An expert in China’s economic development and its impact on Asia and the global economy
Adviser to the World Bank and the Asian Development Bank
Senior Associate in the Carnegie Asia Program
An expert in China’s economic development and its impact on Asia and the global economy
Adviser to the World Bank and the Asian Development Bank
Yukon HUANG is currently a senior fellow at the Carnegie Endowment in Washington D.C. He was formerly the World Bank’s Country Director for China. He is an advisor to the World Bank, ADB, AIIB and various governments and corporations. His research focuses on China’s economy and its regional and global impact. Dr. Huang has published widely on development issues in professional journals and the public media. He is a featured commentator for the Financial Times on China and his articles are seen frequently in the Wall Street Journal, Bloomberg, Foreign Affairs, National Interest and Caixin. His recent books include East Asia Visions, Reshaping Economic Geography in East Asia and International Migration and Development in East Asia and the Pacific. His latest book Cracking the China Conundrum: Why Conventional Economic Is Wisdom Is Wrong was published by Oxford University Press (2017). He has a PhD in economics from Princeton University and a BA from Yale University.
In recent years, China’s economy has grown at a slower pace, prompting many experts to speculate on its future prospects. In this podcast, Paul Haenle and Carnegie’s Yukon Huang examined and debunked certain misperceptions that inform current conventional wisdom about the debt that China has accumulated and the country’s unbalanced growth.
Huang posited that China’s debt is the result of deliberate government stimulus programs and not fiscal mismanagement. He asserted that rising debt levels suggest that China’s fiscal system will need to evolve to fit the country’s needs as an emerging market. Huang also maintained that unbalanced growth is a necessary step for China to grow from a middle-income country to a high-income one.
Yukon Huang is a senior associate in the Carnegie Asia Program. His research focuses on China’s economic development and its impact on Asia and the global economy.
Paul Haenle is the director of the Carnegie–Tsinghua Center for Global Policy. Prior to joining Carnegie, he served from June 2007 to June 2009 as the director for China, Taiwan, and Mongolian Affairs on the National Security Council staffs of former president George W. Bush and President Barack Obama.
Xi Jinping’s anticorruption campaign will only succeed if more is done to address the structural factors making corruption possible.
A decade from now, President Xi Jinping’s reign might be defined more by the success of his anticorruption campaign than his country’s material progress. China has always been the outlier on many economic issues, and so it is with corruption. Studies show that for most developing countries, corruption retards economic growth. They also suggest that developed countries are less corrupt than developing ones. So has China managed to grow so rapidly because or in spite of rampant corruption? And why has corruption in China gotten worse rather than better?
Corruption has featured prominently in China’s dynastic history, but this current bout stems, ironically, from the major reforms launched by Deng Xiaoping. His opening-up of the economy four decades ago paved the way for a hybrid socialist market economy that, similar to the former Soviet Union republics, is particularly prone to corruption during its transition. Deng’s famous saying that “to get rich is glorious” removed any moral qualms about making money—legally or illegally.
The creation of a dual-track economy, with parallel market and state-driven activities and prices, created the incentive for corruptive interaction among three central players. One is the private entrepreneur who saw the potential to prosper by providing a better product but lacked the resources to do so. The solution often was to co-opt a representative of a state enterprise who could provide the resources, especially financing from state-owned banks. Both, however, needed the blessing of the local official—almost always also a Party member—who had the authority to make the collaboration politically acceptable.
Corruption and growth thus went hand in hand. In China’s overly centralized bureaucracy, these relationships helped get around the excessive regulations and controls and thus improved efficiency. Corruption is usually seen as hurtful to growth because it represses investment, but China’s investment rate is widely seen as being too high rather than too low. Its unique, regionally decentralized administrative system checked the growth-inhibiting aspects of corruption by setting investment and production targets for local officials. This fostered a unity of purpose, so that even as corruption flourished, the collaborators worked to make growth the guiding principle for governance.
Corruption in the transition phase was enhanced by the existence of dual prices for consumer and producer goods—one market-determined, the other subsidized. This created the opportunity for illicit gains through price arbitrage. Unification of output prices eliminated most of those rent-seeking opportunities years ago. Today the problem lies in the distorted prices for inputs such as land, energy, capital and labor. That is why Mr. Xi’s anticorruption campaign has been targeting the energy companies and why land-development practices, interest-rate liberalization and even labor-migration policies are so high on the reform agenda.
China’s rapid growth encouraged ever-rising levels of corruption because more wealth creation meant more could to be siphoned off. An economy’s most vulnerable period comes during the transition from being centrally controlled to being market-driven, when the rules and property rights are unclear. The danger lies in being stuck in the transition. Thus the defining question now is whether China will eventually fulfill its Third Plenum pledge, made more than a year ago, that the market—not the state—will be the primary force for allocating resources. Otherwise corruption will continue to flourish.
While corruption in China hasn’t led to economic stagnation, its demoralizing effect on perceptions of social equity and justice is driving the current crackdown. Campaigns tend to be run by “moralists” who argue for fundamental changes in values—in this case to preserve the credibility of the Communist Party. It is this need to maintain legitimacy that drives Mr. Xi’s actions.
Economists like Premier Li Keqiang tend to focus more on altering incentives by eliminating regulations that nurture corruption. Simplifying investment procedures and lowering tax rates are thus the focus of attention, making the negotiation of free-trade or investment treaties the instruments of reducing corruption.
The current corruption campaign is heavy on dealing with nonstructural factors and moral suasion by trying to reign in bribes and greed through enhanced penalties. The chance of going to jail for corruption according to one study, is only 3% in China—making corruption a low-risk, high-return gamble. Persecuting more “tigers and flies” changes the risk-benefit calculation. But ultimately Mr. Xi will succeed only if more is done to address the structural factors driving corruption.
This means breaking the corruptive relationship between the central players in the dual economy, separating the roles and responsibilities of the four major agents driving China’s system—the Party, the government, enterprises and banks. This would require some form of political liberalization to build more effective mechanisms for accountability and transparency that would make it more difficult for corruption to be sustainable.
Many seeking precedents for what might happen in China look to the Arab Spring movement or countries like Indonesia. But more appropriate are the experiences of the very few highly successful developing economies formerly with autocratic political systems, such as Singapore, South Korea and Taiwan. There, rapid economic growth accompanied by the rise of a more urban and services-oriented middle-class triggered gradual political liberalization. This is the likely course for China, albeit managed by the Party.
Contrary to popular belief, banks aren’t the source of China’s major economic headaches. They’re merely the accommodators. The real culprit is the current fiscal system.
Consider the debt issue first. Beijing’s fiscal policies limit local governments’ share of tax revenues to about 45%, even as local governments account for 85% of state expenditures (up from 65% around 2000). This has forced local governments to fund their social and infrastructure spending via off-budget financing, typically from land sales and shadow banking. The result is bank lending for expenditures that don’t generate commercial returns and should have been funded all along out of the state budget. Such debt piles up and is eventually written off with other nonperforming loans.
Then there’s the country’s slowing growth. The problem isn’t a lack of productive capacity to grow at 7% a year. It’s that a 7% rate is unsustainable due to inadequate demand.
China can no longer rely on exports given Europe’s continued malaise and America’s relatively import-weak recovery. Chinese investment rates meanwhile will decline given lower returns and the need to deleverage. Household consumption won’t greatly increase because growth—having been exceptionally high for a decade—will decline as wage increases slow. To date, Beijing is pursuing selective stimulus policies that only heighten the ultimate need for deleveraging.
So how can China deal with its debt issue while also finding the demand to make up for weaker external markets and lackluster growth in investment and personal consumption? The answer lies in restructuring the current fiscal system—and it appears a plan is already in the works.
China’s budget is unusual in its limited size and in how it misaligns revenues and expenditures between the central government and the provinces. The total budget is only 28% of gross domestic product (compared with 40% to 45% for the major OECD economies and more than 35% for upper middle-income countries).
In June, Beijing promised to complete a detailed framework for a major fiscal overhaul within two years. The package aims to reduce local budget shortfalls by expanding the value-added tax (to include services) and instituting new taxes on natural resources and property. It also calls for restructuring local government debts (often into long-term bonds) and eliminating loans backed by land. By introducing multiyear budgeting, the new approach could reduce incentives for collecting off-budget revenue to meet short-term fiscal targets. Local officials will be assessed partly on how they manage their debts.
A restructured fiscal system will relieve the pressure on commercial and shadow banks to fund infrastructure projects. More important, it will enable a more balanced structure of aggregate demand by reducing reliance on debt-fueled investments by state-owned enterprises and increasing the role of state budgetary expenditures.
This may sound sacrilegious to anyone who believes that only private-sector dynamism can cure economic ills, but China’s state is unusually parsimonious in its social expenditures and has plenty of room to grow. As noted in the World Bank’s “China 2030” report, Chinese social spending and transfers as a share of GDP are roughly half those of comparable middle-income economies and a third those of OECD countries. With a stronger revenue base and a clearer mandate to fund social services, government consumption could increase to around 18% of GDP by the end of the decade from 13% today. That would offset significant investment declines and provide the demand needed for 7% growth over the decade to come.
A byproduct of major fiscal reform would be greater public scrutiny of central and local budgets, as citizens would expect rising state expenditures to directly improve their living standards. This would create pressures for more meaningful participation of citizens in the National People’s Congress and provincial assemblies, paving the way for more democratic decision making.
Commentary outside China has largely ignored Beijing’s ambitious fiscal agenda, instead obsessing over small changes in interest and exchange rates. But given the current system, financial liberalization will be less effective than fiscal reform in altering the behavior of economic and political actors.
Success, however, is far from assured. Some reforms already announced may be blocked by vested interests. More work on both strategy and tactics is needed before we can be confident that China has found the path to sustainable high-speed growth.
China needs a new prescription for growth: Cram even more people into the pollution-ridden megacities of Beijing, Shanghai, Guangzhou and Shenzhen.
While this may sound like a recipe for disaster, failing to expand and improve these urban areas could be even worse. That’s because the biggest cities drive innovation and specialization, with easier-to-reach consumers and more cost-efficient public transport systems, according to Yukon Huang, a former World Bank chief in China.
He estimates China’s leaders’ seven-month-old urbanization blueprint, which aims to funnel rural migrants to smaller cities, will slice as much as a percentage point off gross domestic product growth annually through the end of 2020.
“China’s big cities are actually too small,” said Huang, a senior associate at the Carnegie Endowment for International Peace’s Asia program in Washington. “If China wants to grow at 7 percent for the rest of this decade, it’s got to find another 1 to 1.5 percentage points of productivity from somewhere.”
A strategy that supports the biggest cities’ expansion would add $2 trillion to China’s output in 10 years — more than India’s 2013 GDP — according to Shanghai-based Andy Xie, a former Morgan Stanley chief Asia-Pacific economist.
With a population more than four times that of the U.S. living on roughly the same land mass, China should have big, densely populated urban areas, Xie said. To make that a reality, the megacities need to build up, not out, he added, citing Tokyo and its population of about 37 million as a workable example.
“If you do not focus on big cities with concentrated populations, China will become an ecological catastrophe,” he said. “If you pick the wrong model of urbanization, it sets you back not just for years, it could cap your income level for eternity.”
Beijing and Shanghai already have about 20 million people each, while Guangzhou and Shenzhen both top 10 million. Even so, given China’s 1.4 billion population, their concentration is low by global standards. In the U.S., the largest 10 metropolitan areas account for about 38 percent of GDP, about double that in China.
Echoing Mao-era central planning, China’s current urbanization policy decrees that populations will be “strictly controlled” in metropolises with more than 5 million people while expansion is allowed in mid-sized cities and encouraged in small ones. The plan will redress unbalanced development that has left megacities overburdened, with deteriorating environments, Vice Minister of Public Security Huang Ming said at a March briefing.
The edict shows the “persistence of old thinking” even after past attempts to shift people and resources to smaller, less productive cities proved “hugely wasteful,” Andrew Batson, an analyst at researcher Gavekal Dragonomics in Beijing, wrote in an August note.
“Planners still seem convinced that big cities are crowded, terrible places whose growth must be controlled,” wrote Batson, who has covered China since 1998. “In reality, big cities are China’s richest and most vibrant places, and restraining their growth does the economy no favors.”
Premier Li Keqiang is under increasing pressure to boost the economy, which is headed this year for its slowest expansion since 1990. Growth probably fell to 7.2 percent in the third quarter from 7.8 percent a year earlier, according to the median estimate of analysts in a Bloomberg News survey ahead of data scheduled for release tomorrow.
While Li and his fellow Communist leaders have the chance to shift policy priorities when they gather for the fourth plenum that starts in Beijing today, any major rethink on urbanization is unlikely. The conclave will focus on efforts to bolster the rule of law, state media reported last month.
The pace of migration from rural areas to cities, a dynamic hailed by Li as key to the nation’s development, is set to slow by a third in the years from 2013 to 2020 compared with the previous seven years, the government forecasts.
That’s pressuring Li to find ways to optimize productivity. The rapid expansion of China’s cities hasn’t been accompanied by efficiency gains because of impediments including urban sprawl and inadequate infrastructure, according to Cui Li, a Hong Kong-based economist at Goldman Sachs Group Inc.
Achieving the same efficiencies as U.S. cities, which are modest compared to those in more compact European metropolises, could add 1 percentage point to annual growth by the end of the decade, she estimates.
An additional 4.2 million people can be added to Guangzhou and 5.3 million to Shenzhen if those cities had the same population density as Seoul, according to a March report by the World Bank and the State Council’s Development Research Center.
Making changes to land use that would spur denser cities could save China $1.4 trillion from a projected $5.3 trillion in infrastructure-spending needs during the next 15 years, World Bank chief operating officer Sri Mulyani Indrawati said.
There are signs of progress. A bus rapid-transit system that opened in Guangzhou in 2010 has saved passengers a combined 32 million commuting hours a year and is projected to reduce carbon-dioxide emissions by 84,000 tons in its first decade of operation, the United Nations estimates. In Kunming, capital of southwestern Yunnan province, a new district is being developed with a subway system, bus stations and green spaces planned every 300 meters.
Building dense cities around mass-transit systems that balance commercial and residential areas would slash reliance on cars, according to the Energy Foundation, a San Francisco-based nonprofit organization that promotes clean energy. That would prevent as much as 800 million tons of carbon dioxide from spewing into the atmosphere by 2030, more than emitted by Germany in 2011, it estimates.
A continuation of old methods raises the specter of worsening traffic congestion and pollution in the biggest cities if migration continues to outpace policy makers’ plans.
“For the last two to three decades, China’s city planning has not taken migrants into account in their plans for transport, housing and many social services,” said Kam Wing Chan, a professor at the University of Washington in Seattle and author of “Cities With Invisible Walls: Reinterpreting Urbanization in Post-1949 China.” Urban problems including traffic gridlock “are mainly a result of not providing for population growth,” he said.
U.S. President Barack Obama’s Asian tour is intended to revitalize his moribund pivot to Asia. That this strategic initiative is still alive despite the inevitable pull of events in the Middle East and Europe is attributable to China’s claims over disputed islands, which have unnerved many in the region. This has opened the door for a stronger U.S. military presence in Asia while negotiations on the Trans-Pacific Partnership (TPP), which excludes China, provides some balancing weight on the economic front even if Congress has denied a fast-track approval process that would have facilitated an accord.
China cannot win the battle for regional sentiment so long as the debate is about security and sovereignty, on which Beijing’s hard position leaves little room for compromise. Many see negotiations on the Regional Comprehensive Economic Partnership (RCEP) with the ASEAN Plus Six grouping as China’s counterweight to the TPP in pushing the regional agenda towards more mutually beneficial concerns. Yet both of these endeavors potentially pale in comparison with President Xi Jinping’s fanciful idea of reviving the “maritime silk route” during his October visit to Malaysia and Indonesia. This notion builds on the East Asia region’s proven strengths in sharing production and deepening financial links while seeking to make greater use of the overseas Chinese communities in forging relationships to reduce tensions.
The movement of goods along the maritime silk route has a history of over two thousand years, reaching its pinnacle in the 15th century when the legendary explorer Zheng He led an armada of more than 300 ships and 27,000 sailors in voyages from China through Southeast and South Asia to the Persian Gulf. Today these same corridors play a vital role in supporting East Asia’s unique production sharing network which brings components produced throughout the region to China for assembly and then onwards to final destinations in Europe and North America. Building on these links could help build more harmonious interactions throughout the region.
A sharp decline in transport costs along the contemporary maritime silk route allowed all countries in the region, regardless of their size and technological sophistication, to benefit from specialization and economies of scale by producing components rather than complete products. This is the major reason why East Asia has performed so well relative to the rest of the world. With rising labor costs in China, many ASEAN economies now stand to gain from future outsourcing of production. This combines with the trade deficits that China runs with most of its Asian neighbors — in contrast to its persistent surpluses with the West — to make it easier forChina to be seen as an opportunity rather than a threat.
Because the membership base for the TPP is not the same as the regional production sharing network, the interests of the respective groupings are not necessarily aligned. Under U.S. leadership the TPP is pushing for the highest standards, with substantial attention being paid to issues that are often not seen as directly trade related, such as intellectual property rights and the rules governing state enterprises. Many participants are drawn to the potential for spurring structural reforms in being associated with such a group, but some are also motivated by the TPP as a counter weight to China’s economic rise.
While the negotiating process remains closed, enough intelligence has seeped out to suggest that there is a sharp separation between the U.S., which is driving the process, and the other TPP participants on many of the major issues. This is especially striking regarding positions on intellectual property rights, investment guidelines, environment and rules of origin. Relative to the RCEP, which would likely be more open to accommodating economic diversity and keen to protect the workings of the production sharing network, vast differences in development levels among TPP members mean that the less advanced may be harmed by actions that could impede technology transfers while the more integrated may see the competitive advantages derived from production sharing networks eroded by restrictive rules of origin. This will lower the benefits that some studies have estimated will accrue to East Asian participants in the TPP.
Shifts in the pattern of capital flows will also affect economic relationships as China moves from being largely an absorber of funds to also a major provider. Some predict that within a decade as much as a hundred billion dollars will be leaving China annually in the form of direct investment and portfolio flows, with much of it targeted to Asia. This will help to make the renminbi a global currency. Moreover, China’s structural trade deficits within East Asia make it logical to use the renminbi as a regional currency to settle trade balances before it begins playing a meaningful role in the rest of the world. History will be repeating itself as centuries ago Chinese copper coins were used as the medium of exchange throughout the maritime silk route, foreshadowing China’s current ambitions to internationalize its currency.
The most challenging and uncertain endeavor, however, is what Beijing has in mind is building on the role that overseas Chinese have played historically played—and continue to play today—in Southeast Asia. About 32 million of the 50 million overseas Chinese reside in Southeast Asia, including PRC nationals who live abroad and ethnic Chinese who have assimilated into their host countries. They account for a preponderance of the wealth in a number of ASEAN countries and play key roles in the regional production sharing network, aspects of which are coordinated out of Hong Kong, Singapore and in electronics, Taiwan, blurring concepts of what constitutes overseas ethnic Chinese communities and their political status.
During its opening up decades ago when its legal environment for protecting foreign investment was undeveloped, overseas Chinese accounted for as much as two thirds of FDI flows into China. They were able to leverage their identity, understanding of cultural norms and personal networks to mitigate some of the inherent risks that non-Chinese foreigners faced. Not surprisingly, Beijing now sees potential in having overseas Chinese play a reverse role in facilitating China’s outward investment in Southeast Asia, helping to develop major ports, out sourcing industrial production, deepening banking relationships and widening channels for distribution.
Overseas Chinese continue to exhibit an enduring cultural connection to China despite assimilating and naturalizing to host countries abroad. But they have gone through complex historical and political shifts that have complicated relations between China and these countries, and with other social communities within these countries. The role of the Chinese diaspora in influencing foreign policy is subject to diverse motivations but overall these relations have been largely passive. If they are to become more active in the future, the sensitivities involved need to be carefully managed and even then, whether such relationships can be turned into an advantage is questionable.
Beijing has attempted to exert strategic influence in the past on the overseas Chinese with mixed results. Wariness among many ASEAN countries toward China and ethnic sensitivities within countries where overseas Chinese occupy dominant roles in the local economy will likely limit the effectiveness of approaches with overt foreign policy objectives in mind. Most overseas Chinese do not share a bond with China beyond purely economic interests. Other local populations throughout Southeast Asia remain concerned about how greater engagement with China will benefit them directly and not just the diaspora. Such feelings are more extreme in countries like Vietnam and the Philippines but with varying gradations also a consideration in Malaysia, Indonesia and Thailand.
The challenge is reaching out to a broader range of communities and not relying only on the Chinese diaspora in Southeast Asia to facilitate China’s outward flow of capital. This inevitably means that any major initiative or formal contact needs to be done under the umbrella of government-to-government shared interests which would provide a reassuring framework to encouraging informal and largely private contacts with overseas Chinese at the firm or individual level.
More inclusive interactions going well beyond the diaspora communities can help moderate regional tensions that have arisen from the territorial disputes and historical sensitivities. Such approaches would be given a huge boost in credibility if China and the countries concerned could agree on joint development of the disputed maritime resources while setting aside sovereignty claims. This would make it more likely that the concept of a revitalized maritime silk route could help promote more positive foreign policy outcomes within Asia. If so, this would also serve the ultimate interests of the U.S. and other pacific parties in ensuring safe and open access to the major maritime corridors and moderating regional tensions.
Yukon Huang is a senior associate at the Carnegie Endowment for International Peace and a former World Bank Country Director for China.