RunningHeadTheRebalancingoftheChineseEconomy TheRebalancingoftheChineseEconomy: TheirPlan,theirPolicies,andthePotentialResults JasonA.

Fischer MGT681 NiagaraUniversity June2012

TheRebalancingoftheChineseEconomy

Foroveradecade,ThePeoplesRepublicofChinahasexperiencedannualGDPgrowthlevels

above8percent,whilemorerecentlyteeteringaround10percentasshowninChart1.Many economistswereskepticaltoforecastthesuccessthatChinawoulddiscoverasamarketdriven economy,ultimatelycontrolledbyanauthoritarianCommunistParty.Theskepticismhassubsided,but Chinahasbeenleftwithmanycomplicatedproblemsthatneedtobesolvediftheyseektowitnesseven mildeconomicgrowthovertherestofthedecade.HowdidChinamanagetosustaintheseGDPgrowth rateswhiletheglobaleconomyweakenedasaresultofthe2008financialcrisis?TheUnitedStatesand theEuropeanUnion,neglectingthePIGS,entertainedgrowthratesof2.8percentand2.1percent, respectively.The$1.897trillionUSDexportscompose24.51percentofChinasannualGDP.Aslabor costsroseandtheglobaldemandforChineseexportswerereduced,Chinasoughtonesided investmentdrivengrowthinbiginfrastructureprojectsasawaytomaintainGDPgrowthintheirhigh speedeconomy.ThispaperwillanalyzethepotentialeconomiceffectsinChinaastherealestatebubble deflatesandtheirabilitytoneutralizeanyoftheeffects. TheonesidedinvestmentdrivengrowthinChinaduringthepastdecadehasallowedhighGDP

growthratestobemaintained.Chinaisbuildingnearly20newcitieseveryyear,whilevacancyratesfor thesenewhighriseapartmentbuildingsremainatstartlinglevels.Analystshaveestimatedthatthereis anywherefrom10milliontoashighas65millionuninhabitedapartmentsandhomesinthesenewly manufacturedcities.65millionvacancieswouldbeenoughtoprovidehousingformorethanhalfofthe U.S.population.Thegovernmentsobsessionwithbiginfrastructureprojectshaslimitedthequalityof growththatwasbeingcreated.

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ThetwelfthfiveyearplanforThePeoplesRepublicofChinawasdebatedinOctober2010and focusesoneconomicplanningfor2011through2015.("Chinas12thfiveyear,"2010)The17thCentral CommitteeoftheCommunistPartyofChina(CPC)notedtheplanseffortstorebalancetheChinese economybyshiftingemphasisfrominvestmenttowardconsumptionanddevelopment.TheCPC continuedtoseteconomictargetsforthecountry.GDPissettomaintainannualgrowtharound8 percent,annualgrowthofpercapitaincomewillbearound7percent,and2.2percentofGDPwillbe spentonresearchanddevelopmentby2015.Thetargetswillhelptheplancompleteothertasks includingthereadjustmentofincomedistribution,curbtheexcessiveriseofhousingprices,implement prudentmonetarypolicy,intensifyanticorruptionefforts,andaccelerateeconomicrestructuring. (Phan,2011)ThisfiveyearplancouldmitigatethefinancialwoesthatChinawouldexperiencewitha suddendrasticdeclineinrealestatepricingsimilartowhattheUnitedStatesexperiencedbeginningin late2007. AstherealestateboominChinabeginstofizzle,itisimportanttonotethedifferencesin

financiallendingpoliciesbetweentheUnitedStatesandChina.First,theUnitedStateshadasubprime mortgagecrisisthatoriginatedasaresultofpoorpoliciespertainingtolendingandborrowingpractices bybigbanks.Second,U.S.bankswereinvolvedwithhighriskmortgageloansbecauseoftheinaccurate creditratingsbeingpublishedbyagenciesduetoconflictsofinterest.Third,subprimeborrowershad beenenticedtoobtainadjustableratemortgagesbecauseoftheeyecatchingbelowmarketinterest rateforapredeterminedperiodoftimewithoutrealizingthathigherpaymentsweresoontofollow. AlthoughChinasrealestatepricesfelltoa16monthlowinMay2012asdemandexhausted,the declinewasonly0.3percent,inlinewiththeexpectationsofaslowandsteadydecline.Themajor

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differingfactorforChinesehomebuyersandU.S.homeownerswastheneedtoprovideadown paymentofatleast20percentandupto50percentforahomemortgageloaninChina.Theremaybe 40percentofwealthinChinatiedupinhousingcomparedto32percentintheU.S.duringitspeak,but theChineseconsumerwillnotbemiffedasbadlyasAmericanshadbeen.However,theycanexpecta goodportionoftheirwealthtodiminish. ThroughoutthedecadeChinacontinuedtobuildnewcitiesandnewhomes.TheChinesewere

firstpermittedtobuyandsellhomesin1990.Yearswithoutopportunityhaveledtopentupdemand thatisstillbeingfulfilledbutstartingtoplateauincertainregionsofMongolia.Someofthenewcities thatChinahasspentlargepoolsofresourcesbuilding;remainmostlyuninhabited.DatelineSBS reportedonChinasGhostCitiesinApril2011,focusingtheirreportaroundtheZhengZhoudistrict, Dongguan,andOrdos.(Brown,2011)ThevideoreportwithAdrianBrownshowedsatelliteimagesof thenewZhengZhoudistrictonaThursdayduringrushhour.Thenewcityhademptystreets,sidewalks, shops,andthousandsofuninhabitedapartments.AdriantraveledtothenewSouthChinaMallin Dongguan,whichislargestmallintheworldbasedongrossleasablearea,onlytofindthemallalmost completelyempty.Thefactisthatithasbeen99percentvacantsinceitsopeningin2005.Dongguan hasapopulationinexcessof10millionbutthemallresidesinasuburbofDongguanthatisonly accessiblebycarorbus,leavingitinaccessibletothemajorityofthepopulationbecauseofthelackof highwaysandanairport.Themallslocationmaybeoneflawandcauseforthestagnantdemandby bothconsumersandretailers,buttheothermaybethattheconsumerculturehasbeengrossly overestimated.

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ThefinalcityisOrdos,anoldcitythatflourishedinearlyyearsasthedemandforcoalrose, whichhadbeenrecentlyreconstructedin2004atacostof$180billionUSD,wherethemajorityofthe capitalwasborrowedfromU.S.banks.Manyofthenewapartmentshadbeenpurchasedbyconsumers asinvestmentproperties,tryinguptheirwealthandgeneratingnoincome,asdemandissuppressed. TherehavebeensomecomparisonsoftheChinesebuildingfrenzyonhousingtothatoftheJapanesein the1960sandtheUnitedStatesinthe1980s.Historyshowsthatdemandforthosehomesincreased onlyafewshortyearslater,concludingthatthepropertieswereonlybeingbuiltintheanticipationthat demandwouldincrease.Thisisamagnificentcity,asseenfromGoogleEarth,andhasalarge opportunitytobecompletelyinhabitedinthenextfiveyears.Itisestimatedthatnearly130million peoplewillmigratefromtheruralareastotheurbancentersinthenextcoupleofyearsseeking employmentopportunitiesoralifestylechange.Ordosneedstoincentivizelargeservicebased businessestomakeahomeintheircity,ultimatelycreatingnewjobsanddrivinggrowth.Thiswillbe themostsuccessfulwaytocaptureaportionofthemigratingpopulation. Chinaisattemptingtorebalanceitseconomicmodelbycontrollingtheslowdowningrowthand

focusingonkeystructuralreforms.ChenDongqi,ViceDirectoroftheAcademyofMacroeconomic ResearchundertheNationalDevelopmentandReformCommission,accentuatedthatthefirstaction mustbetofurtherloosenmonetarypolicybycuttinglendingratesandthereserverequirementratiofor bankstohelpboosteconomicgrowth.(Dongqi,2012)Chinesepolicymakershavesincepostedtworate cuts,demonstratingtheirdedicationtohaveborrowingplayalargeroleinrevivingtheeconomythat hasbeenoffthemarkfortwostraightquarters.Policymakerscouldhavecreatedcreditbyeasingthe loantodepositratiorequirementsbecauseoftheeffectasmalladjustmentwouldhavewhenthetop

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fourbanksowngreaterthan50percentoftotaldeposits.Reutersreports,Theriskthoughisthat easingtheLDRmightsimplyfuelovercapacityininefficientindustrieswithoutimprovinggrowth prospects.(Yao,2012)TheendresultisthattheCentralBankdeterminedamorefavorableoutcome wouldarisebygivingbanksmoreflexibilityinsettingtheirlendingrates.Ultimately,thiswillstimulate borrowingaswellassatisfytherequirementtocreateamorecompetitivelandscapethatwillfund privatesectorfirmsandboostgrowthinthedomesticprivatesector.Chinawillcontinuetomaintain currentrestrictionsonhomepurchases,prohibitingindividualsfrombuyingmorethantwoproperties, inanefforttocontrolanysignificantincreaseinmortgageratesamidthecutsinlendingrates. ThereareanumberofothershiftsthatmustalsooccurifChinasrebalancingeffortwillbe

successful.First,Chinaneedstocompletetheshiftofitsrelianceonnetexportsandcapitalformationas driversofgrowthandfocusondomesticconsumerdemand.Thecurrentaccountbalancestillmaintains atradesurplus,althoughavolatileonethatiscontinuingtodwindle,whiletheservicesaccount continuestosufferastheChineseincreasetourismandbusinessrelatedtravel.Secondly,Chinahas experiencedacontinuedriseinrealurbanwages,yearoveryeargrowtharound10percentbetween 2003and2008andaround20percentasoflate.TherehasbeensignificantinvestmentinChinaandas aresulttherehavebeensomeimprovementsmadeinlivingconditionsinruralareas.Therehasalso beenademographicshiftastheaverageageoftheworkingpopulationreachesanalltimehigh,in additiontotheimprovementsmadeinruralareas,thatiscreatingalaborshortageinurbanareas. (Jackson,2011)Thelaborshortageisthebiggestdrivingforcebehindincreasedunitlaborcostsinmost industries.CoupleincreasedproductioncostswithanRMB/USDexchangeratethathasgrownfavorable bymorethan30percentsince2005,andyouareleftwithmoreexpensiveChineseexports.Third,

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reformisneededinthefinancialsector.Thegoalistoloosenthecontrolsonforeigndirectinvestment outflowsandincreaseforeigninvestmentbyChineseenterprisesandtoloosencontrolofdepositrates. Finally,Chinamustoverhaulitsstatedirectedgrowthmodelandenableitsconsumerstospendmore ontheirown.ThiswouldsustaintheChineseeconomyandgivetheworldeconomyaboostaswell.If alloftheseshiftsaresuccessful,internalandexternaleconomicbalanceshouldbeachievedandquality, sustainableGDPgrowthwillresult. ThereareanumberofincentivesforChinatochangeitseconomicmodel.Currenteconomic

policiesarecontributingtowastedresources,increasingpolarizationandadeepeningofsocialdivisions, andupwardspiralinginflation.Chart2,adaptedfromMorganStanleyResearch,graphstheConsumer PriceIndex(CPI)from2001to2012.CPIpeakedinJune2011cominginaround6.2percentforthe largestjumpsince2008.CPIstabilizedaround3.5percentinQ12012,significantlydownfromthe levelsin2011.ThiscanbeattributedtogovernmentledRMBcurrencyappreciationthatishelpingto maintainthepriceofimportedgoodsinChina.Chineseleadersunderstandthattheymustincrease socialwelfareinordertoencouragedomesticconsumption.Chinacaneliminatemarketinefficiencies oncapitalallocationbyreconfiguringitsempowermentofmassivestateownedenterprisesatthe expenseoftheprivateindustry. ThePeoplesRepublicofChinasawQ1GDPslowto8.1percent.AstheQ2numberissettobe

releasedinAugust,therearegrowingconcernsthatGDPmayfurthercooltobelow7.5percent.The recentratecutsmayhavesignaledaweakQ2GDPnumberisontheway.AsChinastrugglestohitthe8 percentGDPtargetsetforthinthetwelfthfiveyearplan,thenumbersdonottrulyindicatethe

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economicsituationinChina.ThenumberofnewbiginfrastructureprojectsisdecliningasChinashifts policiestoencourageincreaseddomesticconsumerdemand.Therealestatebubblemayhavealready peakedandisslowlydeflatingwithoutprovidinganyindicationthatChineseinvestorswillbeaffectedas theirAmericancounterpartswerein2008.TheGhostCitiesmaybeonthereceivingendofthe anticipated130millionpersonmigrationfromruralareastourbanareasinthenextfiveyears, eliminatingthetroublingvacancyrates.Coastalcitieswillcontinuetoexperienceannualincreasesin laborcostsasthepopulationshiftsinlandandtheaverageageoftheworkingpopulationreachesits highestlevelever.ManufacturingcompanieswillcontinuetoleaveChina,capitalizingonlowercostsin countrieswithnew,moreefficientmanufacturingplantsandlowerminimumwagerequirements.China needstoexercisecautionwhencuttinglendingratestostimulateeconomicgrowth.Therebalancingof theChineseeconomyappearstobeinmotion,butspecialconsiderationsneedtobepaidtothe aforementionedindicatorsandpoliciesifitistobesuccessful.

TheRebalancingoftheChineseEconomy Chart1

Chart2

TheRebalancingoftheChineseEconomy

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Brown,A.()(2011).China[0seriesepisode].Retrievedfrom http://www.sbs.com.au/dateline/story/about/id/601007/n/ChinasGhostCities

Chinas12thfiveyearplan.(2010,December10).Retrievedfrom http://www.apcoworldwide.com/content/pdfs/chinas_12th_fiveyear_plan.pdf

Dongqi,C.(2012,May22).Chinashouldfurtherloosenmonetarypolicygovernmentresearcher. Retrievedfromhttp://www.foxbusiness.com/news/2012/05/22/chinashouldfurtherloosen monetarypolicygovernmentresearcher/

Jackson,R.(2011).Specialreport:China.Retrievedfrom https://www.chinabusinessreview.com/public/1104/jackson.html

Phan,G.(2011,Marcch5).Internationalbusinesstimes.Retrievedfrom http://hken.ibtimes.com/articles/119137/20110305/chinadeliverskeytargetsthe12thfive yearpan.htm

Yao,K.(2012,July6).Chinaratecutagamblethatbankswillboosteconomy.Retrievedfrom http://in.reuters.com/article/2012/07/06/chinaeconomypolicyidINL3E8I61W520120706