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China Ready to Pull the World Economy Out of the Doldrums?

Economics / China Economy Mar 16, 2011 - 07:13 AM GMT

By: ECR_Research

Economics

Renate van Ginderen writes: The role of China’s 12th Five-Year Plan

China’s twelfth Five-Year plan promises reform in all key areas of the economy. The plan will have to guide China between 2011 and 2016 towards a more sustainable, balanced, stable, and coordinated growth model. However, the problem is that it actually does not differ much from the eleventh Five-Year plan announced in 2006, whereas that plan did only do so much. The new real annual growth target is reduced from 7,5% to ‘just’ 7%: enormous in Western terms, but drastically lower than the 9,3% attained in 2010. So will this drag the economy down? Probably not. The growth target for the 11th Five-Year Plan has been overshoot largely. It is much more likely the central government will not really succeed in redirecting its economy, as will be discussed below.


In 2006, when the eleventh Five-Year plan was announced, China’s premier Wen Jiabao stressed that the country was at a critical juncture. The dependence of exports to the United States was too high; warnings were issued that a downturn in the U.S. consumer demand would drag China down. This is why already then, Wen called China’s growth model Uncoordinated (due to a fragmented system, with a lack of consumption and an underdeveloped service sector). Furthermore, he assessed it as Unbalanced (the discrepancy between the urban Eastern regions and the rural Western regions was too high), Unstable (excessive investment and liquidity, plus a enormous current account deficit), and Unsustainable (the capital-intensive manufacturing sector producing goods for the U.S. was causing environmental degradation). The eleventh Five-Year Plan would have tackled the ‘four Uns’ - as they became known - through reforms in basically the entire economy.

However, for example focusing on the trade imbalances between China and the U.S., trade imbalances even increased, despite the call for a more consumption-led growth model in China instead of an export-based model, and despite the fact that the feared U.S. downturn causing the U.S. consumption bubble to burst implied that demand for Chinese exports declined drastically.

As a response, the central government applied fiscal and monetary stimuli to prevent a Chinese recession via stimulation of exports through export subsidies and large investments in the export sector. The result was remarkably good in growth terms, as the real annualized growth rate in 2009 Q1 was still 6,5% and climbed back to 11,9% a year later. Unfortunately, this recovery was largely based on exports, not on domestic demand. No matter how good the intentions of the central government were in reforming the health and social security system in order to boost domestic demand, local governments saw more in boosting exports or investing in infrastructure to stimulate GDP.

Hence, while the urgency to reform was highest (in the midst of a deep crisis), and when it became crystal clear that a U.S.-led worldwide downturn would affect China’s growth very negatively, the required reforms have been delayed.

This is not all too surprising: the reforms required to transform China to a consumer-led economy could not have been done in one week, month, or even a year.

The most important reform is perhaps the installation of a sufficient safety net (social security system), in order to reduce the incentive of households to save for their retirement. Additionally, consumers’ attitudes need to change, which takes perhaps the time of a generation. So from this viewpoint, it is not surprising that the Great Recession did not lead to more change. Nevertheless, progress has been slow and the contribution of consumption to GDP has even declined further.

What must be concluded from this is that transformation of China’s economy is a very long progress. Hence, the fact that one of the goals of the newest Five-Year plan is to encourage consumption, does not mean that this goal will be attained in the next five years, since it hinges on other factors and reforms that will or will not be undertaken such as the social safety net and tax reforms.

Nevertheless, China remains a growth market with plenty of opportunities. Especially as the process towards a more open financial system is likely to accelerate over the next few years. Fears of the impact of the twelfth Five-Year plan are misplaced. Hope of immediate results is so, too. Nevertheless, the urgency of reform is likely to trickle down to lower levels of society as ‘easy’ growth (from returns on labour and export to the West) becomes more difficult to achieve. Then, China may become an important world consumer faster than many might think.

By Renate van Ginderen

After having finished a bachelor in International Economics and Finance and International Business at Tilburg University, and a short experience of studying abroad (at Université de Lausanne), I went back to Tilburg University to complete a Master in International Economics and Finance with an average grade of 8 (out of 10). After a six-month internship with ECR Research, I started as a full-time analyst financial markets. Research topics include China and Japan. ECR Research is an independent macroeconomic and financial research company specialised in interest rates and currency rates forecasts.

ECR Research (www.ecrresearch.com) is one of Europe’s leading independent macroeconomic research institutes focusing on the main currency and interest rate markets. The ECR reports reach a worldwide audience of sophisticated investors and treasurers and CFO’s within corporations and financial institutions. ECR offers a wide range of research products which are online accessible and updated on a weekly basis.

© 2011 Copyright ECR Research - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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