CHINA is rethinking the economic model that has defined its growth over the past few years, one heavily reliant on export, household consumption, corporate investment and government expenditure. And it has drawn an important conclusion.
Nowadays, if we cannot provide quality projects the market is interested in, if we cannot solve the issue of asset scarcity from the supply side of the equation, no matter how hard authorities try to stimulate demand, their efforts will likely come to nothing.
Supply-side reform isn’t a mere slogan or concept, but a genuine attempt at tackling the root cause of China’s economic malady, namely, a severe shortage of quality projects that service and sustain the real economy.
Against this backdrop, even if money gravitates toward the real economy, chances are that many struggling companies will shun investment in their main business areas — manufacturing — and instead embrace the virtual sector and real estate market. As a result, cash isn’t used to support the real economy.
If the hollowing-out of the real economy is allowed to persist, the sector will be headed for a brain drain, where young creative minds are eager to take up finance as their major.
This could lead to an excess of financial talent and capital and contribute to structural imbalances between the real and virtual economies.
A close look at the overall Chinese corporate performance reveals a conflicting picture.
On the one hand, under-performing businesses still are pumping money into the real economy, while well-performing firms are choosing to withdraw from the sector altogether.
In other words, it will be hard for the former to repay loans and other benefits the government has lavished on them to finance their growth. They could eventually be bailed out only by monetary easing measures when their bank loans come due.
In effect, the costs of such bailouts will be borne by the large majority of Chinese citizens. They are the ones paying the price for over-issuance of the yuan and the consequences thereof, namely a dilution of their buying power.
That is to say, when Chinese citizens realize that prices for everything are increasing year after year, this is actually a sign of their money being made to service the country’s bad debts.
And if we look at the balance sheets of many state-owned enterprises, especially centrally-administered SOEs, most of them have reported losses and dwindling profits.
And they are even less keen on making new investments than the private sector. This phenomenon merits heightened concern, because when investments by even well-performing private businesses are experiencing a nosedive — one that is as dramatic as last year’s fiasco in the lackluster stock market — it suggests that something may have gone badly wrong.
Obviously, many SOEs are still in the habit of making investments along “correct” political lines. They harp about how their investments have made an immeasurable contribution to the country’s GDP growth and employment.
The potential fallout from these investments is reminiscent of the 4 trillion yuan (US$575 billion) stimulus package in 2009 that has somehow left a lingering bad taste in our mouths.
Local governments, SOEs and centrally administered SOEs that ignore the supply-side reform imperative are doing so at their own peril and at the expense of future generations. Sticking to the old ways and prioritizing their own interests will only exacerbate the status-quo.
Many have difficulty adapting to the requirements under the “new normal,” or rather, they are prevented from seeing the bigger truth thanks to the entrenched vested interests they are reluctant to take on themselves.
Jealously clinging to their privileges, many SOEs are unlikely to lead the way in a new market environment where business operations are dictated only by market demands. For them, it is business as usual. Overcapacity, inventory and high debt leverage have combined to exert downward pressure on the Chinese economy.
But instead of cutting capacity and leverage ratios, quite a few companies are still expanding their operations in pursuit of stable growth goals.
Should we opt to find an outlet for excess capacity by executing a bailout similar in scale to the one from 2009, many well-connected SOEs that are otherwise undeserving of further largesse will continue to receive credit from banks.
Sustained by these de-facto subsidies, they’ve already managed to knock out competitors with lower prices.
This is a war competitors cannot win, for it is rigged in favor of SOEs from the outset.
China’s overcapacity has sparked worldwide concern. Why is it necessary for foreigners to point an accusing finger at China and even warn that its failure to reduce overcapacity will spell trouble for the world economy?
I think this is because quite a few local governments still haven’t come to grips with what the much-heralded supply-side reform is essentially about. They are yet unaware that the reform is a call for cutting instead of increasing supply to redress structural imbalances.
They ignore this call and go on to churn out products at incredibly low margins by employing an economy of scale. They then proceed to flood overseas markets with their cheap merchandise — hence the outcries.
This is the reason why the world has been rather frosty toward the exodus of Chinese capacity outside of China. China’s status as the world’s second-largest economy means it will be subject to more scrutiny on compliance issues, which is as much a challenge to businesses as to Chinese authorities. Officials cannot afford to lavish unconditional tax breaks on companies to support low-cost competition with the outside world.
The Chinese leadership made it clear early that the goal of the supply-side reform is to eliminate so-called “zombie enterprises,” the behemoths that are chiefly responsible for generating overcapacity.
Overall business operating costs today are getting higher as a result of our blind commitment to maintaining GDP growth, no matter what. The low efficiency of the Chinese economy can only be compensated for by a reform that truly restores health and prosperity to our sluggish real economy.
This should start with the sinking in of the realization among SOEs that the days when they could count on a steady supply of state protection and cheap loans will finally come to an end. And there is little room for waging price wars.
If Chinese companies were to grab market shares abroad, they need to learn from success stories like Huawei, who compete on brand value, homegrown technologies and even seek to give the yuan an elevated profile in the settlement of deals they strike with foreign partners.
The success of managing overcapacity and sustainable development will hinge upon our ability to manufacture products that really satisfy market demands. Business production ought to be guided by an emphasis on quality over quantity, rather than the other way around. The discrepancy between lofty ideals and lukewarm support of them — or, in some cases, active opposition to them — goes a long way toward explaining why the Chinese economy still faces many tough challenges.
The ultimate goal of the supply-side reform is to free up the strategic resources and space for future growth and then dispense them to market players that are able to leverage these opportunities for optimal benefit.
The author is Director, Financial Research Center, Fudan Development Institute. This article is adapted from a speech he made last year at a seminar sponsored in part by Fudan Development Institute (FDDI). The views expressed are his own. Shanghai Daily staff writer Ni Tao translated his article from the Chinese.