China's Challenges for 2011

By George Magnus Dec 28, 2010 4:05 pm

Here are just five major issues facing China for 2011 and beyond.

George Magnus is the author of Uprising: will emerging markets shape or shake the world economy? (John Wiley, November 2010) and Senior Economic Adviser, UBS Investment Bank.

In 2011 and beyond, China’s leaders will have to address two huge challenges. They must decide if and how to pursue an economic transformation, based on economic and political reforms that go beyond any unleashed over the previous 30 years. And they will have to judge how to balance the projection of power abroad with the exercise of constructive global leadership.

Almost everything China does nowadays impacts large regional neighbours, and countries further afield, including the US. Consider five major issues facing the Chinese Communist Party in the coming year.

First, although the economy is likely to continue expanding at about 9% in 2011, the expansion is also bringing rising inflation. Consumer price inflation, which was -1% a year ago, is expected to cross this threshold in the next few months. The official explanation that food prices are the culprit denies any role to exceptionally easy monetary and credit conditions, persistently above-target loan growth and negative real interest rates. Property price inflation has slowed to about 9% following restraints in home financing, but the volume of housing transactions remains undiminished, and prices continue to advance to new highs every month.

It is widely expected that the Peoples’ Bank of China will increase interest rates during 2011, but it’s also doubtful that it will be allowed to risk the tempo of economic expansion so soon before the Party leadership changeover in 2012.

Second, the Twelfth Five Year Plan, which will be approved by the National People’s Congress next spring, emphasises, among other things, economic rebalancing, higher wages and rural incomes, and a $1.5 trillion investment boost in strategic and high end manufacturing industries, low carbon technologies and alternative energy.

Reading between the lines, this amounts to an ambitious programme of economic transformation that shifts income formation and vested political interests from companies to consumers, cities to countryside, coastal regions to hinterlands, and older to newer industries. It would be surprising if such ambition involving disruptive change did not fall prey to factional bickering and occasional inertia. The longer China’s transformation is delayed, the greater the risk of economic instability in an economy that has become too reliant on investment, under-priced capital and repressed exchange and interest rates.
Third, 2011 will mark the year when China’s extensive demographic transition will begin. By 2050, China will be older and more age-challenged on every important measure than the US. The ten workers that support each person over 65 today will have become 2.5, and the absolute numbers of those aged under 25 will decline by about 140 million, while those aged over 65 will rise by 220 million.

These glacial changes, however, need to be anticipated and acted upon early, as the consequences include lower trend growth, higher labour costs (already evident), inadequate social protection, and because of the chronic gender imbalance, social problems deriving from a surfeit of young men, and a weakening of ‘guanxi’ or family enterprise networks, which account for a high share of jobs.

Fourth, internal tensions within the Party are likely to accompany the transfer of power to new leaders in 2012. The new leader-in-waiting to replace Hu Jintao, Xi Jinping, is thought to be a safe pair of hands, but no radical reformer. This could result in more pronounced differences between those who favour faster economic and some political reforms, and those who are sceptical about reform altogether. China’s politics may be more hidden from view than those in the US, but they may be no less fraught, and no less likely to lead to policy procrastination.

Fifth, the New Year may reveal more of what the Japanese Foreign Minister called the “essence of China” after the recent fishing boat incident in the disputed Senkaku Islands. He is not alone. The US, India, South Korea and other countries all have concerns about China’s growing economic and geo-political influence in and around the South China Sea specifically, and in a wider global context too.

For example, in G20 economic, financial and UN climate change negotiations; and in China’s pursuit of resource access and security in the Middle East and Africa. But there is more to being a benign superpower than having a ton of GDP and foreign exchange reserves. With power comes the responsibility of leadership, and China hasn’t yet figured what this means, or if it wants that responsibility. The Washington Consensus as the lodestone of the global system may need a reboot, but the conclusion that a Beijing Consensus is already replacing it is premature, and probably wrong.

China has weathered the financial crisis and its aftermath well. Fast growth and strong finances testify to the success of economic policy at home, which, in turn, feeds the soul of self-confidence and assertiveness in international relations that has been much in evidence recently. Yet China is not immune from a post-crisis world system that is going through the equivalent of a regime change. The contours of this system are nowhere near as certain as they’re often self-servingly portrayed, and will be determined in part by how China responds to the awaiting challenges.

http://www.minyanville.com/businessmarkets/articles/china-emerging-markets-political-reform-economic/12/28/2010/id/31910