IS CHINA'S ECONOMIC BOOM A MYTH?

This August, I had lunch at Shanghai's American Club, a posh dining room with a stunning view of the city's restored colonial waterfront, with a Chinese-American executive based in Beijing. All around us, American businesspeople were wooing potential Chinese partners, passing around hundred-dollar bottles of Scotch and demanding private tables so that no one would overhear the deals they were making. Though my lunch companion had worked in China for decades, long enough to grow cynical about any place, he shared the other diners' enthusiasm. "I have invested my assets here," he said, gesturing out the window at Shanghai. "If I had more money, I would put it here too. China's economic development is just mind-boggling."

My friend is not alone. Almost all the foreign businesspeople I spoke with in China--even those whose companies have lost millions of dollars in the country--told me that it would eventually become their most important market. Publications such as BusinessWeek and Forbes have run story after story about China's miraculous economic development. A LexisNexis search of U.S. newspapers turns up thousands of breathless articles.

But what if they're wrong? Look closely at the Chinese economy, and you'll find a far less rosy situation than that portrayed in most of the business press. The country's growth rates are vastly overstated, the result of cooked books and massive deficit spending. Companies selling to the Chinese market--foreign and domestic alike--are struggling just to break even. The economy is plagued by persistent deflation and a useless banking system. "Businesspeople have created a lemming effect," says Graeme Maxton, a specialist on China's auto industry. "They have convinced themselves they have to be in China or their competitors will overtake them, so they ignore economic fundamentals." The Chinese economic miracle, in other words, is largely a house of cards. And, when it falls, the consequences could be catastrophic.

China's reputation as a fast-awakening economic giant does have some basis in fact. Over the past two decades, China has made impressive economic progress. In 1978, when Deng Xiaoping began to open the economy, the country was one of the poorest in the world. One American who visited Shanghai in the early '80s recalled the city as a drab metropolis populated by men and women dressed almost exclusively in Mao suits; today, it is a vibrant city boasting dozens of European fashion outlets. Beijing, meanwhile, features a Starbucks in the Forbidden City. And China's eastern seaboard has developed into a low-value manufacturing powerhouse. The Chinese middle class, which comprises slightly less than 10 percent of the country, has seen its disposable income rise sharply; the annual disposable income of urban households grew from roughly 340 yuan ($41) in 1978 to nearly 6,300 yuan ($761) in 2000.

But, despite all the lattes sold at Starbucks Beijing, China is only making positive economic strides, not revolutionary leaps. The Chinese government claims the economy has grown by 7 percent to 10 percent per year for the past two decades. But, apart from the export sector--China's economic bright spot, but only about 20 percent of GDP--the government's numbers do not add up. Thomas Rawski, a groundbreaking economist at the University of Pittsburgh, notes that over the past five years--a time of supposed breakneck growth--China has been plagued by deflation, rising unemployment, and declining energy use, trends normally associated with low growth if not outright recession. Take falling energy use: China's coal-based industries are not known for conservation--on a summer day in the industrial city of Urumqi, I could not see a building across the street--so it is nearly impossible that the country could grow swiftly while using less energy. Looking at energy data, independently compiled GDP figures, and other statistics, Rawski concludes that, between 1998 and 2001, China grew by approximately 4 percent rather than the 7 percent to 10 percent claimed by the government--decent results, but no better than some other developing economies. By comparison, Bangladesh, not a country anyone associates with economic dynamism, grew an average of 5 percent per year during the late '90s. Four percent growth, moreover, is not enough to mitigate the socioeconomic problems that could accompany China's transition from an agrarian economy. According to several Chinese economists, China needs to maintain more than 7 percent annual growth to keep unemployment rates below 15 percent to 20 percent in rural areas.

How could Rawski's numbers differ so much from Beijing's? The primary explanation is that China's national economic statistics, which are compiled from provincial data, have no safeguards against political meddling. When the central government declares its growth targets early in a year-- in 1998, for example, Beijing announced that 8 percent annual growth was "a political responsibility"--provincial officials simply make up numbers to substantiate them. "China's statistics are based on a Soviet-type system where each town and province reports figures, rather than having a national organization do the reports, and many local officials I have met feel intense pressure to meet targets," says Joe Studwell, editor of the China Economic Quarterly. In 2001 alone, according to the government's own State Statistical Bureau, there were over 60,000 reported falsifications of provincial data.

Other prominent economists share Rawski's doubts about China's reported growth rates. Leading Chinese economist and writer He Qinglian told me that, in 2000 and 2001, she traveled around southern China, stopping into provincial officials' offices. When she asked them for their provincial GDP statistics and their methodologies, many were unable to provide either; when they did provide them, the numbers almost never added up.

In private, and when speaking to certain domestic reporters, even China's leaders admit the fix is in. When Rawski and other leading economists chat with official statisticians in Beijing, they often hear that no one in the government believes recent GDP numbers. "American economists are going around the U.S. praising China's economy, and when I come to Beijing the people there are vastly more pessimistic," says Rawski. A cursory glance at Chinese-language newspapers over the past five years turns up reams of stories vastly different from those in the gushing foreign press--articles about economic stagnation, falling wages, and deflation. (Though the Chinese press is still censored, it has grown more open in recent years, and some groundbreaking publications like Caijing and Southern Weekend regularly print information that reflects poorly on China.) Even top officials know China overstates the figures. In 2000, former premier Zhu Rongji, the straightest-talking mandarin in Beijing, warned that "falsification and exaggeration of statistics are rampant."

A similarly dour picture emerges when one investigates the operations of some of the large multinationals and domestic companies targeting the Chinese market. Many Fortune 500 firms tout their China divisions as linchpins of corporate growth--and it's true that some foreign companies such as Motorola have gained a significant market share selling to China. But, this summer, when I contacted nearly 40 major multinationals that focus on the Chinese consumer market, only two--brewing giant SABMiller and fast-food titan Yum! Brands (parent of KFC and Pizza Hut)--were willing to provide even basic information about their China revenues. "If any of these foreign companies were making money in China, they would be talking about it constantly," says Studwell. He believes that less than 10 percent of foreign companies selling to China are reaping profits, a view shared by several other leading China specialists. (Companies that use China as a platform for manufacturing and exporting are a different story: Many have prospered.) The rest, Studwell says, have expanded too quickly, overestimating China's growth and the true number of potential consumers. Recently, as unemployment rises, personal consumption is actually falling.

Though convincing foreign companies to talk about their China operations can be difficult, finding stories about business fiascoes is easy. When Beijing's American Chamber of Commerce surveyed its members in 1999, it found that less than 15 percent of respondents had China operations that generated returns above the cost of capital, the normal standard for profitability. Several times a week, China's vernacular papers and the South China Morning Post, Hong Kong's leading English-language daily, produce stories about another foreign company's troubles. Picking up just a few random issues of the Post and the regional magazine Far Eastern Economic Review last spring, I noticed articles on Pepsi, which has never made money in China despite investing $500 million over two decades; on DaimlerChrysler's failing jeep venture in Beijing; and on AOL-Time Warner's tribulations in China.

Major Chinese companies often are doing even worse. Smaller private companies with decent business plans find it nearly impossible to get loans, since China's indebted banking system remains focused on propping up state-owned enterprises (SOEs) backed by the Communist Party. (As a result, entrepreneurs are forced to rely on illegal neighborhood lenders; some of the biggest loan sharks in China are old ladies who provide capital to family members' businesses.) Foreign bankers estimate that, because of these deals with SOEs, more than half of the bank loans in China are nonperforming. Rating agency Standard & Poor's has estimated that it would take at least $540 billion--yes, billion--to recapitalize China's banks.

Given their easy access to capital, large state-owned enterprises too often turn into vehicles for asset stripping by upper management or unreformable hulks laden with unproductive workers. Minxin Pei, a China scholar at the Carnegie Endowment for International Peace, estimates that corruption costs China as much as 8 percent of annual GDP. The government auditing body has admitted that more than two-thirds of the biggest Chinese companies falsify their accounting--an astonishing statistic given that investors attacked U.S. stock markets in the wake of this year's corporate scandals, even though most economists believe less than 5 percent of American companies cook their books. In many cases, corrupt Chinese managers have used funds stolen from SOEs to build enormous, virtually useless buildings on China's eastern seaboard as showpieces of their newfound wealth. Parts of Pudong, Shanghai's newest commercial district, look like a ghost town. I ventured into several gleaming buildings that, having drawn no tenants, were just empty shells staffed by guards who spent their time alternating between marching in circles and conducting spitting contests.

Largely because of this excess, China's companies actually are becoming less productive. Despite recent stories in The New York Times comparing India's economy unfavorably with China's, India, which receives only 10 percent as much foreign investment as China, has posted only slightly lower rates of growth because it uses its capital more efficiently. While India now boasts globally competitive private firms like Infosys and Wipro, China has not produced such productive multinationals since its largest companies are SOEs that monopolize certain sectors, receive guaranteed loans, and waste vast sums of money. As one leading China banker notes, the Middle Kingdom has not moved strongly into higher-value production; even China's exports of electronic goods are mostly just re-exports in which China's only role is labor-intensive assembly.

Unable to produce better companies, China's rating on the World Competitiveness Scoreboard, a ranking of powerful countries based on efficiency of economic performance, has fallen sharply over the past five years, from 21 to 31, a drop that signifies China's economy is becoming less efficient and competitive. At the same time, South Korea, a country supposedly hammered by the Asian financial crisis, has risen from 36 to 27 on the scoreboard. Increasingly inefficient, China has been unable to generate enough jobs for the millions of peasants leaving the agricultural sector. Though internal security forces try to prevent unemployed workers from moving around the country, many take their chances, adding to socioeconomic fluidity and instability. Standing outside a Shanghai mall featuring elite European fashion outlets, I bought apples from a shabby group of unemployed farmers who had left their villages. My produce shopping ended abruptly when local police brusquely grabbed the migrants and beat them.

If Chinese consumers are spending less money, Chinese SOEs are becoming less productive, and foreign companies are struggling to make a buck, how is the country's economy growing at all? A constant stream of foreign capital helps: According to a survey by consulting firm Deloitte & Touche, 90 percent of foreign-invested businesses in China plan to expand their operations in the next three years. More important, as in the former Soviet Union, growth in China has become dependent on massive state spending. China has posted record budget deficits the past two years, and government expenditures rose by nearly 20 percent during the first three quarters of 2002. "In the early days of Deng's reforms, just the loosening of the economy generated development, but that growth fizzled, and now the economy is propped up by deficit-spending," says one leading Chinese scholar. Though limited deficit-spending can prove beneficial to an economy, China risks becoming dependent on deficit-financing for growth, a situation similar to what Japan now faces. Ultimately, when public debt reaches high levels, as it has in Japan, it serves as a drag on growth and, like a drug, can reduce the public's desire for economic reform.

Along with pouring increasing amounts of money into the economy, Beijing has continued to direct growth. Although China recently joined the World Trade Organization, Beijing still not only pushes banks to lend to SOEs but also vows to protect companies in key sectors, such as steel, in an attempt to create national champions akin to South Korea's massive chaebol conglomerates, most of which ultimately failed. Former Vice Premier Wu Bangguo, for one, admitted that Beijing would continue to support state-owned companies in vital industries.

The party's desire to manage growth has also included intensifying its hammerlock over the legal system. When I questioned foreign executives like Philip Murtaugh, head of General Motors' China operations, about the rule of law, most repeated the same mantra: Although China still has problems, its legal system is developing. Indeed, in recent years, Beijing has written reams of new laws, pleasing businesspeople who have no idea the legal environment is actually getting worse, since most companies settle rather than go to court. The few foreign lawyers in China who take cases to court know the truth: The new laws mean little as Beijing has moved independent-minded justices out of power. One of the most prominent foreign lawyers told me, "The rule of law has deteriorated sharply. ... There used to be a group of Chinese judges who were dedicated to creating a real legal system, but the party bosses couldn't tolerate them, and they are almost all gone." In the past few years, the lawyer said, she has watched many of her clients lose cases simply because her opponent had ties to certain party figures. When I expressed doubt that China's legal system could be regressing, she forwarded me reams of documents about cases that the plaintiff clearly should have won; in some of the cases, she said, the court recessed, and the judges met in a side room with party officials before announcing their decisions.

This assertion of state control will only further inhibit the economy. Without a decent legal system, China will be unable to encourage risk-taking by private entrepreneurs, break up state-owned enterprises' monopolies, and protect the intellectual property rights central to a higher-value economy. Piracy remains rampant: Walking through a market in Shanghai, I saw hundreds of knockoffs of the latest Hollywood films and CDs.

Meanwhile, domestic debt has reached 60 percent of GDP, an unsustainable figure, and favoring certain sectors will contribute to overproduction and more deflation. Already, Beijing's State Economic and Trade Commission has concluded that there are no goods being produced in China for which demand exceeds supply, another astonishing statistic. Realizing that liberalization is not proceeding as planned, municipalities have set up new trade barriers that only add red tape. To help local shippers, Shanghai has prohibited non-Shanghai trucks from entering the city between 7 a.m. and 9 p.m. Factories in Tianjin, a city less than 100 miles from Beijing, are unable to sell goods in the capital without a license.

Ultimately, China's economic facade probably will crack. And, when it does, the consequences may be disastrous. Any decline in foreign investment could depress growth. Rising unemployment could lead to social chaos. (The number of labor protests quadrupled between 1993 and 1999.) Nicholas R. Lardy, a China specialist at the Brookings Institution, predicts that the rising burden of non-performing loans could make the country's entire banking system insolvent by 2008. This banking crisis could lead to millions of Chinese trying to withdraw their life savings from banks, followed by panic when they realize the banks are insolvent and have no backing for their deposits, and potentially massive social turmoil.

When the cracks become deeper, Washington and Beijing will have to reassess their relationship. Over the past three decades, the China-U.S. interaction has been primarily a transactional one. The language of interaction between the two nations is business, and business leaders often smooth over squabbles. Few foreign nongovernmental organizations operate in China, cultural exchange is limited, American and Chinese politicians rarely mix, and the overwhelming majority of forums between the two nations are related to business issues.

During economic booms, these transactional benefits smooth over America and China's lack of shared values. But, in the future, China's growing economic weakness could force its latent anger at the United States to the surface. Already, Beijing stokes anti-Americanism in order to deflect criticism of its own actions and expends little effort explaining its relationship with the United States to its people. Imams in Xinjiang, a Muslim province in western China that I visited this September, have been forced to attend "reeducation sessions" laced with anti-American propaganda. Party-controlled media companies have produced popular videos glorifying the September 11 attacks. In one video, as the camera focuses on the rubble of the World Trade Center, a commentator says, "Blood debts have been repaid in blood. ... This is the America the whole world has wanted to see."

Combined with China's past two centuries of history, during which foreigners dominated the country, this campaign has created a generation of xenophobic young Chinese. Thus far, as China has appeared ready to become a rising economic power, this nationalism has been kept in check, since most younger Chinese assume their homeland is about to take its rightful place as a major trading and business power.

But, if China stumbles on the way to becoming an economic giant, the pent-up anger could burst. Most Chinese university students I have spoken with get angriest when foreign countries seem to be besting China economically, or foreigners appear to be denigrating China's supposed economic miracle. And these Chinese back up their anger with action. When British brewer Bass closed down some of its operations in China over the past three years because they were unprofitable, Bass managers had to hire bodyguards to visit their own plants for fear of physical violence. When economists like Rawski question China's GDP statistics, they are assailed with biting critiques in Beijing's state-run newspapers. When Taiwanese and U.S. companies have won contracts to provide I.T. services to provincial governments, businesspeople say Chinese workers have physically menaced local cadres for selling out to foreigners.

Unlike Britain, Japan, or even Russia, countries with historical ties to the West, China shares little with the United States other than a desire for commerce. Lacking these shared values, if China's economy tumbles more, Chinese resentment toward the West could increase. Then China might actually become an enemy: an unstable country possessing weapons of mass destruction, less restrained by business ties and more likely to embark on diplomatic misadventures--such as an invasion of Taiwan.

Yet the United States continues to view China as a potential threat because of its supposed growing economic power. The main body reporting on China to Congress, the U.S.-China Security Review Commission, recently offered more than 40 recommendations, many of which dealt with China's economic strength. And so, Washington's finest minds have prepared for a rising Middle Kingdom, spending little time contemplating what would happen if China's economy were to implode. Even some of the most experienced China hands seem to have fallen into this trap. As my lunch companion at the American Club in Shanghai told me later that same afternoon, "If I was IBM, or Microsoft, I'd fear Legend [a Chinese computer-maker]. China is coming on strong. ... The U.S. should be afraid." At least on one of his two counts, my friend is correct: The United States should be afraid.

Japan's economy could never overtake America's because Japan's population is less than half of America's (130 mil. vs. 285 mi.). In order for Japan's GDP to be greater than America's, the Japanese per-capita GDP would have to be around $100,000 per year instead of about $40,000. That just isn't going to happen. On the other hand, China's GDP is not limited by population size. A country's population size/labor pool is a major variable in determining a country's "production possibilities frontier" or maximum GDP potential. The more people a country has, the more economic output it can produce. One would naturally expect that if there are two First World countries and the first has a population of 100 mil. and the second has 50 mil., the first country's GDP would be roughly twice the size of the second's. There are other factors too such as whether or not the country's government implements pro-capitalist economic policies, and China's authoritarian government can clearly more expeditiously enact such policies than messy Third World legislatures can.

Thanks for all your sensible postings (as always)

I ask the doomsayers on this forum, "if China's economy did not collapse EVEN at the worst excesses of the Cultural Revolution (1965-1978), why should it collapse now, when fundamentals are a zillion times better ?" Paul Kennedy, the author of "the rise and fall of Great powers", used statistics to prove that China still had good GDP growth rate even during the height of the Cultural Revolution, when there was a complete breakdown of Law and Order and there was total chaos.

Prediction of the impending collapse of China is nothing new, there were such forcasts during
the 1956,
and 1965,
and 1978,
and 1988,,
and recently as 1993
and 1998

But Socialism is only an attempt to get [ie steal] some of the kinder, gentler societal aspects resulting from Christianity, on the part of people who don't know Jesus and don't have the Holy Spirit or the Grace of God. And it shows.

When my imitation watch, says its imitation time, it throws imitation pearls, before imitation swine.

PS Jesus says, "I am the only door. If anyone tries to get into the sheep-fold other than by the door, he is a thief and a robber."

And I didn't say it was NECESSARY, even, for every last spot on earth, but for China, it would be...

So why is Christianity a key part of China's economic policy when it was not NECESSARY for Hong Kong, Japan, or Singapore.

Christianity has some excellent features and still maintains cultural vitality not seen in much of the secular world, but I don't see what it has to do with China's economic growth.

Can recall Jesus discussing monetary policy, infrastructure, etc.

Re #61

I am doubting that Chinese exponential growth curve is sustainable given all internal and external problems. China is going way too fast with shaky economic institutions. Latin America did have its period of fast growth. Brazil once grew at 15% per year back in 70's. Indonesia grew at decent pace for a while.

When Chinese economy turn sour, it will create the similar situations Indonesia is in now.

Re #61

When Chinese economy turns sour, it will create the similar situations Indonesia is in now.

pepsi losing money? well..maybe we better ask how coke is doing in china or number of new plants builts each year...each game has BOTH winner and losers and yes...WHINERS....america boycotting china at best only temporary setback....people FORGOT there are other markets out there like the new united europe.....the problem with americans is..they think all the action is only on their precious little selves.....if one wants to help/solves china's ills.....positive actions migt be better....no use or need for being hostile with a sleeping giant...only ask for trouble...by the way...if i were a multinational doing WELL in china...WOULD I WANT the world or rivals/competitors (new/potential/existing)to KNOW ABOUTIT? best gauge is if things are TRULY that bad is when we see companies PULLING OUT from china....pepsi is only half hearted effort in china because they divided the pie between themselves...india for pepsi,coke for china......look at john and johnson stock performance if any of you armchair geniuses EVER STEP in china...you will see why companies like jnj is being oh so quiet...they dont EVEN need to spent much on advertising.....

Re #62

The size of population is not the reason Japanese economy crashed in early 90's. There are many countries who boast large population which are still struggling. The reason they do not realize their growth potential is the shaky economic foundation not just as Americans see it, but even as other tiger economy or Japanese economy sees it.

As I said many times, the problem of China is not that it cannot grow to be a major economic power some day but rather that it tries to get there in a really unscrupulous way much like Indonesia did. It tends to ignore its vast territory, diverse ethnic groups, and different regional idiosyncracies.

If you keep at it, what will happen is a painful shakeout.

WHINERS!!!!! about dying us companies THE ONLY CONSTANT IS CHANGE!!! i dont think anyone here PREFER black and white zenith tv due to love of motherland.....it is said 17 companies of the original dow 30 has already ceased to exist....is that bad?! did/will america get worse? NOT ADAPTING to change is about one of the best DEATH WISH one can hope for... about WHINERS...lots of chinese brands like facial creme of more than decades old also died with china changing/adapting/evolving with the modern world...
those used by mothers/grandmas of decades pass the modern young chinese today refuse to use and PREFER american brands like something as BASIC as pond's facial coldcreme or sunsilk shampoo who dont need to spent much of advertising but more on new plants/warehousing/distribution facilities

literally hundreds of softdrinks brands died under the coke juggernauy..do we see them chinese companies WHININH about foreign devils? also look at eastman kodak stock...china probably is its last refuge for the soon to be obsolete camera film.....being idealistic is good....but being MISGUIDEDLY IGNORANT about it makes things worst especially for everyone concerned......america has been doing great with FREE TRADE all these decades..lets see how closing some doors will make things better or worst....by the way.....other countries/companies/industries would BE HAPPY to fill in ANY VOID left by america in PARTICIPATION of chinese bonanza....if you disagree...ask any us company RESTRICTED by state department from transfer of technology....germans and japanese are way to happy to fill the gap.....with this policy alone where are jobs gained or loss? oday...china has almost 200 million cellphone users....largets market in the world....if that doesnt define/demonstrate to anyone with out colorblind bias/objectivity...nothing will.....

Re #63

There is always a danger when economy or politics goes wrong. This time, the overheated economy with shaky institution and unstable banking system pose the new challenge which can be more serious. The aftermath of such overheated market is even difficult for mature economy like America. It is much tougher for China which is just started to establish its market economy. The developing economy should keep the banking system simple and well in check.

of course there will ALWAYS BE growing pains.....enforcing/dictating one's own culture/pace of change on another one is misguided if not OUTRIGHT ARROGANCE....newly placed chinese leadership this november has 3 basic legs as vision for the future....one capitalism,two technology,and 3 people's welfare...if we want to improve the conditions of the chinese...work from within...with the EMBRACE of capitalistic materialism and principles...it would be hard for the modern chinese today to have the stomach for war.....everyone is too busy trying to make money......

some people insist things are the same..the chinese currency is not as convertible.....if a government owned factory has a billion dollar loan to a governemnt bank,both is in trouble right? who loses? with this negative bad loan debt? easy...chinese guvment print 1 billion local currency to make up for the loss...dont worry about deflation.....it aint happening..try to overprice or hoard pr price gouging in china and you might get a bullet in the head

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