China in World Economy: The Need to Redefine Public Policy

Good morning everybody. I am very honored to be here today.

You know, being a businessperson in the past 4 years has enabled me to view public policy issues from a broader perspective. If you asked me 4 years ago what should be the most important policy issues between China and United States, I’d probably list topics like trade protectionism, intellectual property rights, and high-tech export em`bargo. Guess what, these are exactly topics between Chinese and American politicians. Politics, too often, is more about attitude, than about solving the problem. Politicians like to talk again and again about the hot topics, and some time they don’t like touch real issues. A good policy advisor should keep bringing the real issues up to the attention of politicians.  I hope I can make up a little bit by sharing my observation, from the angle of a business man, about what are the real policy issues between China and United States. And my picks of the real issues are: wealth disparity, population structure, and financial market.

1.    Inequality matters

Why these are real issues? Well, we have firstly understand why there are superficial assumptions. The policy on China of western world, led by the United States, often swings between two stories: one says that China is a world power wannabe who threats to take down USA as the most dominating power, like that Yao Ming has taken down Shaq O’Neill as the most dominating big man in professional basketball; or, the other story, that says China is a new powerhouse to global economy and is becoming a huge market for everybody. The first story was popular, but in recent years more people seemingly prefers the second one. But the problems is, this one is also more a perception that reality. So far, the fabulous growth of China has been basically a success story for China itself. It hasn’t helped much in lifting the other part of world.  The most frustrating example is about Hong Kong. Ten years ago when Hong Kong returns to China, most analysts expect a great push from the China market to the growth of Hong Kong. That’s never happened. Today Hong Kong is the lest improved economy among the Four Tigers of Asia. The other three, Singapore, South Korea and Taiwan, all do better than Hong Kong.

That frustrates the policymakers of the United States as well. China has been growing much faster than the States. A reasonable expectation might be that the trade deficit to China would shrink. But things went exactly the opposite way. Trade deficit to China is getting bigger and bigger. That doesn’t sound right. Understandably, some policymakers swing back to the first story, that China comes here with no intention to do good. They started to blame at conspiracies of Chinese government. Among these conspiracy theories the most popular one is about Chinese currency. That RMB, or the Chinese Yuan, has been deliberately undervalued to keep Chinese product cheap. Every time in the past two years, when these two governments met, you could bet for sure that the American side would raise the issue of currency exchange rate.

But the impact of RMB on trade imbalance, if any, is not practically remarkable. In fact, RMB has appreciated by 12% in the past two years, at the same time the trade deficit is widened. Last year US statistics estimated a trade deficit to China of $213 billion in the first three quarters, increased by 16.4% over the same period of the year 2006 ($183 billion). And the year 2006 recorded a 18% deficit increase ($256 billion) over the year 2005 ($217 billion). 

A comparison between China and India is even more illustrative. From Jan. 2005 to Sep. 2007, Indian Rupee appreciated about 8% against US dollars, less than the appreciation of RMB( rose by about 9%). During the same period, the trade deficit to China increases by 75% in a quarter, while the trade deficit to India was turned around and became trade surplus. These numbers, if anything, has proven that the exchange rate is not the critical factor here.

What may be the real factor. There can be many answers. And I suggest that one should look into the difference of income distribution between these two nations. Measured by the Gini coefficient, a popular index used to represent the income ine`quality among a certain group of people, China has become one of the most unequal country. Higher Gini means wider income gap, and the number of China was 47.3 for the year of 2004, which is already higher than most nations except for a couple of Latin American and African countries. More, the Gini index keeps rising in China in the past 10 years, while it actually declines in other countries of high ine`quality, such as Brazil, Chile, Argentina and Mexico. As a matter of fact, Mexico has been more equal than China since 2004. If we compare China and India, the degree of income inequality immediately pops up as a major difference between these two big economies, which have many features of similarity. In China the rich people are relatively richer, and the poor people are relatively poorer.

(Source: UNDP Human Development Report, 2007/08)

OK, you may say, “So what? ” Why should we care about the income disparity in China? You just said that there are other countries that are more unequal. Well, none of these countries happened to be the third largest economy in the world. And still, inequality in some of these nations, such as some Latin American nations, had caused some big trouble for United States and the world economy.  

For China, the first and direct impact is that, the poorest Chinese determines the bottomline of “made in China”. Let me ask you a question: Do you know where is the largest immigrant group? The Chinese in Vancouver Canada? Or perhaps Mexican people in TX? My answer is: the largest immigrant group is Chinese inside of China. By estimation there are 150 million Chinese inside of China, who work in places other than their permanent residence, of which 80% are poor immigrant workers from rural area. This group accounts for about 10% of Chinese population, and they are probably the poorest 10% -20%. You might hear about the snow storm which paralyzed half of China weeks ago. But you might haven’t heard that during that snow storm, millions of people – I mean, literately, millions of people – piled up at the railway station of Guangzhou and waited to be loaded. They got stuck there for almost one week, with very limited access to shelter, food or even water. They are immigrant workers who wanted to go home before the Lunar New Year. Maybe you have seen the movie “Planes, trains and automobiles”, starring Steve Martin and John Candy. But what you saw in that movie is nothing, not even close in the most remote sense, compared to what these immigrant workers experienced. These are the people who make the toys, garments and house appliances that will be exported to the United States. No wonder that they will work very, very hard to earn their daily living, if they can stand that snow storm for 7 days just to get back home.

Let me give you another example. In the mid of last year, Chinese press exposed a large scale slave labor scandal in a Chinese province, where adults and even teenagers are forced to work under miserable situation. The exposure triggered a massive action by the local government to close these sites and free these slave labors. However, after the massive action, a considerable number of these labors returned to these sites, and tried to get their “job” back. That shows how low the bottom line could be.

I believe that any sound trade policy with China must begin with improving the bottomline, or, with lifting the situation of the poorest people there. This is not only an issue of “development policy” for World Bank or UNDP, it should also be an issue of trade policy, or, strategic economic policy. But before I go further and use too much time, let me switch to another issue, i.e., the population structure of China.

2.    Obpyramid falls  

In the late half of 20 century, policy researchers around the world reached a consensus: that grand projects, which aim to making drastic and grand change of society, means high risk and usually falls apart. Intellectuals shouldn’t try to replace the role of God, or, the role of natural evolution, of a society. Communism is viewed by many people as such a grand social project, and it has failed. By the way, the current Communism Party in China is not communistic any more, just like Michael Jackson is not black.

However, right now, there is a grand social project on-going in the world, and it hasn’t received much criticism from policy researchers. I mean the family plan policy in China. Under that project, most couples, including all who live in city, are permitted only one child if they don’t want to pay a heavy fine. Only couples who live in rural area and meet some other criteria are permitted two children. This policy has received some critiques from the West, but mostly from religious groups who view abortion as a sin. I know many people here are Christian, but when we talk about public policy in another country such as China, we have to understand that the religious teaching there may vary a lot on some fundamental issues. For example, while Christianity regards life as a gift from God, that must be cherished and protected, most Buddhism teachings believe that “this life” is something we have to discard at some point to reach the next stage of our soul. So actions like abortion or suicide have a totally different sets of ethical meanings in China, and in many other eastern cultures, too.

The real problem with family plan is that it is another grand project based on social prophet by unreliable human intelligence. These so-called expert do some kind of fussy mathematics on natural resource and make goofy prophets on how much population our earth can support, and if their mathematics tells them that there will be too much people, their prescription will be “cut down the number of people”. That was what the family plan policy came from.

This sounds funny. But the consequence on our society is not funny. I am trying to be balanced by telling you that family plan policy has played a positive role in pumping economic growth in China. In the beginning, family plan increased the share of working population because there were less children to be fed, and thereby increased the productivity of the whole society. When time passed by, the share of working population has actually been decreasing because now you have less young working people and more retired people. Once again let’s compare China with India. Young people under age of 25 accounts for 40% of India population, while in China, 11% of population are over the age 60, and that makes China officially an aged society. The gender ratio is also seriously imbalanced. In the year 2006, male/female ratio among newborns is 121/100. That means 20 years later, 1 out of 6 men will be doomed not able to get married.

There is no doubt that such a distorted population structure will have profound impact on China’s economy, and, very likely, on global economy. It troubles me that this issue has not make much louder noise among international policy researchers. The only influential international researcher in this regard is Mr. Leslie Brown, the founder of a Washington DC-based think tank called World Watch Institute. He published a book named “Who will feed China” in late 1990s. Unfortunately, Brown’s opinion went to exactly the wrong direction by claiming that the global agricultural system would be unable to sustain a growing Chinese population. This conclusion, although highly speculative, actually caused panic among Chinese policy makers, and prompted them tightening the family plan policy, besides making other erroneous decisions. 

I believe that we’ll see substantive consequence of Chinese population structure in about 5 to 10 years. It may have already kicked-in. Let me go back to the trade imbalance between China and United States. One reason to the trade imbalance is the extremely high saving rate of Chinese. How can United States increase its export to China if most Chinese just put their money into the bank? By the end of year 2005, total net bank saving of Chinese reached 1.4 trillion RMB, or about 200 billion US dollars. This equals to about 80% of Chinese economy output of that year. Last year the ratio declined a little to 75%, but the total net savings raised to 1.7 trillion. It is said --I have not double-checked these numbers – that the total net saving ranges from 15% to 20% of annual economy output in developed nations, and for Asian nations, where the eastern culture encourages saving, the ratio is between 30-50%. But Chinese saving rate is so high to be explained with the eastern culture. My explanation is that it has something to do with our population structure. You know, middle income class, particular those live in urban area, is the most active spender in a society. However, Chinese middle class in urban area are under the most restricted family plan policy. Today, a typical urban Chinese family tree is obpyramidal, with four grandparents, two parents and one child. And the one child is supposed to support the whole family when all the parents and grandparents become aged. If you were that poor kid, I believe that you’d better consider putting aside more savings. Such a obpyramidal structure, as we all know, is highly unstable. Once again, I am surprised there aren’t more analysts pay attention to this.

3.    Financial system to be upgraded?

The third real issue that may ruin Chinese economic performance is its financial system. I believe modern financial system is one of the two greatest invention in 20th century. The other one is computer and internet. I also believe that, the major reason why China isn’t more contributive to global economy is due to the fact, that China’s financial system remains in the Stone Age although its manufacture sector has mastered the state-of-the-art. I can stand here talk for one whole day how the Chinese financial system stinks. And I tell you: It will be entertaining. So bad that we don’t have time for this. 

To sum up what I put in that article with a few words: China has the most inefficient financial system among major economies of the world. On one side, there are a lot of money there, which we call it “overflow of liquidity”. I mentioned before that Chinese has put aside net bank savings that worth of 80% of the annual output, or GDP (Gross Domestic Product). And Chinese stock market is white hot too. Last October, when Chinese stock market reached its peak, the overall capitalization equals to 105% of Chinese annual GDP. As a matter of fact, Chinese markets is the largest in the world in terms of the money it raised through IPO. In the year 2007,there were 120 IPOs that raised a sum total of US $54.4 billion, that was more than London exchange, $26 billion, and NYSE and NASDAQ, $22 billion, combined altogether. So it is very clear that the money is there. And Chinese government is very concern about that overflow of liquidity, because it is causing inflation.

On the other hand, these overflow of liquidity cannot effectively turn themsself into investment into private sector, particularly, investment into small business. But small businesses make up the major share of Chinese economy. They account for seventy percent (70%) of China’s industrial output and about seventy-five percent (75%) of the non-farm employment. More important, small business is also a good in`gredient to the solution on issues I talked about, the issues of income disparity and population structure. Small business hire more people than huge enterprises, on each dollar they make. Small business also pay better. A strong small business section usually means a booming mid-income class. Also, small business tend to involve more senior employees than big companies, because a lot of them are family business. Parents and grandparents are happy to work there. That helps to ease the tension of an obpyramidal population structure. 

But small businesses in China face a tough financial situation. You know a lot of people asked me whether Chinese stock market is a bubble. My response is that whether it is a bubble is not as important as whether it will leave some real mark on economy. The internet bubble was a bubble, but nevertheless when the bubble busted, we got great companies like Yahoo, Google and eBay. Unfortunately, the inefficiency of Chinese financial system makes Chinese stock market, no matter whether it is a bubble, irrelevant to daily business. You see all the money there speculating on public stocks, but it doesn’t support much of the growing companies who desperately need funds, especially small businesses. And that leaves Chinese small businesses to rely heavily on bank loans for their capital needs. A survey conducted by the Central Bank of China in 2003 said that, for small businesses, 98.7% of their external capital came from bank loans. At the same time, it is estimated that only about 7-8% of all bank loans go to small business. This paradox, the co-existence of liquidity overflow, which may cause severe inflation, and under-funding of small business, who make up the majority of Chinese economy, will surely hurt Chinese economy.

4.    Conclusion

Now let me revisit the main point of my argument. China has been the fastest growing major economy in the world for more than 2 decades. That could have changed the dynamics of global economy drastically, but the fact is, China has not brought much positive change besides being a source of cheap commodities. This is not good for China, and is not good for global economy. One reason is that the West World has, for one reason or another, intentionally ignored China as a potential partner. Only in the most recent years we haven’t heard much talks about “containing China”, and people has started talking about integrating China into global economy. But so far, there haven’t been any major policy initiatives to execute on that concept.

The United States, as a bad exemplar, still set focus of its economic policy to China on “trade issues”. Two month ago, United States and China had a senior level forum in Beijing, China. It was led by US Treasury Secretary Henry Paulson and Chinese Vice Premier Madam Wu Yi. It was called US-China Strategic Economic Dialogue. However, most things US side raised at that meeting is not “strategic”. Guess what Mr. Paulson talked about? You are right. He talked about intellectual property rights, more market access, and, of course, more appreciation of RMB. And Madam Wu Yi, for sure, rebuked US about its restriction on high-tech export. As a matter of fact, this meeting is so lack of strategic feature, that the Associated Press actually reported it as a “trade talk”.

What makes things worse is that China is going to tighten its monetary policy, i.e., to decrease the supply of funds on the market. This is, as I mentioned above, per the concern of liquidity overflow and inflation. The negative side is that a tight monetary policy will hurt small business the most. But China has its reason to a tight policy. China announced this policy one week before the US-China Strategic Dialogue. Why? Because they knew, and everybody knew, that United States was loosing its monetary policy. The day before the Dialogue, Fed, under the “leadership” of Bernanke, cut the rate by one quarter percent. And soon after the Dialogue, it cut the rates again, this time by three quarters.

Now you see what I mean. This is the largest economy, namely, United States, in the world. And this is the third largest economy, China. And they are each other’s  largest, or second largest trade partner. Not to mention the fact that China holds a huge forex reserve of US $1.4 trillion, of which 70% are put in the denomination of US dollar. And still, these two great economies adopted monetary policies at the same time, exactly to the contradictory direction. One wanted to offset the effect of the other. Is it just me or you see something wrong too?

I don’t hold any romantic expectation on US-China collaboration. Efforts to coordinate monetary polices will not achieve until the two governments share more values and have more mutual trust, what is an unrealistic scene in the near future. However, this shall not become an excuse for leaders to ignore the enormous potential of common interests in fundamental areas. Without toughing base on core issues, it will be nothing but an empty promise when Washington speaks about making a responsible world power out of China.

Thanks very much for your cooperation to hold on to your lunch. Now if you can hold on a few more minutes. I can take some questions.