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China's challenges

Wendy Dobson, a leading economist describes the imbalances in the Chinese economy and what its rise means for the rest of the world

Published: Apr 6, 2015 07:07:29 AM IST
Updated: Apr 7, 2015 03:13:12 PM IST
China's challenges
Wendy Dobson is Co-Director of the Rotman Institute for International Business

You believe that China’s growing influence could have profound implications for the way the world economy functions. How so?
China’s economy is on track to become the world’s largest sometime in the next decade or two, and whenever I’m in China, I am impressed by how this prediction drives the way the Chinese—and particularly young Chinese—view themselves. Because of their history as the Middle Kingdom, they believe they merit respect from the rest of the world.  

This prediction also drives external expectations—and some worries—that as China becomes more influential, it will seek to change the way the world economy is governed through the G20 and other international institutions. Some fear that it might try to set its own rules.  In my view, the real question is whether China, as the largest economy, will play a stabilizing role in the world economy or be a ‘free rider’ on the efforts of others. I say that because of the other key aspect of the way Chinese view themselves. Because of their large population, on average they are still quite poor, with per capita income that is only 10 or 15 per cent of what it is in the United States.  China is preoccupied with its own development, and that is very much reflected in its mindset, which is both inward-looking and  domestic in its orientation.  

In my view, China is prepared—at least for now—to accept the existing world order.  It does not seek a leadership role, because that would involve commitments and investments that it believes are needed at home.  However, it is a participant in the world order, and an increasingly active one.  

The Chinese economy is widely believed to be unbalanced in some important ways. Please explain.

The economy has grown at near-ten per cent annual rates for the past three decades. Much of that growth was driven by high rates of investment—as much as 50 per cent of GDP. These were investments in infrastructure, real estate development and export-oriented industries, as well as steady spending on modernizing the military. The problem is, these high investment rates have crowded out consumption, which even in India accounts for nearly half of national income; in China, consumption is one-third of national income.  

There are clear reasons for these low consumption levels. Huge supplies of labour that once resided in the rural areas have been mobilized and millions of people have moved into the modern sector.  But because of the abundance of labour, wages have stayed low, and people save much of what they earn. But China’s politically-determined bank deposit rates mean they earn very low returns. Even so, they must save to cover the costs of housing, education, health care and pensions, all of which used to be supplied by the state in what was known as the ‘Iron Rice Bowl’. In the 1980s and 1990s this state support was withdrawn and is only now beginning to be replaced by new social spending programs.

Another outcome is income inequality. The interior parts of the country are poorer than the coastal areas and urban incomes exceed rural by as much as a factor of three to one. Those with connections and influence and increasingly, those with entrepreneurial smarts, have done very well. Last but certainly not least, the other big symptom of imbalance is China’s degraded environment. Last winter we heard almost weekly about potentially-lethal levels of air pollution in some of the big cities, a concern that has become a major political issue.

By Gini coefficient measures, income inequality in China is now at a dangerous point. Can you comment on this?
Rising income inequality occurs during periods of rapid growth and development, and China is no exception. When an economy grows at 10 per cent for as long as China’s has, and is restructuring from agriculture to a more industrialized and modern economy, opportunities open up for some people and not others.  China is also a ‘catching-up’ economy: they’re  welcoming foreign direct investment that transfers skills and technologies and creates opportunities through diffusion of skills and knowledge for entrepreneurs to do extremely well.  As the middle class grows, people with talent do well, and small and medium-sized enterprises grow rapidly and successfully.  People do not object to that.

However, they do object to something else: wealth that has been accumulated because of who one knows rather than because of one’s own efforts and ingenuity. What matters is what the government does about this. One high-profile response has been to root out and punish corrupt behaviour;  another is to create opportunities and institutions that improve future prospects for much of the population; and yet another is to redistribute income and wealth in politically acceptable ways. This means fiscal reforms that tax fairly and enforce tax rules; it means investing in education and skills training institutions, providing a social safety net and contributing to a sustainable pension system.  It also means requiring the many huge state-owned enterprises to pay dividends—something  they have largely avoided until recently. Instead they have kept their profits for their own uses.

You have said that the stage is set for Chinese-U.S. interdependence to continue to deepen. Why is this?
The two countries are interdependent, in part, because the U.S. has been the biggest market for the labour-intensive consumer goods that China has specialized in producing in the past few decades.  China’s joining the World Trade Organization in 2001 signaled to the world that governments would accept the international ‘rules of the road’. Foreign investment then piled in to take advantage of the cheap labour. Thirty years later, it is the world’s largest exporter, thanks to the open and wealthy consumer markets in North America, Japan, and the European Union.  

Another source of interdependence comes from China’s foreign exchange earnings from its exports and inflows of foreign investment. A large share of those foreign exchange earnings has been re-invested abroad, particularly in U.S. public securities, which have been seen as a safe haven for investors around the world because of the perceived safety and sophistication of the U.S. financial system and low inflation. As a result, China’s government agencies have a strong interest in the ongoing transition of U.S. monetary policy as it ‘tapers’ its purchases of U.S. financial assets without igniting an inflationary outburst.  

Going forward as the world’s two largest economies, other aspects of interdependence create preconditions for political cooperation.  Because of their histories, both have major interests in the Pacific region and have to work out ways to give each other space to pursue those respective interests.  The recent U.S. rebalancing of its military forces, known as the ‘pivot’, was mishandled on both sides: the U.S. was too energetic and preoccupied with security (only later adding economics), while China over-reacted, ever-suspicious of U.S. intentions to ‘contain’ China.  If they thought about it a bit more, however, they would realize that a great power cannot be contained.

More immediately, the two countries’ militaries—which have never really talked to each other—are now engaging in regular consultations, so they have a better idea of what each is trying to accomplish. That reduces the chances of misunderstanding and miscalculation that could ignite conflict.

China and the U.S. will always compete; that’s why the word ‘Rivals’ appears in the title of my book; but at the same time,  there are significant opportunities for partnerships.

What opportunities do you see for partnerships?
Each country sees itself as exceptional.  But because they are the two largest economies, they have certain responsibilities to the rest of us. More partnership and less rivalry in the Pacific would be a start.  The Trans-Pacific Partnership negotiations of a free trade area are one possible focus of economic cooperation that the Chinese are considering joining.  Both sides are also currently negotiating a Bilateral Investment Treaty.

Beyond deeper economic integration are several other possibilities.  They are the largest greenhouse gas producers, so they should cooperate on climate change strategy. In February of this year, the U.S. Vice-President proposed deeper cooperation to clean up the environment, now a major political issue in China.  Recent developments in cyberspace underline the need for a global governance regime; that will only happen with Chinese and US leadership.  With more nations seeking to burnish their credentials as world powers through space exploits, a governance regime is needed around the militarization of space; again leadership from these two countries is a necessary first step.  

You have said that China’s current challenges can be framed by a comparison of South Korea and Brazil. How so?
One of the big concerns is that China’s slowing growth could be deeper and more persistent than expected, and it could fall into the ‘middle income trap’. Once Brazil reached middle-level incomes of around $6,000 to $10,000 per capita per year, income growth slowed and even stagnated, and Brazil has been stuck in this trap for some time.  

Korea is at the other extreme.  At the end of the Korean War, it was a basket case; today, it’s a member of the OECD, and per capita incomes have gone from $1,000 to $2,000 a year to $20,000-$30,000 a year.  The keys to Korea’s success are numerous and perhaps difficult to replicate. Korea has attracted foreign investment, but more importantly, it has been very successful in developing its own car and IT industries by ‘reverse engineering’: taking imported cars apart, and figuring out how to make them themselves.  Along the way, as it has gradually become more successful in industry, it has invested in its education system, from primary levels through university.  

As a result of all this, Korea has grown a solid middle class that has created strong demand for consumer goods and services, but it has also created the human capital required for more sophisticated and high-income industries.  It has run into some problems at high-income levels, but overall, it motored right through what, for others, became a middle-income trap.  

Another smart thing Korea did was to look closely at the role of government, and how and when to withdraw government from the economy as it grew, to let market forces take over.  This is one of the key challenges that the Chinese face, with their state-owned enterprises and the intrusive role of  government.  Brazil’s government, too, has played an intrusive role over the years and has made some costly mistakes. It relied for too long on exporting its natural resources and borrowing abroad to try to build industries which, because of  government protection, failed to become global competitive. Brazil has failed to build a middle class until very recently and has not invested sufficiently in its education system.

The choices Brazil didn’t make reflect the difficult decisions a country’s leaders face about whether or not to modernize their institutions.  The challenge for China is, how do you modernize an autocratic state when you’ve got 1.3 billion people?  Figuring out how to govern effectively and avoiding chaos, or  luan, something the Chinese fear most because of chaotic periods in their long history, is one of China’s biggest challenges.

What implications does all of this have for Canadian business leaders?
I see this as a somewhat urgent issue which I would frame in simple terms: we need a White Paper on Asia.  Canada has no real strategy for Asia as a whole, and of course, China is an extremely important part of that. The Chinese think about the rest of the world in a very Confucian, hierarchical way.  The large states, like India, Japan, the U.S., the European Union and maybe Brazil, matter to them much more than mid-sized countries like Korea and Canada.  As a result, for Canada, just pursuing a bilateral relationship, in and of itself, is not good strategy.  The strategy we need would take account of the entire Pacific region.  I say this, in part, because of the Trans-Pacific Partnership, which, as indicated, China could conceivably join.  

Having studied and traveled in China for more than 25 years, I am struck by how it has sort of receded from the Canadian policy landscape in the past decade.  It seems to have come and gone—much the way Canada is perceived in Asia. Right now, we’re sort of irrelevant and invisible to most Pacific nations (not all) and absent from the region’s main economic institutions.  That is why we need a strategy that talks to Canadians about who the Asians are and why they matter; how they view us and why that matters; and what initiatives we should take.  

The fact is, in Asia, much rests on relationships at the very top.  Relationships between leaders have to be nurtured and worked at.  It’s not enough for the Prime Minister to visit China every now and then and send ministers and bureaucrats in between. That is not the way the game is played, and it’s not going to work. The relationship between Canada’s leader and China’s leader is the foundation stone for everything else that follows, in terms of economics, security, culture and business.

What else should we be doing?
In my mind, we should be developing the Canada brand as a Pacific nation. Vancouver should aim to attract the headquarters operations of Asian multinationals operating in the western hemisphere. Calgary should be the unconventional energy hub for the Pacific, and Toronto could be a financial hub for trans-Pacific financial transactions and institutions.  

We need to develop and coordinate a pan-Canadian approach to China and Asia: instead of every university president trotting off on his or her own to Asia, we should coordinate among ourselves, with the federal government as the convenor, but involving all stakeholders including provincial governments, educational institutions and the private sector. And we need to set ourselves some ambitious goals, for five or ten years from now, in trade, investment and people flows – and follow through in achieving them.

Wendy Dobson is Co-Director of the Rotman Institute for International Business and an Adjunct Professor of Business Economics at the Rotman School of Management. She is the author of Partners and Rivals: the Uneasy Future of China’s Relationship with the United States (Rotman/UTP Publishing, 2013) and Gravity Shift: How Asia’s New Economic Powerhouses Will Shape the 21st Century (Rotman/UTP Publishing, 2009).

[This article has been reprinted, with permission, from Rotman Management, the magazine of the University of Toronto's Rotman School of Management]

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  • Bishnu Prasad Padhy ,blr

    I personally think the challenge that China has are- 1.Because of Communist party administration political system in China seems to be stable, really it may not be.Because corruptions are still reported. 2.China wants to be Wold\'s powerful nation, So it has allowed American companies to set up and because of those american and European companies China\'s economy has thrived a lot, but Outwardly it seems economic developments are because of China\'s own effort. 3. Unlike European countries and USA China lacks in inventions and discoveries ,in most cases Chinese companies copy developing industrial products.

    on Apr 9, 2015
  • Dr.a.jagadeesh

    Critical analysis of Chinese Economy. Dr.A.Jagadeesh Nellore(AP)

    on Apr 6, 2015