Structural Transformation of the Chinese Economy

The processes taking place in Chinese economy are watched either with fear or hope. This decade can bring about great changes in the country called the engine of world economy, since the current economic system obviously cannot maintain the population of 1.4 billion.  The problems of the more and more evidently polarising society must be addressed; without this, it is impossible to stabilise and develop the economy. With a balanced policy, however, the Chinese government may be able to stabilise and develop not only its own economy but also that of the region.

Introduction – Why Is Structural Transformation Timely?

Since the early 2000s all kinds of information was told about the Chinese economy: the news was about the Chinese economic miracle, a diving stock market, a decline pulling down the rest of the world.  Naturally, no extreme phrasing can cover the full picture; on the whole, however, we can say that China’s economy has been subject to serious changes in the last fifteen years. In the early 2000s they were on the threshold of reforms enabling integration into the world economy, and today the world is being driven toward the new economic order by the New Silk Road. However, to accomplish the ambitious plans, a solution for internal problems must be found, and currently it is the transformation of the economic structure. Our analysis examines the problems of this transformation and the solution opportunities.

Antecedents of China’s Economic Transformation

It was not unprecedented in the 20th-century history of China that the country had to implement economic reforms in time of crisis. The antecedent of announcing “reform and opening” in 1978 was a strange crisis, hitting China only: the cultural revolution. Although the Communist Party fundamentally wanted to achieve an ideological renewal, the situation ravaging the whole country also battered the economy just recovering from the Great Leap Forward. Eventually, the Chinese political leadership successfully repaired the damage caused, in which, in addition to the opening of the country’s economy, the comprehensive reforms of the 1980s and 1990s played a significant role. The revolution of the countryside was launched first, which focussed on the transformation of agriculture. A decentralisation process began, diversification of production was encouraged, commercial rules were relaxed. In 1984 the second phase of reforms started: it was urban renewal, which was organically built on the previous phase. On top of renewing inefficient state-owned companies and industrial developments, attracting foreign capital was emphasised, and 14 major cities were opened before foreign companies.

The end of the 1980s, however, brought about tottering and a two-digit inflation rate, which was reflected in the public opinion preceding and enhancing the events on Tiananmen Square. After the political situation had relaxed, a market reform could begin in 1993, resulting in the evolvement of the socialist market economy. At the turn of the 20th and 21st century, a deeper integration in wold economy meant the deepening of reforms, the peak of which was obtaining WTO membership.

In the light of the above-mentioned reforms, we can say that China has been implementing reforms for nearly forty years and their success demonstrates that China is able to overcome temporary crises. It is one reason why we should examine the steps with which China will undertake a radical new enterprise again and even further deepen the reforms also decisive for world economy. It is particularly important because China will remain the primary engine of global economic development: in the case of the growth of 6.7% forecast for 2016, China will contribute to global GDP growth with 1.2 percentage points, which far exceeds the 0.8 percentage point of the USA, the European Union and Japan together.

During Chinese political reforms, the wing of the Communist party urging for change could count on the intellectuals’ support, among whom disagreements arose only in the 90s. The directions, which have become known as the “New Left” and the New Right”, imagine the economic and social policies ideal for China fundamentally differently. In the process of economic development, ideas represented by the “New Right” have come into prominence since they primarily turned toward capitalism and fastest economic development possible, neglecting the issues of the social care system and income disparities.

Naturally, it is not surprising in the phase of initial rise; even Deng Xiaoping himself asserted that some would get rich sooner than others. The new challenges, however, are urging for a change of mindset, and at the door of structural reforms the economic issues of social justice also arise. The “New Left” expects the state to assume a more significant role in the resolution of social problems, which could mainly be embodied in the expansion of the social care system. One of the by-products of Chinese development is a growing wealth gap, and structural changes may offer solutions to numerous social problems as well.

China and Crisis Management

The crisis of the past decade may be regarded as the trigger of the reforms. China was also affected very sensitively by the global financial crisis of 2008 because its export markets, especially the USA, got into a very difficult situation. In addition, the environment of Chinese currency reserves as well as consumer savings became very unstable. Consequently, China took a new role and greater responsibility in world economy to avoid its own collapse as well as the world’s. The Chinese state contributed considerably to the rescue funds and quickly extended its currency reserves, now possessing 30% of the foreign-held government debt of the USA.

In order to balance declining demand, China began providing loans to foreign markets, but it also had to bail out declining domestic demand with a rescue package. The rescue package following Keynesian logic meant an unprecedented financial injection of a value of RMB 4,000 billion ($586 billion) for the country. Local governments, which were usually indebted, also received a significant amount, and apart from debt relief, they were given quite large allocations to develop their social services. Aiding the victims of the earthquake in Sichuan in 2008, which demanded thousands of lives, and the reconstruction of the region were also issues of great importance. The enormous amount spent on the development of the infrastructure, land reform and social welfare programmes also demonstrates that curbing inflation is not a priority for Chinese leadership any more, since the seemingly unstoppable decline of economic growth has become a much more urgent problem.  It was also prominent among the global bailout packages, since the package amounting to 15% of the annual output of China’s economy far exceeded several similar measures of greater economies, for example the USA’s recovery package of $100 billion and that of Germany of $65 billion. However, it was just a temporary solution, which will raise further problems in the future.

Structural Transformation  of the Chinese Economy – Xi Jinping and Six Areas to Be Reformed

China’s current President, Xi Jinping has joined in the process of crisis management. New economic solutions were sought very early during his presidency and the aftermath of the rescue package, as well as the structural problems of the economy becoming more and more evident made the announcement of the “New Normal” inevitable.

The determined ideal pace of growth alone, however, is not sufficient to resolve numerous problems deriving from the structure of Chinese economy. By 2013, the ratio of investments within the GDP had reached  50%, which is extremely high compared to similarly industrialised Asian countries. China has been investing mainly into real estates, infrastructure and assets required for an export-driven economy. In recent years, however, the rate of return on investments sharply dropped, which increased the risk of non-performing loans. Savings are traditionally high in China but since the middle of the 1990s the household savings rate has increased by more than 10%.  At the same time, consumption is low because it is safer to save the income than spending it due to the scarce capacity of the social safety net. However, it makes the shift to the targeted economic model more difficult.

The current scenario was formulated by the 13th five-year plan, which was the first plan put forward during Xi Jinping’s presidency. The plan submitted to the Fifth Plenum of the Communist Party sets goals for “economic and social development” for the period from 2016 to 2020. The catchwords referring to the direction of development appear therein: “innovative, coordinated, green, open and inclusive”. In his Fifth Plenum speech, Xi described his approach as “problem-led and goal-driven”, and for the first time since 1995, “common prosperity” is targeted in a five-year plan In the light of the announced reforms, this statement also reflects on the changes supported by the “New Left”. On top of that, it also acknowledges that disparities pose a serious problem within society. As for precise figures, Xi has set the goal of  doubling the GDP of 2010 and average wages by 2020. In addition, with a 6.5% target set for annual GDP growth, China’s “new normal” of slower economic growth has been accepted, emphasising that the focus of China’s economic growth would be less on speed but more on the quality.

Chinese leadership determined the six major areas in which they are compelled to make changes:

  • The reform of hukou, that is, the household registration system intends to ensure a freer flow of workforce and seeks solutions for urbanisation problems. Its aim is to make the cities of the western half of the country develop, and prevent employees from losing their social benefits due to changing their place of residence.
  • The land reform tries to resolve the greatest problems of rural areas, i.e. the appropriation and unreal pricing of lands, and also intends to stabilise the incomes of agricultural workers.
  • Regarding administration, deregulation and decentralisation are the main aims.
  • In the field of financial reform, the financial market needs to be whitened, resource allocation should be subject to market forces, and competition should be encouraged by letting more private and foreign capital in.
  • The reform of the tax system would resolve the problem of resource allocation between local and central governments and the whitening of taxation.
  • The reform of the prices of resources intends to create a more balanced situation for companies, and to render resources management sustainable. The role of environmental protection is the most prominent here.


Small Steps of Restructuring

In order to achieve goals, the promotion of consumption plays a central role. Contributions payable on wages are lowered, and they try to channel personal savings into consumption. Furthermore, more and more festivities appear which encourage the society to consume, such as the “Singles Day” on 11th November, which allures customers with enormous discounts and from year to year breaks the record of online sales. The encouragement of consumption similarly appears in the budget of the government, since the amount that they spend on the social care systems has increased. They can parallel react to the reduction of the debts of local governments as well as alleviate social tensions. With shifting from an export-driven economy to a domestic consumption-driven one, the role of the services sector is being revaluated. Currently, the third sector amounts to 44% of the Chinese GDP, which reached its all-time high in Q4 2015. Doubts may arise about the extent to which the increase of the ratio of services can throw back productivity. The predominance of the services sector does not mean that production and infrastructure are stagnating since these cannot exist in a vacuum. Consequently, no drastic change can be expected in the pace of economic growth, and sectors, such as education, technology, finance, insurance and others, which have been operating with relatively low intensity but required for the fulfilment of needs on increasing standards, may be reenergised.

In a longer term, China‘s goal is to get higher on the global value chain, since currently the export-driven economic structure keeps the level of products with relatively low added values. The reforms intend to change this, too; but developing the education and increasing the efficiency of the IT sector are essential. It is a serious problem that only a fraction of the profit on countless products stays in the country, because added value is low. This could be resolved by a high level of state subsidies on innovation, but the partnership of the private sector is also required. Several analysts propose solutions to the state, in which the opportunity to increase productivity is frequently included. In the economy, instead of predominant investments, the increase of productivity may boost the Chinese economy with thousands of billions of dollars by 2030. It was the investment-led model that made China an Upper Middle Income (UMI) country.

In 2015 GDP hit its 25-year low, the stock exchange fell by 50%. 80% of the economic profit derived from financial services.  Bringing productivity to the forefront would increase the GDP by RMB36 billion ($5,6 billion) by 2030, and the income of households could increase by RMB33 billion. There are 116 million middle-class related families in China today, but productivity is extremely low: it is merely 15-30% of the average of OECD members, therefore we can say that China is ready for a productivity revolution.  According to the analysts of McKinsey China urgently needs a change otherwise the ratio of non-performing loans may go up as high as 15%, which may cause  a damage of RMB2 billion annually to banks, significantly decreasing the liquidity of lending companies.

Despite the steps already taken, we can conclude that structural reform is a long and painful process, even if there is sufficient domestic demand. Both Chinese and foreign economists called attention to the problems which might undermine the results achieved so far. As dedicated reforms also indicate, the indebtedness of local governments might be a serious factor in the structural transformation. Unfortunately, the costs of the shift undermine the previous development areas in numerous Chinese provinces – Zhang Jun thinks it should be avoided as much as possible, these areas should not be sacrificed for building the new structure.

Challenges are not on a par with the potential purchase power of Chinese consumers, either. The model based on domestic demand works in a much more complex way than the mostly export-driven one. There are specific conditions which should be met first and then structural transformation can be successfully implemented. These include, for example, a well-functioning financial system, free and equally accessible market, highly qualified employees and more expenditure on the research and development sector. Zhang regards poor urban design, and the sharp contrast of rural and urban areas as one of the most obvious decelerator of China’s development, since well-organised urban communities and infrastructure are vital for the integrated operation of finance, telecommunications, research and education. One of the above-mentioned six issues requiring reforms, the hukou system forms one part of the problem. The document limiting schooling and social care to the place of residence, which must be the same as the place of birth, hinders social mobility: if the inhabitants of inner provinces move to Shanghai or Shenzhen, they become extremely vulnerable, without any form of state assistance. This social group of approximately 200 million people cannot integrate into the communities of the cities being their place of residence, since their situation is unstable, and leaving their children behind, which is a quite frequent phenomenon, condemns them to live a very special lifestyle.

The Interrelations of Economic Changes and the New Silk Road

Changing the focus of economic growth has been a part of crisis management in the past decade: instead of export-driven production, the emphasis was placed on the domestic market of products and services. However, China’s integration in world economy will remain of key importance in the future.  The “New Normal” received a great deal of public comments, because it may have a serious impact on world economy. At the moment, the Chinese economy does not seem to collapse, in spite of the fact that alarm bells were often rung, but the slowdown has already started to affect several countries. African countries considered as China’s raw material market outlets, especially Nigeria, has felt the declining demand for petroleum. The new situation affected Brazil similarly, but for world economy the gravest problem is the volatility of Chinese economy. At the  2015 IMF summit held in Lima, the unpredictable and unreliable economic policy of the Beijing leadership was highlighted as one of the greatest risks to world economy.

China, naturally, tries to reassure the world economy that it intends to act taking responsibility for the global economy and by keeping the rules. The concept of the New Silk Road has been unveiled in time from the viewpoint of foreign policy, but also in terms of foreign economy it creates the impression that China feels responsible for the welfare of the countries in the region. However, it would be a mistake to suppose an altruist behaviour; the New Silk Road may be a tool to find outlets for China’s investment surplus, slightly contributing to the mitigation of the costs of shifting from the export-driven model. In some opinions, China’s search for balance will strengthen the position of institutions set up for supporting the Silk Road, i.e. the Asia Infrastructure Investment Bank and BRICS Bank.  Politically, assistance granted through an international organisation is certainly more stable than unilateral lending.

Taking the surplus produced in the field of infrastructure investment abroad creates a win-win situation for less developed economies, since several countries of South-East Asia as well as India are facing serious problems in this respect. The lack of several billions of dollars of infrastructure might considerably reduce the opportunities of the region, which is further hampered by the fact that these countries have already fallen below the radar screen of the World Bank and other multilateral development banks. That is the reason why China was able to come up with a new participant in the market of international financial institutions, and that is the reason why the Asia Infrastructure Investment Bank has been widely appreciated internationally.

In the speeches of Chinese leaders, calling for a new world order, in which China’s role will be even more significant, is a recurring topic.  As we could see, China was able to take responsibility in the course of the crisis in 2008, and currently is definitely the top player of world economy. Based on these, it seems fair enough that the country should have a greater say in the processes determining world economy; one step was that the IMF added the yuan to the basket of reserve currencies. In addition to traditionally US-led international organisations, China further builds its own institutional basis, which offers a greater scope and an advantage in the competition with the USA in Asia.

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