Tuesday, April 8, 2008

China's Economy is not a Zero-Sum

Invited speaker
Barbara & Richard M. Rosenberg Institute for East Asian Studies
Suffolk University, Boston, April 8, 2008

Ladies and Gentlemen,

It is a great honor to be an invited speaker at this inaugural conference of the Rosenberg Institute of East Asian Studies. I would like to add my personal congratulations to Barbara and Richard Rosenberg for their wisdom and leadership. Recent events strongly suggest that Americans and for that matter the people in the West do not understand East Asia and China. Yet students today better get to know about the cultures and peoples of East Asia, because such knowledge or lack of it will impact their careers. I applaud the Rosenberg’s attempt to rectify this deficiency by establishing this Institute.

I picked as the title for my talk, “China’s Economy is not a Zero Sum,” for a very specific reason. I am keenly aware of America’s rather dismal understanding of China and I hope that today I will have the opportunity to clear up some of the false premises about China, either through my prepared remarks or in the Q&A that follows. For the sake of clarity and continuity, I am eschewing the usual PowerPoint presentation, although the organizers have very kindly provided each of you with a set of hand-outs that back-up the factual part of my talk. The hand-outs are in the order of my talk.

My talk will touch on three inter-related issues. Namely, a description of today’s China economy, how China got to this point and what China is not and in doing so, take the opportunity to debunk some of the notions that are flat out wrong about China. As we enter into the heated presidential campaign, China appears to be once again the piñata of choice, a convenient scapegoat for everything wrong in this world. I hope today to neutralize some of the ill wind or at least point out how silly some of the rhetoric about China can get.

It is important that I make a disclaimer at this point of my talk. Although I am an employee of Deloitte and proud to be part of that global firm and rely on the research material and resources from the firm, my remarks today are strictly my own and does not represent in any way the views of my employer.

By any measure, China’s economic growth over the last three decades has been nothing short of miraculous. Nothing of this scale and growth rate of economic expansion has happened in humankind’s recorded history of 5000 some years. China’s annual GDP is now around $3 trillion, having overtaken Germany (or will overtake Germany soon, the uncertainty is due in part to fluctuating exchange rates) to become the third largest in the world. In 2000, China was the 6th largest (just ahead of California) and ten years earlier in 1990, China was 19th just one place ahead of Taiwan, but with a population 50 times larger, and back in 1980 when China had just barely began its economic reform, China was in 30th place with an economy smaller than even Nigeria, Argentina and Iran. Since 1978, China’s economy has been doubling every seven years.

Since China joined WTO in December 2001, its exports have grown five fold in five years. By 2006, China overtook the U.S. as the second largest exporter of goods and is expected to surpass Germany sometime this year. In the early ‘90s, China’s foreign currency reserve was an anemic $20 billion or so. Today, China’s reserve has exceeded $1.5 trillion, an increase of 75 fold in roughly 15 years.

During this period, the lives of the Chinese people have significantly improved. Over 400 million have been lifted out of poverty. China now has more than 140 metropolitan areas with populations over 1 million. The portion of the population now living in urban areas is approaching 50% from around 20% when reform began in 1978. Just about every household, including those in the rural area now owns a TV set. There are over 500 million mobile phones in use, 220 million Internet users, 190 million PC owners.

Already China has more mobile phone and Internet users than the U.S. and closing fast in PC ownership. And these numbers are constantly changing because new wealth is constantly being created. China is the fastest growing market for Bentleys that sell for $3-400,000 each. China is overtaking the U.S. as the source of greatest number of tourists traveling abroad; China sent 35 million abroad in 2006. Furthermore, as Europeans in the hospitality business will tell you, the average spending per Chinese tourist is 2-3 times higher than the American tourist.

How did this come about? Ironically, while the rate of change in China seemed so breath taking, the fiscal policy behind it was cautious with emphasis on gradual, trial and error approach. The policy makers in Beijing took to heart Deng Xiaoping’s advice to carefully grope for the stones while crossing the river. After Deng returned to power in 1978, there have been three premiers that implemented policies of economic reform.

Under Zhao Ziyang, the first premier after Deng’s return, the communes were disbanded giving farmers the chance to determine their destiny by working harder and smarter. Some of the farmers turned to higher value added crops and were soon shipping tulips to Holland, Shiitake mushrooms to Japan and garlic to Gilroy California. Others turn to cottage industries and started collectively owned enterprises. These township and village enterprises were the first non-state owned sector to make a significant economic contribution. Economic experiments were carefully monitored by a dual track system. In other words, a local price in local currency the RMB and a higher price in foreign exchange certificates that that visiting tourists get when they convert their hard currency—not a system pleasing to visiting foreigners.

Zhu Rongji took over as the economic czar, though not formally as premier, shortly after the Tiananmen incident, the memory of which, by the way, has become indelible in the minds of the West, but virtually forgotten in China. He tamed the run away inflation when he first seized control of the national economy—he introduced the economic concept of hong guan tiao kong (宏观调控) (macroeconomic control) to the Chinese population for the first time. Following Deng Xiaoping’s edict that to get rich is glorious, he proceeded to open China wide to foreign direct investments. 1993 was the first year when registered FDI exceeded $30 billion for the year. It has been increasing steadily and leveling off recently at around $60 to $70 billion of new foreign investments every year. No other country other than the U.S. has attracted as much foreign investments.

By the time Zhu retired in 2003, China had entered the WTO and rapidly became the factory of the world. By the time Zhu’s successor Wen Jiaobao took over, a new set of challenges were awaiting. Huge gaps now exist between the wealthy and the poor, the urban and the rural, the coastal region and the interior. Theses gaps are sources of social tension. Ironically, universities have greatly increased their capacity and are now generating many more college graduates than ever. This too adds pressure to growing the economy and creating jobs to meet the expectations of the new graduates. And, I have to tell you that China is struggling to deal with all these challenges and will be doing so in years ahead.

The current premier Wen has a challenging balancing act. On the one hand he has to keep the economy growing to create jobs. On the other he is concerned with inflation. The economic figures for the first two months of this year show ominous signs of inflation as if to reinforce his worry. He has to deal with a strengthening RMB, which has appreciated about 16% since it was taken off the peg to the dollar in July 2005. As a consequence, multinational companies are beginning to look elsewhere to put in their next plant. He also has to worry about the $1.5 trillion of reserves he is holding in dollars that are eroding in value by the day. He is facing rising labor cost, rising energy cost, the need to bring environmental degradation under control and exert tighter enforcement of labor laws. He has just begun his second term of office and he has a tough job ahead of him.

So what did China do to be so successful so far? I would say three main factors.

First, ever since Deng Xiaoping returned to power, China has been stable and had an orderly transition of leadership. Increasingly the leaders are highly educated, all college graduates and some with advanced degrees. The Jiang/Zhu generation was all engineers. In the current generation, a few economists and lawyers have been allowed into the inner circle. More importantly, every leader has been tested and proven that they are capable each step along the way as they rose in rank. Sons and daughters of senior leaders sometimes do enjoy the inside track but only the capable ones end up in key positions while less capable or motivated are assigned to cream puff positions.

Secondly, since Deng, China has taken down the bamboo curtain of Mao days and opened the country to outside ideas. In the early 1980s, China invited Robert McNamara, then president of the World Bank into China. Beijing wanted not just World Bank financing but the rules and conditions that go with the financing. Beijing wanted the World Bank guidance as a framework to establish their own rules of governance for banking and financial institutions, a matter where they had no experience from their past as a planned economy to draw from. This is not your typical third world response where they just want the money but not the discipline and constraints. No wonder then that to this day, the World Bank considers China to be their most successful client. And, as a historical note of interest, the leader representing China in the working group with the World Bank was Zhu Rongji.

Another example of China’s openness is their entry into the WTO. There was a lot of resistance inside China to the idea of entering WTO. Many state-owned enterprises feared open competition in the global market and wanted to protect their domestic piece of the pie. Indeed in the transition, many inefficient factories were closed and more than 30 million jobs were lost. But Premier Zhu recognized that despite near term pain, in the long run, China needs to compete at the international level and forced the country into this multilateral agreement over the objections of many. He was right, of course. Sadly, the need to compete in the global market is a principle some of our political leaders seem to have forgotten.

Third important factor, I feel, is China’s willingness to invest in infrastructure--heavily so. From the first World Bank financing, China has placed high priority to infrastructure investments even when they did not have the funds from internally generated sources to do so. Consequently, China now has a highway network that rival the U.S. Interstate system. There was just one bridge across the mighty Yangtze River when my wife and I visited China in 1974. There are now so many that nobody bothers to keep track. I believe the most recent is around 18 miles long near the mouth of the river connecting Suzhou in the south to Nantong in the north. China has constructed at least two bridges that I know of over 20 miles long, over open water. The port handling facilities, airports, the train system (including the only one in the world to operate above 4000 meters in altitude), the power plants and grid, the telecommunications networks and Internet broadband are all constantly increasing in capacity and improving to keep up with demand. The Beijing government has been running deficits to keep their infrastructure in pace with their economic development and by and large they have been successful.

In summary, many developing countries are now looking at China as a model for development. What they see is a stable government that allows the leadership to concentrate their attention on economic development including prioritizing infrastructure projects and moving away from a planned economy to one where the market is the driver.

Of course, phenomenal as China’s economic growth has been, it has not been without some serious costs. In growing the economy, China unfortunately hewed to the traditional western model, which was pollute now and worried about it later. Anyone that have visited China over a period of years can see that this approach has devastated the quality of air around most cities and severely constrained the availability of already tight supply of clean water. More recently, one can spot occasional improvement in air quality—a friend of mine just returned from Beijing where she saw 5 continuous days of blue sky and she has changed her mind and decided to take her son to the Olympics--but China has a long ways to go. In pollution control and environment remediation, the West has a lot to offer and China represents a market of huge potential.

China is also in the process of rebuilding its tattered social safety net—a system that broke down in the transition from a planned economy to a free market. Their need to restore and improve their health care system is another very large market for outside technology and services. Their need to construct a sturdy national retirement pension plan represents opportunities for financial and macroeconomic experts from everywhere.

All in all, China economic development has been a win for its Asian neighbors that trade with China, for Latin America and Africa where most of China’s foreign investments have been going, and for the West that buys from China, because up to now, the prices have been stable and low and thus help keep us, the American consumer, in a style we are accustomed, all at a reasonable price. Not only China’s economy has not been a zero sum but has been an all around win.

Some critics of China accused China of predatory trade practices and frequently link China to the mercantilist policies of Japan. I see two entirely different models of external trade. The U.S. has been blaming China for its booming trade deficit. Let me break this down for you. In 1997, 27% of our trade deficit is from China while another 43% is from the rest of East Asia, (mainly from Japan, Korea, Taiwan and Singapore). That means a total of 70% of America’s trade deficit came from East Asia. In 2006, ten years later, China accounts for 28% while East Asia adds another 17% to our trade deficit for a total of 45%. The reason is that much of the manufacturing that used to be done in other countries has now been shifted to China.

In percentage terms, our trade deficit with East Asia including China has actually shrunk. Some members of Congress has blamed China’s pegged exchange rate as the cause of “manipulated trade.” Since China’s RMB was taken off the peg, it has appreciated by about 16% but our trade deficit has continued to rise. In absolute terms, our government has not been able to manage our trade and fiscal policies. Our policy makers’ inability to balance our trade should not be blamed on China.

To reinforce this point, nearly 60% of China’s exports come from foreign invested enterprises (FIE), about half from wholly foreign owned factories. On the high end of the export products, anywhere from 85 to 90% of the goods are made for foreign invested enterprises. Let me just cite just one example. China is a major exporter of boom boxes. In 2006, 34% of the exports came from FIEs but accounted for 73% of the total value of this export category. If you do the math, FIE made boom boxes came out 5 times higher in average value than the domestically made ones.

In other words, everybody is benefiting from China’s open economy, not just China.

The U.S. is an important market for China but our perceived leverage may be overblown. In 2007, 21% of China exports were sent to North America including Canada. Europe took 23.5% while Asia is the destination for 46.6% of China’s export.

Another misleading statement frequently bandied about is the lack of consumer spending in China. One recently published book by a veteran Western journalist even goes so far as to say that China has a policy to suppress consumerism. Maybe not comparable to the American consumer but these views fly in the face of the density of TVs, mobile phones and PCs that I mentioned earlier. It is also not consistent with the maker of Bentleys and others who regard China as the fastest growing market for their high profile brands of luxury products.

China’s annual retail sales is already over $1.2 trillion and growing at almost twice as fast the GDP, which as I said is doubling every 7 years. Wal-Mart clearly sees China as its most important market of the future. They have just over 100 stores in China, having added 23 in just last year. The per store sales in 2006 was half of their experience in the U.S. Their public statements indicate that they see an as yet largely untapped potential ahead for China.

According to recent poll of American companies already operating in China, 68% of them are planning to increase their resource commitment in China over the next 12 months, while 30% plans to hold steady and only 2% are pulling back. When asked of their 5-year business outlook in China, 55% are optimistic, 38% are somewhat optimistic and nobody is pessimistic.

While China is one of America’s major trading partner, a major holder of our national debt, and a partner in anti terrorism, for reasons hard to understand, U.S. policy makers insist on seeing China as an adversary. This hostility has a deleterious effect on every Chinese American living in the U.S. The FBI special agent has publicly declared that every ethnic Chinese working in Silicon Valley is a potential spy for China. The federal government nearly succeeded in railroading Dr. Wen Ho Lee to a sentence of life imprisonment on a trump up charge. Recently, an engineer in Southern California was sentenced to 24 years after being convicted of trying to send publicly available, non-classified information to China. The sentencing judge even said that the sentence was intended to warn others of the consequences of spying for China—the judge even used a classic Chinese strategy of killing the chicken to frighten the monkey.

The rhetoric can get down right hysterical sometimes. Let me say for the record that China detonated its first atomic bomb and launched the first guided missile in 1964, detonated the first hydrogen bomb in 1967 and launched the first unmanned satellite in 1970. All of this before Nixon met Mao in 1972 and bilateral relations were normalized in 1979. During that pre-normalization era, there couldn’t be much exchange between China and the U.S. and hard to make a case of blaming China’s achievements on stolen secrets from the U.S.

The Pentagon is proposing a military budget of $515 billion for the coming fiscal year, not including the extraordinary expenditures for Afghanistan and Iraq. The budget will include development of advanced fighter, advanced aircraft carrier, advanced destroyer and advanced submarine. The DOD is not pretending that this is for combat against the global terrorists. The largest one year expenditure request since WWII is for the prospects of meeting a future unnamed adversary. Want to guess who is the unnamed adversary? In the interest of brevity, I will simply make the observation that China’s military budget well under one fifth of the U.S. budget rests on a strategy of maintaining a credible retaliatory threat, a second strike capability against any other global power but otherwise concentrate on domestic economic priorities.

I am a member of the Committee of 100, a national organization of Chinese Americans. At their conference I attended last November in Beijing, China’s Vice Foreign Minister, Zhang Yesui was one of the invited speakers. He said, “We should observe the purposes of principles of the UN Charters and the universally recognized norms governing international relations to promote democracy, harmony, cooperation and win-win progress in international relations.” He goes on the say, “China cannot develop itself in isolation from the world, and the world cannot sustain prosperity and stability without China. China’s active participation and constructive role in the international affairs has boosted its own growth and promoted world’s peace and prosperity.

Indeed China’s foreign policy has been to work within the confines of the United Nations. They have contributed troops and police in 13 of 17 on going UN Peacekeeping operations. Since 1990, China has contributed 9000 peacekeepers in 22 UN operations, more than the combined total of the other four permanent members of the Security Council. As of the end of 2007, China has exercised its veto power on the Security Council a total of 6 times since they joined that body. During that same period, USSR/Russia cast 123 vetoes, the U.S. 80 times, UK 32 and France 18.

Permit me to just mention one example of China’s foreign policy to this audience. In September 2007, China signed a deal with Congo to work on infrastructure projects in accordance with the Congo government’s priorities, which were water, electricity, education, health and transportation. The total cost will exceed $9 billion, far more than Congo’s annual budget of $1.3 billion. To pay for the infrastructure investment, China formed a JV with Congo to extract copper, nickel and cobalt, a $3 billion investment. Other parts of the deal include technology transfer and training of Congolese staff, work on social welfare and environment and subcontracting certain work to local Congolese companies. The deal is neither colonial exploitation nor charity to a destitute developing nation. China is not telling the Congo government how to run their country and make no judgment on whether the government is to their liking. Instead, they just structured a win-win arrangement that will make a difference in Congo quickly. Hopefully the Congolese government is up to the task and its people will see and reap the benefits of this kind of venture.

We can talk about Tibet, Sudan and Darfur and human rights and whatever else in the Q&A if there is an interest. I would like to conclude my presentation by mentioning a historical character that happens to be from state of Massachusetts. How many of you have heard of Anson Burlingame? He was a Congressman from Massachusetts who was appointed ambassador to China by Abraham Lincoln in 1861. He spent about 6 years in China. As he was ready to come home, he was asked by the Chinese imperial Manchu court to serve as the envoy to negotiate with the West while representing China. To my knowledge he is the only person in history who had the privilege of holding successive flip-flop diplomatic posts for two nations. (You can visit my blog, www.georgekoo.com for more about Burlingame.)

My fervent wish is that with the inauguration of the Rosenberg Institute of East Asia Studies in Suffolk University we will see in the future more ambassadors that can bridge the two countries and two cultures and replace the ill will that stems from ignorance with good will that comes from an informed public between the peoples of America and Asia. Thank you for your attention.


Unknown said...

It is really difficult to look clearly at China's economic development through tremendous political and culture records. But this article has clarified one of my biggest confusions: does Chinese rising really threat the state of the US? What is the reality behind the criticisms of western media lasting for tens of years?
Really thanks the author, Mr Koo.

Anonymous said...

Hi Mr. Koo,

It was such an enlightening and great honor to hear you speak this past Thursday at the Competing in Beijing seminar! I've linked your blog to my blog: www.helenstravelcorner.com and started reading the China Daily this morning! I look forward to reading more of your postings and as you pointed out, a more balanced perspective of the Far East. Thanks so much for sharing your thoughts!!