An analysis of China's economic development policies and prospects

Business Economics, July, 1998 by Roger Chen

KEY FACTORS AFFECTING THE SUCCESS OF GOVERNMENT STRATEGIES

The implementation and success of these policies depend upon many factors. But three key areas are worth attention. These areas are: the impact of the Asia financial crisis, foreign investment to China, and reform of the country's financial system.

The Impact of Asia's Financial Crisis

Due to the Asian financial crisis in 1997, China's economic development encountered new uncertainty. Effectively coping with the crisis has become one of the key elements in the success of China's economic development strategies.

The crisis has put China in a difficult situation. On one hand, China is under great pressure to devalue its currency in order to stay competitive in the global economy. This pressure comes from different sources. For example, the country's direct exports to Asian markets (e.g., Japan, South Korea and Southeast Asian countries) will decrease due to the economic recession and currency devaluation in these countries. Similarly, the currency devaluation in these Asian countries makes China's products more expensive and thus less attractive in the Western markets.

The decline in exports could have serious consequences for China's SOE reform, because China's SOEs account for more than 50 percent of China's exports (People's Daily, February 14, 1998). A decline in exports will directly hurt these SOEs. In addition, SOE reform has caused more than 10 million people to become unemployed. In the past China has relied upon export growth to create new jobs, thus alleviating growing unemployment pressure. The decline of exports will further reduce the government's ability to solve the unemployment problem. It will also force many firms to turn to the domestic market, which will exacerbate excessive manufacturing capacity problems in many sectors. It is estimated that overcapacity exists in sectors such as televisions, washing machines, and other consumer durable goods sectors. Increased overcapacity will cause great difficulties to firms, threatening the survival of state-owned enterprise.

The Asia financial crisis will also hurt foreign investment in China, because the devaluation of many Asian currencies will make investments in China more expensive than that in other Asia countries. Because China needs foreign technologies and capital to develop and upgrade its industries, increase exports, support SOE reform and inner region development, the decline of foreign investments will cause serious damage to China's development.

In sum, China faces strong pressure to devalue its currency to respond to Asian financial crisis. However, other factors argue for China to avoid dramatic change in its currency that might cause serious damage to its economy. A drastic devaluation of the Chinese currency would hurt Hong Kong's economy and its Asia financial center position, and could possibly result in a new Asia financial market crash. This would not only cause a political disaster that China wants to avoid, but it would also seriously affect China's economic reform agendas. As indicated above, China plans to support some large SOEs. A key component of the plan is to allow these firms to issue stock, thus raising funds and transforming the firms into stock ownership. Many of these firms are listed on Hong Kong's stock market. If the devaluation of Chinese currency hurts Hong Kong as well as the rest of Asia, it will seriously affect the government's plan to support large SOEs. Such a turmoil would also prevent the government from pursuing other industrial and regional development policies.