www.china-inc.com - economic development in China - Statistical Data Included

International Economy, The, Jan, 2001 by David Hale

From the Internet to foreign investment, China is reforming its economy big time.

It is increasingly apparent that the second most popular language on the Internet in the year 2005 (after English) will be Chinese. China has only 10 million people on the Internet today, but this number is projected to expand to 300 million in five years. Some of the growth will be spurred by personal computer sales, which could soon exceed twelve million a year. Other important contributors will be Internet convergence with cable television, which already encompasses 100 million households, and cellular telephones, which will exceed 100 million in another three years.

China's dramatically growing presence on the Internet is only a proxy for a far greater process of economic transformation, which will have profound implications for both the East Asia region and the world economy in the Twenty-first Century. China is in the midst of one of the most farreaching economic reform programs to occur in any country during the past 200 years. This reform process will create both the risk of political instability as well as opportunities for dramatic economic advancement.

Two decades after its economic liberalization began, China has developed a hybrid economic structure: The state still owns about one half of the economy, while the other half is far more open and competitive than the economies of Korea and Japan were during those nations' high growth years in the 1960's and 1970's.

China currently has about $350 billion of foreign direct investment (FDI) compared to only about $9.5 billion in Korea and $35 billion in Japan five years ago. The stock of FDI in China is also much larger than the totals in other Asian countries traditionally more open to FDI, such as Singapore ($79 billion), Malaysia ($48 billion), Indonesia ($65 billion), and Australia ($118 billion). In fact, the stock of FDI in China is exceeded only by Britain ($394 billion) and the USA ($1.1 trillion). China also has accounted for 25 percent of all the FDI in developing countries since 1990.

The FDI boom in China during the past decade has helped to set the stage for both a dramatic expansion of Chinese exports and such intense competitive pressure in domestic markets that the country has experienced three years of deflation. Foreign owned firms are now responsible for over half of China's exports and the share is likely to expand further when China's ascension to the World Trade Organization encourages further integration with the global economy. Exports have soared from $2.3 billion in 1970 (2 percent of GDP) to $290 billion in 2000 (21 percent of GDP). As with Mexico's entry into the North American Free Trade Agreement seven years ago, China's entry into the WTO will probably give a further significant boost to FDI by improving financial transparency and strengthening the rule of law. In the case of Mexico, FDI has increased from $2 billion a year before NAFTA to $12 billion recently. Some Hong Kong investment banks are projecting that WTO membership will boost FDI in China to levels as high as $100 billion a year before 2005.

Such high levels of FDI in China will have three important consequences for both China and the region: First, it will accelerate China's integration into the global economy. Secondly, it will prod China's domestic firms to restructure so they will be more competitive. Finally, it will help make China a regional growth leader at a time when other East Asian countries are suffering from reduced levels of FDI as well as the after-effects of the great regional financial crisis of 1997-98.

One of the factors that encouraged China's political leadership to pursue WTO membership was a perception that it would strengthen the movement for economic reform within China itself. If the country is to open itself to much higher levels of trade and investment, both traditional state-owned enterprises and privately owned local firms will have to restructure more aggressively to meet the challenge of foreign competition.

This challenge will also have great social consequence, because during recent years state-owned firms have been laying off workers at the rate of five million per year, and some analysts project that WTO entry will force another forty million job losses.

The government is preparing for the shock by setting the stage for reforms in the banking system and the capital markets that will be as ambitious as any undertaken by an Asian country during the modern period:

Bank Reform. First, it has formed an asset-restructuring agency to help clean up the balance sheets of China's four large state-owned banks. These banks represent about 80 percent of all lending in China and their loans have a value of close to 100 percent of GDP. In the past, they have made loans almost entirely to state-owned firms and about 35-40 percent of those loans are now non-performing. The restructuring agencies have already purchased about $100 billion of bad loans, but the final cost could be as high as $300 billion. Such large outlays on financial restructuring could increase China's ratio of government debt to GDP from 20 percent to 40-45 percent during the next few years. But the liquidation and restructuring of financially distressed state-owned companies will probably also increase the private share of China's economy from just over 50 percent today to 70-75 percent by 2005. The banks are also trying to diversify away from state enterprise lending by promoting loans to households for mortgages and durable goods purchases. Personal loans now represent about 30 percent of new lending and should expand their share of total loans to 1520 percent in 2005 from less than 2 percent recently. The government regards home ownership as a useful spur for promoting consumption.