4 25.9 30.3 37.7 36.4 34.2 33.8 33.5 36.3 36.4 36.8 38.2 41.4 47.3 51.2 55.6 59.7

0.3 3.8 1.9 2.5 2.4 2.6 3.4 6.7 6.0 6.4 13.9 6.7 5.6 7.6 15.3 26.6 10.4 5.9 4.0 1.7 –0.2 –0.4 1.1 0.4 0.2 2.2 5.6 1.5 1.9

1.5 2.1 7.0 2.6 1.9 1.2 1.7 7.6 6.5 7.3 18.8 18.0 3.1 3.4 6.4 14.7 24.1 17.1 8.3 2.8 –0.8 –1.4 0.4 0.7 –0.8 1.2 3.9 1.9 2.1

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appendix: general statistical data Table A.4

Year

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Growth in Growth in Real growth real income, real income, in consumer urban rural spending, urban –2.4 19.6 6.2 1.6 5.8 4.3 12.5 0.1 13.8 2.4 –2.3 0.1 8.4 7.2 9.7 9.5 8.5 4.9 3.9 3.4 5.8 9.3 6.4 8.5 13.4 9.0 7.7 8.6 7.8

6.7 17.6 18.2 10.7 21.1 14.7 12.7 11.7 3.2 5.2 6.4 –1.6 1.8 2.0 5.9 3.2 5.0 5.3 9.0 4.6 4.3 3.8 2.1 4.2 4.8 4.3 6.8 5.7 5.2

NA 9.8 11.1 6.7 4.8 5.2 12.1 15.8 10.1 9.1 12.4 2.4 10.5 12.4 18.7 12.5 6.3 8.9 5.8 7.2 11.6 12.1 13.0 7.5 8.2 11.4 14.5 12.7 11.8

Real growth Real in consumer growth in spending, government rural NA 6.9 9.5 10.8 10.0 11.7 13.6 14.3 3.6 6.5 7.3 0.2 1.5 7.8 10.7 6.7 4.8 8.4 14.4 3.6 2.1 5.8 5.0 4.3 5.2 1.3 5.8 5.3 5.3

NA 25.2 0.3 4.2 7.2 7.5 19.6 7.9 8.4 1.6 –2.4 –0.2 7.4 21.5 16.0 12.3 7.2 –4.6 8.4 8.1 9.6 11.1 12.2 10.5 7.7 5.1 4.1 3.4 3.6

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Table A.5 Year

Total consumer products spending (100 million RMB)

Nominal growth of consumer products spending

Real growth of consumer products spending

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

1264.9 1476.0 1794.0 2002.5 2181.5 2426.1 2899.2 3801.4 4374.0 5115.0 6534.6 7074.2 7250.3 8245.7 9704.8 12462.1 16264.7 20620.0 24774.1 27298.9 29152.5 31134.7 34152.6 37595.2 42027.1 45842.0 53950.1 60884.7 68165.1

7.7 16.7 21.5 11.6 8.9 11.2 19.5 31.1 15.1 16.9 27.8 8.3 2.5 13.7 17.7 28.4 30.5 26.8 20.1 10.2 6.8 6.8 9.7 10.1 11.8 9.1 17.7 12.9 12.0

7.0 14.4 14.7 9.0 6.9 9.6 16.2 20.5 8.6 9.0 7.8 –8.1 0.4 10.5 11.7 13.4 7.2 10.4 13.2 9.3 9.6 10.1 11.4 11.0 13.3 9.2 14.5 11.8 10.6

Government Growth in revenue government (100 million revenue RMB)

1132.3 1146.4 1159.9 1175.8 1212.3 1367.0 1642.9 2004.8 2122.0 2199.4 2357.2 2664.9 2937.1 3149.5 3483.4 4349.0 5218.1 6242.2 7408.0 8651.1 9876.0 11444.1 13395.2 16386.0 18903.6 21715.3 26355.9 30512.5 35500.6

29.5 1.2 1.2 1.4 3.1 12.8 20.2 22.0 5.8 3.6 7.2 13.1 10.2 7.2 10.6 24.8 20.0 19.6 18.7 16.8 14.2 15.9 17.0 22.3 15.4 14.9 21.4 15.8 16.3

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appendix: general statistical data Table A.6

Year

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Government Growth in expenditure government (100 million expenditure RMB)

1122.1 1281.8 1228.8 1138.4 1230.0 1409.5 1701.0 2004.3 2204.9 2262.2 2491.2 2823.8 3083.6 3386.6 3742.2 4642.3 5792.6 6823.7 7937.6 9233.6 10798.2 13187.7 15886.5 18902.6 22053.2 24650.0 28360.8 33512.6 38500.7

33.0 14.2 –4.1 –7.4 8.0 14.6 20.7 17.8 10.0 2.6 10.1 13.3 9.2 9.8 10.5 24.1 24.8 17.8 16.3 16.3 16.9 22.1 20.5 19.0 16.7 11.8 15.1 18.2 14.9

Revenue less expenditures (100 million RMB)

10.2 –135.4 –68.9 37.4 –17.7 –42.6 –58.2 0.6 –82.9 –62.8 –134.0 –158.9 –146.5 –237.1 –258.8 –293.3 –574.5 –581.5 –529.6 –582.4 –922.2 –1743.6 –2491.3 –2516.5 –3149.5 –2934.7 –2004.9 –3000.1 –3000.0

Ratio Growth of rural rate of to urban the ratio savings of rural (100 million to urban RMB) savings 210.6 281.0 399.5 523.7 675.4 892.5 1214.7 1622.6 2238.5 3081.4 3822.2 5196.4 7119.8 9241.6 11759.4 15203.5 21518.8 29662.3 38520.8 46279.8 53407.5 59621.8 64332.4 73762.4 86910.6 103617.7 119555.0 139062.3 163211.9

15.7 33.4 42.2 31.1 29.0 32.1 36.1 33.6 38.0 37.7 24.0 36.0 37.0 29.8 27.2 29.3 41.5 37.8 29.9 20.1 15.4 11.6 7.9 14.7 17.8 19.2 15.4 16.3 17.4

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Table A.7 Year

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Growth in Total imports Growth in Total exports loans (100 imports (100 (100 million million million RMB) USD) USD) 186.7 189.6 374.7 445.9 320.4 409.3 1176.2 1139.4 1684.9 1442.0 1518.9 3808.8 3320.6 3657.1 4985.1 6620.2 7032.9 10568.1 10612.5 13757.7 11610.0 7210.2 5636.8 12943.6 18979.2 27702.3 18367.3 23722.1 29740.6

108.9 156.8 200.2 220.2 192.9 213.9 274.1 422.5 429.0 432.2 552.8 591.4 535.5 637.9 805.9 1039.6 1156.1 1320.8 1388.3 1423.7 1402.4 1657.0 2250.9 2435.5 2951.7 4127.6 5614.2 6519.8 7576.6

51.0 44.0 27.7 10.0 –12.4 10.9 28.1 54.1 1.5 0.7 27.9 7.0 –9.5 19.1 26.3 29.0 11.2 14.2 5.1 2.5 –1.5 18.2 35.8 8.2 21.2 39.8 36.0 16.1 16.2

102.0 135.8 181.2 220.1 223.2 222.3 261.4 273.5 309.4 394.4 475.2 525.4 620.9 718.4 849.4 917.4 1210.1 1487.8 1510.5 1827.9 1837.1 1949.3 2492.0 2661.0 3256.0 4382.3 5933.7 7459.8 8396.8

Growth in exports

34.4 33.1 33.4 21.5 1.4 –0.4 17.6 4.6 13.1 27.5 20.5 10.6 18.2 15.7 18.2 8.0 31.9 22.9 1.5 21.0 0.5 6.1 27.8 6.8 22.4 34.6 35.4 25.7 12.6

Note: The increased loan after 1989 covers all of the financial institutions. Note: The figures for 2005 and 2006 in the tables are estimates. (Collected and compiled by Shen Lisheng.)