“Known Unknowns” And China

Business, China, Company Strategy, Economics

By John Richardson

IF the blog had a dollar for every time we had read reports about Chinese growth being constantly buoyed by rising domestic income levels and increasing urbanisation, we would probably be as rich as a mid-level executive in a state-owned enterprise (in other words, very rich – way beyond such an executive’s “official” income).

The reports – some of them penned by those who focus on analysing the chemicals industry – are too simplistic because they do not evaluate potential negative outcomes from the “known unknowns”, to quote Donald Rumsfeld.

The known unknowns include whether China will achieve the transformation in its economic growth model being targeted under the country’s 12th Five-Year Plan (2011-2015). If the latest plan fails all bets are off. Just about nothing can be guaranteed, including social and political stability.

And even if the plan is effectively implemented, a “demand growth gap” that we referred to last year is inevitable as the economy adjusts to its new growth model.

Will the plan survive the 2012-2013 leadership transition? Scores of Communist Party, government, army and legislative senior leaders, including President Hu Jintao and Prime Minister Wen Jiabao, will retire and be replaced by a younger generation from late this year into 2013.

”The Five-Year-Plan is relevant to a certain extent; it is important,” said Cheng Li, director of research at the Brookings Institution’s John L Thornton China Center, in this article in the New York Times.

”But compared to the leadership transition, the plan becomes so totally trivial because any major personnel changes will completely change the policies or agenda.”

And regardless of whether the new leadership adheres to the plan, the vested interests that have done well from the existing system are likely to strongly resist change.

Local government officials are likely to fight hard for the continued right to appropriate agricultural land at knock-down prices, a major recent source of social unrest.

The officials will also need to petition Beijing to stick with its “investment-led growth model” – i.e. further easy bank lending pumped-into building bridges, roads, railways, airports and real estate.

The reason is that if a property-price collapse does occur, as is now a very real possibility following last year’s anti-inflationary measures, the opportunities for making big personal profits from land sales will disappear. A big hole will also open-up in local authority financing as loans start to turn bad at an alarming rate, creating a major bad-debt crisis.

A further consequence of letting the property bubble deflate is an angry constituency of urban residents caught in negative equity, who bought into the boom late-on.

Pumping more air into the bubble, however, risks a rise in social unrest as the land grabs continue. Young, professional people who do not qualify for social housing will also remain priced-out of owning their own homes.

The state-owned enterprises (SOEs) are also corrupt – another potential source of public resentment.

Between 16,000 to 18,000 government officials and executives from state-owned enterprises (SOEs) stole $123bn of public funds between the mid 1990s and 2008, says The Economist, quoting data from the People’s Bank of China. This estimate doesn’t, of course, account for what are likely to be “boom years” for corruption: 2009-2010 when lending by the state-owned banks was raised to the equivalent of one-third of GDP, making proper due diligence on all of these loans impossible.

The SOEs received 85 percent of lending in 2009-2010, leaving the private sector relatively under–provided. And as lending was tightened last year, it was the private sector that suffered the most, as the SOEs were able to corner what credit was still available because of their strong connections to the state-owned banks.

If I were living in China, and I’d just lost my job because of the export slowdown, or had seen land that my family had farmed for generations stolen by a local government official, I would be mightily angry.


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