An analysis of the China s economic slowdown

MSc in Finance and International Business Author: Tanlei Xu Supervisor: Jens Kaalhauge Nielsen An analysis of the China’s economic slowdown School o...
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MSc in Finance and International Business Author: Tanlei Xu Supervisor: Jens Kaalhauge Nielsen

An analysis of the China’s economic slowdown

School of Business and Social Sciences, Aarhus University Master Thesis Exam Number: Date:

 

500224 1/9-2015

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Abstract China is the in the news everyday. Indeed, despite its continuous success maintaining strong growth, the Chinese economy has exhibited worsening structural imbalances in recent years. The purpose of this paper is to put together from the background to today’s China, in order to examine the core structural problems and further reflections regarding to China’s economic growth and slowdown. It seeks to build a general perspective to argue that China’s core problems and whether has possibilities to solve those issues or move into a new transition successfully. The paper describes the background to today’s China, with a general survey using some data and facts to examine how the economy grew to its current level, as well as the reasons for the slowdown. The problem with China’s economy is liked to the growth model, which is characterized as ultra investment driven and export oriented under the government-directed. Following the limits of Chinese growth model, the core problems for China’s current situation can be broken into four major elements: 1) Institutional structures 2) Structural constraints 3) The rebalancing problem 4) Transformation to a post-industrial society China is a limited access society with some insufficiently developed institutional structure and was held “captured” by its political system with the Chinese Communist Party, in this way, the civil society is also weak. As a result, almost all major structural problems are created under the inefficient institutional structures, and drag the improvement of developmental processes in solving supply and demand imbalance and moving up the value chain. Further implication is a discussing section including particularly crucial issues concerning the possibilities to solve. To re-establish an adequate societal and economic resource-allocation in China goes to the heart of the question of reform but can’t not take place without major institutional changes. Until now, the reform plans are highly idealized and flawed to solve the urgent issues in China thoroughly, so in the face of these threats, the principal challenges facing China today are serious.

 

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Table of Contents 1.   Introduction  ..................................................................................................................  4   1.1   Introduction  .........................................................................................................................  4   1.2   Research Questions  ............................................................................................................  5   1.3   Data Description  .................................................................................................................  5   1.4   Boundaries  ...........................................................................................................................  6   1.5   Structure of the Paper  .......................................................................................................  6   2.   Theoretical Framework  ..............................................................................................  8   3.   Historical Background and General Survey  .......................................................  10   3.1   Historical Development of Today’s China  ..................................................................  10   3.2   General survey on Economic Growth  ..........................................................................  11   4.   The Limits of the Chinese Growth Model  ...........................................................  13   4.1   Investments driven model  ..............................................................................................  13   4.2   Export- led Growth  ..........................................................................................................  15   4.3   Financial Repression  .......................................................................................................  16   5.   Institutional Structure  .............................................................................................  19   5.1   China’s state and political restraints  ...........................................................................  19   5.2   Weak civil society  .............................................................................................................  21   6.   Structural Constraints  .............................................................................................  22   6.1   Negative Demographics  ..................................................................................................  22   6.2   Environmental Degradation  ..........................................................................................  26   6.3   Social inequality  ...............................................................................................................  28   7.   China’s Rebalancing problem  ................................................................................  34   7.1   Investment vs. Savings  ....................................................................................................  34   7.2   Consumption  .....................................................................................................................  37   7.3   Debt to GDP  ......................................................................................................................  38   8.   New Transition Towards to a Post- industrial Society  .....................................  44   8.1   Move-up the value chain  .................................................................................................  45   8.2   Move to service sector  .....................................................................................................  50   8.3   Avoiding Middle- income Trap  .....................................................................................  51   9.   Implications  ................................................................................................................  52   9.1   Institutional Reform  ........................................................................................................  52   9.2   Equilibrium in Supply and Demand  ............................................................................  56   9.3   Social Evolution  ................................................................................................................  59   10.   Conclusion  ................................................................................................................  60   11.   Literature  ..................................................................................................................  63    

 

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1. Introduction This introduction part involves a general description for the thesis: the context of analysis, research questions, data description, boundaries and structure. 1.1

Introduction

China has been, bar none, the country that has changed fastest over the last thirty years. To take a quarter of the world’s population, there are also analysts say that China is the world’s growth engine, or at least a country, which contribute a lot to the global growth. Some experts and markets continue to be bullish about the Chinese economy, expecting that high rates of growth will continue indefinitely. Like other rapidly developing Asian economies, China relied on repressed household consumption to make modernizing investments. But the problem is that focus on numbers obscures stark realities and the tendency doesn’t show an optimistic future with coming challenges. Its economic model distorted interest rates, the currency and even legal structures. And it led to burgeoning debt that is becoming increasingly difficult to finance (Pettis, 2013). The time has come for China to adjust its model to the new circumstances success has produced. The principal challenges facing China today are serious. Many of essential issues covered in the further discussion embrace the economy, social development, environment, welfare, demography, employment, resources, science and sustainability. What’s more, China is often criticized for its political system and institutional structures; it is not, after all, a liberal democracy (Beardson, 2014). It is no doubt that the rise of industrialized China and his resurgence as an economic powerhouse is a transformative event in the history of the world economy. However, there now appears to be an emergent consensus that the Chinese economy is facing a turning point, as a result, this paper looks at the background to today’s China, how it got where it is, in order to examine the core structural problems and further reflections regarding to China’s economic growth and slowdown. It seeks to build a general perspective to argue that whether China has possibilities to solve those issues or move into a new transition successfully.

 

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1.2

Research Questions

The rise of industrialized China and his resurgence as an economic powerhouse is a transformative event in the history of the world economy. However, there now appears to be an emergent consensus that the Chinese economy is facing a turning point. In order to have a deeper understanding to China’s economic situation, what are the further reflections on China’s main problems? And whether China has possibilities to solve all the issues facing it? Studying the China’s socio-economic situation can analytically be broken down into four following elements: 1. The rebalance of the economy. 2. The transformation to a post- industrial mode of production. 3. Structural constraints. 1) Negative Demographics 2) Pollution 3) Social inequality 4. The changes in institutional levels

1.3

Data Description

Part of theoretical literature has been found using literature reviews and compendiums from earlier courses. The articles and theories have been chosen with the approach that "newer is better" and "more cited is better", it is assumed that the newer theories builds on and improves the mature theories. Factors and indicators in the China’s economy as well as crucial index affecting the further reflections will be identified and discussed. Analysis of the chosen factors will be done using knowledge from Emerging Markets, Macroeconomics, International Business Methods, etc. Websites that has been used in this thesis are websites regarding the figure of China’s economy and relevant experts’ comments. However, there are several challenges in regards to gaining accurate secondary data. For instance, the Chinese governmental websites often present different answers to the same question that contradicts itself. The Aarhus University’s database has been used as the main tool to find scientific

 

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journals and articles that depict the topic issues. Furthermore, there are still some articles discussed in Chinese for the China’s current situation and future plan, as well as international statistical databases public pages. To get more comprehensive data and analysis, some of Chinese version articles are also used for contributing the thesis.

1.4

Boundaries

When dealing with core economical indicators for China, it is important to leave some margin for error. Since Chinese statistics are of vital importance in painting a picture, but there is woeful lack of clarity about the numbers. It is not so much that information is being concealed as that the facts are not accurately known (Beardson, 2014). Thus official data is not as sacrosanct during the process of analyzing. Talking about China’s socio- economic situation covers a wide range of issues, and there exist a large number of factors that could e taken into consideration in each issue. This paper goes to draw a general perspective in relation to focus on both objective and developmental processes, therefore the paper will be used to narrow down the selection of factors and not go into depth and details with each issue.

1.5

Structure of the Paper

The structure of the paper can be seen in Figure 1. The paper starts by describing the development process of China’s economy, and goes on to determine the limitation of its growth model. Therefore the following part offers a discussion for the core problems. In order to analyze the China’s economic slowdown, this paper will apply three central questions concerning to understand its true position. 1. Why did China slowdown? 2. What are the China’s core problems now? 3. Will China have possibilities to solve all the issues facing it?

 

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The first part of the paper describes the background to today’s China, with a general survey using some data and facts to examine how the economy grew to its current level, as well as the reasons for the slowdown. Second part presents the core challenges China faces, particularly of its structural constraints and institutional structure that frame the basic developmental processes in rebalancing and transformation toward to the post- industrial society. Following this is a discussing section including particularly crucial issues concerning the possibilities to solve. Figure 1. Structure of the Paper

Background and History concerning the formation of today’s China Why did China slowdown?

General survey with basic economic indicators to see China’s growth model

The Rebalancing Problem Transformation to a Postindustrial Society

What are the China’s core problems now?

Structural Constraints Institutional Structures

Equilibrium in supply and demand

Will China have

Social Evolution

possibilities to solve all the issues facing it?

Institutional Reform  

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2. Theoretical Framework Leading up to study China’s economy situation, the following chapter will give a brief description of the new institutional economics theory by North C. Douglass (1990), which incorporates a theory of institutions, then apply its analytical framework to make impact on economic performance over time. As North states that “institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction.” It is based on human behaviors and establishes a stable structure to human interaction in order to reduce social uncertainty. Similarly, organizations are groups of individuals who work toward a common goal where the institutional pattern take a direct actualized form. Court, political parties, schools or unions are all examples of organizations, and their social roles serving the institutional pattern such as justice and open. In North’s new institutional economics theory, he also considers that organization primarily as the agent for institutional change with emphasis on the interaction between institutions and organizations. Contrast to the neo-classical theory, which has made it an institution-free assumption. It describes the world of instrumental rationality institutions are unnecessary, both political and economic factors are efficient. Therefore there’s no distinguish between the real world and the decision maker’s perception, also the choices will be made by rational decision maker from the public knowledge of the real world without the perceptions or modes of calculation himself. As a result, the values as given can be trusted and the decision maker’s computational powers are unlimited (Simon, 1986). However, in practice, individuals’ mental models are partly reflected by cultural environment. It is produced with different knowledge, values and norms which among varies groups and societies. It is clear that different perceptions of the world from different background may not suit for the assumption in the neo-classical theory which postulate the decision maker in rationality. North argues that the incomplete information and limited mental capacity for human beings impose constraints to an absolute efficient market with transaction costs, and institutions are formed to reduce uncertainty in human exchange. Hence, the unrealistic of costless in transaction under

 

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the rationality postulate in neo-classical model should considering institutions, which are crucial determinants of the efficiency of the markets. In this way, North believes that the rational choice theory could work under some certain fixed conditions structured by the institutional framework, which allows for continuous observation of behaviors. So his new institutional approach adds institutions as an important constraint and extends economic theory by incorporating ideas and ideologies into the analysis, modeling the political process as a critical factor in the performance of economies, as the source of the diverse performance of economies, and as the explanation for “inefficient” market. Moreover, North contends that ideas and ideologies do make a difference so that institutions play in a different role. It explains that economic performance is related to the human learning process and tacit knowledge driving by the institutional framework. According to North’s theory, there are several characteristics of economic performance regarding to the institutions. First, both formal rules and informal norms contribute to the establishment of institutions; while the formal rules can be shifted overnight, the informal norms based on social revolution only change gradually. Second, polity is another crucial factor to shape economic performance because it defines and enforce the economic rules. North states that economic growth can occur in the short run with autocratic regimes, while in long run it requires the development of the rule of law and freedoms in civil society and politics. What’s more, the theory also describes that a good economic performance should be under a flexible institutional matrix that will adjust in the context of technological or demographic changes. Therefore, the adaptive efficiency of the institutions and polities is a crucial analytical factor to examine the economic performance nowadays. To apply North’s new institutional economic theory into the analysis of China’s economy in following chapters, institutional structure plays an important role in building China’s current situation, in many cases, the core problems indicate that China goes to the heart of the question of reform but can’t not take place without major institutional changes.

 

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3. Historical Background and General Survey China is in the news every day. It is increasingly seen as one of the major economic powers in the world. Is the attention justified? Experts like Michel Pettis argued that only a country’s contribution to global growth cannot be calculated by measuring its share of global growth, while China’s influence is because its size (Pettis, 2014). To understand first, this part goes back to describe China’s historical development and general survey on economic growth. 3.1

Historical Development of Today’s China

Since China’s establishment in 1949, the Chinese government has been a one- party system, with real power lying with the Chinese communist party. In this way, China maintained a centrally planned economy, which means the state directed and controlled a large share of the country’s economic output; the state set production goals, controlled prices, and allocated resources throughout most of the economy. As a result, nearly three- forth of country’s industrial production was produced by centrally controlled state owned enterprises. However, central planning economic systems and government control caused there were almost no private enterprises or foreign invested firms which made the country’s economy inefficient. The rapidly economy grow is because of China’s tremendous success in the three decades after the reform in 1978. The previous thirty years it was outside the global economy. The growth rate prior to the Deng Xiaoping reforms that began in 1978 was slow and productivity throughout the period was negative (Dwight, 2010). According to the World Bank, GDP grew doubled in 1980 from 4.9 per cent in 1966- 1978. By 1978, China’s leaders knew they must introduce serious measures to restructure the country. Deng Xiaoping and his colleagues presided over some of the most radical reforms in modern history. The famous four-character policy gaige kaifang, a reform of the economic system and an opening up to the outside world, was promulgated. As Huenemann said: “There can be no doubt that the reforms since 1978 generally have succeeded in both the system reform aspect, marked by the decollectivization of agriculture and the dismantling of Soviet-style central planning in industry, and the opening-up aspect, leading to China’s entry into the WTO in 2001. (Huenemann, 2010)”

 

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The sharp rise in the rate of growth after 1978 is almost entirely explained by the rise in total factor productivity. China opened up to imports of high-technology and higher- quality goods in general even before the formal reform period hat began in late 1978. Meanwhile, the government began to try to reform the industrial sector then dominated by large state-owned enterprises. The 1990s saw first a large increase in enterprises established by foreign direct investment. China after decades of prohibiting FDI, formally welcomed it and carried out preferential policy to attract foreign investors. The boom in FDI from that point on accounted for much of the very rapid increase in exports and China’s industrial economy became firmly imbedded in global supply chains. Then in the latter half of the 1990s Zhu Rongji led the effort to join the World Trade Organization, not so much to promote exports that were rising rapidly without membership, but to force the state enterprises to face vigorous foreign competition if they were to survive.

3.2

General survey on Economic Growth

China has been growing rapidly for more than three decades. This is shown in Table 1, which gives output growth, unemployment, and inflation for the periods 1980-1999, 2000-2007, and each of the years 2008 to 2014. Table 1 Growth and Inflation in China, 1980- 2014 Percent Output growth rate Unemployment rate Inflation rate

1980-1999 2000-2007 2008 (Average) (Average) 9.8 10.5 9.6

2009

2010 2011 2012 2013 2014

9.2

10.3

9.5

7.7

7.6

7.34

2.7

3.9

4.2

4.3

4.1

4.0

4.1

4.05

4.09

8.2

1.6

5.9

-0.6

3.3

5.5

2.65

2.62

1.99

Output growth rate: annual rate of growth of output (GDP). Inflation rate: annual rate of change of the price level (GDP deflator). Source: World Economic Outlook database, April 2015   Look at the first two columns of Table 1; the most impressive numbers are those for output growth. Since 1980, China’s output has grown at roughly 10% a year. This represents a doubling of output every seven years. Compare this number to the  

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numbers for the United States with 3.0 and for Europe with 2.2, it shows the reason why the importance of the emerging economies in the world economy, China being the main one, is increasing so rapidly. Turn to unemployment. Numbers for unemployment are typically less reliable in poorer countries because many workers stay in the countryside rather than being unemployed in the cities. Nevertheless, the numbers suggest consistently low unemployment. And inflation, which was high before 2000, is now relatively low. Another striking aspect of Table 1 is how difficult it is to see the effects of the crisis in the data. Growth has barely decreased, and unemployment has barely increased since 2007. The reason is not that China is closed to the rest of world. Chinese exports slowed during the crisis. But the adverse effect on demand was nearly fully offset by a major fiscal expansion by the Chinese government, with, in particular, a major increase in public investment. The result was sustained growth of demand and, in turn, of output. This sustained growth performance raises obvious questions. The first is whether the numbers are for real. Could it be that growth has been overstated? After all, China is still officially a communist country, and government officials may have incentives to overstate the economic performance of their sector or their province. Economists who have looked at this carefully conclude that this is probably not the case. The statistics are not as reliable as they are in richer countries, but there is no obvious bias. Output growth is indeed very high in China. The growth comes from two sources: •

The first is high accumulation of capital. According to the World Economic Outlook database, the investment rate (the ratio of investment to output) in China exceeds 40% of output, a high number. For comparison, the investment rate in the United States is only 17%. More capital means higher productivity and higher output.



The second is rapid technological progress. One of the strategies followed by the Chinese government has been to encourage foreign firms to relocate and produce in China. As foreign firms are typically much more productive than

 

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Chinese firms, this has increased productivity and output. Another aspect of the strategy has been to encourage joint ventures between foreign and Chinese firms. By making Chinese firms work with and learn from foreign firms, the productivity of the Chinese firms has increased dramatically. However, this growth isn’t enough to ensure continued success. The crux of the issue is whether China will be able to maintain a growth rate of the past in the coming decade or even over a longer period of time. The table 1 shows a clear economic slowdown since 2008 indicate that the economic model driven by very high levels of investments was not strength China in a healthy way.

4. The Limits of the Chinese Growth Model “The biggest problem with China’s economy is that the growth is unstable, unbalanced, uncoordinated, and unsustainable.” Said by ex-premier Wen Jiabao at National People’s Congress Press conference on March 2007. Its excessive investment driven model that resulted by artificially controlled with financial repression, and using export to fill the gap between domestic consumption and investment, accompanied the furious growth of China’s economic growth. It seems that the Chinese growth model has much limitations, which would drag China into dilemma. In this section, the analysis listed the main characters of China’s growth model, to explore the reason why China’s economic slowdown. 4.1

Investments driven model

China’s growth relies heavily on external demand and investment with much of that investment concentrated in property market, and this dependence has increased especially after the 2009 global financial crisis. To see it clearly, what kept growth high was a steady increase in the rate of investment as a share of GDP, Figure 2 indicated that a jump over three years of nearly 6 per cent or an annual average rise of 2 per cent. This growth in investment took place in the context of underemployed labor and excess industrial capacity. Because of these underemployed resources, this rise in the rate of investment contributed directly to a higher growth rate of GDP (Dwight, 2010). However, maintenance of the rate of growth of fixed capital would require a steadily rising rate  

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of capital formation as a share of GDP, as a result, the GDP growth rate in recent years has been driven mainly by the massive increase in capital made possible by a high and rapidly rising rate of investment. Figure 2 China’s Gross capital formation/ Investment (% of GDP) 60   50   40   30  

36   35  

42   43   42   44  

48   48   48   49   49   Gross  capital  formation   (%  of  GDP)  

20   10   0  

Source: World DataBank, World Development Indicators.

 

Investment, accounting for almost half of China’s output, most was composed of manufacturing, real estate and infrastructure. Infrastructure development remains a top priority for China’s government, which has long recognized that a modern economy runs on reliable roads and rails, electricity and telecommunications (Chen, 2013), China is far and away the big spender among all of emerging market countries. And stronger housing sales should feed through to an improvement in real estate investment. However, the Wall Street Journal showed that the real estate inventory was higher with the ratio of under construction to sold continuous increasing. In addition, the weak demand abroad and rising costs also influenced China’s exporters (manufacturers). The result of decreasing demand cannot fulfill the huge amount of investment in China. On the other hand, according to IMF working paper in 2012, the study found that China’s state investments have becoming alarmingly wasteful and ineffective. It concluded that the level of over-investment in China was equivalent to about 10 per cent of GDP, and perhaps as high as 20 per cent. So the problem is how efficient of China’s investment. By using incremental capital output ratio (ICOR), a country’s ICOR also estimate investment efficiency; if a country’s ICOR goes up indicates that more capital intensive.

 

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Figure 3. China’s GDP growth rate and ICOR 1991-2014 15  

7.4   8   7.1   7   6.2  

14   13   12   11   10  

3.8   2.6  

5.1   5.2   4.6  4.7   4.4   4.6   4.5   4.2   4.2  4.1  4.3   3.9   3.9   3.7   3.7   3.3   3   3.1   2.9  

6   5   4  

ICOR  

3  

GDP  growth  (%)  

2  

8  

1  

7  

0  

1991   1992   1993   1994   1995   1996   1997   1998   1999   2000   2001   2002   2003   2004   2005   2006   2007   2008   2009   2010   2011   2012   2013   2014  

9  

Source: NBS, CEIC, CEIC estimates The productivity of capital can be listed as figure 3 above. Under the increasing contribution of investment to economic growth was still the prescription to stimulate the economy; the changing in its efficiency can be explained: From 2000s, a new economic cycle started and the economy performed in a healthy running. Although capital investment was large, speeding up of economic growth still decreased ICOR, which leaded to efficiency increases. However, due to against the global financial crisis in 2008, government introduces 4- trillion stimulus package caused huge capital investment, which resulting in the continuous decline of efficiency, what’s more, the investment driven model with the increasing ICOR and decreasing GDP growth indicated that overinvestment has become a huge problem, it could resulted in rigorous financial imbalances, increased diminishing returns and increasing leverage levels, which has already happened in China.

4.2

Export- led Growth

The Chinese model was in the beginning strongly export-led growth. In other words, the Chinese model assumed that foreign consumption persistently would fill out the gap between domestic investment and domestic consumption. The open policy Gaigekaifang and accession to the WTO has allowed China to fully integrate into the world system and catch the comparative advantage in abundant cheap labor supply; China’s exports have jumped more than tenfold especially during 1990 to 2005. To  

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understand more detailed, figure 4 presents the share of export in GDP for the period of 1990- 2014. Since China has joined the WTO in 2001, a surprisingly increased by 15 per cent within 5 years. However, China cannot avoid the influencing come from the global financial crisis in 2008, an obvious decline in exports reflected on the negative growth of export; what’s more, there was no better in the growth of the ratio in recent year. Figure 4. China’s Exports of goods and services (% of GDP) 50   40  

37   39   38   35  

30   20   10  

23  

27   29   29   27   26  

15  

Exports  of  goods  and   sevices  (%  of  GDP)  

0  

Source: World DataBank, World Development Indicators. Since the China’s export sector suffered a serious defeat during the global crisis of 2008, China’s exports were hit by this downturn. As a result, China was influenced from a demand- deficit, which also in part manifests itself in severe industrial overcapacity. In addition to the demand abroad declining, slowing down is also because the Chinese model has run out of its original growth drivers, which has characterized its cheap labor and no low- hanging technological fruits. The most visible damage so far has been reflected on the manufacturers in southern China. Thousands of companies have gone bust, tens of thousands of workers have been laidoff and even the official statistics reveal that 10 million migrant workers have returned to their home provinces or change to a new one (Schmidt, 2009).   4.3

Financial Repression

The financial system in China was characterized by a system of financial repression, which refers to a pattern of governmental policies that result in a situation, where has the low or negative real return on deposits. It was essential for the way societal processes were restrained and it resulted in a system, where savings could be moved

 

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from the households to the agents of the state to the exclusive benefit of the latter. Michael Pettis has said about financial repression in China: “Financial repression, in other words, is not only at the heart of both China’s rapid growth and China’s economic imbalances, but it also explains a number of otherwise puzzling aspects of the Chinese developmental model.” The people’s Bank of China controls interest rates in a way that has led to significant financial repression as inflation has risen in recent years. Figure 5 shows the benchmark nominal deposit and lending interest rates as well as the official inflation rate in China. It can be noted that benchmark deposit rate and lending rate are more stable after 1999, while the inflation during the same period performed unstable. But it is clear that the trend of inflation has correlated with interest rate, the central bank fights inflation by aggressively raising the interest rates. Figure 5. Interest rates and Inflation in China 1990- 2014

Source: World DataBank, World Development Indicators. In addition, figure 5 presents the gap between the deposit rate and lending rate in China was almost fixed after 1999, while it was contradicted with the implications from a financial market where interest rate is determined by the market. As a result, this unchanged gap is because government controlled the interest rates to lock the profit of its state-owned official bank system. Or the interest rates gap would shrink when the credit in China had a surplus. Moreover, figure 5 also reveals inflation in China is not always below the nominal interest rates, especially for the deposit rates.  

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In this way, the economy in China was suffering zero or even negative real interest rates (Lardy, 2008). It is indicated that the official inflation rate was probably underestimate the true inflation in China, this zero to negative interest rate problem is likely to be more serious in fact. It is unbelievable that China has such high annual economic growth rate while the net real return to capital was reach to zero. On the contrast, Bai et al. (2006) calculated that the return is significantly greater than zero. It is commonly believed that the real interest rate calculated from the benchmark rate cannot reveal the true market return to investment. Therefore government set the interest rates well below the market rates to lower the financing cost for its state owned sectors. In this way, government guaranteed that there are enough funds going to their pockets instead of other places with higher return. Besides, financial repression has led to lending rates that are far too low, resulting in excess demand for bank loans. Financial repression is the issue in great distortions in China’s economic situation. Since the official interest rates are modified, people could not save enough in the official banking system. What’s more, the result was a system that could not allocate resources efficiently and where the financial options for non-state actors were extremely limited. In this way under the system of financial repression both the households and the private sector have lived under an iron-wall of restraints and one of the reasons why the property market in China grew out of all proportions is because for quite a long time it was the only place people could place their money. In addition, financial repression is the reason why rapidly emerging pattern of e-banking and shadow banking in China. These shadow banks collect funds from rich households looking for higher return, but introduced higher risk into the economy at the same time. To conclude, financial repression is a political control system, which is a relic from the Communist command economy and which essentially paralyzed a rational allocation of financial resources, especially for the underdogs of China’s society, which are the households and private entrepreneurs. In this way, the financial repression restrained the development of a free market mechanism in China; especially the financial function of the economy was systematically contained.  

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Though Chinese government has tried a few financial reforms, while the depth and enforcement were far from satisfactory, and the effectiveness was quit limited.

5. Institutional Structure Institution is the combined set of action-orientation which characterizes a particular system of standard role pattern. The increasing acknowledgement of the role of institutions in social life involves the recognition that much of human interaction and activity is structured in terms of overt or implicit rules (Hodgson, 2006). Under the concept, institutions have capacities to structure, restrain and empower individual behaviors, which prescribe certain role-pattern correspond with shared value orientation. The problem with China’s economy is linked to its growth- model, which China has chosen. Through the analysis above, it is a model, which has been characterized by an unprecedented credit- fueled investment model (Pettis, 2013), with reaching highest savings- rate and investments rates ever recorded in modern economic history. The model was a reflection of the fact that China is a limited access society and the function of the model was featured in the fact that China never moved out of that mode. In this way, the economic model was essentially a function of the fact that China’s institutional structure was insufficiently developed and was held “captured” by its political system. The current growth model result in China’s inefficient institutional structure, and it is the source for all the core problems come from. More specific insufficient institutions that exist in China’s developmental process will be mentioned in the next chapters. 5.1

China’s state and political restraints

The institutional problems are those kinds of problems, which stand on the highest level of socio-cultural complexity of society (Martin, 2013). One important characteristic through Chinese history is its ironic political structure with the bureaucratic power. To understand that in modern China, China’s Communist Party has been in China since the establishment in 1949, which dominates state and society in China, and maintains the permanent monopoly on power with unshakable authority.

 

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Since 1978, the China’s Communist Party has worked to issue a set of governing institutions and a system of laws and policies of stimulus economic growth such as financial repression in the earlier study. The core principle for these institutions is still maintenance the political functions and the economic model was an expression of this distortion in overprotection. Nevertheless, these institutional reforms haven’t managed to solve the problems in the Chinese political restraints repressed effective governance. Look back China’s growth model; there are several structural problems under the investment-led, and almost the major structural problems cannot be solved if the institution behind these problems remains unchanged. Given an example for the distortion in Chinese institutional structure, financial repression on one hand, led the investment boom, on the other hand, it restrained the societal processes and resource allocation. The result is household and the private sector has lived under the unshakable power with many restrains. As a result, the consumer financing is rising from a very low starting point and so far in a very perverted shape (Oxhorn, 2012). According to the World Databank, there is 12 per cent of Chinese population still live in extreme poverty, while a third of China’s wealth held by less than one per cent of population. Although China has become the second largest economy since 2010, it ranks 83th on per capita income behind Romania (Russell, 2014). As Michael Pettis (2014) has argued that Countries with lower capital stock per capita are less able to absorb massive increases in investment. Usually they are poor precisely because they have a very limited institutional ability to absorb capital productivity. As Lawrence Susan presented in her research (2013), the phenomenon of Chinese political structure is known as “stove-piping”, in which individual ministries and other hierarchies share information up and down the chain of command, but not horizontally with each other. In this way, there’s a govern rank identify the relative importance and affect interaction between officials and their agencies (such as stateowned enterprises), which makes corruption and under table transactions in China is widespread. Many experts have queried that the viability of China’s current political structure in further development, in which the Party above the law and any institution, leadership  

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politics is non-transparent, and civil society have no right to liberalize. It is the historically inadequate level of structural differentiation that has become the source of problems with political power. In this way, without the success of political in institutional structural reform, it is impossible for China to fully institute economic and social structural evolution.

5.2

Weak civil society

Civil society is a subsystem of the societal community, which is defined as citizenship is institutionalized within the social structure. Societal community regulates important parts of exchange-processes link to economic and political system. Talcott Parsons emphasized that civil society is essential the realm of influence rather than that of power. Civil society is part of citizenship is institutionalized with the social structure, which means civil society is controlled by influence of public awareness rather than political power.   Chinese current model under such institutional structure has blocked the major societal allocated processes, and the Chinese political system keep its society in a distortion type. One of the most distorting factors within the Chinese system is the role of the state (Pye, 1990), means China’s historical in absolute political control restrain the development of social community. For any society to move toward the higher level of the post industrial society, it will need to develop all its potentials, societal, cognitive, civil, political and entrepreneurial which is difficult happen in China. Since the late 1980s, the concept of civil society appeared to the public awareness. National statistics presented that until 2014, there were 500,000 NGOs have been registered, and most of them were registered in a decade ago. Although it seems the state has become more tolerant of civil society and NGOs, the political environment in China still creates limitations. According to the economist (2014), there are series of strict conditions for any NGO who wants to register legally. It has to sponsor official organization, usually for the government agency that works related NGO’s interest. This is in order to keep the tight government control over all social

 

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organizations. Besides, such organizations have strict limitations of speech, assembly and press, indicate that is difficult for civil society to grow. Many China scholars argued that the relationship between the state and civil society is still corporatism (Teets, 2013), meaning that Chinese civilization can be characterized by political and cultural processes melted together, which caused the general structural differentiation of society is restrained. Weber (1951) has mentioned that in China there was no natural law, individual rights or personal freedom. Culturally, the original Chinese system was relatively low in structural differentiation. And the persistent feature of Chinese cultural life is the way it is absorbed in the political function (Yates, 2001). To sum up, Chinese civil society remained weak and a system of free institutions beyond the state was close to non-exist.

6. Structural Constraints China’s current economic structural problems are almost created by inadequate efficient institutions. Hence, these structural constraints cannot be solved if the institution behind these problems remains unchanged. The history of China indicates that institutional problems are the origin of distortion. In view of the restrictions of page and words, the discussion is promoted to bypass these many complications and “cut through” to a consideration which are the most influence among China’s economic slowdown: Demographics, environmental degradation and social inequality. 6.1

Negative Demographics

China includes one- fifth of the world population in a geographically huge and varied country. The abundant and cheap labors have attracted lots of foreign corporations built factories last decade, which brought plenty of benefits for China. However, according to the data of the World Bank, in coming decades, China will undergo a notable demographic transformation, with its old-age dependency ratio doubling to 24 percent by 2030 and rising even more precipitously thereafter. In the meanwhile, the low fertility rate also has huge influence to the negative demographics. The demographic factor has resulted in a fast shrinking of the Chinese labor forces and in a process by which China has reached its Levis point far earlier than it wouldn’t have been the case. The core problem is that China might get old before it gets rich.

 

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1) China’s demographic transition In 1979, the Chinese government embarked on an ambitious program of market reform following the economic stagnation of the Cultural Revolution. At the time, China was home to a quarter of the world’s people, who were occupying just 7 percent of world’s arable land. Two thirds of the population was under the age of 30 years, and the baby boomers of the 1950s and 1960s were entering their reproductive years. The government saw strict population containment as essential to economic reform and to an improvement in living standards (Zhu, 2003). So the one-child family policy was introduced. The policy consists of a set of regulations governing the approved size of Chinese families. These regulations include restrictions on family size, late marriage and childbearing, and the spacing of children (in cases in which second children are permitted). Figure 6. China’s population growth and fertility rate from 1965 to 2014

Population   growth  (annual   %)   Fertility  rate   (births  per   woman)   1965   1970   1975   1980   1985   1990   1995   2000   2005   2010  

7   6   5   4   3   2   1   0  

Source: World DataBank, World Development Indicators. According to the Figure 6, the fertility rate was falling in China in the 1970s because of the restriction from one-child policy, it just took China 50 years to go from a total fertility rate of 6 to 1, and the birth rate will probably shrink by another quarter by 2050. The rapid decrease in the birth rate, combined with stable or improving life expectancy, has led to an increasing proportion of elderly people and an increase in the ratio between elderly parents and adult children.30 In China, the percentage of the population over the age of 65 years was 5 percent in 1982 and now stands at 7.5 percent but is expected to rise to more than 15 percent by 2025.28 Although  

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these figures are lower than those in most industrialized countries (especially Japan, where the proportion of people over the age of 65 years is 20 percent), a lack of adequate pension coverage in China means that financial dependence on offspring is still necessary for approximately 70 percent of elderly people (Sun, 1998). What’s more, most Chinese get old before they get rich; pension coverage is available only to those employed in the government sector and large companies. In China, this problem has been named the “4:2:1” phenomenon, meaning that increasing numbers of couples will be solely responsible for the care of one child and four parents. Caring for parents and grandparents, who are living longer, is becoming a growing burden on the young. The McKinsey survey noted that a child’s need to care for parents will reduce labor mobility, while population ageing could cause a massive pension deficit. The weakness of social welfare could be a huge problem for elderly people and the pressure obviously decreasing the purchasing power in the meanwhile. On the other hand, the maldistribution of population led to the main consumer group distributed in the first and second- tier cities, the result in the aging of population and low birth rate also might become a big impact to the property market, especially for third and forth-tier cities. 2) Disappearance of the demographic dividend An increasing proportion of the population that is of working age provides an opportunity to reap a “demographic dividend,” both through both brute force increase in the numbers of potential workers and an accelerated accumulation of capital due to reduced spending on dependents. The demographic transition so far indeed has made contributions to China’s high- rate economic growth and provided a demographic dividend for the country. However, the proportion of the population of China that is of working age is projected to peak in 2011 and generally decreases thereafter. What’s more, the low fertility rate, which has lasted for some time, has pushed China to face a new phase of demographic transition. The demographic dividend is set to disappear and economic growth will definitely receive shocks. Demographers typically use population pyramids to depict the age-sex structure of a population. Such figures are called pyramids because, historically for most  

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nations, particularly in those with persistently high fertility rates, they resemble a pyramid, with a wide base representing large numbers of younger age groups and more narrow bands near the top representing smaller numbers of older people near the end of their natural life span. In Figure 7 we show population pyramids for China in the years 2014. The “pyramids” for China have much smaller bases than the classic shape, there is a bulge for those aged 40-54 (who were born between 1961 and 1975); this reflects the rapid increase in fertility that followed the great leap forward of 1958 and the three subsequent “Black Years” of Famine from 1959- 1961. The smaller cohorts of person aged 25-34 (born between 1980 and 1989) likely reflect China’s renewal of family planning campaigns. Figure 7. China’s 2014 population pyramid

Source: CIA World Factbook In the meanwhile, the working- age population (typically defined as ages 16-64) reduced by 3.71 million, the rapid increase in the elderly share of the population may bring major changes to the labor supple equation. The shortage in Chinese labor market caused the growth of wages higher than the growth of GDP. For example in 2014, the growth of wages was 9% while the growth of GDP was only 7.35%. In order to ease up the pressure of shortage of working-age population, government announced that one child policy has been relaxed: couples in which both parents are only children can have two. Moreover, it might be allowed to have up to two children  

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without limitation thereafter. But the point is the proportion of the population of China that is of working age has reached to peak while the relaxation of one-child policy could not become effective right now. The newborns need 16-18 years to reach their working-age, the gap still hard to be filled. In other words, China has to find the economic power without demographic dividend between the years of 2015 to 2033. Moreover, because of the social pressures and modern ideas, it would not be surprising if there is no change for the fertility rate.

6.2

Environmental Degradation

China’s environmental ills have been widely documented and reported on. Many of the dizzying statistics about China’s air and water pollution, its acquisition of natural resources abroad, and its impacts on global commodity markets are well known, suffice to say that China’s environmental crisis is real and it is planetary in scale. Today, China faces looming environmental issues, as it is becoming one of the largest and most polluted countries in the world. According to the 2014 Environmental Performance Index released by Yale University and Columbia University at the World Economic Forum, China ranked 118 out of 178 countries on the list. 1) Facts in Environmental problems Polluted air is one of the most serious environmental problems affecting the daily life of the Chinese people. Polluted air is everywhere in China. It is especially severe in metropolitan areas. Sixteen of the world’s twenty most polluted cities are in china. According to a scientific report, "the air quality of nearly 70 per cent of urban areas does not meet the country’s national ambient air quality standards (NAAQS)"and "nearly 75 per cent of urban residents are regularly exposed to air considered unsuitable for inhabited areas". What’s more, based on statistics from China’s Ministry of Environmental Protection (MEP), cities in China’s Yangtze River Delta, Pearl River Delta, and Beijing-Tianjin-Hebei region suffer over 100 haze days every year, with PM2.5 (particles with an aerodynamic diameter less than 2.5 µm) concentration two to four times above the World Health Organization guidelines. Millions of people in China are breathing a hazardous cocktail of chemicals every day. These chemicals are caused by coal-fired power plants,

 

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factories and vehicles, and are responsible for heart disease, stroke, respiratory illnesses, birth defects and cancer. Recent studies suggest industrial pollution contributes more to China’s water shortages than was previously assumed. More lakes suffer from sedimentation and diminishing water surfaces as a result of physical and human factors. About 70 per cent of China’s lakes and rivers were polluted to some degree (Chen, 2003; Shao, 2006). In a survey taken in 2014, it was found that 28 per cent of 412 monitored areas of seven major rivers in China were rated of no practical use. Between 2011 and 2013, about 5 per cent of Chinese wells contained more than 50 micrograms per liter of arsenic, which affected 582,769 people. Seventy-five per cent of surface water flowing through urban areas of China is not suitable for drinking, and 90 per cent of urban ground water is contaminated. Nearly 500 million people lack access to safe drinking water (Yu, 2014). Underlying most of this is the reality of China’s growth model. China was the global manufacturing hub of the world; export trade rather than domestic consumption is driving China’s growing pollution and resource demands. Significantly, most of China’s exports are primary goods or manufactured products that create heavy pollution and require intensive resource uses. A whopping 40% of China’s energy use goes into its exports (Horn, 2008). Environmental problems is a very difficult to deal with such a complex project. Chinese factories are still using old technology and many manufacturers lack measures to protect the environment. 2) Consequences of China’s environmental degradation Poverty, disease and environmental problems are the three greatest challenges nations face in the twenty-first century. The three problems are interrelated, but the environmental problem is the most serious and costly one. The environmental degradation has multiple effects; it is a drag on growth and it increases the need for hospitals and pensions systems in China. Environmental problems have directly damaged Chinese people’s health. Air pollution affects respiratory systems and the visibility of the atmosphere. Much of  

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the indoor air pollution in China is caused by the use of solid fuels in simple household stoves. Although China has been experiencing great urbanization, more than 65 per cent of the population is still rural, most of which still uses biomass and coal fuels that produce substantial pollution. Coal and biomass are difficult to burn in simple household devices without emitting pollutants (Smith, 2007). There is great difficulty in premixing the solid fuels and air before burning. Thus, the burning of these solid fuels poses a great health risk to those cooking with the materials. Pollution has made cancer China’s leading cause of death. Air pollution is a major cause of lung cancer, as harmful particles enter the lungs and cannot be discharged. Particle pollution from the burning of coal causes approximately 50,000 deaths per cent of all respiratory ailments. The number of pollution-related deaths has already reached 750,000 per year (Liang, 2010). Keith Florig notes that: “Today, diseases linked to air pollution are among the largest threats to public health in China, ranking with smoking as the most frequent cause of death." China faces a dilemma with its environmental degradation. The costly governance charge and limitation in production is obviously a drag on growth. On the other hand, the increasing need for hospitals and pensions system could not be solved right now. The weakness in China’s welfare system require people have to spend extra money in medical care, which restrain their consumption in other aspects.

6.3

Social inequality

Since the start of the reforms in 1978, China has experienced unprecedented economic growth, which has led to spectacular reduction in income poverty. However, this growth has been accompanied by dramatic increases in inequality, especially from the 1990s (Zhang, 2002). Growing disparities along different dimensions (ruralurban, first and second-tier cities- third and forth-tier cities, etc.) are cited as reasons for growing social unrest, not to mention the fact the poverty reduction would have been even more spectacular has the growth not been accompanied by sharp increase in inequality. The inequality is discussed with China’s income and educational inequality under its Hukou systems.

 

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1) Hukou system and Migrants The Hukou system is a Chinese household registration required by law,which was one of the important institutions to create and maintain such a social and economic configuration. Under this perspective, the Hukou system has served the function of migration control. In Mainland China, all PRC nationals’ personal Hukou status is classified by two related parts: one by residential location and one by socioeconomic eligibility ("agricultural"/"non-agricultural"). The first classification of one’s Hukou registration is the place of Hukou registration. Under its regulation, each citizen is required to register in one and only one place of regular residence. The Hukou registration defines one’s rights for social and economic activities in a specified locality. For example, the person from Shandong can only entitled to social welfare, hospitalization and pensions if he lives there. Moving to work in Shanghai doesn’t change his Hukou registration and he cannot enjoy welfare rights in Shanghai. Moreover, the rule for convert Hukou is strict with tons of requirements. The second classification is the type of Hukou registration; refer to the agricultural and non-agricultural. The specific classification also drive to a two- class structure in China, it determines to keep rural people in the countryside; those who go to work in the cities are ‘on loan’ (Beardson, 2014). It also imposes huge barriers for people with agricultural Hukou to convert their Hukou status. The figure 8 below shown that at least 200 millions of migrants have moved from the inner provinces to the coastal area or from rural to urban in order work such as Guangdong, Zhejiang and Shandong. The problem leading by the registrations rules from Hukou system is that the millions of migrants in the coastal areas have no right to have social welfare, hospitalization and pensions where they actual work and live. Conversion of one’s Hukou registration is far from a matter of personal choice. The designation of Hukou registration place and status for a person is inherited from that of his parents. Change of the Hukou registration has to go through a process of seeking approval from the government. This is not easy for rural-urban or inland-coast migration.

 

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Figure 8. Map visualizes Chinese migration flow

NB: The thickness of the arrows indicates the strength of the flow. Source: NBSC, 2011 Though the reform of Hukou is declaring from the government for a long time and has been a hot issue, the implement process still slow and difficult: the local government can really not afford to implement the Hukou reforms, since the underfunded and economic trouble, paying social welfare payments, guarantee for millions of migrant workers cannot be solved in a short time (Panda, 2014). What’s more, the reform of abolish of Hukou also probably bring more serious regional inequality in China. 2) Income inequality The growth in household income hasn’t been uniformly distributed compare with the growth of GDP. China’s income inequality started rising when the country’s former leader Deng Xiaoping launched market-oriented reforms and opened the economy in 1978. Deng announced, “We permit some people and some regions to become prosperous first, for the purpose of achieving common prosperity faster. (Xie, 2014)” The incomes of the poor are growing, but it appears the rich are getting richer much faster: Until 2012, the income ratio of the country’s richest 10% and the poorest 10% increased to 22:1, according to the World Bank. Driving the

 

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phenomenon are development policies that favor heavy industry, some special economic zones in coastal areas such as Shenzhen. In 2014, urban residents earned 2.45 times more than those in rural areas, while the income of rural residents in coastal provinces tripled from 1989 to 2010. Income inequality is measured by the Gini coefficient, which measures the degree of inequality in the distribution of total resources. A Gini coefficient range from 0 to 100 indicates that perfect equality with all units receiving an equal share to maximal inequality where one unit has all of the resource. As a result, the higher the Gini, the more unequal the society. A 2014 study published in the U.S. Proceedings of the National Academy of Sciences, “Income Inequality in Today’s China,” used several newly available surveys, including a large-scale NBS survey and six independent surveys conducted by university-affiliated organizations, to estimate China’s Gini coefficients for recent years and compare them with those in the U.S. Figure 9. Gini Coefficient in China and the United States

Source: Xie Yu, Income inequality in today’s China, 2014 In Figure 9, it is shown the estimates of the trends of Gini coefficient of family income for China represented by the red line. It is also display the trend in the U.S. by the blue imaginary line. Since the 1980s, income inequality in China has risen at a fast pace than in the United States. From 1980 to 2012, China’s Gini coefficient increased from 0.3 to 0.55, surpassing the U.S. coefficient of 0.45.  

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China’s income inequality has grown rapidly in the last three decades, to a very high level around 2010. The rapid rise in income inequality can be partly attributed to long-standing government development policies that effectively favor urban residents over rural residents and favor coastal, more developed regions over inland, less developed regions (Xie, 2014; Hannum,1996). According to the analysis above, it seems reducing the rural-urban and regional disparities could reduce and eliminate the two- class society in China. But it is hard to implement in a short time. 3) Educational inequality Until the 1980s, China’s distributional policies manifested a strong urban bias (Lin, Cai, & Li, 1996). The rationing system introduced in the 1950s enabled urban residents to have access to food, housing, education, and healthcare at much lower prices. Almost all urban residents in the working age group had guaranteed jobs in the state or collectively owned firms. Because these jobs were permanent, the socalled “iron rice bowl”, urban unemployment was virtually nonexistent. These jobs also provided urban residents with many benefits such as free or subsidized education and healthcare. Basically, enterprises and government agencies were responsible for providing social welfare to urban residents. While compared to the level of social expenditure in cities, rural areas received far less. China’s state education system, which offers nine years of compulsory schooling, According to the data from the World Bank, the ratio of school enrollment for primary and secondary increased by 25% from 2006 to 2013. While there is still a huge gap in educational opportunities between students from rural areas and those from cities is one of the main problem. Some 60 million students in rural schools are “left-behind” children, cared for by their grandparents as their parents seek work in faraway cities (Gao, 2014). In contrast, urban peers attend schools equipped with advanced facilities and well-trained teachers, rural students often huddle in decrepit school building and struggle to grasp advanced subjects with dearth of qualified instructors.

 

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Table 2 presents the levels of illiteracy for overall, rural, urban, inland, coastal, females, and males in China. Several striking features stand out from the table. First, the illiteracy rate has declined steadily over the years, reflecting the success of 9-year compulsory education and the high primary school enrollment rate. Second, there exist large rural–urban and gender-gaps. In 2000, the rural illiteracy rate was more than double of the urban illiteracy rate. The illiteracy rate among females is more than twice as high as the male illiteracy rate, suggesting a strong gender bias against girls. The illiteracy rate in inland areas is about 15% higher than that in coastal areas. Table 2. The level of illiteracy rate in recent China Year

National

Rural

Urban

Total

Female

Male

Total

Female

Male

Inland

Coast

1980

31.9

34.8

49.1

21.1

16.4

24.6

8.9

33.7

29.1

1990

22.2

26.2

37.1

15.7

12.0

18.4

6.1

23.8

19.6

2000

15.1

19.9

27.9

12.1

8.7

13.2

4.1

16.0

13.9

2010

9.3

10.6

16.7

9.9

7.2

9.8

2.3

12.7

9.3

Source: World DataBank, World Development Indicators. What’s more, for migrant children who follow their parents to cities, the opportunity for a decent education is similarly limited, as various government policies foil their attempts at full integration. The hukou system talks above, denies rural children the right to enter urban public schools. Many migrant children are relegated to private schools that charge higher tuition and offer subpar education. In this way, there are millions of workers are lack of skilled for specific roles, the gap would never to be filled. Social inequality has multiple implications. First, people live in a social setting and do care about their relative positions in a society. High social inequality is often in relation to low happiness. Second, large social inequality often leads to more crimes and social instability, which in turn contribute negatively to investment environment and economic growth. What’s more, it lowers the consumption level, the household of productive capital and the interpenetration of cognitive institutionalization that are the key to solve the rebalancing problem.

 

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7. China’s Rebalancing problem The rebalance of the economy is fundamental for the efficient functioning of China as an economy system. This is a process of absolutely objective necessity, which require supply and demand eventually have to be balance if China’s economic shall met an absolute minimum of system efficiency and questions of survival, since it is unrealistic to assume that export in the future can remain China’s main demand axis. The fundamental imbalance in China is the very low GDP share of consumption. This low GDP share reflects the growth model mentioned before that Chinese growth is driven largely by the need to keep investment levels extraordinarily high. What’s more, the very high growth rate in investment, combined with significant pricing distortions, especially in the cost of capital, has resulted in overinvestment, which in turn has led to an unsustainable increase in debt. China cannot slow the growth in debt and resolve its internal economic problems without raising the consumption share of GDP. Based on the analysis of the growth model above, China is an investment-led economy, also its growth driven by the export- oriented model. This is because fundamental to its growth model are policies that systematically force up the savings rate—to levels even higher than the extraordinarily high investment rate—China must resolve domestic demand imbalances by exporting either the excess saving or the excess of what it produces over what it can consume or invest domestically. China’s high trade surplus, in other words, is simply a residual that is necessary to keep investment- driven growth manageable under conditions of repressed domestic consumption. 7.1

Investment vs. Savings

According to the analysis of China’s growth model before, high investment is the key features of China’s pattern of growth. Since the reform in 1978, investment in China has been high. As a share of GDP, it continues climbing from 36 per cent and peaked at 51 per cent of GDP in 2013. In order to get its investment level down, China will need to get its savings-level down, as domestic savings are the predominant financing source of investment. The remarkably high household and enterprise savings is the crucial part behind China’s high total savings.

 

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Through Figure 10 below can be found that since 1990s investment have been relatively steady at levels, and also savings always in a higher level than investment. Both of them have surged since 2000, led China’s national saving rate climbing to over 50 per cent of GDP in 2014, which was among the world’s highest for any economy of a significant size (Bernake, 2005). Figure 10. China’s saving and investment rate, 1978-2014 (per cent of GDP) 55   50   46  

45   40   35  

51   50   50   49   49   50   48   50   48   49   48   49   49  

44   42   43   42  

investment  rate   Saving  rate  

38   37   36   35  

30   1990  2000  2005  2006  2007  2008  2009  2010  2011  2012  2013  

Source: World DataBank, World Development Indicators. From data according to National Bureau, figure 10 shows the gross savings by sector in China from 1992 to 2014, half of China’s savings are essentially SOE savings. Since 2000, corporate savings were roughly as large as household savings, and began to surplus by 2 per cent of household savings in 2002. Enterprise savings from retained earnings constituted a significant source of savings in China, which has risen sharply in recent years. China’s high corporate saving rate is commonly claimed to be a key driver for the country’s large current account surplus. One reason for such high corporate savings was occupied by state owned enterprises. To conclude, corporate savings in China is a key driver of its current account surplus, and the high corporate savings is mainly a result of high saving rates by SOEs due to mis-governance. Over the period from 1992 to 2014, the share of household savings in national savings has not changed much, as it is shown on the figure 11 below. On the other hand, according to National Bureau of Statistics, Chinese households save in a large share of their disposable incomes and their average saving rate has increased over last decade from 26 per cent in 2004 to 41 per cent in 2014, and what’s more, the pattern

 

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was particularly adapt to urban households, which account for about two-thirds of national income. On the contrast, compare to rest of emerging Asia, households saving rate were both under 15 per cent. Figure 11. Gross Savings by Sector in China 1992- 2014 60 50 40 30 20

0

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

10

Households

Enterprises

Government

Source: National Bureau of Statistics (Flow of Funds data) Chamon and Prasad have argued in 2010 that China’s urban households saving rates by age was distributed like a “U-shaped”, which means younger and older households would save more. The weak public provision of education, health and housing services motivated households for saving more. So this can explain why the saving rate distributed like that: younger households accumulated assets to prepare for future education and housing expenditures, and older households prepare for provision after retirement and health expenditures. As a result, it is clear to see that the insufficient welfare insurance contributed to higher aggregate savings. The uncertainty using for health care and prepare to response higher housing purchase could be the most crucial motivator contributed to China’s households high saving rate. On the other hand, according to Ma and Wang’s working papers in 2010, China’s high saving rate has been influenced by number of institutional reforms launched in 1990s. First, the corporate restructuring led to large-scale labor retrenchment, such corporate restructuring tended to directly enhance enterprises’ efficiency and reduce job security, lifted both corporate and household savings. After that, the 1997 pension reform transformed the previous pay-as-you-go system to a partially funded three  

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pillar scheme, while the new reform cut pension benefits as before, increased contributions and introduced pre-funded individual pension accounts. This institutional change reduced pension wealth and trend for population aging both influenced the saving rate rising in China. What’s more, another reform related to private home ownership also related to the increasing saving rate. As part of the corporate restructuring, state owned firm did not provide housing for the hires any more, and introduced housing provident funds instead. The sharply increased demand for housing has been a key driver for both high investment and savings in China in the past decade. What’s more, with the China’s housing market continued to boom during that time, the unimaginable increasing price pressed households savings lifting.

7.2

Consumption

According to the definition of GDP, there are three sources of demand—domestic consumption, domestic investment, and net foreign consumption and investment (trade surplus). Growth in all three, however, is constrained by various factors. China’s trade surplus by the middle of the last decade was so high that it could not reasonable be expected to generate much more growth in demand. Household consumption, meanwhile, was a relatively limited source of demand in China representing roughly half the US and Europe consumption ratio. As it is shown on figure 12, since 1990s, Chinese households consumption ratio was below the levels compared to other nations, while the gap turned larger from 2005, which indicated that spending levels in China sharply shrink at that time. Referring to estimation from McKinsey (2013), the average ratio for emerging Asia is about 55 per cent and world’s average of 60 per cent, China as a result of the proper consumption level should reach over 50 per cent of GDP based on the historical levels. So there has a more than 15 per cent gap between the real and normal level in consumption. This too small share also a reflection for China’s economic growth distortion.

 

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Figure 12. Comparison of Household final consumption expenditure (% of GDP)

Source: World DataBank, World Development Indicators. There are several reasons for the low level in China’s consumption ratio compares to other nations. One is that China doesn’t have a complete social-security system as it stated in earlier study. Wang from McKinsey China Council of Business Economists argued that by 2013, less than two-thirds of the urban population was covered by Chinese welfare system and most of rural residents live without any social security or in a very low level. And also the cost for education, medical care and property pricing has increased quite rapidly, which has much faster than China’s GDP and income growth. The distinction between urban, rural and migrants consumption also could be another cause factor for the low consumption level in China. Chen et al (2012) found that during past decade, urban households accounted for over 70 per cent of total household consumption in 2013 compare to rural households, and urban residents consumed 30 per cent more that migrants without Hukou rights.

7.3

Debt to GDP

“China has a $28 trillion problem. That’s the country’s total government, corporate and household debt load as of mid- 2014”, according to McKinsey& Co, it’s equal to 282 per cent of the country’s total annual economic output and far above the average for developing countries and higher than some advanced economies including Australia, the United States, Germany and Canada (Curran, 2015).

 

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As it is shown on figure 13, China’s level of debt has grown rapidly since 2009, the initial debt surge was the result of a deliberate, state-driven stimulus program undertaken in response to the global financial crisis. While total debt accelerated from 148 per cent to 282 per cent of GDP over 2008- 2015, boosting average GDP growth to 8.75% during that period. Debt has been used to support growth, while the new debt becomes less effective at creating growth (Ide, 2015). Figure 13. China’s debt- to- GDP ratio with borrower segment (% of GDP)

Note: financial institution credit is excluded and only half of entrusted loan amounts are included due to double counting Source: PBoC, China Bond Online, Gao Hua Securities Research The credit boom comes with some risks. The credit boom after crisis has resulted in an almost unprecedentedly sharp rise in China’s leverage, China’s addictive in debt to fuel growth also suggested recent growth rate is unsustainable. The risk is rising as debt seems continue to expand as fixed investment has a diminishing impact on GDP, which threat of a sharp slowdown. 1) Corporate debt The aggregate credit-to-GDP ratio covers government, corporate and household debt. From the Figure* above, it is clearest area of concern for China’s corporate debt. Over 80 per cent of the rise in China’s debt- to- GDP ration can be attributed to the explosive growth of corporate debt, which rose form 96 per cent of GDP in

 

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2007 to 178 per cent in 2015. It is much more menacing than household debt, and it now makes up 60 percent of China’s total debt. According to the data from the investment bank Goldman Sachs estimates that China has one of the highest corporate- debt- to- GDP ratios in the world, even compared to major developed economies like the United States, while with a much lower income per capita it was a clear outlier. According to a Caixin magazine report showed, the People’s Back of China injected a combined $62 billion worth of capital into two state-owned lenders that are referred to as policy banks, as they carry out government objectives. China has started to transit into a more consumer-driven economy from an emerging market with real estate and heavy industry leading by most State-owned enterprises in China. Figure 14. Breakdown of China non-financial corporate sector debt 2015 Chemicals Machinery 4% 4%

Real Estate 16%

Construction Materials 3% Airlines 3% Transportatio n Infrastructure 2%

Construction and Engineering 10% Oil& Gas 12% Power and Renewable Electricity 12%

Other 24%

Metals and Mining 10%

Source: Capital IQ, Goldman Sachs Global Investment Research Real estate and heavy industry accounted for the 61 per cent of corporate debt as it shown on figure 14, the emerging in real estate market in China driven by the massive credit expansion. And for many analysts, the Chinese economy was partly stimulated by the housing bubble, with unexplainable price acceleration that the most crucial driver for price was the belief that prices will continue to rise in the future (Shiller, 2005). Data from CEIC indicated that the outlook for such property investment would fail to rebound as strongly as expected. The ratio of real estate  

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inventory was sharply increasing since 2009, and the proportion between the real estate under construction and sold was much higher now than several years ago. What was worse, even if the gap is continues growing, the trend for new projects in real estate market with debt are still rising in the meanwhile, which lead the debt problem getting worse. What’s more, the new debt flow to SOE has its own problem. Research by Goldman Sachs in 2013 indicated that SOEs have seen their returns fall from around 6.7 to 4.5 per cent, while private enterprise have been seen the returns rise from 8 to 11 per cent. However, meanwhile non-SOEs have been deleveraging. Besides, some SOEs were performed as so-called zombie companies that means they can continue to operate even though they are insolvent or near bankruptcy. The main problem for these zombie companies is that they could get persistent credit flow to survive while they have no adequate base in productivity. According to Michael Pettis: “Many of China’s SOEs are essentially insolvent but are the receivers of bondless amount of loans from China’s large banks. (Ricardo, 2008)” In other words, not only has the amount of new debt since the financial crisis been extraordinary, the debt also has been allocated inefficiently. China cannot growth without throwing credit on the economy, especially for the flow of credit to keep zombies alive. 2) Local government debt Government debt, which is incurred significantly at the local level, is not as high as corporate debt nor has it grown as dramatically, while its complex structure still indicated hidden risks. Even the performance seems outstanding in the central government’s balance sheet stressed that the debt to GDP ratio has declined form 29 per cent in 2009 to 25 per cent at the end of 2013 (Ho et al. 2013). The calculation didn’t account for China’s local government accounts, which take the majority of the public debt. As it is shown on figure 15, when the 1978 reforms introduced to liberalize the centrally planned economy, SOE profits plummeted. The government’s revenues fell from over 30 per cent of GDP in 1978 to less than 12 percent in the mid-1990s, leading to a major fiscal reform in 1994 (Huang, 2014). Meanwhile, the increased  

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government expenditure exceeded far more than the revenue after 1994, which means of local governments have been running deficits since then, and drove much of their reliance on borrowing to filling this gap. In particular, local governments rely heavily on local government financing vehicles (LGFVs), means local governments establish some SOEs to conduct activities like building railways and power plants in order to serve them economic need. Referring to Huang’s research, China has excess 10,000 LGFVs active so far. These enterprises under the support of local governments are more easily borrowing through bank loans and bond issuance. Altogether these transparent sources of credit accounted for 40 per cent increase during recent two years (Williams et al. 2014). Figure 15. Comparison between local government revenue and expenditure

Source: Chinese Ministry of Finance, International Monetary Fund The rapid growth in lending by local government indicated that the fiscal problem because of under budgeted, and “many of which may not be able to repay”, reported by McKinsey. Moreover, the under budgeted local government’s economy also reflected the core of multiple problems in China (Scissors, 2014). The budget gap is also linked to the low consumption level because the local government can’t afford to use much money on social welfare and hospitalization and so on. 3) Shadow banking Shadow banking is an issue of cutting across both corporate and local government debt. It is financial intermediaries, which is unregulated by the government or only

 

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is regulated to a limited extent. Shadow banking includes informal lending between individuals and companies, loans made by nonbank financial institutions like trust funds, brokers and securitization vehicles, etc. Around a third of total outstanding debt in China is provided by a highly opaque shadow banking system, made up of various forms of non-bank lending. In China, shadow banking in China is extremely complicated phenomenon; it is the outcome of China’s system of financial repression with low interest rate and high debt growth in the sense that shadow banking perform more profitable. Based on the Goldman Sachs estimates in 2013, in general, shadow banking activities in China have expanded dramatically since the end of the bank credit stimulus in 2009. Shadow banking provides the private sector and local government with the loans and the higher yield. In this way, the flow of new credit has more than doubled from 22 per cent in 2008 to above 50 in 2014. There are also risks behind the blooming phenomena in shadow banking. Shadow banking has often been highlighted as the most risky part of financial system. With the borrowing is not regularly disclosed and difficult to track, on one hand, credit risk would increase by lending to financially weak borrowers. What’s more, local governments also borrow through the less transparent shadow banking system. “Local governments have so far made a lot of efforts to limit the effects of trust defaults, which is why some of the problems haven’t been fully visible yet” said by economist Mr. Lian. China has overtaken the U.S. as the world’s largest issue of corporate debt, according to Standard& Poor’s Rating Services. Local governments also generated large amount debt through LGFVs to fund construction projects. What’s more, shadow banking caused by financial repression is playing a risky role in China’s economy. The country has to begin deleveraging, but this is rarely achieved by reducing the absolute amount debt in a country, or even by halting its growth. Rather, the key to deleveraging will be enabling GDP to grow more rapidly than credit while obviously hasn’t happened so far. The gap between increased leveraging and the decline of economic growth is absolutely unsustainable.

 

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8. New Transition Towards to a Post- industrial Society According to Masahiko Aoki’s research, the rise of industrialized China and her resurgence as an economic powerhouse is a transformative event in the history of the world economy. However, there now appears to be an emergent consensus that the Chinese economy is facing a turning point, that is to say, another transition after the thirty years of successful transition to the market economy from the command economy. The nature of this new transformation may be understood within a new conceptual and analytical framework that unifies development economics and demography in a long-term perspective (Galor 2011; Aoki M. 2012). After a rather long transition out of the Malthusian state (1911- the late 1940s) and then the phase of governmentmediated initial industrialization (the early 1950s- the late 1970s), the era of high growth ensued, driven by favorable demographic factors such as demographic dividend (Bloom and Williamson 1998) and massive domestic migration of labor from the rural agricultural sector to the industrial sector. The concept of post-industrial society was first came up with Daniel Bell in 1973, which referred to an industrial society passes from a manufacture dominant mode of production to one where the service industry. In other words, service industry becomes highly professionalized and that this shift also establishes a shift of the role of information and knowledge as factors in the production. So this post- industrial phase requires that improvements in the quality of human resources rather than an expansion of their quantity needs to become a major driving force of further development. This transition to the phase of human capital- based development is the key for China to sustain per capita income growth. This may mean that the changes also embody the seeds of resources for meeting the challenge that they pose as well. But it is widely recognized that to make the nest use of then, economic policy, mechanisms and institutions may need to be adapted accordingly. Therefore, the challenges for China’s transformation towards to a postindustrial society can be listed as follow:

 

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8.1

Move-up the value chain

According to the study above, it has become clear that China has been running out of old drivers without being able to attain new ones. China needs to regain its productivity capacity. (For example, it should be noticed that the productivity of China’s service sector lack significantly behind that of the advanced economies.) To move up the value chain, is a socioeconomic processes through which a social system or an economy is improving its socio-technological capabilities, including improving the capacities of its human capital. In other words, productivity problem can be solved by technological upgrading but the premise is China moving into a knowledge based society. 1) Old drivers Over past decades China has become the world’s factory. Huge amount labors with low wages attracted investment in labor-intensive industries that create lots of jobs, even though they had limited skills. The changing form agricultural to industrial which introducing lots of machinery and low hanging out technical fruit quickly pump up growth, in this way, foreign capital helped build China into a low-cost manufacturing powerhouse while the increasing urban population derived higher wages and other cost climbed as well. Figure 16. Wages (US$) comparison among ASEAN countries

Source: World DataBank, World Development Indicators.

 

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Over past decades, millions of jobs have moved to China as factory owns try to cut costs. While in Guangdong, the top exporting province in China, wages have almost doubled within these three years (Dexter, 2013). As it is shown on Figure 16, real per capita income in China has a fivefold increase between 1990 and today, and at the same time, the growth has surplus other countries like Vietnam, Thailand and Indonesia. What’s more, the trend seems to continual increasing in a high speed. In other words, as a result of a long-term trend of rising wages and other costs that have made China less attractive, China is losing its competitive edge as a low-cost manufacturing base, more and more factories were relocated to cheaper places in Southeast Asia. As a result, more and more factory owners relocated and moved out China. Then, contrast to Vietnam got 27 per cent increased in foreign investment in 2013, a 13 per cent fall into China indicated that China has lost its competitiveness. Taken an example to see what happened, China produced 40 per cent of all Nike shoes while Vietnam got only 13 per cent. Forward to 2014 China’s production share shifted to 30 per cent while Vietnam has lifted to 42 per cent (Cai, 2014). On the other hand, since the development of China’s manufacturing, there were no low-hanging technological fruits any more. During the past, China gained a lot through advanced technologies at that time to enhance productivity and improved production method process, which accelerated the growth of China’s economy. As time goes by, technological upgrading must be imperative, in this way, the level of human capital has to be enhanced. 2) Human capital China’s rapid growth was fueled by substantial physical capital investments applied to a large stock of medium-skilled labor acquired in the past three decades. Since the old drivers were run out without being able to attain new ones, China’s productivity is declining and it has lost its competitiveness. To enhance the productivity issue is relate to technological upgrading, which requires a higher level of human capital. As China has to move from an investment- led economy to a consumption-oriented one, from being the workshop of the world transfer to a focus services sector, it will need more high-skilled workers, however, the amount  

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of high-skilled labor small, the increasing in demand for higher education has built a skill gap in current China. As it is shown on Figure 17, it is clear to see the distribution for Chinese school enrollment. Primary school enrollment has satisfied for all people since 1990s, and secondary school enrollment also climbing from 40 per cent to almost 100 per cent. However, these limited educational labors can only fulfilled for the old industrialized China, working for manufacturing, following instructions and with no creative during the work. In contrast to see the proportion for higher education enrollment in China, though it has increased by 25% for recent 25 years, the amount is still very small. Figure 17. School enrollment in China 1990- 2014 (% gross)

Source: World DataBank, World Development Indicators. In other words, China’s transformation to the post-industrial society makes a daunting skills gap facing both its workers and its managers. According to new Mckinsey research, the supply in low end of labor market will surplus the demand, it is forecasted that in 2020, there will be at least 14 per cent more than job suited for their limited education; while on the other hand, at the upper end labor market, Chinese employers will demand 142 million more high-skilled workers those with university degree or specific knowledge training. And there is over 33 per cent gap between supply and demand in such higher-level human capital in China. As a result, instead of leaving the skill-gap and delay to develop or expand, companies

 

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might fill this gap with less-skilled workers, which would get lower productivity or poorer quality products and services. McKinsey estimated that if China could not bridge this gap by 2020, more than 2.3 per cent of GDP would loss, which this number is greater than the economic output of Hong Kong. Referring to earlier argued in educational inequality, fast-growing first-tier cities like Beijing and Shanghai are powerful with raising tertiary enrollment and higherskilled workers; going metropolises or costal has become the main stream for people from inland regions. Nevertheless, those without well-known institutions degrees or high quality education live hard in such intense competitiveness. Hence big cities have more high-skilled labor than they can use, while smaller size or inner cities lack of. This mismatch in human capital distribution is also influence the future growth for China’s transformation into a post-industrial society. What’s more, the demand for high-skilled workers will increase since China has to shift to service and knowledge-based society. Right now China’s negative demographics could bring about 8 million fewer university-educated workers than the country will need (Chen et al. 2013). The supply-demand gap would getting wider with an expected shortage of 16 million people. Survey from McKinsey presented that many employers consistently argued the hires those with the skill levels were really graduates of universities or technical schools. A large amount of hires were lack of technical training, inadequate language skill and deficient innovative and creative capabilities. The quality of education system in China might be another challenge for the situation to enhance the human capital. To conclude, China has to improve the quality of its human capital to move into a knowledge-based society, more people and more machines would no longer enough to enhance productivity. So the problem is if China can bridge and narrow the skills gap with such a lot issues corresponding in China’s current situation.

 

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3) Innovation One of the questions for moving up the value chain has often been associated whether a society has become “innovative”. On one hand, it is a kind of spirit nurtured from a society. However, it requires a high-level of civil society and a strong sense of political entitlement among the common people. Innovative is a concept that more correlated with a kind of liberal ideas, which come from the societal processes into more freedom. In China, it is clear that government-directed and centrally planned mode present the political repression and weakness of China’s civil society, the transformation seems very difficult or even impossible to achieve (Teets, 2014). What’s more, in order to shift from a manufacturing-centric model to an innovation-knowledge based economy to enhance productivity, China has invested more in new technology and R&D expenditures especially among these years. According to R&D magazine in 2013, China has increased its R&D investments by 12 per cent to 20 per cent annually for each of the past two decades; most of China’s R&D investment was linked to national goals for industrial growth, stable domestic evolution to an advanced economy, power projection and international prestige. Besides, government was also issuing bonus for those who invented socalled technological innovation. Wu Jinglian has argued that there has distinguish between science and technology, any technological innovation should be tested and rewarded by the market, not by the government. Because government has no capacity to judge which technological innovation can be succeed in the market, even the technology is advanced itself, its prospect still cannot be forecasted. The problem is whether such huge amount investment in R&D can improve real technological development in the whole society before the socio-cognitive level of society has reached certain thresholds of institutionalization and systemic integration. Besides, China has proceeded through a kind of technological adoption during the industrial phase, which lack of innovative capacity is also harmful for China’s technological upgrading and move up the value chain. Moving from an industrial to a post industrial society is not only an economic mode shift, but a shift in the cognitive mode of orientation that need to be correlated with wide-spread institutional change.  

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8.2

Move to service sector

With the development of industrialized China, the latter process is paramount for the growth of the service sector and moving from consumer society. There has a trend showed that the proportion of residents’ consumption is changing from material to service products, which involve education, communications, health care, transportation, etc. According the World Databank, though the service sector’s share in GDP has climbed from 32 per cent in 1990 to 48 per cent in 2014, it is still a significantly lower level than for a country with such a high economic growth. Figure 18 below compared each sector evidenced that the service sector spending in China’s economy, which was much lower than the global average. Figure 18. Comparisons of GDP Breakdown 2014 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Service Industry Agriculture

China

India

Total Global

United States

Source: World DataBank, World Development Indicators. While the service sector is constantly expanding, it is still smaller than it should be for an economy at China’s stage of economic development, and not easy to get a comprehensive view of its general competitiveness (Deng, 2013). To develop the service sector, new orders and employment all need expanded by higher skilled human capital and require for the process of social evolution. According to Chi Fulin’s report, so far China’s service supply cannot meet the demand of its society, the capital misallocation caused the investment gap in service sectors. This is also a part of question related to Chinese leaderships preference for infrastructure project, which blocked the transformation into the post-industrial

 

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society reflected a weak Chinese civilization. In this way, moving up the sociotechnological ladder, which is not only important for China’s manufacture industry, but also the question of the future of China’s service industry has particular interest in this regard.

8.3

Avoiding Middle- income Trap

The middle income trap refer to when a country enter the post- industrial society, are unable to move into the highest income bracket like the most developed countries, but get stuck in a middle income mode. It is a phenomenon of the rapidly growing economies stagnating at middle-income levels and failing to graduate into the ranks of high-income countries. That could happen in China because first at start China was really in a poverty condition, it generated GDP growth and raise incomes simply by pouring out labor and other resources into a modern economic system. Hugh amount labors with low wages attract investment in labor-intensive industries that create lots of jobs, even though they had limited skills. The changing form agricultural to industrial which introducing lots of machinery and low hanging out technical fruit quickly pump up growth, as it is said in earlier study. However, when the “starving” situation was gradual over saturation, the rising costs and basic industries become less competitive and productivity declined. The increasing wages and declining productivity requires for developing more intellectual property and improving the skills for the labor force to move up value chain, and if the productivity could not enhance and society hard to shift into a post-industrial society, China would not develop with serving higher income to escape the trap. Figure 19 presents China’s income per capita recent years compare to the level of middle income and upper middle income. It is clear to see that China has surplus the middle income level in 2007, while even the income grew persistently, there was still a distance reaching to the upper middle income. Data from the Worldbank indicated that in 2013, upper middle income per capita is $3506 contrast to China only achieved to $2712.

 

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Figure 19. China’s income level compare to middle and upper middle income

Source: World DataBank, World Development Indicators. This could be a problem for China is because China has run out of the drivers of a manufacture mode of production yet have been unable to move up the value chain at least relatively from the point of view of global competition. Chinese firms have to learn to innovate, improve product quality and build brands, it also requires they enhance their productivity and management expertise. There are many indications that China is heading in this direction, while the way to escape the middle-income trap is to successfully change China’s growth model and transit to a post-industrial society under effective institutional structure, according to the analysis above, this huge picture in current situation is difficult to implement.

9. Implications Following the analysis this is a discussing section involving particularly crucial issues concerning the possibilities to solve. Based on the four elements analyzed before, to aim at each core problem, the probable solutions can be listed as institutional reform, equilibrium in supply and demand and social evolution.   9.1

Institutional Reform

As analysis before, the economy distortion and insufficient institutional structure was a reflection for China’s limited access society, which under government’s political repression. The Chinese model was a result of a pattern maintenance syndrome, which was locked into an overprotection of political functions and the institutional

 

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structure was a reflection of this mega-distortion. It is clear to see that this is because of the Chinese system is the role of the state; in this way unless such of this cultural lag can be improved, the institutional restructuring simply not really happen in China. To restructure and adequate societal and economic resource-allocation, China has to do some institutional reform. It is obvious that financial repression restrain the development of free market oriented society in China. While in reality, the removal of the system of financial repression is almost impossible to the current Chinese financial system. However, to see if there’s any other possibility for the success of China’s institutional reform, following section referring to the important step for institutional restructuring is about national welfare and SOEs reforms. 1) National welfare As the analysis talked before, in order to lower the saving-rates of the Chinese households, China has to develop a national welfare system and made its hospital system not only better but reach to the level with free of charge. Moreover, other welfare institutions like Hukou system need to be improved at the same time, and then the Chinese household might perhaps save less. Based on Lu’s research on 2013, the announcement of social reform and welfare system rebuilding has introduced since 1990s while the effect was little. According to Lu’s research, the Chinese government has taken few steps to improve the social welfare system focusing five areas: poverty reduction, old-age support, education, medical care and housing. Back to the current situation, the gap between rich and poor is worsening; funds for old-age support and medical care insufficient with the coming population aging; unaffordable housing is still one of the biggest pressure for most people in China; and there has strong educational inequality between rural and urban, inner and costal cites. Though the situation might be changed and improved compared to before, the effect was far away from the balance point. Besides, there are still set of reasons this might prove to be a very difficult task. First, All the social welfare expenditures in China are facilitated by the local governments, as the earlier study above, the local governments are lack of funds  

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and with debt; so that one of the main problems in China today lies in the fact that the local governments’ general budget-conditions are restrict the welfare improvements. Therefore, China’s economic slowdown places local governments under worse pressure; it is very unlikely that they have sufficient resources to improve their whole welfare system with the huge amount citizens. In addition, to lower the level of social inequality in China will probably improve the consumption level step by step. The initial step is to improve the Hukou system, or even eliminate it in the future some day. To reform of the Hukou system can make it easier to eliminate social inequality for migrants. “China’s hukou reform a small step in the right direction”, said Li Bingqin in 2015, he argued that there was no significant changes in the new policy introduced in July 2014. The new reform still maintains the principle of population control; and though the reform severed the long-term residents with equal access to social services and welfare, the degree of practicable depended on the budget of local governments. As a result, it is very hard to replace the older Hukou barrier and even more difficult for migrants to settle down in the first-tier cities such as Beijing and Shanghani than before. Building an effective welfare system and promoting more social programmes is a way of investing in human and social capital, it is not only crucial for the economic growth, but also transformation into a post-industrial society. While the ineffective and difficulties in enforcement could make these reforms fail. Freya Beamish has argued that consumption in China has been pressed so far down that as it can’t simply jump-up in no time and become a driver for the Chinese economy (Beamish, 2014). It is undoubted that changing the savings-pattern of nation with welfare system reform takes quite a long time even under the best of circumstances; China’s economic slowdown won’t have enough power to support this huge change in a hurry, what’s more, household also need a time reflection to change their minds to reduce savings to consume more. So even the reform has undertaken, it is still a very tough task. 2) SOEs reform When reforms started in 1978, SOE’s dominated China’s industrial sectors in every aspect while over 40 percent of SOE’s are losing money in late 1990s (Lin et  

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al. 1996). So far, the analysis above also indicated that the situation for SOEs is getting worse. To characterize by poor efficiency, high debt ratios and bureaucracy, State-owned enterprises played an essential role to drag China’s economic slowdown. In other words unless one change the investment structure and “profitability” of the SOEs, one can’t really get the savings and debt-levels down in China. In this way, SOEs reform is quite imperative for reducing China’s economic situation. What’s more, to narrowing the difference compared to private enterprises’ higher return, SOEs have to improve productivity. Fidelity Limited’s report mentioned that supported by the Chinese leadership’s commitment, a new round of SOE reform has accelerated in the past year. Based on Financial Times on July 15, SASAC, the supervisory body for SOEs in China, announced that six SOEs had had been chosen to participate in four pilot reform programmes. The programmes include: establishing state-owned capital investment companies, developing mixed ownership structure, granting authority for board of directors to hire and sending disciplinary inspection teams into central SOEs. It is obvious to see that these programmes were not relevant to the central problems in SOEs and China’s economy, and this kind of pilot reform was just like windows dressing, no more effective thing was happening. As Xu Gao has argued, “SOE reforms is key to China’s rebalancing.” Unfortunately, even the reform has introduced since 1990s and recent years the concept of SOEs in enterprise-style management has carrying out, there was not so much really happened in changing the essence. SOE reforms are vey difficult because the SOE is an integral part of inner citadel of the Communist party (Wang, 2014). And the mechanism for SOEs is also a reflection for China’s old control system. Any restructuring of the SOEs which seriously would rearrange their organization and capital structure will probably weaken the Communist party’s control over society. For this reason the SOEs reform and restructuring has introduced so far was just change on surface without really happened in essence.

 

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9.2

Equilibrium in Supply and Demand

Referring to the rebalancing problem, which is a question that supply and demand in the Chinese economy must have to meet. Since it is unrealistic to assume that export in the future can remain China’s main demand, it has to make the investment level down, and expand individual consumption at the same time. 1) Investment level down-- deleveraging Fueled by real estate and shadow banking, China’s total debt has risen from $7 trillion in 2007 to $28 trillion in 2014. As Beamish (2014) argued that China cannot growth without throwing credit on the economy. In this way, to get the debt level down, China has to decrease the financial leveraging. There are several ways for making deleveraging easier. First, to deleverage one can grow oneself out of the problem by being able to facilitate a very high real GDP rate. Based on the analysis above and China’s current condition, with an annual GDP growth rate 7.5 per cent since 2012, the estimate GDP growth rate can only maintain around 7 per cent. China’s economy is slowing down; the very high GDP growth rate has not existed. Besides, a situation shows that credit growth proceeds slower than GDP growth. From the analysis above, the increasingly Chinese credit growth has far extent its economic growth since 2009. With the GDP growth rate of 7.4 per cent in 2014, the total credit growth rate was 21 per cent, according to the World Databank. Moreover, one can deleverage through massive defaults; this is essentially a process, where the bad firms are separated from the good firms through a very painful process. However, the Chinese government do not allow large-scale defaults, all information in the system is extremely distorted (Beamish, 2013). The business transaction is obscured, since the price mechanism is persistently perverted, in this way, the system seems inefficiency. Additionally, one can ease one’s debt through high inflation real GDP rate. The data from the World Bank presents that China’s GDP inflation had sharply increased from 2009 to 2011, with 8 per cent growth, while since 2011; the inflation rate became slower with 2 per cent in 2012 and 2013, and 1 per cent in 2014. It is clear that the deflationary tendencies could not cut down the debt level with a high inflation rate.  

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Nevertheless, the People’s Bank of China announced cut interest rates to a record low after its stock market slump in the August 2015, lowering its one-year deposit rates by 0.25 per cent point, while lending rates would be cut by 50 basis points (Bloomberg, 2015). Lower interest rates reduce repayment expenses for the nation’s indebted businesses and give the banks more scope to lend. To sum up, it is clear that China’s current situation is that it doesn’t fit any of these conditions, which make the rare deleveraging so far. On the contrast; the trend for China’s accumulating debts is going worse. 2) Expand individual consumption The Chinese growth miracle was based on investment pump and export-oriented; while the inefficient in investment and export decline indicate that China has to increase domestic consumption to rebalance economy. Baker et al. (2012) reported that the Chinese authorities have taken some steps to support household consumption. On one hand, the VAT has been reduced on several items such as autos to stimulus consumption. On the other hand, government spending on health and education has increased by 3 per cent from 2005 to 2014. The government also intends to develop a universal basic health insurance system for both urban and rural residents. Under the current growth model as the analysis above, China’s consumption-led growth could not succeed unless by the implementation of structural reforms. The current institutional structures serve as barrier to boost consumption, which also led to a high level of households saving rate in China. The low level of social security combined with Hukou system restraint migrants to access public services. Hence, they have to save more of their disposal income to assure against risks because of their limited access to public service. Based on a large set of migrants in China, it can be explained lower consumption expenditure related to the Hukou system. On the other hand, household consumption could be lifted by rising wages and labor productivity. In recent years wages has been rising but since productivity was  

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declining, wages have risen above productivity, which means that profit has been squeezed (Kaiman et al. 2015). While given the deflationary pressure, the wage growth would slowdown, which further reinforce the deflationary trend and place a brake on the rise of consumption. 3) Special Case: Chinese stock market crash The China’s stock market has fallen sharply from June 2015. As it is shown on the figure 20, until June, China’s CSI index has rose by around 60 per cent since 2015 start, reaching a highest point of 5325 on 12th of June. However, then the bottom fell out of the market. It had 32 per cent decrease in Chinese stock market. To deal with this stock market crash, government came up with series of extraordinary interventions trying to stabilize the market and push it back to increase 12 per cent. While the interventions only maintained less than two months, the market index fell to 3017 in the middle of August, around 25 per cent further decline to reach the lowest ever among 2015 (Shiller, 2015). In fact, the turbulence of China’s stock market is related to the current slowing economic situation. Figure 20. Real downers in CSI 300 Stock Market Index 2015

Source: Thomson Reuters; Robert Shiller; NBER According to Bloomberg (2015), China’s latest stock market boom was fueled by debt. As Chinese regulators have relaxed strict limits on buying stocks with borrowing money since 2013. The tendencies of accumulating debt and stock market have the same direction, as a result, the stock market reached to the peak in June 2014 most with borrowed money. Nevertheless, borrowing plays a crucial role in stock market bubbles through the world’s stock history such as America

 

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and Japan. Moreover, Chinese manufacturing shrinks also made the stock market crash worse. As a result, China’s government decided to devalue the currency response to the slowing economy, especially in export. In this way, the central bank let the currency drop by about 3 percent in order to boost to the Chinese economy by making exports with lower price to foreign buyers (Lee, 2015). But this movement could not save further declines in the stock market. Many ordinary Chinese invested their savings into the stock market because of the Chinese poor welfare system and financial system; therefore they move their money to get higher return. Though it was stated that there are 80 per cent of investors in Chinese shares are individuals, the crash was not because of the desperate by them. Most of China’s listed companies are majority state owned enterprise, so the point is that the share price of these SOEs were not quite related to the management.

9.3

Social Evolution

Based on the North’s new institutional economics and development theory (1990), he argues that long-term economic growth entails the development of the rule of law and the protection of civil and political freedoms. However, the most fundamental factor in Chinese civilization was political and cultural processes melted together in the features of the state and the resulting restricted the social differentiation. What’s more, the post- industrial phase requires that improvements in the quality of human resources rather than an expansion of their quantity needs to become a major driving force of further development. This transition to the phase of human capitalbased development is the key for China to sustain per capita income growth. On the other hand, to become “innovative”, China will have to enhance the process of cognitive institutionalization as well as other integral components of its cultural system. Though China has changed fastest over the last thirty years with fast economic growth. The short-term impact of rapid economic growth on democratization may be negative (Pei, 2006). In this way, the polity in China drags the developmental process of social evolution and transform to a higher-skilled level society.

 

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Regarding to the analysis before, it is obvious that China’s communist party is firmly in power; democracy is not a concept inherent in Chinese culture and polity. While behind the political inefficiency and stagnation on the surface, China should take its path in enhancing democracy. The question of China is essential one of two questions; one is the logic of social development is universally valid, the other is that all societies are “unique creates” and always a combination of these two. So far no major nations in the world have ever move into the highest bracket of a post industrial society without either being a democracy or becoming a democracy in the process. In other words, democracy is correlated with higher developed societies, which can be understood in a more narrow sense a democracy is a political system based on regular and fair elections to a multiparty characterized parliament, while it never happened in China.

10.

Conclusion

China has been growing rapidly for more than three decades. The sharply rise of industrialized China benefited from the world economy. However, one of the great questions facing China is whether or not its economy can continue to produce the rapid gains in wealth for its giant population that the country has witnessed over the past 30 years. To understand the “Chinese mystery” in a true position, the growth model played in a crucial role in China’s economic boom and its slowdown also. The problem with China’s economy is linked to its growth-model, which has characterized by the following points: •

The excessive investment driven model with an issue of government-led market economy. The investment pump catalyzed China’s economic growth over any other considerations, and which resulted in a system reached the highest savings-rates and investment rates ever recorded in modern economic history.



The level of investment and leverage in China is really a sign of an economic system totally out of control. Regarding the Chinese growth model, it reflected and derived serious of problems.

 

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The Chinese model was in the beginning strongly export-oriented, while China has suffered a demand-deficit since the global crisis of 2008. And the Chinese model has run out of its original growth drivers with cheap labors and technology adoption.



The financial system in China was characterized by financial repression by giving a lower interest rate, which is a political control system to restrain the development of a free market mechanism in China.

As a result, the core problems which determined by the growth model can analytically be broken down into four major elements: 1) Institutional structures. The growth model was a reflection of the fact that China is a limited access society with some insufficiently developed institutional structure and was held “captured” by its political system with the Chinese Communist Party, in this way, the civil society is also weak. As a result, almost all major structural problems are created under the inefficient institutional structures. 2) Structural constraints. These structural restraints will function as a drag on China’s economy and societal developments. The demographic factor has resulted in a fast shrinking of the Chinese labor force; the environmental degradation is a drag on growth, increase the need for hospitals and restrain consumption at the same time; social inequality has multiple functions that reflected in China’s core problems, and the high level of social inequality lowers the consumption level, the household of productive capital and the interpenetration of cognitive institutionalization that are the key to solve the rebalancing problem. 3) The rebalance of the economy. Since it is unrealistic to assume that export in the future can remain China’s main demand axis, the imbalance between Supply (extremely high investment) and demand (low domestic consumption) is the core problems for China’s economic situation. To get its investment level down, China has to get its savings-level down. However, the proportions for savings in China is half of China’s savings are

 

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essentially SOE saving. In other words, unless efficiency SOE reforms are carried out, the saving-levels cannot really get down. On the other hand, households’ savings depends on the development of national welfare system; the lack of government funds, high level in social inequality are all drag the process in rebalancing. 4) The transformation to a post-industrial society It has become clear that China has lost its competitiveness and been running out of old drivers without attain new ones. Since export-oriented growth no longer feasible with higher labor cost and no low hanging technological fruits, the productivity issue is related to the question about moving up the value chain; in this way, the problem can be solved by technological upgrading and become innovative. In China, it is clear that government-directed and centrally planned mode present the political repression and weakness of China’s civil society, the transformation seems very difficult or even impossible to achieve. Added to all these analysis above, the core boom and slowdown in China comes from its policies and institutional structures. To re-establish an adequate societal and economic resource-allocation in China goes to the heart of the question of reform but can’t not take place without major institutional changes. Related to there are no sufficient reforms and institutional changes can be performed in a short time, and without reforms, China could not enhance its human capital to move up the value chain in the speed, the transformation into a post-industrial society process would move into a dilemma as well. Meanwhile, the declining productivity and lost competitiveness probably would make China trapped in the middle-income trap. Until now, the reform plans are highly idealize and flawed to solve the urgent issues in China thoroughly, moreover, it is extremely important to be aware of the timedimension in all reforms or transitions; the Chinese economic slowdown is coming with its investment boom, bad debt, lost of old drivers, etc. The changing needs years of time to get transformation even China act effective reforms now. China does not have endless time to solve all the problems. The consensus has it that China’s economy is stagnating or at least failing to grow as much as expected. In the face of these threats, the principal challenges facing China today are serious.  

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11.

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