Market summary: Buoyed by a very strong economy, U.S. stocks are moving ahead. It turns out that the...
China Needs to Step It Up
07/22/2010 2:35 pm EST
Every pundit and China hand says it: The next decade will be a critical one for China.
After an unprecedented three decades of 10% annual growth in gross domestic product (GDP), in which hundreds of millions of its people were lifted out of poverty as the country became the workshop of the world, China faces a more difficult second act.
Its government must spread the wealth beyond the great coastal cities of Beijing, Shanghai, Guangzhou, and Shenzhen to deep in the interior. It must find work for its young people while providing for a growing number of retirees. It must encourage people to spend more and save less to “rebalance” the economy away from exporting and towards domestic consumption.
How the Communist Party-run government handles this transition will determine whether it will retain the support of the Chinese people, despite its inherently undemocratic nature, and avoid the social upheavals that are the bane of all authoritarian states. It will also decide how great a power China will become.
I pondered these questions during and after a recent family trip to China. (I shared my direct observations here last week.) I have been a China skeptic for some time: In October 2007 I warned about a bubble in Chinese stocks, when the Shanghai Composite index topped 6,000. It’s trading just above 2,500 now.
But our trip did give me a new appreciation of how much China has achieved. It’s hard not to be impressed by the glittering new buildings, smooth roads, and gleaming subways. And the optimism of the people is a refreshing antidote to the gloom and doom you hear all the time in America these days.
Of course, they’re moving up in the world and we’re the established superpower, so there’s only one way to go, right? Also, all our mistakes are cycled endlessly through cable news channels and the Internet, but in China, the government keeps a tight lid on news.
Nonetheless, the government-run English-language China Daily displays surprising candor about certain issues, such as corruption, the direction of the economy, and increasing concerns about the gap between the rich and poor in China.
Early retirees play mahjong in Hangzhou. Caring for the aged will be
a big issue as China's population peaks.
Those are the big issues the Chinese government faces, and the crunch time is now as party members and intellectuals debate the big issues that will be addressed in the next five-year plan (oh, yes, they still have those). Typically those debates continue until the Party Congress adopts the plan, then everyone gets in line. The sense of urgency is compounded by the fact that the party leaders will be anointing a successor to President Hu Jintao over the next few years.
Stephen Roach, chairman of Morgan Stanley Asia, who will be teaching at Yale University in the fall, told the South China Morning Post that “the upcoming 12th five-year plan for 2011-2016 ‘will be a watershed for China and the rest of the China-centric region.’”
He told Bloomberg that GDP growth will remain strong this year, but China must “up the ante” to boost domestic consumption, which now stands at a lightweight 36% of GDP, a bit more than half the percentage in the US.
How? He says China needs to develop a stronger social safety net, raise incomes in the rural areas, and boost employment in the service sector. We certainly saw evidence of the latter on our trip. A growing army of hotel and restaurant workers serve tens of millions of visitors from inside China and abroad.
Next: The safety net is key|pagebreak|
The safety net is key. Right now, many Chinese retire early—often with government pensions. But by 2015, there will be some 200 million Chinese aged 60 and over and a shrinking population to support them, thanks to the one-child policy instituted in 1978. With the Communist-era benefits dismantled, Chinese feel they must save more to take care of living and medical expenses in their old age.
That’s where the “rebalancing” comes in. “It’s going to be difficult, [but] they have the wherewithal to do that,” says Christopher McNally, fellow of the East-West Center and an expert on China.
China has an amazing $2.5 trillion of foreign-currency reserves, two and a half times that of Japan, the next largest. And it has a secret weapon, according to McNally—its corporate sector.
He expects some of the famous state-owned enterprises (SEOs), like PetroChina (NYSE: PTR), China Life Insurance (NYSE: LFC), and China Unicom (NYSE: CHU) to boost their already nice dividends—ranging from 1.8% to 3.5%—to cover more social programs.
“You can get a virtuous cycle taking money away from these monopolies and oligopolies and [rerouting] it to the populace,” he says.
That would be anathema in America, of course, but remember, Chinese SEOs are still 60%-70% owned by the government, which can then recycle that money elsewhere.
And with real estate prices so high, public housing may be the linchpin of the rebalancing, says McNally. “You have people spend less on housing...and you take some of the social pressure off,” he observes.
On our trip we saw both brand-new luxury developments in the most fashionable areas and older apartment houses built ten to 20 years ago for middle-class workers that already had laundry hanging on balconies and looked like slums.
But the Chinese would find acceptable things we would never tolerate here, so any serious effort on public housing or medical care or social security, no matter how modest, would probably go over well.
As it tries to expand the safety net and the service sector, China is also pushing to boost development in the interior. Its recent stimulus package included billions of dollars for highways, high-speed rail, and other infrastructure across the country.
“China is expected to build some 1,000 gigawatts of new power-generation capacity over the next 15 years,” The Wall Street Journal reported recently. “That is about equal to the current total electricity-generation capacity in the US—a level achieved over several decades of construction.”
Again, China is catching up after years of neglect, and its population is four times the size of ours. But that’s pretty amazing.
The government has set up Chengdu, capital of Sichuan province, as a software hub and the emerging giant of Chongqing as a new electronics center, says McNally.
Significantly, the new trade agreement between China and Taiwan was signed in that city in southwestern China, a center for heavy industry and automotive manufacturing that’s also near the famous Three Gorges Dam.
By one measure, Chongqing is now the world’s biggest city, with over 30 million living in its metropolitan area. Few Americans have heard of it, yet it’s key to China’s move to develop the center of the country.
Will China be able to pull off the transition? These changes are far more difficult than the creation of the export juggernaut China is today. Given what they’ve accomplished, though, I wouldn’t count them out.
But the transition will take years, and it’s likely to be bumpy as the population’s expectations rise. In the meantime, China will have to keep growing and that means keeping the export engine humming. As it continues to produce low-end goods and begins to move up the value chain, it will become an even more serious rival to America and the West. We’ll get into that in my next column.
Howard R. Gold is executive editor of MoneyShow.com. The views expressed here are his own.
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