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Making sense of China growth numbers

An international comparative perspective is useful in assessing China’s growth
performance. So far the record holders of high growth are Taiwan and Korea,
which have experienced high economic growth lasting for about 40 years. Japan’s
high growth period lasted for 18 years. By comparison, China’s high growth
period has so far lasted 27 years. This puts her ahead of Japan, but still short of
Taiwan and Korea.

China’s high growth has been achieved through high rates of fixed capital
investment and of export growth caused in turn by a large amount of foreign dir-
ect investment. In addition to the equipment and machinery investment, the fast
pace of infrastructure build-up and investment in real estate and urban housing
construction (induced by rapid urbanization) have contributed to China’s high
investment ratio. The trinity consisting of local governments, developers, and
four state-own banks, has been one of the main propelling forces behind this
investment spree.

China’s high economic growth and rapid urbanization have however given rise
to some new contradictions that cannot be ignored. Among these are: (a) decline
of the rural economy (especially in inland and mountainous areas, which are trad-
itionally not rich), manifested in large-scale depopulation (b) emergence of a class
of landless peasants, and (c) emergence of urban poor, including peasant migrants.
These contradictions have already graduated from being economic problems into
becoming social problems. Unless the government deals with these problems,
these may turn into political problems. In fact, the number of various distur-
bances has been increasing over the past years. More than half are related
to land expropriation by governments and developers. It will be difficult for China
to sustain high growth without resolving those newly emerging contradictions.

Changing population dynamics will also affect China’s economic growth pros-
pects in the near future. There are three anticipated changes. First, new supply
of young labor will decrease sharply in the near future owing to the continued
enforcement of the “one child policy” and the rapid spread of education at senior
high school level and above. The growing tightness of the labor market finds
manifestation in the fact that wages have been rising since 2002. This is bound to
affect China’s exports. Second, the Chinese society is aging at the fastest rate in
human history. Taking care of the aged, who will now comprise a higher propor-
tion of the population, will entail a greater financial burden on the government
and the society. Third, the total population of China will reach a stationary state
around 2020, much earlier that previously projected.

In view of the emerging contradictions and the population dynamics, it is
necessary for the Chinese government to bring about changes in its policies. In
particular, it has to change the financial redistribution system, which has so far
favored the trinity comprised of local governments, developers, and state-owned
banks, and make it work more in favor of the poor and the needy. At the same
time, China needs to change her industrial policy to make it more congruent
with the goal of sustainable development.

Future prospects seen from the viewpoint of population dynamics

It is necessary to emphasize two points in making judgments about China’s long-
term future. The first is the rapid ageing of the population. Internationally, a soci-
ety is said to have become an “ageing society” when the ratio of the population
above 65 years of age to the total population reaches 7 percent. When this ratio
crosses 14 percent, the society is called an “aged society.” In comparison with
Japan, which is considered to have become an aged society at the fastest pace,
however, China may soon surpass Japan’s record. Shanghai is already approach-
ing Japan in this regard.

In earlier article, depopulation of Chinese rural areas caused by exodus
of the young, we observed that 73 percent of county and county-level cities have
already entered into a depopulation phase. Taking care of the older folks left
behind in depopulated rural areas is therefore emerging as a serious new prob-
lem. Since urbanization has proceeded so rapidly, China as a whole has not yet
prepared itself for tackling this emerging problem.

It also needs to be emphasized that according to the projections, China will
reach a static population stage some time between 2020 and 2023. Many Chinese
scholars on population issues anticipate that the population will stabilize in or
around 2030, at a level of approximately 1.6 billion. However, we think that this
projection involves overestimation.

If we look at the changes in the total fertility rate of Japan and China,
approximately 30 years or so after the total fertility rate falls below the 2.1 line,
the population of a nation begins to decrease. Japan’s total fertility rate fell below
2.1 in 1974, and in 2005 its total population began to decrease. China’s total
fertility rate is now around 1.15, a figure far below Japan’s 1.25 in 2005. China’s
fertility rate seems to have fallen under 2.1 around 1993, although the statistics
are not always accurate. Taking these points into consideration, we think that
China’s population will stabilize sometime between 2021 and 2023, at 1.52 bil-
lion. Thus, China will arrive at the stationary stage of population earlier, unless
the Chinese government changes its “one child policy.”

These two factors, namely rapid aging of the population and cessation of popu-
lation growth, will work to slow China’s economic growth down. One important
policy for avoiding a fall in the economic growth rate in the coming 10 to 15
years is to implement in China’s financial system a drastic change aimed at redis-
tribution of the dividends of the rapid economic growth to the poor and poor
areas. This policy will require a struggle against the current formidable trinity of
local bureaucracy, developers, and state-owned banks.

Two factors slowing down export expansion

There are two factors that may potentially slow down China’s export expansion.
One of these is the possible appreciation of the value of the Chinese currency
Yuan, by at least 10 to 20 percent in the near future.

The other factor is the rise in wages. During the rapid economic growth periods
in Japan, Taiwan and Korea, land prices, wages and retail prices rose simultan-
eously. In China, though land prices in urban areas have generally increased,
retail prices and wages have not kept pace with this increase. However, this is
changing. If we compare the annual nominal GDP growth rate and annual
increase in the nominal wage in urban areas, we see that since 1998, the annual
rate of increase in wages has surpassed the nominal GDP growth rate. It is to be
noted that this happened 20 years after rapid economic growth started in China
in 1978. Such a long delay in rise in wages was possible because China had a large
surplus labor in rural areas.

Until 1998, wages rose only for high-class staff or skilled laborers, or in new
industries, such as finance, real estate, and media, but not in manufacturing. The
wage levels in export industries, such as textile, miscellaneous industries, and
even electronic appliances, have remained unchanged. With the beginning of
the twenty-first century, this situation has changed. A general labor shortage is
surfacing. This represents the effects of China’s one child policy and the spread
of compulsory education. If we check out official projections about incremen-
tal labor supply in China up to the year 2010, we see
a gradual decline leading to a negative value in 2010. Anecdotal evidence also
points to the emergence of a situation of labor shortage in certain parts of China
For example, in 2004, the regulated minimum wage was
raised by 20 percent to 40percent in many cities. Most observers agree that since
2002 Guangdong area has been experiencing a shortage of young labor, and this
shortage is gradually spreading to the Shanghai economic zone.

These two factors, namely the appreciation of yuan and the increase in
wages will surely raise the cost of export unless China is able to implement
technological innovation at a sufficient pace. China is now at a turning point,
where it may no longer be possible to increase exports on the basis of low
wages alone.

Declining efficiency of fixed capital investment

If we look at the efficiency of fixed capital investment, measured as additional
GDP divided by total fixed capital investment undertaken in that year, we see
that fixed capital investment efficiency has declined over time. While the effi-
ciency measure ranged between 0.7 and 0.4 until mid-1990s, it has since declined
to values ranging between 0.3 and 0.1 in more recent years.

This decrease may be a result of wasteful and lavish designs in public infra-
structure projects. Roads, for example, are planned so that each side has three
lanes, then a green belt, and then one or more extra lanes, sometimes for tractors
or bicycles. What is more, gorgeous memorials can be found at each crossroad
or roundabout. However, there are often very few cars on these roads. Similarly,
Chinese local governmental office buildings are often larger and more splendid
than those of the Japanese central government! Different local governments seem
to be competing with one another in terms of grandeur and lavishness.

How is it possible that the Chinese local governments can construct such big
and gorgeous roads and buildings? One possible reason is that they do not have
to pay for the land they acquire for the construction purposes. This is a form
of institutionalized wastage. This system lowers the efficiency of fixed capital
investment.

Structural Contradictions: Landless peasants

If we compare rural-urban populations, since 1990s, the annual growth rate of
urban population in China has been 4.8 percent or more. This is fairly high by
international standards. Such rapid urbanization automatically
leads to expansion of urban city areas. It is estimated that a 1 percent increase in
urban population leads to an expansion of urban area by 2.26 percent in cities that
are above middle scale. Gigantic infrastructure projects also require land. How is
the land for such urban expansion and infrastructure construction obtained?
Under the land law, arable land is collectively owned, and cannot be sold or used
for another use. Only if the land is reclassified as to be under state ownership, can
it be legally expropriated for non-agricultural use.

If a town or village devises a plan to develop a certain land area for industrial
or commercial use, it must get administrative permission from a higher govern-
ment level. The level differs depending on the acreage, but it was generally the
county level or the provincial-level government which used to grant the
permission. However, in order to prevent abuses, the central government in 1999
moved the right to give permissions from the county level to the provincial level.
When permission is granted, the land is placed under state ownership. Once local
governments get the permission for development, the peasants on that land lose
all rights and are merely paid a certain sum for compensation prescribed in the
land law. The sum paid for compensation is usually six to ten times the annual
revenue derived from the land. In coastal areas an additional sum equaling to
four to six times of annual revenue is paid for resettlement.In the central and
western areas, the compensation is lower. The compensation is far lower for land
to be used for public use, such as infrastructure or construction of government
buildings. Since arable land cannot be marketed, peasants cannot reap capital
gains. The local governments choose the developers, and when the development
is completed, they sell the land to users. As already mentioned, most of the rev-
enue from sale goes to developers, local governments, and banks, leaving very
little for the peasants. In the case of land for public use, the land price is fixed at
negligible levels. This is one reason for the construction of wide roads and monu-
mental governmental and university buildings in China.

By the beginning of 2005, applications for the development of more than 850
industrial parks or commercial sites had been made by various local govern-
ments, including those of towns. This is because local governments hoped to gain
revenue through land management to pull themselves out of financial crisis. In
1994, the central government introduced a new tax system eliminating taxes that
had been lucrative for local governments. As a result, the financial performance
of local governments, especially town- and village governments, deteriorated rap-
idly. The accumulated debt of town and village governments is estimated to be
about 1 trillion yuan in 2005, equaling to 7.2 percent of GDP. This may be com-
pared with its 1998 value of 326 billion, equaling to 4.1 percent of GDP in that
year. More than 60 percent of these debts are considered to be bad loans. No
wonder that local governments try to generate revenues from land sales in order
to improve their financial position.

This is the background of the emergence of landless peasants. Their
emergence is the other side of the coin of the real estate investment wave. The
number of landless farmers increases as more fixed capital investment is carried
out. Their total number is now estimated to be between 40 and 50 million. They
receive no social welfare support from the central government and have difficulty
finding new occupations, as most of them are over 40 years old. Some scholars
call these people sanwu nongmin (peasants with no land, no social welfare, and
no occupation).

At the People’s Congress in March 2006, the central government decided to
abolish the agricultural tax and to give financial support to compulsory educa-
tion in rural areas. This is an epoch-making step in the Chinese history. However,
these two policies will not be sufficient to stop the immiserization of peasants.
The abolition of the agricultural tax will lead to a further deterioration of the
financial situation of town- and village governments, as this tax was one of their
most important sources of revenue. For many years,
education in rural areas was financed by rural communities rather than by the
central government. Given this background, the new policy represents a step for-
ward. However, it comes too late. This kind of policy should have been introduced
in the 1980s. There is still policy discrimination between rural and urban areas.
For example, people in rural areas have to construct infrastructure at their own
expense and receive no social welfare from the central government. The question
now is whether or not the central government will adopt a policy to redistribute
the gains from high economic growth to the underprivileged classes. If it fails to
do so, the new contradictions will become social or political issues. To prevent
this possibility, a basic financial reform is needed aimed at dissolution of the trin-
ity of local bureaucrats, developers, and state-owned banks.