June 2011


Bitter fruits

By Andrew Charlton
Women tend a garden under the gaze of history. FROM LEFT: Hu Jintao, Jiang Zemin, Mao Zedong and Deng Xiaoping. © Reuters/Stringer Shanghai
Women tend a garden under the gaze of history. FROM LEFT: Hu Jintao, Jiang Zemin, Mao Zedong and Deng Xiaoping. © Reuters/Stringer Shanghai
China’s twelfth five-year plan

In its first season on Chinese television, the smash-hit series Wo Ju captured the zeitgeist of China’s restive urban youth. By the time government censors stepped in to kill the series, they were too late. It had achieved immortality as an internet sensation. Wo Ju, which roughly translates as ‘Snail House’, follows the life of two youthful sisters, Haizao and Haiping, who leave their home in rural China to live in a cramped apartment on the shabby fringes of a glittering city. The sisters struggle with modern challenges such as soaring housing costs, corrupt municipal officials and the amorality of urban life. As hardship dims their dreams, Haizao wonders, “Why is the world so full of unfairness, with the limelight only splashing on the prettiest spots in the city?”

Wo Ju depicts a generation trapped between hope and despair. The series was wildly popular because it captured the human dimension of China’s astonishing economic story. China’s industrial growth has swept tens of millions of young Chinese from their traditional lives of rural poverty into an urban jungle of rapacious capitalism. Haizao discovers that, while incomes in the city are better, the cost of living is higher, and virtue has its price.

Chinese officials are not blind to these popular concerns. Last year, China’s 68-year-old premier, Wen Jiabao, reached out to millions of young Chinese via an online chat and web forum. Wen said he identified with the characters in Wo Ju as he once lived, as a child, in a 9 square-metre room with his five-member family. Asked about the challenges of modern urban life, Wen acknowledged the uneven pattern of China’s development. He pledged to address China’s challenges with initiatives to bring hope and confidence for the future.

The release of China’s five-year plan in March gave the world perhaps its clearest ever picture of that country’s plans for the future. China’s twelfth five-year plan is a colossal document, methodically listing challenges, initiatives and targets that touch every corner of Chinese social and economic life from health care and alternative energy to school sports programs.

The twelfth five-year plan ranks as perhaps the boldest strategic document in Chinese history. If executed successfully, China will reach 2015 with not only the world’s largest population but also the world’s largest greenhouse gas emissions, largest army and, according to some purchasing power measures, the world’s largest economy (bumping the United States from the position it has held since 1890).

The twelfth five-year plan sketches a pathway from emerging power to full superpower status. This epoch-making transition has global consequences, especially for the Asia–Pacific region. Arguably, no other document will have a more profound impact on Australia’s prosperity, security and climate.

The twelfth five-year plan embodies a recognition by the ruling Communist Party that China must change if it is to enjoy continued success. The Chinese Communist Party (CCP) is the world’s largest and most powerful one-party regime. Economic planning is central to its rule. Lacking conventional democratic legitimacy, the CCP bases its authority on its ability to deliver stability and progress. Following the reforms launched by former CCP leader Deng Xiaoping in 1978, the party has presided over three decades of modernisation and prosperity, delivering a 12-fold increase in average urban workers’ incomes. These achievements have earned the CCP the acquiescence, even devotion, of many Chinese citizens. But aspirations for political freedom spring from the same well as economic progress. The CCP fears that an economic stumble could threaten its longevity. Unemployment, inflation and inequality are existential threats to the regime.

The problem for the CCP is that China’s successful economic model has reached its limits. For three decades, China has followed a simple economic formula: produce ultra-cheap manufactured goods, export them to the world and reinvest the proceeds back into the industrial sector to build ever more rail, ports, factories and skyscrapers.

Many western commentators seem to regard the Chinese economy as an invincible juggernaut. They are wrong. China’s economy faces tremendous hurdles. Each element of its economic model is now beginning to fray at the edges. For one thing, exports cannot continue to drive the Chinese economy in the way they once did. Consumers in the US and Europe were badly battered by the global financial crisis. They simply cannot be counted upon to continue to purchase an ever-growing quantity of Chinese products.

Also, the cheap labour that has fuelled China’s industrial juggernaut has started to dry up. Long-suffering Chinese workers have a saying, chi ku, which is literally ‘eat bitterness’, but actually expresses a more positive sentiment akin to a Chinese version of the Protestant work ethic or the British idiom ‘stiff upper lip’. As the country becomes richer, however, inequality rises. Currently the average income of the richest 10% of the Chinese population is 65 times greater than the average income of the poorest 10%. Recently chi ku has come to express more cynicism than stoicism.

Chinese workers are beginning to demand their share. Disaffected workers launched a wave of industrial action across China last year, forcing large local employers, such as Honda and Foxconn, to grant pay rises of around 25%. Even the China Daily, one of China’s official newspapers, sympathised with the striking workers, editorialising that a failure to “tilt income distribution” in favour of the workers could “fuel already rising tensions”. Inequality creates a dilemma for the Chinese economy: keeping wages low would stoke social discontent but raising wages would gradually erode China’s export competitiveness.

Another problem with the Chinese economic model is its environmental cost. In China’s megacities, pollution is a part of life. Shanghai residents grumble that on bad days they can’t see the street below from a fifth-storey window. Over the last two decades, the increase in China’s carbon emissions has more than offset the combined reduction achieved by every signatory to the Kyoto Protocol. At current rates of growth, China’s carbon emissions will more than double over the next ten years (an increase that will offset the impact of Australia’s emissions trading system more than 50 times over).

Chinese people also worry about immediate environmental disasters. In July last year a copper smelter leak caused outrage when nearly 10 million litres of acid-laced waste was released into the Ting River of Fujian Province, destroying the local fishing industry and endangering the health of the surrounding region. In January more than 200 school children were found to have been poisoned by lead fumes escaping from a nearby battery factory in Anhui Province. In March China’s environment minister, Zhou Shengxian, recognised the need to move to a greener economy, saying “the exhaustion of resources and the deterioration of the environment have become serious bottlenecks constraining economic and social development.”

For these three reasons, China’s economic model based on manufacturing exports is starting to exhaust its potential. Unless change comes quickly, the CCP may face rising unemployment, social unrest and irreversible environmental damage. Premier Wen recognised these problems when he articulated the doctrine of the “Four ‘Uns’”. He declared China’s current pattern of growth “unstable, unbalanced, uncoordinated and unsustainable”.

The twelfth five-year plan tries to deal with these challenges. The CCP’s strategy is to maintain growth and social stability by turning the current economic model on its head: dramatically lifting wages in the manufacturing sector, shifting tens of millions of workers to higher paid service industries and refocusing the economy on supplying domestic rather than export markets.

This transformation will be an extraordinary task, like taking apart a Volkswagen Beetle and putting it back together as a Toyota Prius – all while keeping the vehicle moving. The five-year plan has three key initiatives to execute the strategy.

First, the plan aims to share more of the national pie with working people, targeting a 13% annual increase in minimum wages and a more than doubling of take-home pay for average workers by 2015. “We want the fruits of development to benefit the people,” Premier Wen said. The plan also commits to building 36 million affordable homes (more than four times the total number of homes in Australia). The high cost of urban housing is a major gripe for the characters in Wo Ju, and the millions of urban Chinese who spend up to two-thirds of their income on housing.

The second major goal of the five-year plan is to create millions of new jobs. Every year more than 10 million Chinese workers leave their rural villages in the inland provinces seeking to find work in China’s coastal cities. For the last two decades, China’s miraculous manufacturing sector has grown rapidly enough to create jobs for this staggering torrent of migrant labour. But with export manufacturing now slowing, China’s leaders fear there won’t be enough jobs for the annual influx of rural workers.

As manufacturing slows, the five-year plan aims to create millions of jobs in service industries, lifting the service sector’s share of the economy from around 35% five years ago to around 50% by 2015. This would be a massive economic transformation, achieving in one decade what took more than five in most western countries. But China’s government has little choice. Only the service sector can create enough high-paid jobs to stave off rising unemployment.

The expansion of the service sector is also essential to restraining China’s greenhouse emissions. China has committed to reduce its CO2 emissions per unit of GDP by 17%. This target is backed by a range of initiatives including measures to boost renewable fuels, energy efficiency programs and tougher vehicle standards. But the growth of the service sector is key. By far the easiest way for China to meet its commitments is to transfer economic activity from the relatively high-emissions manufacturing industries to the relatively low-emissions service industries.

The third objective of the five-year plan is to encourage Chinese families to spend more of their income. China and the US suffer from opposite economic problems when it comes to consumption; American consumers live beyond their means, Chinese consumers live beneath theirs. Chinese families typically save up to 50% of their incomes. But too much thrift is a bad thing. If Chinese families don’t start to lift their shopping habits there will be nobody to buy the output of China’s emerging goods and service industries.

Some put China’s thrift down to ‘Confucian values’, but the truth is Chinese families save because they have to. Housing, education and health care are expensive and credit can be hard to come by. Also, pensions and unemployment assistance are woefully inadequate, forcing families to build up precautionary savings for the future. The five-year plan aims to boost public health insurance, old-age pensions and unemployment benefits in the hope that a stronger social safety net will tempt household savings out from under the mattress. In five years, China aims to roll out a social welfare system that took half a century to develop in western countries.

These three sets of initiatives, if executed successfully, will transform China from an investment and export dependent economy into a modern economic powerhouse. By sharing China’s wealth more widely, the five-year plan hopes to simultaneously soothe concerns about inequality and boost domestic purchasing power to take up the slack left by anaemic western consumers.

But achieving change will not be easy. On releasing the five-year plan in March, Premier Wen described corruption as China’s “biggest danger”, because it threatens the effectiveness of its leviathan government. The antihero in Wo Ju is a glamorous and influential government official, Song Siming. Song woos Haizao with his charm, gifts and glimpses of a fabulous city lifestyle beyond her reach. Even though she knows Song is married and involved in corrupt real estate deals, Haizao succumbs to his advances in return for cash and a luxury apartment. After a surprise pregnancy and an official investigation cause their lives to spiral out of control, Haizao and her sister regret their decisions but defiantly observe that everyone takes “shortcuts” to succeed in modern China. Haiping says: “Why should I hold on to my morals when less principled people don’t have to struggle as much?”

The sisters are not alone. A poll reported in the China Daily last year found that almost 60% of respondents put corruption among government officials as their most significant concern. The China Reform Foundation estimates that as much as $1.3 trillion, or 30% of China’s total national income, goes unreported every year. At least a part of that is hidden income siphoned off by CCP officials and their family members.

So how will China’s five-year plan affect us? The answer depends on whether the plan fails or succeeds.

The failure scenario is the less likely of the two. China’s economic resilience and successful policy making during the global financial crisis have buoyed confidence in its ability to manage risks. But the ranks of China bears are growing. Kenneth Rogoff, former chief economist at the International Monetary Fund, and perhaps the world’s pre-eminent expert on financial bubbles, is a long-time China sceptic. Rogoff believes that the economy has been artificially inflated by “years of state-directed lending to profitless government enterprises” causing over-investment and numerous financial bubbles. He claims China “is an accident waiting to happen”. Some prominent global risk managers agree and are starting to put their money where their mouth is. Jim Chanos, a legendary hedge fund manager, says China is on an “economic treadmill to hell”. Chanos is backing his opinion with massive investments in short positions betting that China will stumble.

And here’s the rub for Australia. Foreigners are substantially prevented from investing in Chinese stockmarkets, so investors such as Chanos bet on China indirectly. They take positions on companies and countries linked to China’s booming construction and infrastructure industry. Australian stocks (especially our listed miners) and the Australian dollar are two favourite China positions for global hedge funds. According to one analyst, as the Chinese and Australian economies become increasingly integrated, investors think of Australia as ‘the twenty-third province of China’. Certainly the balance of investor sentiment is still positive, but if the five-year plan fails, Australia will be among the first to follow China down.

In the more likely event that China avoids an economic meltdown and successfully executes much of the five-year plan, the consequences for Australia will be less dramatic, but potentially equally significant. Until 2008 the global economy enjoyed what the Bank of England’s governor Mervyn King has called the “NICE” (Non-Inflationary, Consistently Expansionary) decade. China played an extraordinary role in this period of prosperity. In Australia the ‘Made in China’ label has become ubiquitous on clothing, toys and household goods. And every year the televisions, toasters and T-shirts we buy from China become a little cheaper. Low inflation was (at least in part) a valuable side-effect of China’s cheap export dominance. But this may come to an end if wage increases targeted in the five-year plan lift the costs of goods China exports to the world. The change is already upon us. The largest supplier of products to American retailer Walmart, Li & Fung Ltd, announced its export prices will increase as much as 15% this year, and one of Britain’s largest retailers, Next plc, expects higher labour costs in China to result in an 8% increase in its high street prices.

In addition to lifting prices, China’s economic transformation could push up global interest rates. For the last decade, China’s massive surplus of savings has bankrolled the world. China has lent enormous sums to borrowers in the West, including more than $1.1 trillion to the American government to fund its deficit. As the five-year plan encourages households to spend more and keep less under the mattress, Chinese consumption will rise and savings will fall. “The impact on the global capital market would be enormous,” says former President of the National Bureau of Economic Research Martin Feldstein. If China reduced its excess savings, the world’s supply of cheap credit would contract and “the net result would be higher interest rates on US and other bonds around the world.”

For Australia, the net economic impact of China’s growth is overwhelmingly positive. The five-year plan will shift China towards cleaner, slower growth, but this is unlikely to translate into less demand for raw materials. Growth in housing and continued rollout of infrastructure in the central provinces will fuel demand for construction materials and the raw inputs supplied by Australia, sustaining our extraordinary mining boom.

During the preparation of the eleventh five-year plan in 2005, the Chinese government performed a subtle linguistic shift. Ever since the Communist Party imported the concept of central planning from the Soviet Union in the 1950s, the official term for the plan has been jihua, which implies detailed planning and intervention. In 2005 jihua was quietly substituted for the word guihua in all references to the plan. Guihua can also be rendered in English as ‘plan’, but actually has a more managerial meaning akin to ‘guideline’ or ‘objective’.

The new nomenclature may betray self-consciousness about the Stalinist origins of the five-year plans, which now seem out of place in an increasingly capitalist Chinese economy. Or perhaps it simply reflects the reality of an economy that is increasingly decentralised. Either way, it underlines a contradiction at the heart of China’s politics. China needs radical economic change, but the new economy will be increasingly complex, private and difficult to control with the traditional tools of central planning. The great question of the next five years is whether an authoritarian state can give birth to a modern economy. For the world’s sake, let’s hope everything goes to plan.

Andrew Charlton

Andrew Charlton is the author of Ozonomics and Fair Trade for All (with Joseph Stiglitz) and two Quarterly Essays, ‘Man-Made World’ and ‘Dragon’s Tail’. From 2008 to 2010 he was senior economic adviser to Prime Minister Kevin Rudd. He is co-founder of the strategic advisory business AlphaBeta.

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