By staff reporter Zhang Hong

From Caijing Online

Creativity and resolve will be needed to turn a corner for restructuring China’s economy. But a rule of inertia suggests that the heavier an item, the harder it is to steer a new course.

Growth in China -- the world’s fourth largest economy – relies first on exports and second on investments to increase exports. This pattern has become increasingly difficult to break. While most agree the ultimate goal is to switch the nation’s engine for economic growth from foreign to domestic demand, not everyone is willing to do it right now. Many fear such an adjustment may be frighteningly painful.

The export sector has created tens of millions of jobs. It’s been a crucial pillar of a labor force with huge numbers of ex-farmers who gave up unprofitable agriculture jobs and sought new ways to make a living. As a result, securing a stable labor market now is essential for successful governance.

The tremendous significance of this labor force bred the mythical 8 percent rule. Supposedly, 8 percent is the minimum annual growth rate needed to sufficiently guarantee balanced employment. With this in mind, government officials have every incentive to repeat practices linked to scaling up investments. They’ve seen how easily investments can paint a picture of attractive growth rates. And as bureaucrats know, higher growth rates can lead to job promotions.

A motto for recent government talks has been “enhance domestic demand.” But government actions do not suggest a real readiness to transform. Investment is still what comes to mind first.

More Consumption, But How?

Beijing announced November 9 an impressive and sweeping economic stimulus package that calls for investing 4 trillion yuan by the end of 2010, primarily in transportation and agricultural infrastructure. While this investment plan has been recognized for steering away from overbuilding production capacity and focusing on infrastructure to fill long-term needs, it still falls short of the kinds of measures needed to beef up domestic consumption as a necessary substitute for weakening exports to overseas markets.

To encourage Chinese consumers to spend more requires not only increasing their incomes, but building a comprehensive and effective social safety net to free people from having to save large amounts of money. In a mid-term review of the 11th Five-Year Plan, the government admitted that the economic structure has not improved, as trade still accounted for 66 percent of GDP in 2007 and the nation’s consumption rate fell to 48.8 percent from 52.1 percent in 2005.

A government review submitted to the National People’s Congress on December 24 said the key to stimulating domestic demand was “strengthening the driving role of consumption as the ultimate demand for economic growth.” It also listed several issues to address, such as modifying the distribution mechanism in favor of low income households, extending social security coverage, and improving markets, especially for housing and cars.

Later, the government unveiled its first policies directed toward promoting consumption. Concrete measures included renovating and building stores and logistics centers in rural areas, subsidizing electrical appliance buying among farmers, standardizing food markets, and developing second-hand markets in cities. Other consumption-oriented steps include supporting mergers and acquisitions among logistics companies, offering more credit to small retailers and trading firms, promoting new types of spending opportunities such as tourist attractions and exhibitions, and reinforcing food quality surveillance. The package also contains funds earmarked for developing a rural logistics system and promoting the services sector.

These are necessary measures for facilitating the market. However, people with no reason to expect higher incomes are hardly inclined to spend more. And incomes can’t be expected to rise as long as the government continues food price caps that limit farm revenues, or unless taxes are cut so that more wealth enters the private sector instead of state coffers.

More importantly, nothing in the package speaks of opening access to markets for health care, financial services, education, information technology or culture. Encouraging these markets has long been expected. But businesses in these fields may still find few opportunities for growth.

While stressing the need to promote consumption, the government also made it clear it will take additional measures to promote the export-oriented economy. As exports slid 2.2 percent in November from a year earlier -- the first negative growth in seven years -- the government unwound previous policies designed to hold back excessive export growth. Tax rebates for machinery and electronic products were increased for the fourth time since September, while restrictions on processed goods trade were relaxed.

It’s doubtful these measures will actually help Chinese exporters as intended. Exporters have been on the weak side of the negotiating table, so these tax rebates may wind up supporting foreign importers. Although the moves may keep some factories afloat, China is also at risk of being accused of protectionist, and provoking retaliation by trade partners.

Yuan as the Settlement Currency

A novel measure recently adopted by the government is a test for using the yuan as a trade settlement currency for business with Hong Kong, Macao and members of the Association of Southeast Asian Nations. Some hailed it as a first step toward the yuan’s internationalization. But the measure is short on details. For example, we don’t know how the government will assure Chinese exporters and trade partners that yuan assets are less risky than those denominated in reserve currencies. Another question is whether other countries are willing to hold the inconvertible yuan in foreign exchange reserves.

The yuan’s value against the dollar has stalled in recent months, raising suspicions that Chinese authorities might devalue the yuan to boost exports. But yuan settlements hardly benefit Chinese traders who have to agree to other terms to compensate for use of China’s currency.

Having reached a point where reshaping the economic structure can no longer be postponed, China now needs a strong push to counteract the inertia that favors sticking to the original course. Policymakers need more creativity to address persistent problems shielded by a powerful resistance. They also need firm resolve.

1 yuan = 14 U.S. cents