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Study Notes

Risks for the Chinese Economy

AS, A-Level, IB
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 29 May 2017

Here are some notes on the following essay question: “The risks to China’s economy today are a price worth paying for the successes achieved over the past 30 years” To what extent do you agree?

Former Premier: Wen Jiaboa speaking in 2007 was quoted as saying "China is unstable, unbalanced, uncoordinated and unsustainable.” To what extent are the risks facing China a price worth paying for the successes the country has achieved over the past 30 years?

Risks for China

  • Identify some of the risks facing China
  • Distinguish between short-term and longer-term risks
  • How significant are these risks? Which risks are most important?
  • How can Chinese policy-makers address these risk factors?

Short term risks for China

  1. Bursting of the credit bubble - huge levels of household and municipal debt / over-heating housing market - China's debt to GDP ratio rose to 277 percent at the end of 2016 from 254 percent the previous year. Expansion of shadow banking makes it hard to assess scale of debt / credit risk. China may be long overdue for a banking crisis although not perhaps the same as Lehman et al in 2007-08 - the financial system will not collapse because it is state-owned
  2. Slowdown in economic growth - there are many challenges of adjusting to a new normal economic growth rate of between 4-6>#/span###
  3. Over-capacity in Chinese economy and the drag from zombie state-owned enterprises - feeding into stalling productivity and risk of price deflation.
  4. Risks of a housing crash - what has driven the Chinese economy is largely construction - it has become one of the main engines of the Chinese economy. First tier cities are still booming with housing demand exceeding supply, but there are some cities with large excess supply.  
  5. Falling currency (Yuan) and risk of capital flight as investors get nervous - the Yuan fell nearly 7 percent in 2016, making it the worst performing major Asian currency.
  6. Protectionist threats (perhaps now dissipating?) from the Trump administration - in part from Yuan weakness - protectionism e.g. EU response to allegations of Chinese steel dumping will hit an export sector that is already slowing down. Risks of trade war - a chance to bring some game theory into the answer!

A good read: McKinsey: 

Statistics on UK trade with the Chinese economy

Medium to long term risks for China (structural vulnerabilities)

  1. Demographic challenges - China has a fast-ageing population, reaching the Lewis Turning Point (leading to high wage inflation) - note the collapse in fertility - 11.3 million children were born in China in 2015, down from more than 13 million in 2012, in large part because of a decline in the number of women of child-bearing age, a trend that will continue. This compares with more than 25 million births in India.  
  2. Environmental risks - growing scale of pollution crisis, water scarcity already known but likely to worsen considerably - environment is a big driver of current policy-making
  3. Economic imbalances - regional issues, over-investment and under-consumption, the long term effects of financial repression e.g. growth for too long has been funded by cheap credit and a very high rate of household saving. China wants to become an advanced economy, but her financial system is not robust enough. The banking system us fragile and will require a clean up (scale of non-performing loans is much higher than official figures suggest)
  4. Social tensions linked to rising inequality - rising expectations from middle class, criticism of corruption, bottom 40% not benefitting fully - Bureaucracy, corruption, and a lack of transparency are key obstacles to conducting business in China
  5. Competitive challenges from other emerging Asian countries including Vietnam and also from sub-Saharan Africa and fast-growing India

A good read (PWC):

Successes achieved over the past 30 years

  • Millennium Development Goals all achieved
  • Cutting extreme poverty / rising per capita incomes
  • Increase in relative living standards / improved HDI outcomes
  • Rising share of world output  - China is the biggest economy in 2016 by GDP (PPP)
  • External trade surplus, expansion of sovereign wealth funds, China a net donor of aid especially to African countries
  • Rise of globally scaled businesses / Chinese MNCs - e.g. Huawei is now the world's top maker of wireless and fixed-line telecoms equipment,
  • Increasing soft power and voting rights in world institutions such as the World Bank and the IMF, China driving new organisations such as the Asian Infrastructure Investment Bank and may replace the USA in leading the Paris Climate Change Accord

UBS Analysis on China:

"As the country transitions to a consumer-led economy, its savings rate and trade surplus are declining. These changes contribute to a need for more foreign capital. As part of this drive, the government has made its exchange rate more flexible, and early this year unveiled a further 20 measures to reduce regulation on foreign investors."

Addressing the challenges

  1. China’s key challenge is to re-balance the growth model and deal with excess capacity in her economy
  2. China is seeking to move up the value chain - they have a number of targeted sectors including renewable energy, micro-chips including industrial robots, e-commerce
  3. China has the macro policy tools and resources to put in place shock absorbers and lower some of the risks - for example, it runs a current account surplus, has low external debts and still huge foreign exchange reserves
  4. People’s Bank of China can cut monetary policy interest rates if needed and use capital controls to manage currency volatility
  5. 13th Five Year Plan is an important landmark in changing the quality and composition of growth and development in China + end of one child policy, tougher anti-corruption drives, moves to introduce carbon trading, an expansion of green financing, big increase in renewable energy investment
  6. Key aim is to shift output towards services - one implication of this is that services are less trade-intensive than manufacturing

An essential read! Graham Watson:

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