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Volume 7, Number 1
January 1999
Murray Weidenbaum is chairman of the Center for the Study of American Business at Washington University in St. Louis. He is co-author of The Bamboo Network (Free Press, 1996). Harvey Sicherman, Ph.D., is President of the Foreign Policy Research Institute and a former aide to three U.S. secretaries of state.
This Wire draws on the proceedings of an FPRI conference on the Chinese economy, held on September 16, 1998. The full conference report will be published in early February, with papers by Murray Weidenbaum, Nicholas Lardy, Charles Wolf, Jr., and Avery Goldstein. (Free for members, $15 for non- members).
In September 1997, the World Bank met in Hong Kong, marking the occasion with a major study of the Chinese economy. “China 2020” seemed to confirm the conclusion of many observers: the explosive economic growth of the People’s Republic of China was destined to continue for many years. The rate of growth, estimated to be at least 8 percent annually for some time to come, would transform the world’s largest nation into the world’s second largest economy.
This scenario also fueled the growing American debate over whether China would be a future partner or an adversary. Beijing seemed poised to enjoy a geopolitician’s paradise,able to afford both guns and butter, swelling from regional power to great power, perhaps even superpower status.
But even as the World Bank celebrated China’s growth rate,two other events threatened to curtail it. When PRC President Jiang Zemin consolidated his authority at the People’s Congress in March 1998, he pledged an economic reform program that would resolve the growing problem of inefficient state-owned enterprises (SOEs), which were still the backbone of the economy. The SOEs employ most urban Chinese and consume an estimated two-thirds of the country’s domestic investment, but produce barely one-third of its gross domestic product. A reform of this magnitude would obviously pose important problems. Yet the World Bank and other models projected 8 percent growth regardless of the course of the reform, its success or its failure.
The second event was the financial panic in Asia. The problem arose first in Thailand and then quickly spread to other East Asian nations, especially Korea, Indonesia, and Malaysia. The key manifestations of financial distress were plummeting currencies, failing banks, massive layoffs, and a whole sale flight of foreign capital. Because the mainland Chinese currency, the renminbi (RMB), was not fully convertible, it was thought to be immune to the “contagion,"but this was a short-sighted and overly narrow estimate of the impact. Other areas with important links to the Chinese economy were clearly affected. The newly established Hong Kong Special Administrative Region, China’s experiment with the “one country, two systems” concept, came under speculative pressure to devalue its currency, long pegged to the U.S. dollar. Taiwan, a major source of investment for the mainland despite the conflict over sovereignty, was also linked to the American currency. And the overseas Chinese trading communities, often the conduit directing foreign capital to the PRC, were heavily invested around the region .This “bamboo network” would not be untouched by Asia’s financial travails.
We therefore began to consider a “new scenario,” one very different from the straight-line projections of 8 percent growth. The outlook for China, in our view, was not that of bust or boom, but rather a slower expansion and probably a more jagged trend line. To understand the impact of this change, it would be necessary to examine how the different parts of the network that influenced China’s growth — Hong Kong, Taiwan, the overseas Chinese — were reacting to the Asian crisis. We would analyze the potential changes in Chinese domestic and foreign policy that could be anticipated from lower growth forecasts. Finally, we wanted to see what impact all of this might make on U.S. policy, not least Washington’s handling of its trade deficit with the PRC.
When FPRI’s conference on the “New Scenario” assembled on September 16, 1998, some of our speculations had already become reality. Hong Kong had been badly hurt by the panic over Asia’s economic prospects, defending its dollar “peg” with high interest rates and Beijing’s pledge to support it with its own foreign reserves. Taiwan had devalued its currency. Overseas Chinese were reeling from falling property values and stock markets, compounded by political upheaval in Indonesia. The United States and the International Monetary Fund were under heavy pressure to rescue the region and then, after Russia’s financial collapse, to rescue the entire global economic system. In Beijing, Jiang Zemin and Prime Minister Zhu Rongji promised not to devalue the RMB while agreeing with President Clinton that Japan had to do more to prevent further damage. The PRC was still insisting that it could achieve 8 percent growth for 1998, but clearly all bets were off for the years to come.
These developments made our new scenario less a matter of debate than a baseline for analysis and informed speculation. To this end, we commissioned papers by eminent experts and then subjected them to a wide-ranging discussion by distinguished panelists. These included analysts with backgrounds in economics, politics, and business. Dr. Charles Wolf, Jr., the senior economic advisor at the RAND Corporation, gave the first paper on “The Greater Chinese Economy in Its Regional Settings.” Dr. Nicholas Lardy, a senior fellow at the Brookings Institution, presented the second paper on “Chinese Economic Reform and Sources of Growth.” Dr. Avery Goldstein, the director of FPRI’s Asia Program and an associate professor of Political Science at the University of Pennsylvania, presented the third paper, “China’s Changing Domestic and Foreign Policies.” Finally, Dr. Murray Weidenbaum, chairman of Washington University’s Center for the Study of American Business, delivered a keynote address entitled “U.S. Policy Toward China: Impacts of a New Economic Scenario.”
The papers were reviewed and discussed by panels of experts including Professor Gregory Chow of the Department of Economics at Princeton University; Professor Thomas Christensen of MIT’s Political Science Department; Dr .Theodore Friend, Senior Fellow and Indonesian expert at FPRI and former president of the Eisenhower Exchange Fellowships; Dr. Mark Groombridge, the associate director of Asian Studies at AEI; Dr. Howard Perlmutter, Emeritus Professor of Social Architecture and Management at the Wharton School of Business; and Dr. Arthur Waldron, the Lauder Professor of International Relations at Penn and the director of Asian Studies at AEI.
In addition, an audience of other scholars, business executives, and economists participated in the discussions. Those present included Mr. C.C. Chang and Mr. Ezra Chen of the Taipei Economic and Cultural Office in Washington; Mr .Raymond Fan, Director of the Hong Kong Economic and Trade Office; Ms. Gao Jian, Counsellor at the Chinese Embassy; Mr. Wang Qi, Third Secretary at the Chinese Embassy; and Mr. Jimmy Wang, Senior Information Officer, and Dr. Yuh-Chao Yu,Director of Information Division, at the Taipei Economic and Cultural Office in New York.
We made no attempt to achieve a consensus among the participants. Nonetheless, some common themes did emerge:
1. The impact of the Asian “contagion” on China is only delayed, and more bad news is likely to come. The PRC is the least affected by the crisis thus far. Indeed, China and Taiwan are now the only growing economies in East Asia. Yet the Chinese economy has serious financial weaknesses likely to be aggravated by the turmoil in world markets and new caution on the part of foreign investors. These include the excessive growth of credit and its attendant problems —excess industrial capacity, negative returns, and nonperforming loans. Related to this is the over-reliance of business on bank credit and weak central bank control. Corruption — the Chinese version of “crony capitalism” —could also aggravate the problems. Some participants argued that a crisis in China could be triggered by credit contraction as the government attempts to reform the system.
Taiwan’s position is strong in part because its business structure is not as highly leveraged as the others. Unlike South Korea, it follows the U.S. model of economic development more than the Japanese version. Taiwan’s economy also consists in large part of small- to medium-size businesses — this was a factor in the government’s decision not to defend the link to the dollar with high interest rates that might have produced a recession.
The Asian financial crisis has also exposed Japan’s key role in the region’s prospects. Tokyo, more than any other capital, could set the framework for the recovery of the rest of East Asia by cleaning up the ailing Japanese financial system and preventing a disastrous deflation. But the Japanese seem slow to act and the political system appears impervious to outsiders. Meanwhile, the Chinese have made clear that their own policy will be heavily influenced by Japan’s efforts to recover, given Japan’s role not only as regional investor but also as a key export market for Chinese goods.
2. China’s future growth depends on reform of its finances, especially the state-owned enterprises. China’s future growth depends on reform of its finances, especially the state-owned enterprises. On this issue, discussants diverged into several camps: those who foresaw greater or lesser degrees of both economic reform and growth, and those who admitted no specific prediction other than the fact of palpably slower growth. The optimists cited Beijing’s long-term commitment to its reform process and the pragmatic nature of its leadership. In their view, the authorities in Beijing were well aware of the contrast between the poor performance of the SOEs and the relative success of the foreign- and privately-owned enterprises. Jiang Zemin and Zhu Rongji had steadily reduced the role of the SOEs and were experimenting with novel solutions to financing,including stock ownership plans. They also understood the important role of town and village enterprises which, along with export industries, were the engines of growth. Some argued that growth could actually accompany reform, if led by reform in the banking sector. The optimists are persuaded that reform is proceeding about as quickly as possible and quickly enough to spare China from economic disaster.
The pessimists reminded us that China’s fast growth proceeded from a very small base, and that growth covered up many mistakes. The most notable are the accelerating bank loans to SOEs, few of which can be repaid, thus threatening banks’ solvency. These loans have come from the savings of the Chinese people. Indeed, it can be argued that one reason for China not to devalue was fear that domestic savers might lose confidence in the banking system. The resultant asset bubble continues to grow, thus making a “soft landing” increasingly difficult. It was noted that, in part, the poor performance of the SOEs results from the many expensive social welfare costs — housing, health, education —imposed on them. While it would be desirable to shift these unrelated financial burdens from business enterprises to government, as yet no such “safety net” exists. The Chinese also face growing pollution problems, especially in the energy sector, and this summer’s disastrous floods opened Beijing to charges of serious environmental mismanagement that could harm China’s potential growth.
The pessimists concluded that China’s economic reform would persist, but was too slow to arrest the problems now being aggravated by the international economic crisis. The most pessimistic took this a step further, being skeptical that the reform itself would really continue. In this view, the Chinese were likely to take the easy way out by continuing to prop up the SOEs, avoiding an unemployment problem even at the risk of further enlarging the bubble. This made an eventual credit contraction likely, triggering recession and a potentially huge devaluation.
In addition to the optimistic, the pessimistic, and the most pessimistic, there was another view — the “mystic.” In this scenario, we simply cannot expect to forecast the future with precision. What counts is the fact of a slowdown itself. In a system expecting continued boom, a drop from 8 percent to 5 percent growth would constitute quite a shock — the best that can be expected is that the shock takes place in slow motion rather than in the form of a sudden, dramatic downturn.
3. China has reaped some important diplomatic benefits from the crisis. President Clinton and Secretary of the Treasury Rubin have hailed Beijing’s refusal to devalue its currency as a major contribution to regional stability. China has thus gained in stature compared to Japan’s paralysis and Taiwan’s sudden devaluation. This appears to reinforce what some analysts viewed as the PRC’s latest strategic shift.
Following the Taiwan Strait crisis of 1996, Beijing had begun to mend fences in both Washington and the region. This included two summits with the Americans, the Russian border agreement, and the PRC’s behavior in the financial crisis .The objective seems to be to promote Jiang Zemin’s government as both responsible and benign, giving outside powers a stake in good relations. The Asian economic distress allowed Beijing to score points over its rival in Taiwan, but it has also been promoting a cross-strait dialogue concerning crude military threats. Similarly, China has gained ground vis-a`-vis Japan, but has not been inclined to persist with “Japan bashing.” All of this reflects a new-found Chinese interest in multilateral cooperation that would be overlaid on a developing U.S.-PRC “strategic partnership.” It is the international counterpart to domestic policy that stresses stability and growth while carefully controlling the pace and extent of political change.
Thus far, the economic slowdown would not seem to have altered this picture. Yet, depending on its severity, it could affect important parts of the scene: relations among China’s top leaders, China’s entry into the World Trade Organization, and reliance on a perhaps saturated export market to the United States. The regime has also placed enormous prestige on its pledge not to devalue the RMB, a pledge it might not be able to keep.
Other analysts saw Beijing coming up against hard choices .Simply put, slower growth would make the guns-plus-butter policy difficult or impossible to sustain, and guns might win out. One of the chief problems is the weakness of the regime’s legitimacy. With communism discredited as an ideology and abandoned in all but name, the government’s authoritarian system now relies on economic growth, prestige abroad, and the occasional use of brute force to maintain its monopoly on political power. The Chinese government has long stressed the mantra of “stability,” partly to counterdemands for political change. In the event of financial crisis, however, widespread unemployment, increased poverty,and resentment of corruption could disrupt the social peace and produce enormous pressure for greater democracy —pressure which has remained, for most of the last decade,largely latent in the face of economic improvements. This could shatter the post-Tiananmen Square strategy of accelerating economic growth and selective political openings, which could in turn force the leadership to choose between drastic political change and widespread repression.
In dealing with the United States, China might revert to the tactic of the “double-edged sword,” arguing that the American desire for regional stability should out weigh their revulsion over Chinese policies. Elsewhere, the government might attempt to bolster its legitimacy by mobilizing aggressive nationalism — which to some extent is already shared even by the younger generation — on the issue of Taiwan, to take the most dangerous example. Thus, any gains in China’s diplomatic stature may be only temporary, and today’s apparent domestic calm may in fact mask a set of dangerous pressures.
Finally, it was pointed out that the entire international economic system is undergoing rapid change. One analyst argued that the magnitude of this change, while unpredictable, would at the very least “shake out” the non-competitive players in international trade. The Chinese leaders certainly had a vision of their country as a major part of the global economy, but if their understanding of that economy turns out to be too limited, then none of the policies enunciated thus far would be adequate to boost China into such a role.
4. The U.S. faces important new strains with China. The United States has experimented with various policies toward the PRC in the Clinton years, emphasizing human rights, then economic relations and, more recently, a “strategic partnership.” In Washington, the Chinese often appear to be simultaneously part ally and part adversary. The U.S. political system has great difficulty in finding a consistent approach. Still there is general recognition that a good relationship between the two countries is a paramount objective given their respective impacts on world events.
From the U.S. point of view, bringing a historically isolated China into constructive international relations with the rest of the world is a major priority. Yet the fact remains that this has not yet happened — a modernized China still does not belong to key organizations, such as the World Trade Organization, and it does not participate in the annual economic summit of the G-7.
While mainly complementary, the U.S.-China economic connection is still lopsided. “Partner” is a euphemism: the U.S. imports four times the dollar amount from China than it exports to China, far more out of balance than comparable data for Japan. This trade is also not a significant portion of the American economy. In contrast, the United States, as the destination of one-third of China’s exports, is key to Beijing’s acquisition of modern technology and accumulation of foreign exchange.
The relative unimportance of China to the U.S. economy may explain why opposition to China trade has, until now, come from human rights critics and others with noneconomic agendas. Nor, despite much debate, has an American consensus emerged over whether continued opening of the Chinese economy will help to spawn greater democracy.
A slowdown of Chinese economic growth could ease several points of tension. Beijing might choose “more butter and less guns,” relieving fears of its intentions in the region .Slower production could mean less environmental pollution and less potential for trouble over energy sources in the South China Sea.
Two problems, however, are likely to challenge both governments under a scenario of slower growth. The first is relatively recent: the Kyoto treaty over Global Warming. The U.S. Senate is unlikely to approve such a treaty unless the less-developed countries — China, above all — are willing to do their part.
The second is that new political pressure will develop in the U.S. over the uneven nature of U.S.-China trade if Beijing’s reaction to a slowdown is to increase barriers to imports from the United States. Such protectionism is already evident in the growing Chinese subsidies to exporters, a kind of hidden devaluation; greater informal restrictions on imports; financial actions, such as the recent bankruptcy of non-bank institutions operated by provincial governments, that discriminate against foreign investors; and lack of action on legal reforms that protect foreigners and foreign investment.
These pressures argue for a new political scenario in the United States. The president should organize a consensus around these points:
Finally, the international economic crisis should remind American policy makers that the United States alone does not have all the answers. Last year, leaders in Beijing, Taipei,and Tokyo indicated their willingness to participate in a"regional rescue fund.” It was a mistake not to have pursued this idea when it first appeared, and the United States should explore the concept further.
To sum up: the old scenario of a steady high growth Chinese economy is out of date. Both domestic and international developments are replacing it with a new scenario of slower growth — perhaps much slower — and this creates new uncertainties about China’s modernization, political evolution, and foreign policy.
As a consequence, both Beijing and Washington will face new difficulties and narrower margins for error. China’s leaders may be tempted to delay necessary actions, but only at the price of postponing full membership in the global marketplace and foregoing opportunities for modernization. The United States will have to sustain a balance in its policy that does not allow any single dimension, be it human rights or economics, to override long-term security interests.
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