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adapted from the Australian Financial Review November 7th 2002 Hidden beneath China‟s world-best GDP growth figures is an economic quagmire1 that could well sink the new Chinese Communist Party leaders set to take over after this week‟s historic Communist Party Congress. China‟s economy continues to record income growth accelerating to a scorching 8.1 per cent in year-on-year terms in the September 2002 quarter. But China‟s sexy headline GDP figures are largely the result of massive pumppriming2 by the central government, with capital construction expenditure alone soaring by 44 per cent in the first seven months of this year. China‟s reforming Premier, Zhu Rongji, has made no secret of his desire to retire when his term expires early next year after the formalities of the 16th Party Congress, which begins on Friday. Zhu may have got China off to a good start, but some analysts think that far more difficult economic problems lie ahead for the country‟s new breed of leaders, such as Hu Jintao and Wen Jiabao. Zhu is likely to be replaced in his position as Premier and chief economic manager by Wen, one of his deputies. Wen is one of the great survivors of Chinese politics, which may indicate consummate political skills or merely an ability to offend as few people as possible.

The 60-year-old Wen is perhaps best known for his appearance at the side of Zhao Ziyang in Tiananmen Square at the height of the 1989 student protests there. But Wen‟s ability to satisfy the main factions does not provide evidence of any drive to push economic reform harder. „China has been implementing expansionary fiscal policy for five years,‟ says Huang Yiping, a Hong Kong-based economist with investment bank Salomon Smith Barney. „Between 1998 and 2001 the government directly invested Yuan 510 billion ($A110 billion) – mainly on infrastructure projects – and called for another Yuan 2 trillion ($A430 billion) in bank loans on companion projects,‟ Huang says. „Such investments helped prevent a drastic fall in the pace of economic growth at a time when the external environment deteriorated markedly.‟ Government bond issues in China have risen from a mere 0.5 cent of GDP in the late 1980s to 5.1 per cent this year, and the central government‟s Budget deficit is also under pressure. Salomon Smith Barney reckons China‟s fiscal deficit this year could approach 4.3 per cent of GDP, well above the Zhu target of 3 per cent. But an even greater risk for the Chinese Government, says Huang Yiping, is the potential fiscal crisis

a muddy pit that if you step into it, you can‟t get out of it 2 spending

associated with the country‟s effectively bankrupt financial system. After decades of government-directed loans to the country‟s dilapidated stateowned enterprises, China‟s banks are all but insolvent [bankrupt] by international standards. China‟s central bank claims that the non-performing3 loan ratio for the country‟s four big state-owned banks stood at 25.37 per cent at the end of last year, although a recent report form the Bank of International Settlements puts the figure at closer to 42 per cent. Researchers at the International Monetary Fund have issued equally alarming warnings on the state of China‟s financial system. „The weak performance of state-owned enterprises has burdened the state commercial banks with a large amount of non-performing loans, creating contingent4 liabilities that could threaten medium-term fiscal sustainability,‟ IMF researchers say in a research paper released late last year. Yet China‟s state-owned enterprises have not only bankrupted its financial system, but efforts to make them more efficient have lead to tens of millions of workers losing their jobs over the past few years. Earlier this year, Nomura International economist Pu Yonghao estimated the total number of Chinese workers who had lost their jobs as a result of the restructuring of state-owned enterprises at 43 million since 1996.

„Officials have publicly acknowledged that the actual unemployment rate in China was about 7 per cent to 8 per cent at the end of 2001, instead of the recorded rate of 3.3 per cent, and projected a sharp rise in unemployment this year,‟ Pu said. This level of unemployment has placed enormous pressure on the Chinese Government to maintain the fiscal stimulatory policies required to sustain strong employment growth. „China needs to create 10 million jobs a year to absorb the annual 5 million more laid-off state industrial workers,‟ says Qu Hongbin, a Hong Kong based economist with HSBC. „Jobs must also be found for surplus rural labour,‟ Qu says. But the Chinese Government has not only had to try to maintain strong jobs growth, but also take care of the tens of millions of workers from state-owned enterprises who have not been able to find new employment. This has put added pressure on the Chinese Government‟s already woefully inadequate social welfare system. In the days of the „iron rice bowl‟ Chinese workers were guaranteed a job for life, along with subsidised housing and medical care, and a pension funded by their former employer when they retired. But with so many Chinese state-owned enterprises closing down or technically bankrupt, millions of workers have been left without social welfare payments. „Setting up a viable safety net is crucial to reduce the social cost of SOE reform,‟ says Qu.


A non performing loan is one where the borrower does not make the required payments on a regular basis 4 possible


Many of these workers from China‟s gradually disintegrating public sector make their way to private companies, which by some estimates now account for close to half of the country‟s annual GDP. Yet according to a report released by the New York-based human rights group China Labour Watch last month, the working conditions in the exportorientated factories now being set up throughout coastal China are appalling. These workers also have to compete for jobs with an estimated 100 million former peasants who left the countryside over the past decade or so in search of higher wages in China‟s increasingly industrialised coastal provinces. That still leaves close to 900 million Chinese living on the land. Many are caught in the types of poverty traps that make working in the dark satanic mills of China‟s manufacturing sector look appealing. The glaring disparity between the stagnant rural sector and the booming urban-based manufacturing sector has also led to an ever-widening gap between income levels. Rural incomes in China are now less than a third of those in urban areas, according to Chinse Government statistics. This has helped China move from the most equal society in the world to the most unequal in less than 20 years. China‟s accession to the World Trade Organisation – championed by outgoing Premier Zhu Rongji – is

likely to exacerbate5 problems in the country‟s rural areas. Deutsche Bank has estimated that China will have to import close to $A160 billion more in food and agricultural products over the next 10 years as a result of its decision to join the WTO Up to 1.5 million peasants will be made redundant6 every year for the next five years as a result of WTO membership, according to Deutsche Bank research. China‟s 900 million peasants are also hit hard by the corruption that is now endemic7 in the country‟s system of government, forced to pay onerous8 taxes and fees to support the lifestyles of local party officials. Almost 200,000 Chinese party and government officials were arrested for corruption last year, an increase of 30 per cent on the previous year. Estimates are difficult to come by, but respected Chinese economist Hu Angang reckons that official corruption has probably cost the Chinese Government something in the order of Yuan 1.3 trillion ($A380 billion) over the past three years. The official People’s Daily newspaper recently reported that as much as $U30 billion ($A53 billion) simply „evaporates‟ in China every year as a result of the money laundering [illegal accounting practices] and activities of corrupt government and party officials.

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Questions Q.1 What is “fiscal policy”? Q.2 In what ways has the Chinese Government implemented expansionary fiscal policy? Q.3 How did the Chinese Government fund this expansionary fiscal policy? Q.4 Why has the Chinese Government implemented this policy? Q.5 Outline the crisis in the Chinese banking system. Q.6 Why has the sale of loss making state owned enterprises made life difficult for many Chinese workers? Q.7 What crisis does the Chinese Communist Party face within itself?

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