China must change

Cho Yoon-jae

Global markets have been anxiously eyeing China on signs of a slowdown and a possible credit burst. Malaise from the shadow finance sector that burgeoned on a government-led credit boom to bolster real estate construction and infrastructure over the past several years has surfaced as some of the high-risk borrowers and reckless lenders began to sour.

China’s annual growth, which maintained a pace of more than 10 percent, slowed to 7.7 percent last year. The International Monetary Fund and the Beijing government expect this year’s growth to reach 7.5 percent. But many believe the economy will underperform. The worst-case scenario is that some in the nonbanking sector - especially trust securities - will fall one by one and spark a run in capital and liquidity crunches, making the housing bubble burst.

That would trigger an exodus of capital and would translate into a major crisis. Due to problems in China’s economy after decades of rapid growth, the worries may not be entirely far-fetched. In many aspects, China is in a transitional period. The state-led growth based on infrastructure investment and exports has hit its limit and demands a new engine to expand domestic demand, rationalize distribution in resources and raise productivity.

Beijing is now focused on balancing out wealth and economic disparities that deepened in the process of fast progress. The new generation of leadership that was inaugurated last year clearly defined its policy direction and is now carrying out reforms in the financial and labor sectors. Interest rates were liberalized and capital market was opened further.

China announced that it would reform its “hukou” census system to allow an additional 100 million people in rural areas to become urban residents by 2020. It is also sharply raising its minimum wage. But the scope and depth of China’s problems cannot be solved through public policy revisions.

The country requires an overall structural makeover. To prevent corporate insolvencies and an economic slowdown from a liberalization of interest rates, the excessively high reserve requirements of banks should be reduced and the government should refrain from interfering with the foreign exchange rate in support of exports and manufacturers.

Public finance would have to take on much of the responsibility in the liquidity flow offered by banks. That would require greater tax revisions to increase revenue. State enterprises came under government surveillance and control through lenders that were provided with state funds.

But once they can raise funds directly from the capital market if the financial sector is liberalized, they will face fewer constraints from the government on running businesses and lending. Liberalization only can exacerbate distortion in resource allocation, and without corporate discipline in investment, financial integrity and financial security cannot be sustained.

But state entities are mostly governed by the elite and family members of the Communist Party. The governing base in the single-party system could be in jeopardy if it departs with its stake in state enterprises.

One of China’s imperative reforms is the liberalization of its finance, labor and land markets. Unlike the commodities market opening up in trade and price liberalization as in past reforms, they are complexly intertwined and connected to vested power, state power and governing structure.

If China cannot overcome these challenges, it could fall victim to the middle-income trap. South Korea could not have weathered the challenges of democratization in the 1980s and the financial and corporate crisis in the 1990s without undertaking sweeping restructuring.

It is highly unlikely that China will face a mass-scale liquidity crisis in the near future. The country sits on an enormous amount of foreign exchange reserves and has sufficient cash reserves to buffer any market insecurities.

In case of a financial burst, the government - as a last resort - would carry out bailouts and nationalize lenders. But most regulated lenders are already state-owned in China. Despite the ballooning debt in local governments, China’s overall public debt remains at a passable 48 percent of total national output. But this could be a blessing in disguise.

The leadership in Beijing is fully aware of the problems and the economic challenges it faces. But it lacks a specific vision and action plan to take up the staggering challenge. Its actions have so far been no more than gestures that would help the economy muddle through and buy time. But makeshift measures cannot retool the economy to combat its challenges.

A country’s advancement is determined not by the problems but the ability to combat them. Countries of Chinese ancestry - Taiwan, Singapore and Hong Kong - have overcome these challenges successfully. There is no reason why the mainland cannot.

China inevitably would have to go through a transitional slowdown in the process, which would have negative repercussions worldwide. Changes in North Korea may be one. We must be vigilant for any precarious movements.

Translation by the Korea JoongAng Daily staff.

JoongAng Ilbo, April 12, Page 30

*The author is an economics professor at Sogang University.

BY Cho Yoon-jae