A warning to Canberra

From the ANU’s East Asia Forum comes this sobering assessment of the challenges facing the Chinese economy:

China recently wrapped up the National People’s Congress (NPC) and Chinese People’s Political Consultation Conference (CPPCC) with the approval of the 12th Five Year Plan (FYP) (2011-2015).

At the top of the new blueprint is a commitment to transforming China’s development model from the current low-efficiency, high-growth model to a more balanced model that seeks to address a whole range of increasingly important concerns. The targets of the new model include economic growth, structural adjustment, social services development, carbon mitigation and environmental protection, and transparency and governance reforms.

Calls for the transformation of China’s economic development model are not new. Since the early 1980s, China has been aiming to improve efficiency, and move from a GDP-oriented, export-oriented model of growth to a ‘well-being’-oriented, home market-oriented, low carbon model. This time the call has different implications.

In the past, calls for a new development model were for marginal improvement of the model. This time, there are two deeper motivations. The first is to avoid potential economic crisis, and the second is to help China reach its ambitious carbon reduction targets. Behind China’s average 9.8 per cent GDP growth lie a host of issues that have the potential to lead to serious problems in the future.

New economic risks and imbalances are emerging beneath the surface of China’s high growth economy. Trade surpluses have resulted in huge foreign reserves, excess liquidity, high inflation pressure, and bubbles in the capital and property markets. High GDP growth has not brought about a proportionate increase in human well-being across society, and public services are facing supply bottlenecks. Regulation and monopolies have unbalanced industry, and while there is an oversupply in the manufacturing industry, there is a shortage of service sector providers, particularly in medicine, education, finance, and banking. Finally, there is now a huge and growing level of risk associated with government debt, particularly local government debt.

If these issues are not dealt with properly, they may lead to real crisis in two ways. First, the risks associated with these issues may simply accumulate until they are untenable. Second, if growth slows down — likely to happen as China’s industrialisation cycle ends — the problems that are now hidden will be plain for all to see.

Rapid growth has also brought about rapid environmental degradation, a fact that makes China’s shift to a low carbon economy increasingly imperative.

China must achieve two transformations. First, it must take the economically and socially ‘balanced’ model of high-income Western societies as a benchmark. But this is not enough. All countries, including China, need to initiate low-carbon growth, both to lower emissions and to deal with fossil fuel depletion. The 12th Five Year Plan has set a target for reduction in carbon intensity by 17 per cent, and an increase in the share in consumption of renewable energy options. This is in the broader context of China’s 2020 goal of reducing carbon emissions by 40–45 per cent.

China sports distinct advantages in the move to a low carbon growth model. The transition cost will be lower for China than for advanced economies, as it is not locked into a high carbon model to the same extent. It also does not face a competitive disadvantage relative to advanced economies in ‘green’ industries. Green technology levels are relatively similar in the developed and developing worlds. China has a dynamic economy, and it has the opportunity to continue to feed growth with new renewable energy industries.

In his report on the NPC and CPCC, Premier Wen Jiabao urged the government to ‘comprehensively deepen the reforms and open up,’ and ‘to further enhance the governmental reform.’ In the past, calls to transform China’s development model have been unsuccessful as there has never been an attempt to enforce these calls to action. Now, there is real impetus for change. The potential crises hidden in the current development model are being more widely recognised.

If these challenges are responded to properly, then China may be able to achieve even higher growth in the future. China still has a long way to go to catch up to the Western world in terms of per capita GDP. China needs this transformation to be successful for it to continue to grow and deliver higher levels of welfare to its people. Thus, the 12th Five Year Plan is not just a domestic issue; it is an issue for the rest of the world as well.

Yongsheng Zhang is Senior Research Fellow at the Development Research Center of the State Council (DRC), PRC and Professor of Renmin University of China.

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.


  1. In the short term, the biggest threat to the ‘China story’ will happen in May. From what I have read about the US political situation right now, the debt ceiling will not be extended. The US House Republican is going to play ‘political chicken’ with the issue.

    The debt ceiling will eventually be raised, however the China may lose faith in the US Government and start dumping US bonds. Thing wills then get very ugly for everyone.

  2. In my view, this is just sabre rattling. Ask yourself, is it in China’s interests to dump the $US and bring on a double dip recession? No. Is it in China interests to precipitate a $US crisis? No. Is it ready to float the yuan? No. Is a sudden correction in the Chinese surplus in its interests? No.

    • China needs the US. The US needs China simple as that. Either one trys to F$%K the other one the whole world economy goes to S#$T. You can argue all the stats and crap you want but it is simple as that. Its catch 22 all the way. Australia, UK, Brazil, Japan etc economies are nothing compared to the US and China. When the US and China quit playing chicken with each other then the world might rebound and really take off again.


    • It’s Chinas way of saying; “Tim, Ben sort your shit out, we’ve had enough of your inflation exporting crap policies.”

    • China does certainly need the U.S for the foreseeable future; however that relationship is far from solid. The moment China can divorce itself from the United States without seriously impacting the world economy it will. The fact remains that the U.S will continue to play a massive role in the direction of the world economy at least for another 20 years, so China will be unable to do so any time soon.

      China has begun to take more of interest in European bonds rather than those of the United States even buying up Spanish and Greek bonds. The fact that China is buying up almost toxic European debt at the same time it is deleveraging itself of U.S debt certainly gives us a bit of an indication of the feeling in Beijing of the future of U.S bonds. If the Chinese government feel more confident in Greece being able to service and more importantly pay back the debt than the U.S there are certainly storm clouds brewing on the horizon for the United States.

      • Tarric,

        China wont be a major player in 20 years as they will have screwed themselves like the Japanese did and will be in the same mess. Read Arthurs comments below which are spot on.

    • H&H,
      From a purely financial standpoint, you are absolutely right. The chinese are not so stupid as to shoot themselves in the foot.
      However….there is another dimension to this symbiotic relationship that has developed between the largest communist state in the world and all them thar capitalists (strangely enough, the commies look more like capitalists now than the capitalists do).
      That other dimension, of course, is sovereign power (that is, of the muscle-flexing kind). China is a large economic power, but it is also a large military power – one that marches to a different political drum – and in the years to come, as it tries to improve the lot of its 1.5 billion or so citizens (mainly chinese, I believe) it will need resources, territory, and maybe even the odd heart and mind. Now it could, of course, do all this through the barrel of a gun, as one of its erstwhile late leaders once espoused. Alternatively, it could achieve some of the more difficult and competitive objectives by the turn of a much simpler mechanism, sometimes known as a thumbscrew, but often applied to other parts of the anatomy.
      As a US general once said of Vietnam “When you’ve got them by the short and curlies, their hearts and minds will follow”.
      Well, now, who’s got who by the financial short and curlies now, I wonder?

      • George as far as military situation goes, China is an insect compared to the US and their army is hardly a professional force. My sister-in-law who served as a captain in their military certainly agrees with me on this one. check out how much of their budget is spent on defence and you will soon understand. China is not stupid, I think they know a military power is an irrelevant bygone tool these days. Technology and businees are the tools they wish to use to have their empire and I think that is the smart move.

        • Yes, Harold,
          That is why I thought I made it fairly clear in my post that China was more likely to use the thumbscrew rather than the gun. The point I was trying to make, perhaps not as clearly as I should, was that although the economic linkage to the US is important to China, it will not necessarily be the defining factor in the years to come. I can’t see China happily playing loan-shark and second fiddle to the US forever. When that day comes, I doubt that the current economic interdependence will be a a deal-breaker, and if it is, it is quite possible that the US could come off second-best.
          Incidentally, my reference to military power was not solely concerned with the size, or even competence, of Chinas army. Conflicts today are often fought, and sometimes won, with few boots on the ground – evidence the current use of the predator drones, spy satellites, so-called smart bombs, and the like. I don’t think the Chinese are likely to be slouches when it comes to the development of military technology – although a couple of million blokes with guns does help as well.
          And one last point – it takes money to run a defence establishment – something the US is a tad short of at the moment. Which I guess is why Obama is proposing cuts to military spending.

    • If the US Government cannot behave like ‘grown ups’, you can expect a bill to stop interest payments on bonds owned by the Chinese until China float the RMB.


    • Yep ,Their as weak as Bruce Lee and as hopeless as the Last Olympics….
      Hows your feet…Arthur.
      cheers JR

    • Arthur,
      If you’re going to hang around and wait for the chinese cheques to bounce, I suggest you muster up a comfy sleeping bag, and a semitrailer load of hamburgers and VB. Oh, and if you’re going to wait for their foreign reserves to run out, I’d make that two semitrailers.

      • Dave From Pakenham

        George – i would start thinking about china’s reserve’s as a proxy for their NPL’s – perhaps a mirror of.

        So in your parlance perhaps a ute would suffice!!

  4. Didn’t the May say the world ends in 2012?
    Maybe after all it was that a new aera is coming when china and the US are falling apart….

  5. Interesting view points, I’ll throw another one out there….If I was China.

    Firstly I understood the US is NOT China’s No.1 customer, Europe is and why China is actively purchasing bonds of Spain etc supporting the European economies.

    If I was China I wouldn’t want to raise the currency against the US to stem the effects of Inflation, as a rising currency will mean a loss of further exports to Europe and may increase unemployment and worsen social unrest.

    Secondly I would unload ‘all’ my US held reserves. Unfortunately this will place further pressure on the US dollar. Unless the US did something like relinquish trading commodities in US dollars.
    If commodities are traded in Yuan,SDR’s or commodity backed currency instead of US dollars, this may benefit China and possibly relieve inflation in other countries.
    The effects of past and future QE would predominately be confined to the US, as the unwanted US currency would flood back into the US.
    What are the chances of the US relinquishing the reserve status….buckley’s, at least not without a fight. That would be relinquishing, in the words of Jeremy Clarkson, powwwer.

    Fanciful, maybe, but after reading about the history of money in the US from the early 16th Century,anything is possible. (wet long weekend)

      • LBS
        Yeh i know, i see that as well.
        I’m thinking in the short term a crash, but after that, won’t see em for dust.

        Andy Xie givhttp://english.caing.com/2011-04-22/100251567.htmles a good account.

        “A hard landing in China would bring down commodity prices and reduce inflationary pressure in the United States. Hence, the Fed’s policy is sustainable as long as China fails to handle domestic inflation.

        Even if China does have a hard landing, though, it would be back on its feet in a couple of years. It’s unlikely that the United States will be able to resolve its problems quickly.”

        Unless Donald Trump becomes President…(joke)

        • China and their economy wont become a world power until their people start consuming/spending and they are a long long long ways off from that. Until then their govt cant keep printing and spending money like they are now on malinvestments. It will run out and they cant defied the fundamentals of economics. Japan, USSR, Europe and US have never defied the fundamentals of economics and China is no different. If they crash they wont get back up that quick. They need internal consumers to spend otherwise they are throwing money out into thin air.

          • LBS,

            There are a couple of economies that have encouraged their citizens to spend and consume over the last 10-15 years. They are the USA and Europe – and look how well it has all worked out for them of late.
            Granted, China needs a middle-class that provides a domestic market for their otherwise export-dependent industries. But they would be making a big mistake if they emulate the western economies, where consumption now constitutes over 60% of the economy.
            If the west continues on its current path, it will know only how to consume that which is made by others, and lose entirely the ability to make things for itself.
            A very dangerous situation indeed.

      • LBS and mrobbo,
        Both interesting articles – and probably grains of truth in each.

        It’s interesting that the detractor in IBTimes article cites:
        “Moreover, the economic model that propelled China’s prosperity for the last few decades was based on debasing their currency and selling cheap goods to the US. So if China’s economy depends on US consumption, how can its size ever overtake the US?”

        Yet only a few paragraphs earlier he berates the IMF and world Bank:
        “Economists at institutions like the IMF and World Bank have little imagination and assume that current conditions will continue indefinitely. Their “projections” should be more aptly named “adjusted extrapolations.”

        Now I wonder who is really demonstrating a lack of imagination, and simply extrapolating the status quo? Isn’t looking back over the last couple of decades, and assuming that the same situation will prevail into the future just a tiny bit unimaginative?

        Has this bloke ever heard of Africa, North and South Asia, and South America? Does the more than 50% of its trade that China conducts with Europe count for nothing in the face of American purchasing power (what’s left of it)?

        To me, the most telling comment is in the Market Watch report:
        “We have lived in a world dominated by the U.S. for so long that there is no longer anyone alive who remembers anything else.”

        It has been very, very different in the past, and there is no good reason why it won’t be again in the future.

        China was already a very wealthy country, and the chinese were consumate worldwide merchants and traders, long before Christopher Columbus was playing with toy boats in his bathtub.

          • Wow! Not bad for a bunch of insects, eh Jason?

            Speaking of military insects – I recall a news item sometime in the recent past – apparently China had a satellite of some sort or other that had reached its use-by date – rather than let it crash and burn, as is the usual procedure, the Chinese decided to shoot it down – while it was still in space. Of course, there were some who said they were doing it simply to prove that they could – well, they got that much right at least.

            There’s absolutely no doubt that China will run into many speed bumps along its way, as has every other developing society throughout history – but the overall trajectory is now set in concrete. Let’s hope for all our sakes that the destination is somewhere we’re all happy to be.

            Thanks for the link – no doubt the list will grow in the years to come.