Monday, December 15, 2003

China's Growth

Economics Editor
Financial Times, London

Dear Martin:
I really enjoyed reading your very interesting and though provoking article (FT 12/9/03) on China’s growth. However I have some questions and comments on some of the points that you raised.

1. Bad policies (policy distortions) lower the rate of growth. Therefore when these policies are reversed (distorting policy corrected) we would normally expect the growth rate to revert to the normal level. It does not follow that if a country (any country) can grow fast even with a number of bad policies the reversal/correction of these policies will allow it to grow even faster. In fact the inverse is as if not more likely; if the bad/wrong policies are not corrected, the rate of growth will eventually fall, perhaps even collapse and the only way to sustain growth at anywhere near the high levels is to undertake the reform. For instance rising tariff protection may allow an economy to grow faster for a certain period of time, but this higher growth cannot be sustained indefinitely as tariffs spiral upwards. Eventually the growth must decline unless the tariff rise is stopped and reversed.

2. Your point about NPA’s in China being possibly twice the officially acknowledged percentage of 23% of GDP is very pertinent. So is the fact that 60% of loans are to State-owned enterprises. Recall that about five years ago NPA’s were officially declared to be about 25%, while perceptive observers like Nicholas Lardy asserted that they were actually about 50%. This was followed by the setting up of Asset reconstruction agency to which all most of the NPA’s were transferred and the balance sheets of the banks cleaned up. Five years latter we seem to be back where we started. Thus China seems to be accumulating NPA’s at between 5% and 10% per annum.
If 60% of the declared NPA’s and 100% of the undeclared ones are to SOEs and provincial governments then 80% of the actual NPA’s of 46% of GDP are from SOE and provincial governments. You also noted that the private sector has little access to bank finance. Given the status of the private sector in China, its high rate of growth and its relative profitability I would not be surprised if the NPA’s from this sector are close to the global norm of 5%. In other words they contribute less than 0.5% to 1% of GDP to the overall NPAs [5%*(15% to 27%)]. Thus virtually the entire NPAs are really arising from the SOEs and provincial governments. If NPAs are defined as loans that cannot be repaid because of adverse changes in market conditions than it is a misnomer to call these NPAs, as they were given with the prior knowledge that they cannot or will not be repaid (or alternatively the probability of repayment is very low). Thus they are really subsidies to the SOEs and provincial governments and indirectly to exporters who are supplied inputs by SOEs and other facilities by provincial governments.
Putting these two sets of facts together leads to the conclusion that since 1990 the Chinese government has been subsidizing exports by an amount equal to 5% to 10% of GDP per year. Though this has probably accelerated the growth of exports as well as that of the economy, it cannot be sustained indefinitely. Growth will eventually slow down unless the subsidy policy is reversed.

3. You also note the remarkable fact that 50% of total gross exports are by foreign owned companies. But aren’t these foreign owned enterprises globally competitive? Yes the enterprises producing labor intensive goods for export our certainly globally competitive today. But that does not mean they did not and do not receive a subsidy. Firstly provincial governments have provided them one time (variable) subsidy by providing them with all their requirements of land, infrastructure facilities etc. no matter what the cost to ensure that the perspective foreign investor chooses their province. The second channel for subsidy is the urban facilities and civic amenities and utilities under the control of the municipalities. Finally intermediate inputs produced by the SOEs can and are supplied to potential exporters at prices that are lower than the landed cost (before tariffs) of globally traded equivalents. It is quite likely however that the 50% of exports by non-foreign invested enterprises and particularly exports of capital and skill/technology intensive goods receive the bulk of the continuing/revenue subsidies (as against one time capital subsidies).

4. I agree with you that as the efficiency of foreign invested enterprises and domestic private enterprises is higher than that of SOEs the overall efficiency is likely to rise as their share in total production rises given their higher growth rate. It is however questionable whether better allocation of investment will lead to massively improved performance. The rate of growth of the Chinese economy has been on a down trend since the mid-nineties. Better allocation will be needed to keep the growth rate from decelerating further.

5. There is another time bomb that you have not noted in your article. The worsening of China’s income distribution during the period of high growth is quite remarkable. Though part of the worsening can be attributed to the unsustainable flattening of the income distribution during the Maoist period, the income distribution is now much worse than it was prior to this flattening. It can be argued that an artificial, policy induced suppression of real unskilled wages in manufacturing has so far sustained the almost incredible growth of labor intensive exports. None of the high growth economies that you have indicated as models for China’s future growth possibilities had either a worsening income distribution or a constant real wage rate over decades. On the contrary, real wages of manufacturing labor grew at a faster rate in these economies than in most other economies of the world. The assumption of unlimited supply of labor, the 300 million workers over the next 2 &1/2 decades (mentioned in your article) at constant real wages, will not materialize. If the present trend continues, well before the end of these 2.5 decades, the income distribution will become so bad that the poor will rise in social revolt.

Arvind Virmani

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