commentary

(Shanghai Daily)

September 27, 2004

China Shows Advantages of Accessible Economy

by William H. Overholt

Why has China’s economy continued to grow fast during the past 20 years, even when the world economy cools down?

One reason is that China has shifted to domestic-led growth. All the Asian major companies have initially been driven by exports, but since the late 1990s China shifted focus to domestic housing, retail sales, automobiles and infrastructure.

Americans tried to persuade Japan to make that shift back in the 1970s. When the Japanese government intended to in 1986, their domestic politics made it impossible whereas China made it — quickly as well.

The second reason is China’s economic openness to the world. China is a much more open economy than Japan.

This provides two benefits. One is that an open economy becomes very flexible and accustomed to adjusting to world market changes. The other benefit is that it is more open to foreign direct investment. Some other Asian countries rely heavily on foreign borrowing rather than direct investment. When there’s trouble in the economy, bank loans cease and stock investors flee. But direct investment in factories and stores does not flee. China has more of that, so it is more immune from international financial crisis.

The third reason is China’s institutional globalization. China has been very pragmatic about looking around the world and saying: “What is the best practice? We’ll take that.”

For instance, the structure of the People’s Bank of China is following the model of the US Federal Reserve. And the growth model is similar to that of South Korea.

This is what Japan did more than a hundred years ago. They sent delegations around the world and decided to take Germany’s education system, the British navy model, and so forth. All these accelerated Japan’s economic takeoff. But since then they have become a more rigid nation.

A fourth reason is that China embraces competition. For instance, in the mobile phone industry, China has been introducing foreign and domestic competition, while India followed the traditional model of supporting home companies. As a result, at the end of 2002, China had 200 million mobile phones, while India had only 10 million.

The fifth reason is that China has become an entrepreneurial society. Some of the early entrepreneurs created an explosion of entrepreneurship in both rural and urban areas, and the government has been supportive.

This means thousands of people are willing to seize any opportunities to develop enterprises.

The final reason is that although the central government once relied heavily on state-owned enterprises, it now tries to keep its distance from big enterprises and at the same time impose big reforms. But in many other Asian countries, the government is closely related with bug corporations, which restrains the government from carrying out reforms.

Despite the above achievements, there are also challenges for China’s further development.

First some bubbles have been created with excessive money lending. China’s bank lending doubled last year. No bank can safely increase its loans that fast. If the problem can’t be handled properly, serious financial problems are possible in the next three to five years because of non-performing loans, or NPL.

This is also related with the second problem – the banking system. Sooner or later, China’s banking system needs radical reform.

The third problem is about budget. China has had a wonderful experience of rapidly rising revenues. Fast economic growth, rising rates of tax collection, etc., have helped revenue to increase 17 to 22 percent annually. But several years from now, when problems come together — the NPLs of the banks may have to be paid by the government, and pension funds, healthcare, social security, and rural development all need to be funded — the budget will be squeezed.

The final issue is the process of social adjustment. In the past 20 years, China has had very different decisive leaders with a lot of difficulties in terms of economic and political reform. That process has been so successful that people have almost taken it for granted. China’s fast economic growth depends on reform, as reform reallocates the economy’s capital and labor. This produces social stress and requires political decisiveness and social sensitivity.

China today has huge advantages and huge problems. It is like a running man chased by a lion. If you focus on the man, he is running very fast. But if you focus on the lion, the man will likely be eaten by the big cat.

William H. Overholt is Asia policy chair at RAND Corp. in California.

This commentary originally appeared in Shanghai Daily on September 27, 2004. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.