China: Is China heading for a crash?

Rapid economic development over 20 years led some commentators to claim China could deliver sustained global growth. But it has started to falter, and risks becoming a destabilising factor in the world. And the dramatic growth has created vast inequalities within this vast country.

China, for two decades the world’s fastest growing economy, has become a major force in the global economy. But as the ostensibly ‘communist’ regime in Beijing struggles to put the brakes on an economy which is experiencing an extreme form of overheating, euphoria among the capitalist class internationally has given way to nervousness. As Steven Roach, chief economist at investment bank Morgan Stanley, warns, "the world may be unprepared for the impact of a Chinese slowdown".

Last year, according to official statistics, China’s gross domestic product (GDP) grew by 9.1%. For years, independent economists have viewed official Chinese statistics with scepticism, believing them to be exaggerated. Today, many believe the figures understate reality – the economy may have grown by 11 or 12% in 2003. One reason for the discrepancy is that city and provincial governments are playing down local growth data in order to avoid penalties from Beijing aimed at reining in overheated sectors such as property, steel and cars.

Investment in new steel capacity rose by 87% last year and total output is set to double – again – in two to three years. The director of a stainless steel mill on the Yangtze river, owned jointly by South Korea’s Posco and China’s largest private steel company, Shangang, told the UK Financial Times: "Do you realise, that in a few years this complex alone will be making as much steel as the whole of France?"

The steel sector is an example of the uncontrolled expansion of capacity taking place throughout the economy, much of which is ‘blind’ or ‘duplicative’ according to the government. This is creating huge imbalances: chronic shortages of electricity, water and raw materials. Blackouts, often forcing factories to halt production, are commonplace even in the most developed cities.

Despite huge investment in recent years, road, rail and port capacity is overloaded. These shortages are being exploited by capitalists and corrupt officials for huge speculative gains. Shipping costs for freight in northeast Asia rose by 400% last year on the basis of surging Chinese orders, with scrap metal, coal and iron ore for the steel industry accounting for half this sea-borne traffic.

While mining and energy transnationals made bumper profits from the Chinese boom, other branches of the world economy have been squeezed by higher prices for raw materials. Just months after President Bush lifted his controversial tariffs on steel imports, there are calls from US industry for ‘export tariffs’ to stop all the steel leaving the country!

Another 20 years?

In December 2003, Martin Wolf in the UK Financial Times asked: "Can China continue to grow at anything close to current rates for another two decades, or even more? The answer", he added, "is a resounding Yes". This echoes the prevailing view of the Chinese regime. Recently, however, media comment on China has struck a more cautious tone.

Signs of overheating are unmistakable: an explosion of credit; rampant overcapacity (nine tenths of manufacturing goods are in oversupply); and the return of inflation (2.8% in the first quarter of 2004). President Hu Jintao, and his prime minister, Wen Jiabao, have assured financial markets that ‘resolute’ measures are being taken to rein in excessive investment and engineer a ‘soft landing’ for the economy but, so far, with no discernible impact.

"China is in a situation of severe over-investment", noted Credit Suisse First Boston’s Hong Kong office. What’s more, this investment is chasing diminishing returns. According to The Economist, China currently needs $4 of investment to generate each additional dollar of annual output, compared with $2-3 in the 1980s and 1990s.

Ominously, China displays many features of Asia’s ‘tiger economies’ in the period leading up to their spectacular crash in the summer and autumn of 1997. Last year, fixed asset investment accounted for an unprecedented 47% of China’s GDP, with the construction sector accounting for half this figure. By comparison, in 1992-96 fixed asset investment in South Korea, Thailand and Indonesia averaged 40% of GDP, still extremely high by international standards. In the same period, Indonesia, Malaysia, Thailand and the Philippines experienced money and credit growth rates of 25-30% a year. China’s money supply grew by 20% last year, and bank credit (new loans) by 56%.

The main problem in the case of the ‘tigers’ was that their exports became uncompetitive on world markets just as this new industrial capacity came on-line. The sharp rise of the US dollar in 1995, to which most Asian currencies were linked, priced them out of world markets.

China, although it exports 25% of national output, is less dependent on the world market. The super-Keynesian measures of the government – implemented in response to the Asian crisis – to boost demand by slashing interest rates six times since 1997, and by financing huge infrastructure projects, have increased the specific weight of the home market. But this market is chronically oversupplied.

Workshop of the world

China is now the world leader in many branches of manufacturing, including cellular phones, colour TVs and computer monitors. Since the start of its global export offensive 20 years ago, manufacturing industry in China has shifted from low-tech sectors like textiles, toys and simple manufactures to computers and electronics which now account for 60% of exports. Reflecting the increased role of high-tech production, China accounted for 14% of global semiconductor consumption in 2003. Also, perhaps more surprisingly, 16 million manufacturing jobs have actually disappeared since 1995, as Chinese industry has upgraded its technology. Shanghai Baosteel Group, for example, the world’s sixth largest steel producer, cut its workforce to 100,000 from 176,000 five years ago.

As industry in the southern and eastern provinces has become more capital intensive, low-tech production has shifted to the poorer (and cheaper) inland provinces. This right now is where there is greatest resistance to government attempts to curb new investment.

China still lags behind the advanced capitalist countries in the application of new technology, but the gap is closing. A million engineering graduates leave Chinese universities every year and there is an ongoing transfer of technology from the huge network of foreign partnerships and joint ventures. A survey by the Japanese newspaper, Nihon Keizai Shimbun, based on interviews with 350 Japanese corporations, concluded that, "in the field of technical development China would catch up with Germany and Japan within ten years".

China’s integration into the capitalist world economy means that huge swathes of US and European industry are now dependent on components or finished products from Chinese factories. "In a crisis", warned Ted Dean, managing director of consultancy firm, BDA, "Chinese labour could become as destabilising a force for the world economy as oil prices".

Profits squeezed

These indisputable facts are often cited by capitalist commentators to present a picture of unstoppable economic progress: a 20-year Chinese boom. This ignores the laws of capitalist economy which, as its Stalinist centrally planned economy is dismantled, play an increasingly dominant role in determining the rhythm of the Chinese economy.

The telecom industry is an illustration of this. With 282 million mobile phone subscribers, China is the world’s biggest market. But growth rates are already slowing, with fewer new subscribers in the first months of 2004. Overproduction – too many phones chasing too few buyers – has caused prices to plummet, which in turn squeezes profit margins. The Economist survey on China (20 March 2004) pointed out: "China has 40 mobile phone makers selling over 800 models. Annual demand should rise from 80m units to 100m in the next two years, but supply will double to 200m".

This survey reported from one phone-maker, Bird, based in Zhejiang province: "Bird’s modern factory is full of industrious workers and high-tech machines, but Dai Maoyu, Bird’s executive vice-president, looks tired. The former economics professor says he is making phones he cannot sell, that a price war is destroying everyone’s margins and that Bird wants to diversify into cars".

As this report makes clear, ‘modern factories’ and ‘high-tech machines’ do not in themselves mean profits. And what happens when companies like Bird, faced with falling returns, "diversify into cars" or other product lines? This only aggravates conditions in these sectors which, in general, already suffer from overcapacity.

The re-emergence of inflation (rising prices) in China is mainly due to the rising cost of capital goods, some farm products and services such as education. A more serious problem, however, is the longer-term potential for deflation (falling prices) arising from such extreme levels of overcapacity. Deflation not only squeezes profits, it magnifies the problem of debt, making repayments costlier in relative terms. This is a potential time-bomb for the Chinese economy which has financed its investment boom with unprecedented levels of credit. Nor is this a purely Chinese problem: if the country’s pool of unsold goods is re-routed onto world markets the result will be a massive injection of deflation into the world economy.

For years, Chinese labour has been a source of super-profits for global corporations and local capitalists. Manufacturing wages averaged just 61 US cents (€0.52, £0.34) an hour last year, compared with $16 in the US and $2 in Mexico. One hundred thousand Chinese workers die every year from industrial accidents or work-related illnesses.

Low wage levels impose severe limits on the growth of a mass consumer market. Obviously, Chinese workers can only afford to buy back a fraction of what they produce. The car market, for example, despite sales of 1.8 million units in 2003, is still fundamentally a luxury market. One third of the cars sold last year cost over $25,000 – 24 times annual urban income levels – and 70% of these were paid for in cash!

While average per capita incomes have risen rapidly in the last 20 years, the gap between rich and poor is now the biggest in the world. This has been a largely urban boom, with average incomes in the cities six times those of rural ones. Shanghai, with 16 million inhabitants, has the same per capita GDP as Portugal. But the poorest region, Guizhou, has a per capita GDP lower than Bangladesh.

Although incomes for China’s 800 million rural population are now rising due to a rise in prices for farm goods, the Financial Times pointed out that, "a consumer society has largely failed to materialise among two thirds of China’s population". Less than half of rural households have televisions and less than 20% have fridges.

Even in the cities, predictions of hundreds of millions of wealthy consumers are wild exaggeration. The pressure of migration from the countryside – with up to 400 million set to move to the cities by 2020 – will tend to hold down wage levels.

Beijing consensus

The Chinese economy is a peculiar mix of the remnants of a Stalinist planned economy – the dictatorial rule of the Communist Party – alongside what James Kynge of the UK Financial Times called, "a ferociously competitive brand of raw capitalism". The nearest comparison is the state-led capitalism prevalent in other East Asian countries like South Korea and Taiwan. High levels of state investment, in China’s case around four fifths of total investment, have stimulated industrial development in a way which is unthinkable in the advanced capitalist economies under current neo-liberal policies. This year, China is adding the equivalent of Britain’s entire electricity generating capacity to its generating plant, and plans a similar expansion in 2005. A new $15 billion natural gas pipeline from Xinjiang province to Shanghai is bringing cleaner fuel to the coastal areas while being uneconomical from a strictly ‘market’ standpoint. Eighty-six new subway lines are under construction.

These policies, rather than aiming to improve living conditions for the masses, aim to create a more effective framework for the exploitation of Chinese labour. In the absence of democratic control of these projects by workers’ organisations (non-existent in China), waste, corruption and abuses such as environmental degradation and the forcible relocation of local communities are legion.

These policies have won admirers within the capitalist class internationally, most notably Joseph Stiglitz, the World Bank‘s former chief economist. The term ‘Beijing consensus’ has been coined to signify an economic model opposed to the IMF’s neo-liberal ‘Washington consensus’. But while this growth has been spectacular, the crisis of 1997 showed that Asian economies have not invented a new, teflon-coated capitalism, immune to recessions and crises.

According to prime minister Wen, the Chinese economy has reached a ‘critical juncture’. Despite a raft of government measures since the end of 2003, there are few signs yet of any cooling off. Beijing’s dilemma is that it does not want to be too successful and precipitate a sharp decline or slump, which is a real danger in the current situation.

The retreat from central planning and the growth of market forces have limited the scope for government intervention. Government efforts so far have concentrated on curbing credit growth – total loans are equivalent to 145% of GDP – and property speculation. Twenty-six thousand square kilometres of farmland – an area the size of Albania – have been turned over to building developers in the last five years, one of the factors behind falling grain harvests and rising prices.

In April, the central bank raised the minimum level of deposits that banks must keep in reserve from 7% to 7.5%. Smaller banks were ordered to halt all lending temporarily. This has been backed up by police measures: a crackdown on ‘illegal’ sales of farmland, and beefed-up environmental and other controls at new factories and construction sites.

But these measures are being thwarted by alliances of capitalists and corrupt local officials who want to shield their own areas from cutbacks. China’s banks, despite being state-owned, are described as ‘multi-storey’ in that regional and local offices enjoy a wide degree of autonomy. The Economist commented: "Branch managers often have closer ties to local officials and businessmen than to their own bosses, which breeds corruption".

This goes a long way to explain why investment in property continued to grow at the explosive rate of 41% in the first quarter of this year, according to the national bureau of statistics. Housing construction in China is overwhelmingly pitched towards the luxury market and, again, overcapacity in the form of vacant properties is rife. Still, property prices rose by 25% last year and are approaching US levels in cities like Shanghai and Beijing. This points to the danger of a crash in land prices which, in turn, could trigger a banking collapse. China has "the weakest banking system of any large economy", in the words of the UK Financial Times. Bailing out the banks could cost as much as $500 billion or 30% of GDP.

Currency peg

It looks as if the government will soon be forced to bite the bullet either by raising interest rates, for the first time since 1995, or abandoning the renminbi’s peg to the US dollar. That both options have been under discussion for some time indicates how reluctant the government is to move on either front. Higher interest rates would be the most effective way to regain some control over credit levels and investment, but the results may be too dramatic. By encouraging people to save, and making consumer loans more expensive, this could undermine consumption at a time when the opposite is sorely needed. A rise in interest rates will also aggravate the banks’ problems with ‘non-performing loans’ which, according to official estimates, are equivalent to 20% of GDP. Some economists believe the figure is closer to 40%.

Yet another problem is the huge sums of so called ‘hot money’ – around $12 billion a month – which is pouring into China as foreign banks and hedge funds bet on an imminent rise in the renminbi (yuan). Higher interest rates could trigger even bigger speculative inflows which, as the experience of the ‘tigers’ showed, are highly destabilising.

Revaluation of the renminbi is not a painless option, either. On the plus side, it would ease inflationary pressures, cheapen imports of raw materials, and perhaps postpone the need for a rise in interest rates by putting the brakes on some forms of investment. It would also help to cool trade tensions with the US, China’s biggest export market.

But the risks are considerable, not least because the central bank may not be able to control the currency’s rise once the present dollar peg is abolished. Exports would suffer, as would foreign direct investment, but the financial system, too, could be placed under new pressures from speculative assaults on the renminbi. The global effects would be considerable, especially if China was forced to begin selling its massive foreign exchange reserves, worth $440 billion in May 2004, which have helped finance the twin deficits (Federal budget and balance of payments) of the Bush administration in the US.

More than anything, the regime fears ‘political instability’, and a movement of the working class. Literally every day there are labour protests somewhere in China, though mostly, at this stage, among unemployed workers, laid-off from the state sector. These movements have so far been isolated, local outbursts, which have been defused by a combination of concessions and repression from the authorities. The most famous protest in recent years led, briefly, to the formation of an independent trade union among workers in Daqing and Lioaning, north-eastern China. Two of the leaders of this movement, Yao Fuxin and Xiao Yunliang, are now serving long prison sentences.

Given the now pivotal role it plays in the global economy, it is clear that any re-run of the Asian crisis in China, would have major international implications. Even a soft landing, resulting not in a slump but in a more ‘normal’ rate of growth (say, 4-5%), would be a body blow for Asian and world capitalism, not to mention China’s ‘stability’. The Economist survey concluded that a slowdown "carries with it the risk of massive job losses and social upheaval, recalling the days of the Tiananmen protests in 1989". This is the spectre which haunts the Chinese regime and its friends and supporters in global big business.

China & the world economy

Although it accounted for just 4% of world GDP last year, making it the sixth largest economy in dollar terms, China’s role as the number one market for capital goods (minerals, fuel, building materials and machinery) made it the main locomotive of global growth. World GDP grew by 3.2% in 2003, with China contributing a third of this growth, or 1.1%, while US capitalism accounted for just 0.7%.

China’s role within Asia, the only region of world capitalism experiencing strong growth, is now crucial. In 2003, it accounted for 70% of Japan’s total export growth, and 40% of South Korea’s (Asia’s first and fourth largest economies respectively). By surfing the Chinese wave, Japanese capitalism recorded its highest ever level of exports in the first quarter of 2004. This export boom is the main factor behind the current upturn in Japan’s crisis-torn economy, which has seen GDP growth exceed 5% (annualised) for the last two quarters.

Last year, China became the world’s third largest importer after the US and Germany. For the first time since 1993, it is heading for a trade deficit in 2004 (with imports exceeding exports on an annual basis). The surge in Chinese demand in 2003 drove world prices for industrial raw materials up by 73%. China consumed half the world’s concrete output, a quarter of its steel and one third of its iron ore. China is the world’s biggest steel producer, accounting for one fifth of global output in 2003 (220 million tonnes) – as much as the US and Japan combined.

In 2003, China also became the world’s third largest market for motor vehicles with sales growing 60%. But here too, capacity growth is outstripping demand. Driven by herd mentality (a fear of being left behind), transnationals like GM, Volkswagen, Toyota and Honda have stormed into the Chinese market, announcing more than $20 billion of new investment in 2003. By 2007, capacity is forecast to reach 15 million vehicles, against sales of 7 million. In this case, China’s pool of unsold cars would be greater than the entire Japanese market (6 million cars per year).

Already prices are falling. While steel prices rose 35% in the twelve months to February 2004, car prices fell 5.1%. Fierce competition between car-makers makes it impossible to pass on rising costs to consumers, so profit margins are falling.

Its share of world cotton consumption rose from 25% in 1999 to 32% last year, reflecting the predominant role of its textile industry. It consumed one third more refined copper (20% of the global total) than the US, reflecting the explosive growth of telecoms. A similar picture emerges in category after category.

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August 2004