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 is DOOMED due to pure demographics of a society no matter how rich that will evetually need to spend its wealth and resources to take care of its considerable aged population.....canada,australia current open door policy for YOUNG immigrants is addressing this potential social problem now and in the future....they are openminded earlier to get the creme of the crop while those who delayed will scrapped the bottom of the barrel later.....everyone knows now and in the future of the chronic shortage of health care...entire hospitals wings have to close due to lack of staff and firghtfully escalating cost of medical care from overworked medical personnel.....america...open your eyes.....see your future!!!!

Again, you are ignoring simple reality. Pick up a newspaper and look around the world today. You have Third World republics all floundering and requiring IMF bailouts while China races ahead. All the time you are predicting that China is the country that's going to fail, it is today's Third World republics which are actually failing. Of course, you are completely oblivious to this. In your mind, only democratic developing countries can possibly perform well economically. But again, I ask you, just pick up a newspaper. As we speak, all of Latin America is growing disillusioned with democracy and electing socialist leaders. In Poland, the shipyard where Lech Walesa led the Solidarity movement had to be re-nationalized recently by the Polish government because Poland's economy is failing. Not only that, Poland's new President is a communist. Most of E. Europe is actually putting a bunch of communists back into power. In African Third World democracies, the majority-poor black populations are using their new voting powers to confiscate the white farmers' lands. Again, please just pick up a newspaper.

On Japan, it's again a simple numerical fact that Japan's per-capita GDP would have to be around $100,000 in order for Japan's overall GDP to be bigger than America's. You seem to have a lot of opinions and theories for how the world is supposed to work but no appreciation for facts.

On Indonesia, it was doing fine up until it adopted democracy a few years now. Prior to that Indonesia's economy was growing 10% a year, now it's been experiencing $10 bil. in capital flight a year for each of the past 4 years.

China's institutions are not perfect, but they're getting the job done more effectively than the institutions of today's Third World republics. After 50 years of democracy, India's parliament has not yet enacted even the most basic economic reforms like new labor laws due to constant legislative gridlock and opposition from India's majority-poor population. In India today, it's still illegal for private businesses to hire and fire workers freely. In addition, India's tariffs today are still 2-3 times higher than China's because India's pro-big government politicians jobs will get voted out of office if they don't continue to protect India's bloated, inefficient industries from foreign competition.

After Russia democratized, what happened? Capital flight. After Indonesia democratized, what happened? Capital flight. After even Taiwan democratized, what happened? Capital flight.

Are you sure your theory about how democracy is the only way to go for developing countries is correct?

As a matter of fact, it is precisely because today's Third World democracies are unstable, dysfunctional basketcases, plagued by neverending legislative gridlock, that foreign investors largely avoid today's Third World democracies and invest in China instead.

All the time you are predicting that China is the country that's going to fail, it is today's Third World republics which are actually failing.
In African Third World democracies, the majority-poor black populations are using their new voting powers to confiscate the white farmers' lands.
Republic or Democracy?
What exactly is a "third world republic"?
Of course, you probably believe that they're the same thing and that just because "republic" is in the name it is the same as the Founder's concept of republicanism.
How did that go again...USSR (Union of Soviet Socialist Republics)
They sure didn't have the republicanism of the Founders in mind when naming their Union. Wasn't it Communism and Socialism they had in mind?
The "experiment in Democracy" goes global...

"As we speak, all of Latin America is growing disillusioned with democracy and electing socialist leaders. In Poland, the shipyard where Lech Walesa led the Solidarity movement had to be re-nationalized recently by the Polish government because Poland's economy is failing. Not only that, Poland's new President is a communist. Most of E. Europe is actually putting a bunch of communists back into power"

Formosplastics, why don't you just go ahead and admit that you are a Communist/socialist sympathizer who probably works for Formosa Plastics of Taiwan--maybe even based on the mainland, and that Formosa Plastics has millions of dollars of investments in Red China. For you to argue the truth and against the Communists would be like speaking out of both sides of the mouth.

Come on and come clean.

Why don't u just admit the truth -- that Third World republics need one IMF bailout after another and, even after 50 years of democracy, India doesn't look like a mirror image of the USA? The problem with you people is that you have no appreciation whatsoever for reality or common sense. You're too busy imagining that Third World republics are flowering into mirror images of the US today, when in fact they are sinking deeper into the cesspool you've created for them.

Um why is Christianity neccasary for successful capitalism?

Maybe if they all converted to Judaism it would work, too, but that doesn't even seem remotely possible so it wasn't mentioned.

Of course, if they all converted to objectivism, they would be even more successful.

Of course, if they all converted to objectivism, they would be even more successful

I agree Im basically an objectivist I have 2 main disagreements( 1. I only believe forced altruism is evil 2. There is such a thing as rational religion ie the universe existing in time must have a cause outside of time or else the timeline goes back forever with no point of origin).

I agree Im basically an objectivist I have 2 main disagreements( 1. I only believe forced altruism is evil

I agree with you on that, I'm really not a rank-and-file Objectivist. I haven't read any of the books, and I don't believe one iota of socialism will destroy our capitalist society. I just gravitate towards some of the ideas.

"India just let two generations of Indians wallow in poverty while blowhard, socialist-demagogic Indian politicians gave useless speeches all day in India's dysfunctional, gridlock-plagued parliament."

But India didn't "final solution" 65 million Chinese and 1.2 million Tibetans. In fact, India gave home and hearth to the fleeing Tibetans from Red China's "liberation" of Tibet.

Come on, formosplastics, tell us that you work for Formosa Plastics doing millions of dollars of business in Red China--and that's why you are a Communist sympathizer.

Again, if the Chinese have been so busily genociding themselves over the past 50 years as you naively believe, then how on earth did China ever get a population of 1.3 billion today? Certainly, many people died in China around 1959-1961 during the great famine, but there's a difference between people dying due to genocide and people dying because of misguided communist agricultural policies. And, if you're so willing to want to condemn China for losing so many people in a famine, shouldn't you also be praising China for adding about 800 mil. new souls to its population in the last 50 years? In the last 20 years alone, China added another 300 mil. new people! 300 mil. is bigger than America's whole population today, which took several centuries to develop, but China added more people than that just in the past 20 years!!! You've got to say that's the biggest feat of "life creation" in all of human history. And, yes, that staggering population growth did occur under the CCP.

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