Ernst’s Economy in discussion at BNR Newsroom: the China issue!

Last Monday on 18 November, I was present again at BNR Newsroom, the semi-live talk radio show hosted by Paul van Liempt.

This week’s topic of BNR Newsroom was China. This topic was so interesting and there were so many distinguished guests, with a good story to tell, that I print the contents of this show in two separate episodes.

The first guests were:

• Professor Patrick Reinmöller of the Erasmus University’s School of Management in Rotterdam and the Cranfield School of Management, who is a core member of the China Business Research Centre in Rotterdam;
  
• Professor Haico Ebbers – International Economics – of Nyenrode Business University. Ebbers is chairman of the Europe China Institute at Nyenrode and guest professor at the Renmin University and the China Europe International Business School. 

Both these professors were extremely eloquent and shared some very interesting details on China, which is still a very peculiar country for many western people.

Paul van Liempt: We are going to talk about China. Politically, there is a lot going on in China. According to president Xi Jinping, there should be more free market in the country and less state interests in the economy. What are the consequences of this for The Netherlands, when it comes to imports and exports.

China wants to reform. Plans concerning these reforms have been presented to the outside world. A little bit more 'market' and less 'state'. How will this be in practice?

Patrick Reinmöller: First, these are very ambitious plans, in which sixty different reforms have been presented. The speech by President Xi Jinping has been magnificent, but the implementation of it will be very hard. The devil is always in the details. The current president has about ten years to implement the presented reforms, before his successor will be presented in the media. 

Patrick Reinmöller of Erasmus University Rotterdam
Picture copyright of: Ernst Labruyère
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Paul: The president said that implementing these plans would lead to less growth. The Chinese population won't like this. Why did the president do that anyway?

Patrick: First, China is no small, developing economy anymore. To the contrary, it is a huge economy. It is virtually impossible to let such a large economy grow by 10% per year every year.  

Second, the Chinese economy needs a cool down, otherwise things could go wrong from a political point of view. The economy needs to remain under (political) control and it needs to turn from a manufacturing and export-driven economy into a consumption-driven economy. This should happen through a slow, evolution-like process. To achieve this, the 10% growth is not necessary anymore. 7% or 8% growth on an annual basis is more than enough for this huge economy.

Paul: In my opinion, the middle class is the most important class now in China. This middle-class should establish itself and grow larger. Is the growth of the middle class in China something that worries you? Or will it come naturally?

Paul van Liempt of BNR News Radio
Picture copyright of: Ernst Labruyère
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Patrick: As an academic, I am a bit worried, but as a private person I see the enormous opportunities. In the next 12 years until 2025, the country will move 250 million people from the rural areas to the cities: this is a mindboggling operation. It is like you would move the whole population of Western-Europe to the cities in less than 12 years and you would change their lifestyle from being farmers into consumers and factory workers.

Paul: Where do you see the social and economic problems emerge?

Patrick: Moving is very awkward for Chinese citizens in general. When they move to the cities, they lose all their personal social rights and benefits, that are attached to the place where they were born. They have to build up a whole new life from scratch: without any right for social security and utilities.

Paul: So, in fact these people will become second rate citizens in the cities, even if they belong to the middle class then?

Patrick: One of the things that Xi Jinping promised to do is removing these barriers for people from the rural areas. If he achieves to do so, it would be a giant leap forwards, when it comes to a planned change of China into a consumption driven, capitalist economy.

Erik de Munk (audience): Do you think that the democratization process will bring the Chinese economy into a ‘pitstop’? Is this not a transformation process, like we saw in the Middle-East? There has been a Chinese village, Wuchan, were workers have been rioting before such a transformation took place. They have to go through a process of friction, before the transformation process is finished?!.

Patrick: My academic opinion is that capitalism and a blossoming economy don't go necessarily together with more democracy. There is not such a connection. Until now, the Chinese growth took place without a western kind of democracy.

However, Chinese consumers become wealthier and as a consequence, they might feel a diminishing need for increasing economic prosperity. They already do have a car and a television set after all. They want to invest more in the happiness, health and wellbeing of their children. Good babyfood, a healthy environment, you know, We saw that in all developing countries and we will also see it in China.

Ernst: Do you think that the Chinese government will ever loosen its iron grip on the population? We had f.i. the recent troubles with the Uyghur and Tibetan parts of the Chinese population.

Patrick: The West sees the sixty reforms as an attempt to bring the Chinese population at ease and avoid further growing unrest. The Chinese leaders do so by making promises that the circumstances on some important terrains in China will change for the better. As a matter of fact, this is an attempt by the Chinese government to maintain its iron grip on the country. Whether the Chinese government will succeed in this, I truly can't say.

Paul: Haico Ebbers, can you tell something about the economy in China?  To start with the income of the middle class?

Haico Ebbers: This is in fact the story of the possible hard landing of the Chinese Economy at the short and long term. When looking at the short term, we know that we need to push some buttons, especially the demand button in the Chinese economy.

People in China must spend their money and they must invest in the manufacturing and export of their goods. However, in the long run, we should start to look at the supply side of the economy, as only this truly opens the path to sustainable growth.

Managing the supply-side is very awkward in China: supplying a larger labour force is virtually impossible, due to the progressive aging process in China [there are many elderly people and relatively little children, due to the ‘one child’-politics – EL]. At the same time it is also hard, to supply more capital and make more investments, as the 'airports have already been built';  there is already a lot of infrastructure.

Consequently, there is only one way for growth and that way is ‘productivity’. To enhance productivity, we need to push the buttons of the supply-side of the economy: deregulation, privatization, openness and innovative behaviour.

Haico Ebbers of Nyenrode Business University
Picture copyright of: Ernst Labruyère
Click to enlarge

If you fail to do so, you get caught by the middle-income trap. You build up momentum and speed, like a plane, but when you take off - i.e. the phase in which everything should happen - your plane starts to stall in mid-air.

Many countries remain in this so-called take off phase, as they refuse to put real energy in their openness and deregulation. The following data comes from the Worldbank: from 120 investigated countries, only 18 made the leap to being a high income-level country.

It has not been an easy ride for all these countries, if you think for instance about Ireland and Greece. Nevertheless, they managed to grow into a high-income country. Therefore we know quite well what China needs at this moment.

Countries like f.i. Korea and Japan are an example for the Chinese leaders: they know from these countries which steps they should make to become a high-income level country.

Paul: This is what Xi Jinping tries to explain to his country?! That the productivity should go up substantially and that the only opportunity for such an increase in productivity is a more moderate growth?

Haico: Yes, the 7% is indeed better than the 10% growth: the productivity should go up and also the wages should go up to. It might sound strange when a country wants to increase its wages, but for China this is necessary. Higher wages always trigger innovative behaviour of workers.

Besides that, companies can only compensate these higher wages by increasing their efficiency and effectiveness, which also spurs innovation.

Paul: Are wages an underrated subject in this matter? China is quickly turning into the world's number one economy, but average wages are still not very high there, right?! Especially when you compare these wages to US and European average wages?

Haico: Many companies went to China for the market potential, not for the low wages.

However, companies that aim at the lowest loan costs would seemingly be better off in Vietnam, Myanmar and Cambodia, as the wages are much lower there than in China these days, right?!

In reality, however, this is not true; the higher productivity, as a consequence of the clustering of manufacturing companies and their suppliers and subcontractors, makes the production in China so much more efficient, that it is still worth your while to stay there.

The loan expenses per fabricated unit in China are still lower than in those earlier mentioned countries, in spite of the soaring wages. You can still make a profit through productivity improvement. This is how China is still able to compete.

Paul: But how high is that Chinese salary?

Haico: That is about $6000 in purchase power units per year for the lower middle class. Nominal it is $4000 per year.

Ernst: As a consequence of nationalistic trends around the world, we currently see a phenomena called 'nearshoring': companies, which are returning their production facilities to their home country or state.

Is that a danger for China, as it could lead to companies abolishing their production facilities in China?

Haico: The impact of (foreign) investments on the Chinese economy is not as large as we think. Western people look at China as an export driven country, in which the real money and growth is made through exporting products. However, that is not reality anymore.

The added value of investments in exports is quite low, as a matter of fact. The withdrawal of production capacity, as a consequence of nearshoring, will definitely have effects on the Chinese economy, but this effects will not be as big as you might think.

Patrick: Nearshoring is a very interesting story indeed. Initially, companies were offshoring their whole production lines to the Far East, only to realize later that it is not the most sensible solution for strategic products, which need to be at the domestic markets fast.

And now this development leads to an optimization process of the division between offshoring and nearshoring. Companies offshore all products they can offshore, but keep the products in domestic production that are strategically important for the domestic markets.

Ernst: Will the massive emergence of a Chinese middle class, with soaring purchase power, not lead to enormous shortages in raw materials, like food and commodities worldwide?

Patrick: To give a philosophical answer: Once, in the time of Malthus, we thought that the world population was growing too quickly for the world to cope with it, when it came to food and commodities.

Fortunately, the Chinese, Americans and Dutch people have been so creative that they found innovative solutions for this issue, that made this growth possible after all. They all found ways to get more produce from the soil and thus managed to keep the world population alive and healthy. I am quite optimistic about that, fortunately.

Paul: Currently, reforms are taking place in China and these reforms go into a certain direction. What is your expectation about the way in which China develops in the coming years, mr. Ebbers?!

Haico: I put my money on a soft landing of the Chinese economy. At the short term, the Chinese middle class has enough purchase power and growth potential to keep the total spending in the economy at a high level.

At the mid-range term, the challenges are the environment, income differences between poor and rich people and the Chinese system wherein social benefits are connected to the place where you are born. This system must be adjusted. The  middle class is the bedrock for the Chinese economy AND politics.

Paul: Will the enormous 'mass-migration' towards the Chinese cities not lead to massive problems and uncertainties?

Haico: In the eighties the urbanization level in China was 20%, against 50% now. Of course there are these megacities with their own issues, but in reality we hardly notice the enormous frictions between people in these cities.

China made a giant step in urbanization; of course this urbanization will continue up to 70%.  And of course there must be adjustments in the cities. People are working on social housing projects, in which new, social housing will be delivered.  People are also working on adjusting the current system for social security, in which the social benefits are only limited to the place where you were born.

I will explain this: when you move from the rural areas to the cities, you are allowed to work. However, you are not treated equally in comparison with people who were born in the city, when it comes to social benefits and privileges. This leads to social inequality.

Paul: This is an essential question, right?!

Haico: This is very important indeed, as there is already a (structural) labour scarcity. Now, there is still an influx from the rural areas to the cities, but that will change. This whole influx might even disappear in the future. That is the reason for the vast wage increases today. Consequently, there will be scarcity of labour in the future.

This is the reason that China has to make optimal usage of the enormous population that they have today, by letting this population work in the country’s factories.

Paul: Will the fact that China is on the brink of leaving its one child policy, influence this process? Women, who are allowed to become pregnant more often, will consequently make less working hours, I guess?!

Haico: Yes, they might. However, on the mid-long term this is a favourable development, as these children will become new workers in about twenty years. And at short term, there are still other ways to increase the labour participation, like increasing the retirement age.

And with 7% growth, the economy will double in size within 10 years. This enables China to become the number one economy in a number of years, like Goldman Sachs predicted.

Paul: Do you take the Chinese growth rates seriously? Many economists don't believe one bit of those data!

Haico: the economic data are much, much better than ten years ago. And the trend in China is still favourable. When you look at China, you see the enormous economic change that is happening there. 

This is the end of part one. Tomorrow, part two will be printed...