The Financial Crisis and China’s Future Growth
The 2008 Beijing Olympic Summer Games offered a spectacular demonstration of the success and prosperity achieved by Chinese reform policies that opened the door to the outside world. However, as China enjoys the record-making growth rates stimulated by the connection to the global economy, it also becomes more vulnerable to global uncertainties, such as the U.S. sub-prime loan crisis and resulting financial meltdown and economic downturn.
The current crisis may directly or indirectly create economic problems for China, but China will not reverse direction and move away from opening doors to the outside. However, the current global financial crisis strengthens the Chinese government’s belief that China’s growth strategy will need to change.
China cannot rely solely on exports as a growth engine. China has to adjust its economic structure and start looking inward for sustained growth. President Hu Jintao has outlined a new, balanced growth strategy that stresses stimulating domestic demand as a center piece for the economy’s future development.
Many academic scholars view this as a wise move. But research shows that household consumption as a share of total economic activity has actually decreased as reforms deepened (Qi and Prime 2008 1 ). This poses serious challenges to the new growth plan.
However, Beijing is determined to experiment with and develop policies to “pull up domestic demand” (ladong neixu).
This refers not only to increasing investment demand, which has been the main force driving China’s economy, but also to expanding household consumption. The lack of a well-established social security and insurance system has led Chinese households, especially urban households, to hold large amount of savings in banks. Rural households largely depend on land and offspring for financial security. Collective management of social security and insurance is highly desirable to free Chinese households from precautionary savings.
Education is another main spending item for Chinese households. A large proportion of precautionary savings is for children’s education particularly for low-income rural households. The Chinese government in recent years has allocated a large amount of funds to fulfill a goal of providing nine years of free, obligatory education goal for all children. To ensure the successful implementation of this program, the central government made great efforts to earmark fiscal transfers from upper level to lower level government units.
Additionally, a floor is being placed under the social security system to ensure that low-income households meet minimum consumption and living standards.
Policies aimed at “pulling up domestic demand” go much further than the above-mentioned expenditure-oriented measures. The government has begun some critical institutional reforms that will fundamentally change the economic structure. One of the policies is to allow rural farmers to transfer their land use rights in the market. This is largely consistent with the ongoing rapid urbanization process and will substantially enhance land allocation efficiency. With more free choices to rural households in allocating economic resources, income levels and living standards are expected to rise.
Fiscal system reform is also under consideration to nurture a more dynamic microeconomic environment. In fact, the current global financial crisis may speed up some specific reform steps. In particular, favorable tax and fiscal policies being considered to help small-and-medium enterprises aim to provide more sales outlets in the domestic market. In the long term, all these institutional changes should greatly help boost domestic demand and domestic market development.
There will be many adjustments along with way. To many Chinese people, “sub-prime” is a new and unfamiliar word. Indeed, the financial products offered to Chinese consumers are much more limited and conservative than those available in the U.S. For example, all Chinese consumers we talked to were surprised to discover that U.S. consumers can borrow to finance a 20% down payment to purchase a house. “Here, the 30% down payment is non-negotiable. We never dreamt that we can buy a house without saving up for a 30% down payment,” said Hu Wei, who is considering purchasing an apartment near the 5th ring road in Beijing.
Merchants in the export sector have already felt the shock of the global economic downturn, although many are still trying to understand what sub-prime is and are baffled by how quickly Wall Street has tumbled.
Yiwu, a city that was unknown to the Chinese people and the world not long ago, is now the frontier of China’s light-industry export sector. Business has been slowing since January. “We are getting fewer orders from foreign buyers stationed at Yiwu,” says Jing Zheng, who regularly goes to the Yiwu International Commodities Fair. This downturn is felt by thousands of enterprises, which are reluctantly adjusting their production plans and inventory. Further, some are concerned that the economic recession in the U.S. will boost the anti-free trade movement.
The newest business data confirm the concerns of these enterprises. Yiwu’s exports to the U.S. dropped by nearly 5% in the first quarter of this year, the first decline since the start of the Yiwu International Commodity Fair in 2002.2
The banking sector also worries even though assets generally have not been lost. Thanks to the still rather tight control of international capital movements, most Chinese banks do not hold a large amount of securities and assets that have been battered by the U.S. financial crisis. China holds a large amount of U.S. Treasury bills and does not want to see a weakening dollar. Still, China is not likely to dump U.S. Treasury Bonds in the short or medium term because the economy is highly dependent on foreign trade.
The Chinese banking industry welcomes U.S. government’s rescue plan but is concerned about more indirect losses. Cutting interest rates may help boost demand for loans but may shrink bank profit margins. A banking official we talked to also pointed out that many enterprises will have to delay plans to go public in the U.S. market as this is a bad time for IPOs. This no doubt will restrain many Chinese firms from raising capital in the international market.