The
government has tried monetary stimulus, a stock market bubble, and now a bond
market bubble. Nothing has worked.
China is closing out 2015 with probably the weakest
growth rate in a quarter of a century. Unfortunately, 2016 will be more
difficult. Financial bubbles have kept afloat unviable companies and
speculative spending. But, as the renminbi comes under increasing devaluation
pressure, the resulting capital outflows may deflate these bubbles despite the
strong support from official propaganda.
Nothing reflects better China’s economic difficulties
than the collapsing commodity market. After a 15 per cent decline in 2014, the
CRB index dropped another 27 per cent in 2015. China-dependent iron ore has
seen its price halved again in 2015 after halving in 2014, and the price of
Brent crude is down by two-thirds in 15 months.
To extricate itself, China must develop a comprehensive plan to stabilise
the economy, absorb cyclical losses and rebalance the economy
Financial markets have been hoping for a government
stimulus to reverse the trend whenever disappointing numbers are released, even
though such hopes have been dashed again and again for the past three years.
The pattern is likely to persist into 2016. The government has tried monetary
stimulus, a stock market bubble, and now a bond market bubble. Nothing has
worked.
China’s economy is mired in a structural and cyclical
quagmire. To extricate itself, China must develop a comprehensive plan to
stabilise the economy, absorb cyclical losses and rebalance the economy.
Piecemeal measures only increase confusion and dig a deeper hole for the
future.
The government must shift income to the household sector
by decreasing contributions to social welfare funds, and cutting consumption
and income taxes. Photo: APTo improve the short-term economic outlook,
the only effective measure is to shift income to the household sector by
decreasing contributions to social welfare funds, and cutting consumption and
income taxes. The shift must be over 3 per cent of gross domestic product. For
example, the contributions to social welfare and insurance funds should be cut
by half for three years.
Playing with monetary policy just doesn’t work. It is
intended to boost investment demand. But, with so much overcapacity everywhere,
why would anyone want to add more? Instead, it destabilises confidence in the
exchange rate. The resulting capital outflows are making economic management
that much harder and may even precipitate a financial crisis similar to the
1997-98 Asian financial crisis. One lesson from history is that, when the
financial system is precarious, don’t play with the currency value.
China may have overinvested up to 40 trillion yuan (HK$48
trillion) since 2009. Its physical manifestation is in empty buildings and
industrial overcapacity. Several prominent steel industry executives believe
the industry should produce 20 per cent, or 160 million tonnes, less per annum.
On top of that, the industry is rumoured to have 200 million to 400 million
tonnes of overcapacity. The dire situation is common among all commodity
industries. New industries like smartphone manufacturing already have a large
overcapacity. Even power plants are hugely underutilised.
To get out of the vicious spiral of China’s
investment-led economy, the government must loosen its control on the economy,
especially financial resources. Photo: AFPTo stabilise the financial
system, the government must establish special teams to enforce capacity
reduction and absorb the resulting bad loans. The inability to accept the
financial consequences of past mistakes is a major barrier to meaningful
economic reforms. In that regard, political decisions must be made on how to
mete out punishment for past mistakes.
If the right
reforms are instituted, the economy will boom for the next decade. If no
reforms are carried out, stagnation, instability and crises await us
China’s overcapacity is a consequence of enormous forced
savings due to government policies. Household savings account for less than
half of net savings and a third of gross savings. As a savings glut exerts
deflationary pressure on the economy, the government has tried to promote
investment to support demand, which makes the future worse. This is the vicious
spiral of China’s investment-led economy.
Declining efficiency and rising forced savings are two
sides of the same coin. To get out of the vicious spiral, the government must
loosen its control on the economy, especially financial resources. Government
spending and that of state-owned enterprises account for about half of GDP. The
level must come down by half for the economy to be stable.
China has enormous potential. Its labour productivity is
comparable to that associated with per capita income of US$20,000, 2½ times the
current level. The huge gap is to pay for the system’s inefficiencies. China’s
current economic difficulties are entirely due to the inefficient governing
system. If the right reforms are instituted, the economy will boom for the next
decade. If no reforms are carried out, stagnation, instability and crises await
us all. SCMP
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