China and the Global Financial Crisis

Is China’s current economic model sustainable in the long run? The recent reformations in increased government activism spell out an altered era for the Chinese economy. Prior to the global financial crisis the Chinese state allowed for an enhanced marketisation within the country. This, however, came to a halt when the global economy came tumbling down, and the world witnessed an increased presence and control by the CCP within China’s economy. The Chinese government sailed through this crisis and preserved their citizens from economic and financial harm that other nations had to endure. Nonetheless, China’s increased spending on infrastructure and social services, as well as direct involvement within the market bear risks. Will China be able to formulate an economic policy different from the West and nonetheless remain successful and wealthy? This paper will explore China’s economic rise over the past decades and how Beijing was able to respond to the crisis so successfully. In addition, I will provide a deep analysis of the current benefits and disadvantages of its economic model, as well as provide an insight into the possible future direction of China’s economy.

Background

China has accomplished a tremendous growth level over the past few decades, positioning itself as the second largest global economy and defying the common growth models of the West. These remarkable developments are attributable to a number of factors, which China was able to use to its advantage in order to break through its largely undeveloped economic potential from the 1950’s onward. From the ‘Hundred Flowers Campaign’, over the ‘Great Leap Forward’ with its backyard steel furnaces and horrifying famines to the ‘Cultural Revolution’, China and its citizens have faced tremendous hardship and suffering. Nowadays individuals “have […] become accustomed to the image of China as global manufacturing house, but this is a very recent phenomenon” (de Haan, 2010). Since Mao’s death, the progression of the economy and subsequently the nation as a whole, can largely be summed up into two different eras: firstly, the marketisation of the country from 1978 up until 2005, and secondly the harmonizing of society with the economic growth under Wen and Jintao onward. I will explore both of these time periods in order to shed a greater light onto China’s current situation.

Marketisation

Since Mao’s death in 1976, China witnessed colossal changes in its market structure. The absence of the former leader enabled it to “[undergo] a smooth transformation from a planned economy to a market-oriented economy” (Guaqiang, 2011). The power of the government was essentially decreased to some extent, while the controls of economic forces were augmented within the country. This form of “depoliticization” was the source of rapid development (Chen, 2002). Although the CCP supported the opening up of the economy, it, nonetheless, sought to maintain its power over the market on a macro level. It desired to do so through the construction of a “socialistic market economic system” (Hou, 2011). Essentially, individual firms and corporations were still able to manage their own affairs to a much greater extent, and take an increased input from international markets rather than the CCP. However, the government retained the right to step in and maintain its control over market aspects as it deemed necessary. Aspects concerning labour, management of raw materials, and sale of finished products and so on were now regulated by private forces and largely influenced by global players. Subsequently, this growing marketisation has had impacts on other aspects of Chinese life. The original financial system, for example, was unable to keep up with the rapid developments, and thus had to transition “from the centralised national banking mode to a more flexible one, with micro-entities more diversified and financial resources more decentralised” (Yao & Wu, 2011). In 1985, the CCP Politburo stressed the importance of science and technology and its detrimental influence on China’s future success. This is a drastic deviation from how the government had regarded intellectuals and scientists in the past, especially during the ‘Hundred Flowers Campaign’ (Hou, 2011). During the 1990’s, China’s integration into the global economy quickly deepened, as an increase in demand heightened its popularity amongst international investors (de Haan, 2010). For example, in 1996 China lowered the import tariff of over 4000 products (Hou, 2011). In addition, China’s application to the World Trade Organization was accepted in 2001, which greatly influenced its economy and opened doors to multiple other trading partners. This new membership also gave China a more polished reputation since it was now recognized by the international market community. All these developments marked significant and enormous changes in the operating structure of the economy. In summary, these great progressions are attributable to “recognizing individual interests, offering economic freedom, encouraging people to create wealth, introducing competition mechanism […[ as well as carrying out [the] opening up policy” (Guaqiang, 2011).

Although China’s economic reform allowed greater freedom within the country, there were some negative side-effects that tainted the positive image of the developments. Naughton, for example, explains that “the expansion of the market was mirrored by an equal, dramatic decline of the state, and a corresponding reduction in the provision of public goods”, which primarily reflected in rural education and health care (2011). As the market was ‘depoliticized’ and corporations and firms gained greater power, nobody was there to contribute to the lacking social sector of the country. From an economic point of view, the supply of social services to workers is a cost that lowers the profits of a company. Therefore, it is in a firm’s best interest to minimize these contributions in order to maximize its own bottom line. Naughton explains that “more and more people fell out of the social safety net” (2011). De Haan contributes that “dramatic rises in incomes have been accompanied by a virtual collapse of public provisions, education, health and social security, particularly in rural areas” (2010). Prior to the market changes, communes within the country side, were able to offer local farmers some form of support and protection, as communities were forcibly united in order to work together and benefit each other. With the abolition of these social and economic constructions, farmers were left to fend for themselves, which, unfortunately, left many of them in the dust. In addition, there was and still presently is a large problem with the expropriation of farmland by government officials (Pond, 2011). Land in the country side and adjacent to major urban areas is valuable as it presents a great investment opportunity for international businesses. With the low price of labour, transnational and multinational corporations have a stark interest in China in the form of foreign direct investments. These allow companies to open up factories and other businesses within another country to produce goods. Then these products are shipped to consumers over the rest of the world, and sold at a high mark up price. Oftentimes, little to no compensation is offered to farmers, who have lost their livelihood (Pond, 2011). Landesa reports that since 1987, 37% of surveyed villages had suffered at least one case of land expropriation, while 29% of those affected were not notified in advance (Pond, 2011).  Another problem that has been created due to the vast economic expansion within China is the issue of Chinese migrant workers and effectively their rights and working conditions. Fan’s dramatic documentary “Last Train Home” extensively demonstrates the horrifying destitution that factory workers have to undergo in order to earn their miniscule wages (2009). These individuals oftentimes work and live within the same building, and rarely leave the premises, which makes them appear like modern-day slaves. From unsafe working conditions to lack of education and health care support, these individuals live difficult and unsecure lives. Therefore, although China’s economic boom is largely regarded as a great success, there are losing parties to these developments.

Harmonization

Hence, since 2005 and already prior to that year, the CCP has made a greater effort in creating social structures, which are designed to support and protect the poorer and more vulnerable members of Chinese society. De Haan explains that “while the 1980s focused on privatisation and economic growth, explicitly accepting the rapidly rising inequalities, during the late 1980s and early 1990s the forces for strengthening government in public services started to grow” (2010). In 2005 Hu Jintao announced that the goal of the CCP was to build a ‘harmonious society’ (de Haan, 2010). The emphasis was placed on ‘harmonious’ because there were a number of things that were inharmonious and threatened the social fabric of the country, as I mentioned already previously. The growing income gap between the few Chinese that were able to profit from the opening up of the economy and the poor rural workers, who could barely support their families, proved to be an increasing problem. In addition, land expropriation was only one aspect of the corruption that was stifling the party and increasing social distrust and unrest. There were numerous other occasions that tested the support and trust between citizens and the CCP. Adding to these problems was the lack of a public welfare system, which had collapsed during the marketisation of the economy (Naughton, 2011). Although the living conditions of many Chinese “improved beyond the imagination of many, including the planners of Chinese economic reforms”, the wealth was still mostly concentrated in the pockets of few (Yao & Morgan, 2008). Consequently, the Hu-Wen Administration sought to invest in human resources and technology (Naughton, 2011). Its goal was to “improve production efficiency, to reduce dependency on non-renewable energy, and to create a better economic and market system to enable the country to become more competitive internationally” (Yao & Morgan, 2008). In 2004, therefore, the CCP introduced a number of “pro-rural, pro-agricultural and pro-peasant policies, including the abolition of agricultural taxes in 2006, free education for rural children up to year nine, and healthcare insurance and social security subsidies” (Yao & Morgan, 2008). Naughton states that the creation of a rudimentary cooperative health insurance system and an increased support for universal elementary education were amongst the most prevalent changes (2011). They would allow for a greater disbursement in wealth and would support the creation of a Chinese middle class, who in turn was going to maintain the economy through labour and increased product consumption. Because of these changes, farmers and workers would have to save less money for health and education, so that they are going to be able to spend their money on consumer goods. Prior to the New Cooperative Medical Scheme (NCMS), many individuals had to put their income aside for tough times, such as in cases when they fell sick and were unable to work (Naughton, 2011). The CCP has, therefore, made a strategically well planned step. In conclusion, the two major economic eras of the recent past, marketisation and harmonization, have helped create the China that ultimately dealt with the global financial crisis (GFC).

Beijing’s Response to the Crisis

Although the GFC had been developing gradually for a little while, its effects became fully noticeable in mid-2007 and 2008 when an increasing number of firms and financial systems started collapsing, and numerous governments had to implement bail-out packages in order to salvage remaining aspects of their economies. Trade throughout the global market slowed down tremendously as people lost their jobs and consumption of consumer goods and services decreased. China, with its export-oriented economy, therefore, was also going to be affected although it held no real fault in the events. However, the CCP reacted swiftly by implementing measures in order to avoid a catastrophic blow to its export industry through the implementation of a substantial stimulus package. In 2008, therefore, the government introduced the following policy changes, as stated by de Haan:

– “reduction in taxes, changes in value-added tax rebates to promote exports

(previously used to slow down the economy), a loosening of credit (according

to some, possibly leading to a bubble, and followed by reduction in lending

mid-2009), measures to stabilise housing and stock markets, and

subsidies for the purchase of consumption goods”                                                                                                                                                                (2010)

In addition the CCP announced its plan to spend approximately US$586bn on various national infrastructure and social welfare projects by 2010 in order to create jobs and boost its economy (Liang, 2010). De Haan argues that the investment in these infrastructure projects has been one of China’s main strengths and strategies throughout the crisis (2010). Although the fund is a huge number, it only amounted to approximately 12 per cent of China’s GDP that was to be spent over a period of two years (Naughton, 2011). A far more important development “was the dramatic expansion in bank credit that occurred in 2009”, which essentially “[gave] government officials an additional 15-16 percent of GDP in unencumbered cash to play with in 2009 alone” (Naughton, 2011). This gave the government an increased amount of freedom, so that projects under the stimulus package could be financed and realized. In 2010 then, as credit growth continued to flourish, it reached an unprecedented 20 per cent of China’s GDP (Naughton, 2011). As mentioned, many of these policies and changes were implemented in order to deal with the banged up export rates of the country. The banking sector, however, had a very different experience. De Haan explains that the impact of the global financial crisis on China’s banking sector was restricted due to the “limited openness of the financial sector” (2010). This has mainly been attributed to the fact that Chinese banks had rather “limited exposure to toxic assets issued by US financial institutions” (2010). In addition, since the late 1990s, the CCP has been working effectively to reduce the large amount of nonperforming loans, therefore, making the banking system more efficient and effective. These changes resulted in a rather strong and healthy financial system within China. These factors played a tremendous importance in the overall evaluation of Beijing’s response to the global financial crisis. China’s reaction to the tumults in the global market is largely regarded as a success.

Results

Although its economic growth slowed down, while the number of unemployed individuals rose across the country, China’s annual growth continued at approximately 8 per cent in 2009 (Liang, 2010). This is somewhat of a miracle, when considering how badly battered some other economies were at the exact time. Nonetheless, it is estimated that approximately 20 million jobs were lost and 67.000 factories closed as reported in ‘The Financial Times’ (de Haan, 2011). However, matters could have been much worse if the CCP hadn’t responded in the quick and effective manner in which it did. In 2009, for example, during its investment period in infrastructure and other projects, China surpassed the US as the world’s largest auto market nation (Kynge, 2010). The infrastructure developments enabled to shrink the spaces between the rural and urban populations. For example, through the creation of highways and better roads, consumer goods and services were able to travel at a much faster and more efficient speed and rate between parts of the country. Kynge explains that these projects “would knit regions closer together, creating supply chain efficiencies and supporting the shift of manufacturing capacity inland from the coasts” (2010). In addition, this process and “would enhance the emergence of hundreds of millions of new consumers – both urban and rural – that would render China less dependent on foreign markets” (Kynge, 2010). Overall, therefore, “the Chinese Government was praised by the world for its swift and effective reactions to the crisis” (Liang, 2010). The combination of social, fiscal and economic policies, as well as the stimulation package provided China with an excellent opportunity to show the global market what it was capable of achieving. While many other nations across the world suffered through the financial meltdowns of economies, China sailed through the crisis as smoothly as it could have, given the fact that its GDP mostly relied on exports to other nations that were heavily affected by the GFC. Naughton praises that “the Chinese response to the crisis itself was robust, rapid and widely viewed as successful (both inside and outside China)” (2011). As the Western model of orthodox market reform crumbled in the public eye, China’s approach of “vigorous, coordinated, top-down measures” gained great respect (Naughton, 2011). The events that led to the crisis, as well as all the results that have been observed throughout the GFC have shown that the neoliberal model of market structures may not necessarily be the ultimate economic model that every country ought to strive for. At the least, the financial and economic issues of these years show that there is more than one right approach when shaping and organizing the economies of the world. China’s specific responses have highlighted its strength as a controlled and structured economy that is still strongly intertwined with its political sector.

Future

What does the future hold for China? In this section, I am going to explore two different viewpoints. One shares a very optimistic view on China’s economic growth and development, another presents cracks within the Chinese market system and cautions against the frenzied government intervention projects. Guaqiang argues that China “has reached a crossroad in its economic reform – to further deepen the reform along the direction of letting the [the] market play a really prominent role by limiting the government […] or to move along the direction of further expanding the state sector by reducing the private sector” (2011). This is a crucial decision as it will determine the overall success of this economic giant, as well as have tremendous influences on markets worldwide. It is very important for the CCP to continuously disburse funding to the best performing sectors and businesses in order to maintain GDP growth; this is the only way for keeping risks of defaults low (Yao & Wu, 2011). The difficulty lies in determining which projects and policies are more profitable and beneficial for the Chinese, as well as deciding how extensive the government’s involvement in these should be. I am, therefore, presenting two different views, one that sees China’s future in a positive light, and the second, which regards the future of the titan as rather troublesome.

Positive

Many scholars and economic analysts regard China’s direction into the future as prosperous and triumphant. From this standpoint, China’s stunning developments over the past decades are going to continue well into the coming years. De Haan states that the stimulus package during the GFC was not just a temporary measure but rather a stepping stone into the reconstruction of its economic model that specifically seeks to target and support domestic consumption of consumer goods and services (2011). The construction of roads, apartment buildings and gigantic malls was aimed at promoting the creation of a middle class, who would stimulate the economy by using these new developments. Furthermore, the policy shift from marketisation to harmonization would certainly aid this venture. When this change was originally brought forward in 2003, the entire agenda of the government transformed in order to promote stronger state intervention, so that the ongoing market renovations could be shaped according to the CCP’s vision (Naughton, 2011). As was discussed earlier, these efforts only intensified during the GFC. Many argue that the government spending on health care, education and elderly services reduces precautionary savings and, therefore, increases consumption. In addition, Liang argues that “the provision of these services is itself an important driver of the economy” (2010). These developments create jobs and increase disposable income, which in turn will increase the demand for goods and services within China. Subsequently, it is beneficial to expand the social services sector, in order to promote these changes (Liang, 2010). Not only is the creation of a middle class and the expansion of the above named services crucial to the success of the Chinese economy, but also the manufacture of national brands in order to decrease the economy’s dependency on foreign direct investment. As the world’s most populous country, with over 1.3 billion inhabitants, China boasts with an enormous labour, as well as consumer force. If their market switched from an exporting to a domestic consumer oriented structure, it could achieve astronomical growth. From 1976 to this day, China has become “the developing world’s largest recipient of foreign direct investment” (Whyte, 2009). However, currently China still lacks the power of its own national brand champions in order to substitute all the foreign created and developed products. However, Dickson explains that the Chinese business sector is actively working towards the establishment of these new Chinese labels (2011). It is in the interest of the government to replace the numerous, small and unknown enterprises with large, dominant and successful national brands that could be sold overseas. The creation of these new Chinese goods would, once again, stimulate domestic consumption and aid in the development of a middle class (Dickson, 2011). In order to achieve this, the CCP is attempting to replace “some of its low-wage, low-skill workforce with higher wages for skilled labour and white collar professionals” (Dickson, 2011). The development of these national brand champions as well as the creation of various social sectors and other shifts in the economic structure of the Chinese market, therefore, presents a very optimistic view of the coming decades.

In conclusion, from a positive standpoint, the CCP has taken the rights steps over the past years, and actively continues to do so in order to guarantee its future success. If everything goes according to plan and the above named policies and objectives are implemented correctly, China could achieve its goal of quadrupling per capita GDP from 2000 to 2020, which would catapult it into becoming an “innovation-oriented state” (Yao & Morgan, 2008). By laying the foundations of its future success early, Yao and Morgan estimate that by 2038 China’s nominal GDP could grow to become as large as that of the United States (2008). Naughton adds that although “the acceleration of government activism represents an enormous gamble by the Chinese government” China has the possibility of “[leaping into middle-income status with a speed of transformation never seen before in human history” (2011). The foundations for these possibilities have certainly been already put into place through the construction and development of new cities, highways and bridges, as well as the strengthening of the social aspects of its nation. The next few years are going to show whether the CCP will be able to retain its control over the market and blend all these new policies together in order to create a more robust and independent economy.

Negative

Despite all the positive aspects of recent economic changes in the face of the GFC, there are many troubles that are slowly brewing on China’s horizon. The construction of new infrastructure projects, for example, has led to a completely new issue that threatens to burst the positive GDP. The problem is that many of these cities are currently largely unoccupied because these housing projects are unaffordable for a large part of the Chinese nation (Bloomberg, 2011). Currently, approximately ten entire new cities are built within China every year, which consist of entire apartment blocks, shopping malls, highways and public buildings, such as swimming pools and libraries (DatelineSBS, 2011). But since nobody is living in these new communities, the CCP cannot actually gain a positive return on its investment and is subsequently incurring a loss. Although its GDP has been positive throughout the financial crisis, it is not the quantity but the quality of the GDP that matters at the end of the day (DatelineSBS, 2011). Hence, there is a general worry that this bubble of infrastructure investments is eventually going to burst into the CCP’s face (Hou, 2011). In addition, the highly praised increase in expenditures on the social sector also has trouble standing its ground when challenged with criticism. Hou argues that the new medical plan covers sickness only to a very small extent and that its reimbursement rates are so extremely low, that in reality a large part of the “Chinese lower middle class are one major illness away from poverty” (2011). Yao and Morgan add that the assistance in rural development came essentially too late because urban incomes continue to increase faster than the ones in the countryside (2008). Another issue also presents itself with China’s goal of creating national brand champions, as mentioned above. The problem is that China has generally been exporting products that are situated at the bottom part of the value-chain (Yao & Morgan, 2008). It is going to be difficult to shed the associations that many consumers in the world link the phrase “Made in China” with. From lead-contaminated baby food to recalls in electronic products, in order to effectively create these national brand champions, China is going to have to address and conquer a wide array of stereotypes and negative conceptions that consumers associate with its goods and services.

Therefore, the measures and economic plans of the CCP generally look good in theory but their effectiveness in reality is questionable.

In conclusion, the CCP has challenged the GFC with high-cost intervention in order to protect its economy from a complete meltdown. However, Yao & Wu warn that there is a large disparity between the financial system and the real economy (2011). This disjunction poses a threat in the sense that all the preventative measures and economic restructuring could essentially lead to nothing but a steep decline in GDP, once the gap between the two entities closes. Naughton also reserves that “the scale of resources committed to these programs will contribute to macroeconomic imbalances, creating inflationary pressures and making it more difficult for China to adopt a consumption-led economy” (2011). Despite its past successes throughout the financial crisis, caution is advised. Guaqiang argues that the past accomplishments of a certain direction in policies do not necessarily guarantee future achievements with the same method (2011). It’s a slippery slope argument that is not completely dependable. Consequently, high state intervention cannot guarantee eternal economic success.

Analysis

Given the positive and negative implications of the CCP’s market intervention during the global financial crisis, it is difficult to determine what the future holds for China. The theory behind its economic model is certainly rational and potentially holds great growth and many achievements. Nonetheless, there are many factors that cannot be controlled by the CCP, which could negatively impact China’s plans and as a result send its markets tumbling down. Yao and Wu caution that the measures were successful in the short-term but that they have completely different consequences in the long-run (2011). They argue the following:

“Settling financial crisis by administrative measures is to re-allocate the resources, which will lead to financial repression and subsequently a further disjunction between the financial system and the real economy. Therefore, it will bring more bad loans and further accumulate financial risks which in turn increase the dependence on administrative measures. In a word, the stability of China’s current financial system is a temporary balance with administrative resources allocation to counterbalance the internal and external risks”

                                                                           (Yao & Wu, 2011)

In order for the CCP to maintain is political control, as well as guarantee future economic success, the government has to ensure that it remains adaptable and changes its policies as is needed. This has generally been China’s strength, as it quickly changed and acclimatized its objectives and ambitions in order to continuously prosper and grow in the past. Although some scholars worry that the large state-intervention is a “huge gamble”, the possibility of large success is still evident (Naughton, 2011). It is feasible that the CCP creates “a stable regime committed to governing better and enjoying a significant degree of popular support” (Dickson, 2008). However, the improvement of some key factors is needed in order to promote sustainable growth. Many of these deciding aspects, such as the creation of the middle class and foundation of national brand champions amongst others, are addressed by the CCP were discussed throughout this paper. In addition, scholars warn about the dangers of corruption within the party. If the CCP continues to operate its country with a high level of corruption, it may falter abruptly under the discontent of the people (Yao & Morgan, 2008). Pollution, the urban-rural divide and other common Chinese problems, are not going to be as much of an issue as the discontent of its citizens if the CCP does not increase its transparency to the public. With a growing openness of the economy, the nation is able to access and view the living conditions of others in the world, which increases the chances of its revolt against some of CCP’s injustices against the population. As the service sector grows and the involvement of rural Chinese in the economy staggers, it is important that the environment for the market is just and transparent, so that disgruntlements and distrust between the government and the Chinese is minimized. Hou argues that “corruption in China is not only widespread; it also goes up very high among government ranks” (2011). In these conditions it will remain difficult for the CCP to transform its population into a consumer nation, which will greatly challenge its future economic achievements. Chen also warns that “the economic state may fail should the new social ills prevail over the cause of reform” (2002). Therefore, the occasion for some positive and strong changes it now, if China decided to seize the moment.

In conclusion, the GFC has catapulted China into a period of great challenges, as well as tremendous opportunities for the future. Whether the CCP and its nation seize the change in order to emerge as an ever stronger and increasingly growing market economy is still undecided. Nonetheless, its swift and strong interference send a sturdy message to the West, and opened up questions about the previously assumed righteousness of the neoliberal system. In summary, the key determining factors for China’s future are going to be whether the CCP can transform from a development-oriented to a service-oriented entity, and whether the Chinese nation are going to welcome these changes (Guanqiang, 2011).

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