Somewhere in Beijing, Xi Jinping is pumping his fist like he just won the lottery. On April 15, the China-led Asian Infrastructure Investment Bank (AIIB) announced its official approval of 57 prospective founding members. As of that date, the bank was also set to raise $100 billion dollars in initial capital, with half of that figure being supplied by the Chinese government. Since the bank’s unofficial announcement in 2013, China has taken on an impressive, responsible role befitting of a rising world power. Yet even more noticeable is the blow the United States’ credibility has taken, thanks to its staunch opposition to the project. Seldom in international relations does U.S. policy fall so painfully flat on its face. The rise of the AIIB, however, seems to be one of those rare instances.
Indicative of U.S failure is the list of Prospective Founding Members, which are not limited to Asian powers or China’s closest allies such as Pakistan and Russia. The bank’s membership has brought together historically bitter rivals, including Iran and Israel, as well as Pakistan and India. Most astounding, however, is the fact that despite staunch pressure and condemnation from the Obama administration, some of the United States’ closest allies have signed on, including South Korea, Germany, France, New Zealand, Australia and even the United Kingdom, with Japan and Canada as the only two major powers yet to agree to the bank’s terms.
It is also important to remember that the AIIB is set to serve an important function in the Asia-Pacific Region. A 2010 report by the Asia Development Bank (ADB), a similar intergovernmental financial institution, forecasted a need of $8 trillion between 2010 and 2020 to meet physical infrastructure demands, with 51 percent being spent for electricity, 29 percent on roads and bridges and 13 percent on improvements to lacking telecommunications networks.
Skeptics, namely Washington, have cited the fact there already exists two well-established development banks in the region––the World Bank and the ADB. While there is certainly validity to the argument of oversaturation, unlike its counterparts the AIIB is geared less toward poverty reduction and more directly toward infrastructure development. Furthermore, the reality is that the World Bank and ADB’s lending capacities sit at approximately only $300 billion and $11 billion, respectively, figures far short of the $8 trillion that is required over the decade. Therefore, it should come as little surprise that World Bank president Jim Yong Kim has been nothing but supportive of the AIIB, stating, “We welcome any new organizations. We think the need for new investment in infrastructure is massive.”
The Obama administration has also voiced concerns over the governance and oversight of the AIIB, citing equal representation and environmental oversight as two potential problems. Yet the ADB and World Bank have been faced with similar problems of their own. In fact, one of the ADB’s largest projects, a coal power plant in Mae Moh, Thailand, is considered by Greenpeace to be one of the worst ecological offenders in all of Southeast Asia. As for the World Bank, a 2010 report by the United States Senate Committee on Foreign Relations noted the institution’s poor record of “achieving concrete development results within a finite period of time” and needed to work on “strengthening anti-corruption efforts.”
While it is naive to assume the AIIB will have a spotless pro-environment, corruption-free record, the fact that the bank is still in its inaugural stages means there is room to effectively work on stamping out these issues that would be more difficult in already established institutions. Indeed, at the bequest of some of its European founding members, the AIIB leadership has already begun drafting a series of environmental standards for its projects, including requiring Environmental Impact Assessment documents (EIA) and environmental management plans (EMP) in order to receive funding.
The final and most pressing concern for the U.S. government is what it sees in China using the AIIB as both a hard and soft power tool, threating the historically U.S. controlled World Bank. There should be little doubt that the AIIB is, in part, an attempt by China to force its way into a heavily U.S.-dominated scene. As Zhao Changhui, economist at the state-owned Export-Import Bank of China, candidly admits, “the founding of AIIB is a challenge to the U.S.’s economical and political dominance. It’s also a challenge to the establishments controlled by the U.S., such as the World Bank.” Yet such statements pose little threat to the United Sates. China, the world’s second largest economy, is an ascendant power that is eager to claim the authority it proportionally deserves due to its size. Rather than fight a losing battle, the United States ought to join the AIIB. As an active member, the United States would be able to work with the other members, many of whom are allies, to shape the direction of the bank in a mutually beneficial manner.
But first, the United States must loosen its fears of a rising China and the implications of the AIIB. Many in Washington perhaps fear the bank’s establishment as the formal decline of American financial supremacy. Yet China is not in the same position that the United States was in when it formed Bretton Woods at the end of the Second World War. The United States and Europe are simply too powerful to be overshadowed in such a way by China, which lacks the unipoliarity of the post-war United States. On the eve of Japanese Prime Minister Shinzo Abe’s White House state dinner on April 28, President Obama took a cue from Chinese culture and attempted to save face, remarking that the AIIB “could be a positive thing.” This about-face only further highlights China’s upper hand.
Last year, the International Monetary Fund (IMF), the most prestigious international financial institution in the world, ranked China as the largest economic superpower in the world (IMF, 2014). With a 2014 GDP estimate of $17.6 trillion dollars ($300 billion higher than the United States), China has witnessed recent economic growth that has placed it in the center of global economic conversation (IMF, 2014). Companies and businesses around the world have suddenly redirected their energy to cracking Chinese markets, opening up branches and boutiques all around China’s modernized cities. In the 1950’s, American consumerism transformed the global economy. Now, it appears it is China’s turn. Reaching $3.3 trillion dollars, China’s private consumption currently makes about eight percent of the world’s total (Economist, 2014). Walk the streets of Hong Kong at 10 A.M on a Saturday and you’ll see lines of Chinese shoppers eagerly waiting outside luxury boutiques to splurge on goods. Luxury car sales in China have risen 450 percent in the last year and Chinese consumption of expensive Swiss watches now equals more than the United States, U.K and Japan combined (Raconteur, 2015).
The unique dynamic of Chinese consumerism has made the Chinese market even more enticing to foreign companies. Not only do the youngest age bracket of the Chinese population make the most money, but they are also the most willing to spend it. Many Chinese migrant workers are engaging in a growing trend called “buying up,” in which they use some of their savings to buy similar luxury goods that the upper class buys. Research by the IDEO, a consultancy, found that many young migrant workers earning less than $830 a month would spend a entire month’s wage on an Apple IPhone (Economist, 2014). This phenomenon has triggered huge growth in companies catering to the lower class’s demand for luxury goods. Alibaba, a Chinese company centered in providing “budget smartphones” to China’s mobile users, is now the fourth largest tech company in the world with a net worth of $215 billion dollars (WSJ, 2014). The future of consumerism and the global economy, it would seem, rests in cracking the market of the new Chinese generation.
Yet, many economists are overlooking a growing trend in the Chinese population that could stalwart private consumption and diminish China’s future influence in the global economy. Despite their recent explosion of wealth, the new Chinese generation is saving more than ever. In the last 15 years, China’s average rate of urban household savings has risen 11 percent (Business spectator). At a current 51.5 percent of net income, China’s saving rate is ranked second in the world, only under oil-rich Qatar (World Bank, 2015). To put that in perspective, the average Chinese citizen saves more than three times as much as the average American. This growing savings rate is, without a doubt, a result of a feeling of instability trigged by the recent political and economic events in China. In an effort to defuse this feeling, the Chinese government has tried to enhance education, healthcare, and other public sectors etc., in hopes of loosening the wallets of Chinese consumers. Yet, savings as a percentage of GDP has continued to rise as spending’s percentage continues to fall. The inescapable reality is that this trend in savings will only get worse. The wind steering the direction of this course has nothing to do with any of these mentioned public sectors, but rather, one of China’s defining initiatives: the one child policy.
In the next few decades, China will undergo the world’s largest demographic shits. To begin, China’s population growth has already begun to slow. From 2001-10, China’s population inched up at just 0.57 percent annually—only about half the level of the previous decade, and only one-fifth of the level in 1970, when controlling population growth first became a priority (Wang, 2012). The driving force of China’s slowing population growth rate is its low fertility rate, which has languished well below the replacement level of 2.1 births per 100 citizens for two decades. China’s fertility rate is only 1.4 births per 100 citizens, one of the lowest in the world and well below the developed country’s average of 1.7 (Wang, 2012). In the past few decades, China has repeatedly failed to reach population targets put in place to control growth. For the 10th Five-Year Plan, the National Population and Family Planning Commission set a population growth target of 62.6 million, but China recorded an actual population gain of just 40.1 million. For the 11th Five Year Plan, the population gain of 34.2 million was far below the 52.4 million target (Wang, 2012). This sustained low population growth will cause the number of young workers to decline tremendously.
By 2020, the number of people aged 20-24 is expected to fall 20 percent in China (Wang, 2012). Not only that, but the labor participation rate in this age group will also fall due to rising participation in higher education. Annual higher-education enrollments tripled from 2.2 million to 6.6 million in 2001-10, while the number of college students (mostly aged 18 to 21) rose from 5.6 million to 22.3 million (Wang, 2012). In short, China’s labor force, the foundation of its profound economic growth, is disappearing. At the same time, China will see a surge in the rise of older aged citizens. By 2030, China is expected to see its percentage of people over 60 in total population double (Economist, 2011). China’s ratio of workers to retirees will change dramatically, dropping from roughly 5:1 to just 2:1 (Wang, 2012). This huge shift in demographic will have far reaching effects beyond just labor supply. For example, tax burdens for each working-age person will have to increase more than 150 percent (Wang, 2012).
Most members of the new Chinese generation are actually saving in response to this problem. The population is getting older, and the one-child policy places huge economic strain on the new generation. Commonly referred to as the “4-2-1,” the members of the new generation will have to save enough money to singlehandedly look after themselves, their two parents, and their four grandparents (China Outlook, 2014). The most common, and expensive, purchase of the new generation will not be designer handbags and luxury cares, but rather, healthcare to help aid their family. The effect of this profound economic pressure is visible all around China. A decade ago, impoverished migrants gathered outside factories in cities like Dongguan, desperately searching for work. Now, Dongguan’s streets are full of banners and notices advertising jobs as workers protest in demand for higher wages (Economist, 2014). As diminishing labor supply and increase in labor activism continue to pressure employers, wage rates in China are actually beginning to increase. Yet, this increase in wages represents only half of the new generation’s woes.
The price of healthcare in China has remained inaccessibly high. At the same time, China’s poor living conditions, high rates of pollution, and general crowdedness have caused it to have one of the world’s highest rates of chronic diseases among high-income countries (Strong, 2005). Specifically, China has seen a rise in the rate of cancer as a result of intensive air pollution, now estimated at an index 20 times higher than the maximum safety limit (Nelson, 2014; ABC, 2013). In a recent statistical analysis by Lancet, one of the world’s leading medical journals, China now contributes to 25 percent of cancer deaths globally (Strong, 2005). As a result, China’s expenditure on health care has increased by more than 600 percent since 2000 (BBC, 2014). The Chinese government, to little avail, has attempted to lower the cost of public health care through pledging more funds. In 2009, Beijing allotted $173 billion dollars to help alleviate the cost of public healthcare (Time, 2014).
Yet, to most of the general population, health care prices still remain too high and most health insurances may only reimburse up to 40 percent of the cost for treatment (Time, 2014). While Chinese health care spending has jumped up two percent of total GDP, China’s health care expenditure by GDP has yet to surpass many developing countries like Afghanistan (Time, 2014). As much of the population continues to wait for health care prices to fall, there are those who have simply run out of time. Zheng Yanliang, a local of the town of Dongzang, for example, took to performing his surgical amputation himself, sawing off his own limb with a hacksaw (Time, 2014). A testament to the inaccessible prices of health care, Yanliang’s story also speaks to why so many Chinese citizens have begun to fear the uptake of sickness and have consequently raised their rate of savings. In a time of increasingly inaccessible healthcare, illness entails death for many of those who cannot afford to treat it.
In the next few decades, China could lose all of its key advantages that make it “the world’s next superpower.” If the population growth rate continues decrease, China’s cheap labor supply will disappear. Manufacturing companies, one of the greatest contributors to GDP in China, will find themselves scrambling to find workers and forced to raise wages even higher. Those who do work will be forced to save more to not only purchase healthcare, but also to pay off the incredibly high tax burdens. As a result, private consumption will drop, and the consumption of healthcare will increase even more dramatically then it already has. Foreign companies that invested their assets in exploiting Chinese markets will begin to find themselves stuck in slowly crumbling private market and China will find itself in the economic chokehold of a dwindling population that is become ever more frugal.
Yet, the solution to all of these problems couldn’t be clearer. A modification of the one-child policy, more affordable and accessible public healthcare, and an initiative to reduce tax burdens on future workers sprung by the huge increase in retirees would alleviate the effects of this demographic shift. But, it is the execution and implementation of these changes that will pose the greatest challenge to the Chinese government. If the health care crisis in China isn’t effectively solved, then the future of Chinese consumerism lies in the sector of global healthcare. Therefore, the future course of Chinese consumerism, and the many economies reliant on it, rests not in the hands of the new Chinese generation, but rather, the Chinese government.
For decades, the Chinese economy has been facing an increasingly disturbing wealth gap between its predominantly urban elite and rural poor even though the rapidly growing economy has helped mitigate the building discrepancy in the most destitute areas. In October 2014, though, The Economist noted that the number of rural poor declined by over 16 million in 2013 as a result of national growth. The New York Times also mentioned that month that China’s economic overhaul in the 1970s lifted 660 million citizens out of poverty. In January 2014, Chinese Premier and leader of the ruling Communist Party, Li Keqiang, in a Lyndon B. Johnson-esque fashion, declared a war on poverty. China’s celebrated its first annual “Poverty Alleviation Day” later that year, an event characterized by academics and bureaucrats attending conferences across the country about the future of its lower class. Even with these huge steps, the world’s most populous nation has a long way to fully alleviate poverty.
National growth alone is not enough to eradicate poverty; more responsible government intervention is required. Last October, the Wall Street Journal estimated that 82 million rural Chinese still live on less than $1 a day. This figure is staggering when considered alongside the statistics that roughly 55 percent of the population reside in the countryside and 40 percent of total employment is in rural China. Historic reliance on agriculture in rural areas means that urbanization, while increasing, will never help the entire Chinese population. With this in mind, the persistent poverty must be addressed by state-initiated action since mere growth has proven to not be enough. Many of China’s current poverty subsidies—especially those for villages and communities—have not been as successful as anticipated.
Part of the problem is that the statistics, while standardized, do not have homogeneous interpretations. By setting the poverty threshold at 20 cents below than the international line for “extreme poverty” set by the World Bank, the Chinese government has been able to claim a that smaller portion of its population is poor. Under the World Bank’s standards, some 200 million Chinese citizens in rural areas would qualify for substantial, government aid. While the Communist Party has not released official figures about the number of citizens receiving poverty relief, the total amount of government spending on poverty alleviation subsidies is around $2 billion each year. Xinhua, the state news agency operating out of Beijing, reported last year that multiple urban structures appear opulent while their residents are the opposite. With so much manipulation regarding what constitutes poverty and to what extent it exists, the allocation of poverty relief subsidies becomes incredibly inefficient.
Financial aid is most commonly administered at the community level rather than on an individualistic basis in China. Unfortunately, the eligibility criteria at the county level is even murkier than those for individual aid. When deciding which localities to assist, the Party usually compares the average incomes, poverty rates and inflation rates of nearby provinces. On occasion, though, it also chooses to revise from an ever-changing list of secondary qualifications. In an article from April 2015, the Economist noted that while countless Chinese localities have been listed and delisted as qualifying for government aid over the past two decades, the total number of villages receiving aid has been constant at 592. With an unofficial cap on counties receiving aid, the communities themselves have an incentive to appear poorer than they may be in reality. In essence, the poorer one appears on paper, the greater the chance of aid.
The Communist Party government’s poorly defined system of awarding subsidies to combat poverty leads to inefficient targeting. Communities that need the most help often end up being unfunded, while comparatively wealthier ones benefit. County towns like Tianzhen, which have received government aid for the past several years, do not even fall into the impoverished category by China’s present standards. Last year, a piece in the Legal Daily, a Party-owned newspaper, called into question the actual use of the funds by local government. The author argued that multiple county governments were distorting their poverty statistics, using government money and refusing to disclose how the aid had been spent. State television brought the issue of bureaucratic abuse to national attention last year when it noted that two counties in the Ningxia and Hubei provinces, both of which receive poverty relief from the federal government, each spent around $16 million on new government headquarters. Although chastised by citizens at home and abroad, the Chinese government took no action to rectify the excessive expenditures.
The smokiness of the process at virtually every level of distribution makes the government’s job of poverty alleviation significantly more challenging. A necessary step in bettering long-term outcomes, then, is the creation of a more transparent process with accountable participants. This will require a major commitment on the part of President Xi Jinping and the rest of the Communist Party. For starters, the government has to remove the cap of 592 localities receiving aid. Part of the reason so many communities manipulate their numbers is partly due to the competitive the process of receiving federal aid. Lessening competition for a select few spots would bring back some modicum of authenticity to yearly poverty figures. It would also legitimize the subsidies by making them truly means-tested, rather than a function of the connections and political clout a county may wield.
What China needs now is smarter poverty reduction, not just more of it. Such change is possible, but it has to be orchestrated more appropriately by the federal government and overseen every step of the way, rather than ignored immediately after funds are disbursed. Poverty alleviation in China is making progress, but it’s not time to celebrate quite yet.
China’s consumption rate has been growing at an exponential rate over the past decade and the country’s increasingly wealthy consumers have become brand-obsessed. The top five brands in 2011 for Chinese consumers were Louis Vuitton, Chanel, Gucci, Dior and Armani. Recent market research indicates this trend won’t show any signs of slowing. According to reports from leading consulting firms McKinsey and Bain, Chinese consumers will account for more than 20% of global luxury consumption by 2015 and have already surpassed Americans as the world’s biggest luxury spenders. And compared with the Japanese, who started luxury shopping sprees during the economic boom in the late ‘80s, the Chinese are consuming luxury on a greater scale and at a higher level of intensity.
Many Chinese consumers new to the luxury market choose to start their luxury shopping experiences by purchasing the most iconic items under the most famous brands (often completely bypassing lesser known labels). In fact when it comes to the actual selection of goods, Chinese consumers value the perceived enhancement of utility over the aesthetics. “For luxury consumption, it is mostly about the brand name. The design itself really does not matter much, as long as it is not viewed as ugly by the mass,” said one of the luxury shoppers during an interview.
“Sometimes you see those new bags in Vogue that are actually really ugly. But somehow celebrities all over the world favor them and your friends around you start to carry them. It somehow makes me end up buying them as well, even though I still think they are ugly,” another interviewee commented.
It appears that the more expensive an item it, the more desirable it becomes. “I do not like Prada or Gucci very much because they are often on sale, sometimes 50% off! In this way, they are not solid in value and are not good items for investment. Hermes and Chanel never have sales and their items are thus worth much more,” said one of the interviewees. Three other interviewees provided very similar comments against brands such as Coach, whose average prices are relatively lower compared with other luxury brands such as Chanel and Hermes. According to qualitative market research, many of the more accessible brands are often considered as entry points for the “beginners” among the luxury consumers and are thus avoided by the more sophisticated consumers, who would not purchase any goods except for the “It Bags” (globally popular brand-name bags) or “limited editions.”
While luxury consumption is a way to buy social capital through exclusivity, it is also a way for consumers to emulate public figures and just fit in with their more fashionable friends. The top Chinese celebrities are often the spokesperson for many high-end luxury fashion houses in China and many of them appear in public only in the latest fashion designs from top labels. For example, actress Bingbing Fan is one of the most prominent celebrity figures and is widely viewed as a trendsetter for women’s fashion. An interviewee noted, “I used to like Prada wallets a lot because their vibrant colors and girly design. But many girls around me started to use those simple and solid Hermes wallets, which are seen as the most prestigious and expensive. So I ended up using it as well in order not to feel left out.” The overriding concern here is a fear of being left out from the “ingroup.”
And it’s not just the super rich who are consuming these elite brands. Average consumers, under social competition and peer pressure, often feel urged to make luxury purchases in order to maintain a desirable social status and image even if they can’t exactly afford them. “I cannot afford any of the luxury stuff but I just want to look good when I am around people who are rich and powerful” says one of the interviewees. The Chinese also have a deep respect of reciprocity when it comes to gift exchanging. Receivers are encouraged to send gifts of a similar price tag to fully demonstrate their sincerity, even at an extraordinary financial cost.
On the other hand, not all luxury consumers are succumbing to the social pressures and expectations of contemporary China. From my research, it seems that the more experienced and sophisticated consumers show interest in a much broader range of brands, some of which have minimal brand visibility and recognition in the Chinese market. This group of consumers displays a relatively high level of confidence in their own tastes and stresses the importance of the actual design and aesthetics of the goods. Their confidence allows them the freedom to make purchasing choices based on personal preference instead of on a public one. However with an increasing group of wealthy, class-conscious, and fashion savvy consumers, don’t expect the Chinese fixation over Prada and Gucci to evaporate any time soon.
Note: This is an edited excerpt from Gabrielle Chen’s thesis on luxury consumption in China.
Chinese housing prices have risen in the past year for 69 of 70 of the largest Chinese cities, as tracked by the China Statistics Bureau. Furthermore, 10 of these cities have experienced housing price increases of over 10%. This general increase in prices is in part due to government policies preventing all except those who have government connections to import and export businesses and from investing outside the country. Thus, investors are left with two options: stocks and real estate. However, investments in the Chinese stock market are both risky and generally have low rates of return. Overall, the Shanghai SE composite index has declined 31.37% in the past 3 years while the bond market can also barely offer rates greater than the rate of inflation. Because of this, real estate is a far more common investment option. This has in turn created an increase in housing price driven by speculation and a real estate bubble in China.
There are those who argue that the real estate bubble is not actually a bubble and that the increase in price demonstrates a real increase in demand for housing due to increased urbanization and wage inflation. In the past year, China’s real GDP has increased 7.8% and income per capita has increased by 7.3%, reflecting inflated incomes. Furthermore, some economists believe that even if a supposed housing bubble were to burst in China, the effects would not be nearly so widespread or severe as the burst of theU.S. housing bubble due to the fact that China has a much lower residential mortgage debt than the U.S. at the time. In 2009, the U.S. had mortgage debt the size of 81.4% of its GDP while Chinese residential mortgage debt is only 15% of its GDP, as most Chinese buyers use cash for their real estate purchases.
However, the potential consequences of the rapid increase in housing prices cannot be ignored. Currently, the value of China’s residential property market is 115 trillion yuan, compared to 23 trillion for the stock market and 26 trillion for the bond market. As housing prices rise higher and higher, more and more Chinese savings are tied up in real estate. Right now, over 60% of households’ assets are in real estate and only around 20% in cash deposits. Furthermore, because housing investment now accounts for 11% of China’s total GDP, a decrease in housing prices resulting from the housing bubble’s burst would cause a significant decline in consumer spending, and this would in turn hinder China’s goal of encouraging consumption-led growth.
In addition, Premier Li Keqiang has set a 7.5% growth target for the economy this year and has stated that a growth rate below 7% would not be tolerable. Because of this, the government has still not announced any new policies regarding the regulation of real estate investment since former premier Wen Jiabo enacted a policy requiring higher down payments for second-mortgages in cities in April 2010. Continued lack of government effort in controlling the housing bubble in China could cause housing prices to plummet, as was the case in Wenzhou.
From the start of 2010 to the end of 2012, home prices in Wenzhou plummeted around 60%. This was mostly due to increased government regulations that came about October of 2010, in which restrictions on purchases were enacted and higher down payments on mortgages were required. As a result, demand for real estate dropped and a panic resulted in which investors scrambled to sell their properties. Were such a panic to happen on a large scale in the Chinese economy, households’ assets would be greatly affected, and as such, consumer spending would likely decrease. Due to this, the government is hesitant to enact more restrictive measures regarding real estate investment for fear that doing so will cause a rapid decline in housing prices and thus cause China to not meet its economic growth goal.
Certainly, there have been significant increases in housing prices in China in the last five years. However, whether this increase in real estate price signifies the presence of a housing bubble is debatable, as there are other factors pushing demand for housing to rise that are not purely speculative. Also, while the inflation of housing prices is somewhat concerning, as it creates the possibility of a panic driven real estate price tumble, at the moment it does not appear as though the Chinese government will pass policies to curb the increase in housing prices. At least for the immediate future, real estate will likely still offer the most lucrative rates of return for Chinese investors.
Two point seven million; 70 percent; 400 billion. These numbers aren’t just members of a string of trivial figures. According to the Economic Policy Institute, the first is how many US jobs were displaced between 2001 and 2011; the second represents the proportion of the American adult workforce that saw a $1000+ drop in yearly income; and the third gives the dollar amount that the US has lost in export opportunities. What could have possibly caused such huge losses? In a word, China—or rather, its practice of currency manipulation.
Currency manipulation is a country’s practice of artificially devaluing or inflating its own currency, so that the exchange rate between that currency and others around the world is different than what it ought to be in a free market. This imparts a cost advantage to the exports of the currency manipulator, because their goods suddenly become cheaper on the global market relative to other countries’ exports. In an open economy, exchange rates should adjust to trade balances, so that as capital accumulates, demand for local currency would drive up its value. In other words, China’s surpluses should lead to an appreciation of the yuan, eliminating their pricing advantage.
But China doesn’t play by such normal rules. According to prominent national economist Paul Krugman, China uses its trade surpluses to constantly print more of its own money, flooding the market with Chinese yuan and creating demand for American dollars. At the same time, it uses its newly-printed currency to aggressively purchase US dollars and government debt; as of December 2012, China held over $1.2 trillion dollars in US-specific debt and had acquired a massive imbalance of over $3.4 trillion in foreign currency reserves.
Until June 2010, China actually dictated the value of the yuan against the value of the dollar, in essence “pegging” the worth of the yuan relative to the dollar at a ratio of 6.8 to 1. Although China has abandoned this hard peg, the Peterson Institute for International Economics still estimates that China undervalues its currency by up to 40%.
So what does this mean for the United States?
First, it means the distortion of competition. Because currency manipulation makes Chinese goods cheaper relative to those of the US, it also makes American products proportionally more expensive for Chinese citizens to import. Every business day, American consumers buy $1 billion more in Chinese goods than American manufacturers sell to China, which fuels the same kind of trade imbalance that fuels China’s currency manipulation in the first place. Indeed, the Economic Policy Institute estimates that were China’s currency to experience a full revaluation, the U.S. trade balance would improve by up to $191 billion, thereby increasing U.S. GDP by as much as $286 billion, adding up to 2.3 million U.S. jobs, and reducing the federal budget deficit by nearly $1 trillion over 10 years.
Second and more importantly, Chinese currency manipulation translates into the potential for real economic disaster. US dependency on foreign savings exposes our economy to certain risks, but China’s distasteful currency practices only make this truth harder to swallow. According to the New York Times, China’s amassment of trade surpluses is “the most distortionary exchange rate policy any nation has ever followed. Most of the world’s largest economies—the US included—are stuck in a liquidity trap as a result—deeply depressed, but unable to generate recovery by cutting interest rates because the relevant rates are already near zero.” In effect, China’s unwarranted surplus policies have imposed an anti-stimulus that the world’s economies can’t offset. Their artificially under-valued currency is more attractive to businesses and investors than the capital that US banks are reluctant to lend, which siphons demand away from domestic consumption.
While this may just sound like a lot of theory, the unfortunate reality is anything but. Many scholars, including Wayne Morrison of the Congressional Research Service, believe that China’s purchasing of US securities—the predominant mechanism by which China manipulates its currency—was a major contributing factor to the 2008 sub-prime mortgage crisis and subsequent global economic slowdown. “Such purchases kept real US interest rates very low and increased global imbalances,” Morrison argues. As China continues to buy up US debt to fuel its enormous expansion, the American-Chinese deficit only becomes more pronounced, and the scales are further tipped toward the prospect of future asset bubbles and distortions.
Yet the United States isn’t the only nation that languishes beneath China’s currency devaluation. Surprisingly, China’s economic policies have created distortions within the Chinese market itself. On the surface, China appears to be thriving, a competitive economic player in the global exchange—so competitive, in fact, that the Council on Foreign Relations predicts that China’s GDP will eclipse that of the United States in five to ten years. But sustained growth of such enormous magnitude and duration comes at a price, particularly given Beijing’s centralized economic governance structure.
China reserves large parts of its markets for state-owned enterprises, demanding that its government firms dominate industries such as coal and railway infrastructure—these industries can’t go bankrupt. Indeed, the Heritage Foundation observes that state-owned banks control as much as 90% of China’s assets. With such a tight rein on the economy, the Chinese government has unintentionally created a structural distortion in China’s central monetary practices, one that is only magnified by currency manipulation.
Analysis from a study published by New York University’s Stern School of Business notes two distinct mechanisms by which China’s banking practices and central domination destabilize the Chinese economy.
First, it creates an insurance effect on banks. Knowing they can’t become insolvent, bankers become more sensitive to loan volume than to the risks of those loans, which encourages risky lending practices. As loans are given out below the efficient rate, increased demand in the housing sector causes an aggregate increase in borrowing, which increases prices in the real sector above their fundamental value and creates a bubble.
Second, as banks allocate fractions of deposits from savers into the housing sector, they may face interim deposit withdrawals or draw-downs on corporate lines of credit. In this case, unable to meet their liquidity shortfalls, banks are forced to sell assets at short notice or raise equity in the markets, incurring a liquidation cost. And since private Chinese investment and consumption is inversely proportional to the demand for American dollars created by currency manipulation, banks are forced right back to the risky loans incentives that produce the aforementioned economic bubble.
The end result of this economic mess? Massively escalating debt. By China’s own estimates, total local government debt amounts to $2.2 trillion, or around one third of total GDP. Kenneth Rogoff of Harvard University furthers that waves of municipal defaults could present even greater problems for the central government, which is sitting on another $2 trillion debt of its own. On top of that, total corporate, public, and household debt in China totals to about 206% of current GDP. This debt spurs a vicious cycle, whereby China manipulates its currency—and thereby attracts foreign trade and investment—to cover its own economic inefficiency, but this short-term growth produces unsustainable long-term damage.
This sort of economic situation has happened before—China isn’t the first Asian nation to employ currency manipulation in order to rapidly create a booming industrial economy while at the same time producing artificially high growth rates. Japan tried the same thing decades earlier, but crashed in 1990; South Korea, which copied Japan’s developmental practices, experienced its own meltdown in 1997. Indeed, the phenomenon is so common among rapidly expanding East Asian countries that Time Magazine has referred to the situation as the “Asian Developmental Model.”
Under these circumstances, firms rely on heavy-handed direction and subsidization by the state in order to create massive industrial growth. Credit is made cheaply accessible to these firms, which funnel money—both private and public—into government-controlled operations, all while the state continues to reproduce conditions that make local goods attractive (in China’s case, currency manipulation). The problem is that prices can’t stay wrong forever. State-owned companies don’t have to show the same kind of capital returns that private companies do, leading to bad investments and heavy borrowing. Under this pressure, banking sectors buckle and investment bubbles explode. If China continues on its current path, there is a very real possibility that it will become another data point in this economic model.
Is China’s economic collapse looming on the horizon? No one can say for sure. But China’s subsidization and investment through currency manipulation amounts to around 50% of its GDP, unprecedentedly high even for the Asian Developmental Model. As China continues to explore its role in the global marketplace and the global community, it would do well to remember the limits of economic centralization, painfully exposed with the fall of communism in the 1980s. The economy of tomorrow is dependent upon the cooperation of all its players; in the game of globalization, China’s conduct may earn it three strikes and an out.
Where can the U.S. and China collaborate in renewable energy? With the state of competition between the two countries both in the Olympics and in other arenas, areas for collaboration may seem dim, but actually there are possible areas for doing so.
Definitely there is a need for collaboration to make renewables reach grid parity, meaning that renewable sources become just as cheap as fossil fuel based sources. Feed-in-Tariffs, or fixed prices per kilowatt-hour that have been preset in order to attract investors in solar and wind have been under attack in many countries. This despite the fact that external impacts for coal and fossil fuel power plants (such as public health respiratory impacts ) have not been captured in their energy pricing, and their subsidies remain untouchable at the moment. For example, ask coal plant investors about the health impact of emissions and the handling of byproducts such as coal ash, and many will say it is not their concern. A carbon tax should capture these fossil fuel external impacts, but as public opposition in Australia shows, implementing a carbon tax is not a cake walk.
Publicly funded government research institutes, such as the Department of Energy Sandia and Lawrence Livermore laboratories are probably not high on the list for collaboration venues. Unwarranted collaboration is one ticket for scientists to be charged with improper handling of classified information, such as what happened in the case of Dr. Wen Ho Lee, who was eventually cleared by the courts. Anything is possible of course. Nixon did fly to China in the seventies for his pingpong diplomacy, but surprises like that are either fodder for films or novels. If it happens, it happens, but don’t count on secret American or Chinese government labs suddenly ushering in a new spirit of cooperation.
Nevertheless, research however in public and private universities like Tsinghua and Dartmouth should be strengthened. Jointly authored journal papers in technology areas like solar, wind, hydro, biomass, energy efficiency and other energy topics are probably the most basic way of encouraging some type of collaboration. The exchange of scientific ideas should be unfettered in order to march forward – a brilliant and breakthrough idea can now come from anywhere in the world. For example, the efficiency of polysilicon based solar photovoltaic panels are now hovering just above the 20% range. Breakthroughs in making solar photovoltaics more efficient, such as combining photovoltaic technology with the Seebeck effect on the same wafer, are possible areas that scientists can collaborate on.
Standards are another area of collaboration. In the semiconductor industry for example, many chip companies realized early in the ballgame that it does not make sense for wafer sizes to be different, as the resulting lack of standardized deposition tools will simply redound to unwarranted expense for all. So standards result in equipment and materials that can be marketed to different companies, resulting in cost savings across the entire sector. At the moment, the situation in the solar photovoltaic sector is that some companies still resort to custom built manufacturing equipment, which is basically what made the early days of the chip industry uncompetitive.
Then there is of course private company research, both in core technologies owned by the company and technologies that reside in its key suppliers. Microsoft, Intel and other Fortune 500 companies have their own R&D labs in China, employing Chinese scientists who work closely with their American counterparts. Collaborative research in this framework is determined to a large extent by corporate strategy, including access to markets. Collaboration within companies in the same sector, such as solar, will probably happen to a larger scale in the future in the same manner that American chip companies banded through the SEMATECH alliance to improve their competitiveness. However, there is a very low likelihood that this sort of cooperation will happen between the U.S. and China, except perhaps for a couple of non-core business and technology areas.
Related to this is the global supply chain for renewables. Some materials, like polysilicon, are important for the manufacture of solar panels. While the cost of this commodity item is driven by supply and demand, and made efficient by the many decades it has been there and by the number of companies who use it, nevertheless any opportunity to lessen its cost should be examined, if at all this is still a concern. Having reliable strategic suppliers to the wind and solar sector, or a framework for developing these suppliers, can be a good area for collaboration.
Manufacturing research, both in the U.S. and China, need to be coordinated – if not shared. While asking for sharing may be difficult as there are intellectual property issues to contend with, a certain framework that allows different creative minds to dance to the same tune will always be helpful. For example, manufacturing cost savings developed by Chinese manufacturers will not help if new American technologies will not be manufacturable using those new technologies. Again, having industry standards that companies actually comply with is key.
Access to markets, in order for renewable energy companies to grow, is important. No one will pay a corporate research scientist any money to do research if there is no business. Therefore, one area of collaboration for both China and the U.S. is unfettered access to markets. This is easier said than done of course – the new U.S. tariffs on Chinese wind turbines, and earlier on solar panels, undermines access to markets.
Finally, there should be common support for the Green Fund by both the U.S. and China. Most of this Fund will be used to pay for capital expenditures in renewable technologies like wind, solar and others. By having this money available, it can jumpstart a market that will signal to renewable energy companies, be it in China or the U.S., that the slack from the slowdown in Carbon Development Mechanism (CDM or “carbon credit”) funds will be taken over by the Green Fund. Once economies of scale have taken over – with demand for renewables coming from many parts of the globe, the current opposition to renewables determined mostly by its current cost should go away, and ensure healthy growth for all renewable energy sectors such as solar and wind in the years to come.
Dennis Posadas is an international fellow (based in the Philippines) of the Climate Institute Center for Environment Leadership Training (CELT) and a former engineer/analyst for a leading U.S. semiconductor firm. He is also the author of Jump Start: A Technopreneurship Fable (Singapore: Pearson Prentice Hall, 2009) and Rice & Chips: Technopreneurship and Innovation in Asia (Singapore: Pearson Prentice Hall, 2007)
With the world’s second largest economy after the United States, China has definite potential to exert strong influence on the global economy. However, largely due to the government’s reluctance to laissez faire, it hasn’t yet fully capitalized on its clout, especially in the global financial sector. But all that may soon change, as China’s central bank chief said in early April that China may loosen overseas investment regulations for private investors.
Historically, China first voluntarily opened up to foreign trade and investment under Deng Xiaoping in 1978 with his new capitalist-inclined system that promoted market forces. Since then, China’s financial sector has undergone significant reforms but it still exhibits the legacy of a centrally- planned economy in which the government, to this day, plays an instrumental role in credit allocations and pricing of capital. In addition, the government instituted a myriad of regulations that control both foreign investment into China and Chinese investment in foreign investments. Hindered by a maze of administrative procedures, foreign investors in China have complained that the Chinese government does not allow them to compete fairly with native businesses. Chinese investors that want to invest overseas, too, are heavily limited by esoteric guidelines.
However, beginning in October of 2011, the Chinese government took a significant step toward freeing up its hold of the financial sector. The deregulations include allowing foreign companies with RBM deposits outside of China to use their offshore account to directly invest in China, and allowing direct investment overseas for private Chinese investors in Wenzhou, also known as a “general financial reform zone” experiment. The government, afraid of the volatile international financial sector, decided to allow Wenzhou–a city in China recognized as the “birthplace of China’s private economy” due to its role as leader in developing a commodity economy, household industries, and specialized markets in the early days of economic reforms–to experiment with direct investment overseas. Concerns over inflation and property risks have held back the Chinese government from allowing a larger-scale deregulation, but nonetheless the Wenzhou experiment is widely acknowledged by the international community as a significant step forward.
Besides de jure governmental regulations, there are many de facto barriers to Chinese involvement in foreign trade. The most prohibiting factor to foreign trade is not what the laws say, but rather the existence of confusing, and often conflicting, laws at all levels of government. A unitary state with 23 provinces, 5 special autonomous regions, 4 self-governing municipalities, 2 special administrative regions, and a hierarchy of departments at all levels, China has innumerable bodies with legislative and enforcement powers that can influence foreign firms’ operations. Many foreign, and even native, companies have vocalized the impossibility of navigating the Chinese bureaucracy. A common phrase in Chinese business circles is, “It’s okay since no firm is 100% in compliance with regulations.” This trend poses significant legal risk for potential foreign investors.
Another substantial barrier to investment in Chinese markets is the inability of foreign private equity firms to freely convert RBM into other currencies. In terms of entry into Chinese market, foreign entrants must obtain special permission from the Ministry of Commerce to make investment in China using foreign currency-denominated funding pools. The Ministry of Commerce, then, picks certain transactions that it considers beneficial for the country and its policies. Later, the lack of RMB convertibility means that it’s difficult for a company to get its profits out of China. Again, companies require Ministry of Commerce permission, and are subject to different regulations depending on which individual in the Ministry handled the case, and his or her interpretation of the laws. Currently, successful foreign companies in China exploit the murky financial environment by taking advantage of unpredictable legal enforcement and shady accounting through local knowledge and networks.
However gloomy and risky foreign investors view the opportunities in China, one thing is for certain: they all want a slice of the large economic pie. “The more open China is to the world, the more benefits China will get and the more competitive local industry will be,” said Li Xiaogang, director of the Foreign Investment Research Center at the Shanghai Academy of Social Sciences. Following a similar philosophy, the Chinese government has begun responding to international pressure and removing itself as the referee in the financial markets. Ironically, Chinese deregulation may eventually level out the playing field in China’s financial sector, and with foreign companies as players, all the participants may reap benefits.
There is no denying the growing interconnectedness between the Chinese and American financial markets. Like other global financial centers, upswings and downswings in either the Shanghai Stock Exchange or the New York Stock Exchange have often been preceded by similar trends in the other. The surplus of recent global financial headlines and heightened index volatility appears to have strengthened this relationship. A simple investment simulation suggests that the Shanghai Stock Exchange can be moderately useful as an intraday trading strategy for the Dow Jones Index during the current periods of volatility.
Although this correlation has not always been present, the Chinese and American markets have gradually shifted toward each other. From 1993 to 2001, the Dow Jones Index China had only a 0.0332 correlation coefficient with the Dow Jones Industrial Average, suggesting no observable correlation. But a loosened economic policy has led to more intertwined financial markets between the U.S. and China. From 2000-2009, the correlation coefficient between the Shanghai Stock Exchange and the Dow Jones had risen to 0.731, indicating a strong relationship.
The trading strategy I’ve tested is quite simple: use a moderate rise or drop (0.85% or more) in the Shanghai Stock Exchange (SSE) to invest in the same direction in the Dow Jones when the New York Stock Exchange opens, six and a half hours after the SSE closes. For example, if the SSE opens at $100 and closes at $100.86, then I would buy shares long on the Dow since the SSE gained greater than 0.85%. If the SSE closed at $99.14, I would short the Dow.
After running this model from 04/20/09 through 10/14/11, excluding the holidays of both exchanges from the model, the total return was 83.81%, with annualized returns of 27.57%. The hit rate for positive gains, in which a 0.85% increase in the SSE led to any positive gain for the Dow, was 64%, while the hit rate for negative gains was 54.55%. Total return from positive gains was 44.62% and total return from negative gains was 39.19%.
With a modest hit rate but a significant return, this trading strategy seems to capitalize on the volatility of both exchanges. Essentially, when the Dow goes in the same direction as the SSE, it’s able to rise or drop high enough to offset the losses incurred when it goes in the opposite direction as the SSE. Moreover, it seems that those losses incurred are also quite minimal. As a result, although this trading strategy does not have a very great predictability factor for total positive or total negative gains, it does suggest a sort of dual volatility.
This should come as no surprise. The rise of a deeply intertwined and globalized financial market has inevitably strengthened the relationship of the Chinese and American financial systems. At the same time, financial crises with implications for the world economy have increased volatility and shaken investor confidence. Although this is not a long-term trading strategy, it may have strong returns in the near future by taking advantage of the US-China correlation and world market volatility.
The People’s Republic of China cannot continue to enjoy the same economic prosperity it has enjoyed in the past through its manufacturing-export-driven economy in the next decade. Instead, it must focus its attention on improving domestic consumption of goods and services.
Export-driven economic growth has had an important place in Chinese history. During the imperial era, the Silk Road brought silk and other “exotic” goods from China to the western world. The Silk Trade brought such prosperity to the Chinese empire such that the palace mandated execution for any individual that revealed the process for silk-making.
Since then, China has gone through economic and political turmoil, culminating in the rule of Mao Zedong in the second half of the twentieth century. Deng Xiaoping’s subsequent ascension to the role of “paramount leader” saw economic liberalisation, bringing great wealth and prosperity to the regions that participated in a new manufacturing-export-driven economy.
China experienced a steadily high GDP growth rate over the past 30 years due to foreign investment, lifting many peasants out of poverty and bringing luxuries unimaginable to the previously poor populations in the country.
Through careful economic planning, China has become one of the dominant exporters of consumer goods in the world. Its GDP per capita has risen from a mere $439 in 1950 to over $3000 today.
However, in the recent decade, China’s socioeconomic condition, as well as the global economic downturn in 2008, has necessitated action on part of China’s leaders to change the direction of the nation’s economic planning away from its current method of growth.
China’s success in building consistently high-performing manufacturing-export-driven economy is because of its comparative advantage in the provision of labor.
Due to its large population, China can provide cheaper manufacturing for products ranging from iPods to t-shirts.
However, with the implementation of its One-Child Policy for population control, China’s capability to produce at a cheaper rate has slowly declined. The population growth rate decreased from 1.5% in 1980 to 0.6% at present.
Although annual net population growth is considerable, China faces a rapidly aging population because of the One-Child Policy, and thus there will be a decline in the labour force available for manufacturing-intensive jobs over the coming years.
Furthermore, the standard of living in China has risen dramatically over the past decade, in-line with the growth in per-capita GDP. Labour is no longer as cheap as it was before, and workers in China now make three times as much as workers in Pakistan and Vietnam. There is a shortage of workers in some regions, and some producers have found themselves hiring recruiters to go into the countryside, offering improved benefits and higher salaries to entice workers to join their factory.
In addition, there is a wealth gap between the coastal regions of China, which have seen rapid urban growth and development of infrastructure such as high-speed railways, and the inland, rural areas of China, many of which are still without electricity. The GDP per capita difference between the richest province and the poorest is ten-fold. There is a lack of affordable health care and social security in China, and combined with poor infrastructure in rural areas, social instability is clawing at the central government.
Faced with these issues, it is imperative that China’s government focus its efforts on developing itself internally and encouraging domestic consumption. With a three trillion US dollar currency reserve[v], the government is well-positioned to spend vast sums of money on civil infrastructure, such as electricity and communications delivery. If modern technologies available in cities were brought to the rural areas of China, there would be a change towards a more domestically-driven economy.
China should also increase individual household consumption. Currently, China’s household savings rate is over 30%, dramatically higher than those of many other nations[vi]. This is due to the lack of social security and the need for Chinese men to own a house in order to marry.
Although Chinese people do consume tremendous amounts of luxury goods, they fear economic uncertainty, and especially with the lack of a government safety net, Chinese households tend to save more money for emergencies, and to provide for elderly family members.
At the same time, there is a low savings interest rate paid by banks, since they are state-run, which cannot keep pace with inflation. These factors combined make the life of the average Chinese citizen less pleasurable than beforee.
The changes facing China’s economy are of potentially great benefit to the standard of living for the Chinese people – better-developed domestic infrastructure would improve the quality of life for millions of peasants living without modern amenities in the countryside, while government incentives for consumption of non-essential goods could provide an opportunity for many Chinese families to acquire new products and live a wealthier lifestyle.