Economists: China’s economy needs an overhaul

Declining exports and a stagnating real estate market have slowed China’s economy from double-digit to single-digit growth rates in the past year, and economists are suggesting that the slowdown offers a glimpse at deep-seated structural problems China must battle to build a modern, high-income society.

With structural reforms, a World Bank report estimates, annual growth rates will further slow to 7% annually in 2016–2020 and 5% annually in 2026–2030.

For now, the threat that China’s annual GDP growth rate could drop as low as 4% this year has become a lot less likely than a few months ago, according to Deloitte’s second quarter “Global Economic Outlook” report.

“China seems destined to avoid a ‘hard landing’ for now,” Deloitte’s report says. But it goes on to say that there are still reasons to worry that a European and US recovery won’t automatically lead to a revival of strong growth in China.

That’s because economic growth in China can no longer be sustained by continuing the massive investments in construction and capital equipment that the government supported in the past four years, according to a Knowledge@Wharton report. This investment represented 48% of GDP and 5% of the 9.2% GDP growth China reported for 2011.

Other structural problems include a lack of public services and social welfare, inadequate medical care and social security, and education that is a huge cost for most families, the Knowledge@Wharton report says. Local governments have borrowed $1.7 trillion, the Deloitte report added, but revenues are down.

China avoided a hard landing in the first quarter because the People’s Bank of China boosted liquidity and credit market activity by twice lowering the required reserve ratio for commercial banks. Also, the Chinese government has begun to try to boost consumer spending. According to Deloitte, the minimum wage in Beijing, Shenzhen and Shanghai has been substantially raised.

The Chinese government will try to spur domestic consumer spending with tax breaks and rebates, Gordon Orr, a director in McKinsey’s Shanghai office, reported in “McKinsey Quarterly”. Chinese policymakers are likely to extend a popular programme offering rebates on purchases of electronics and appliances that generated about $71 billion in revenue from 2009 to 2011, Orr said.

He also expected the government to invest heavily in manufacturing, particularly in the central and western regions, by offering incentives to attract industrial companies inland, where the cost of labour is lower.

Structural reforms, however, would require much more, Deloitte suggests.

The World Bank report, which was produced in collaboration with the Chinese Development Research Center of the State Council, calls for more privatisation of state-run enterprises, more reliance on market forces, the end of restrictions on internal migration, a boost to the social safety net in order to boost consumer spending, more transparent capital markets in order to funnel capital to the most profitable investments and better fiscal controls for local governments.

Nobody expects these reforms to be implemented this year, because China’s leadership will change later in the year.

Outgoing Premier Wen Jiabao and his expected successor, Li Keqiang, have spoken about the need for reforms, but the nature and the timing of future reforms remain unclear.

—Sabine Vollmer (svollmer@aicpa.org) is a CGMA Magazine senior editor.