Investments  

Awakening dragon

The issue that faced China’s historical model was twofold. First, it was part export led. The rise of manufacturing in China over the past 30 years has been staggering, leading it to produce and export an enormous amount (for example 83 per cent of the world’s shoes, 90 per cent of the world’s PCs).

It was the reliance on other economies in this export-led mechanism that left it to the mercy of global demand, creating high cyclicality in downturns.

The second issue was having a part investment-led economy due to resource constraints. It is home to 19 per cent of the world’s population and consumes 20.3 per cent of its energy, yet it has only 1.1 per cent of the world’s oil resource.

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As such, a movement away from this export and investment led growth was needed.

Growth

The ruling Communist Party realised, through the lessons of other emerged states, such as Korea and Taiwan, that the creation of a consumption-orientated economy was the only pathway to sustained growth.

Cutting through the red tape and other regulatory barriers to entry would aid the proliferation of private industry in a country dominated by state-owned enterprises.

Furthermore, the government realised that income disparity, fuelled by corruption and nepotism, needed subversion to avoid social unrest. The effective implementation of this transition, through freeing capital and labour, could create an efficient and somewhat self-sufficient society, giving any ordinary citizen the opportunity to create wealth for themselves.

The challenge: to make this transition smoothly. It is an enormous economy. To give an idea of scale, the Cypriot banking crisis, much publicised in the press for fear of contagion, has an economy worth around $25bn (£16.2bn). China grows by this amount every week. As such the reforms and the way in which they are implemented are key, and the list is long.

In the near term there are two under focus; first is reducing the influence of lumbering SOEs – they encapsulate all that is inefficient.

Historically, they have been necessary in capital-intensive industries; they represent 5 per cent of total enterprises, use 20 per cent of the working population, but swallow 50 per cent of the nation’s corporate debt and have performed very badly. In the first four months of this year SOEs profits grew 2.7 per cent year-on-year whereas private industry profits were up 17.9 per cent.

Over the whole of 2012, SOEs profits actually declined 5.1 per cent compared with private growth of 20 per cent.

Liberalisation

Of critical importance are the market based reforms to liberalise the private sector ranging from interest rates to utility tariffs, freeing up access to banking and finance, and cutting the regulatory red tape to lower barriers to entry and enable private investment for industries currently dominated by SOEs. As the profit ownership of large industrial firms shows, the liberalisation is well on its way.

The second focus is the Hukou reform – an archaic system nestled into a transformed economy, a mismatch that makes no sense.

Hukou, or household registration, was not uncommon in Asian countries and introduced in the 1950s by the Communist Party as a way of keeping the 85 per cent of the population based in rural China away from urban areas. These citizens were to produce food, feeding the remaining 15 per cent in the cities who would be building industry.