International Herald Tribune

Paris, Monday, September 28, 1998

Economic Crisis in China as the Reform Effort Stalls

By Gerald Segal International Herald Tribune
SHANGHAI - China is undoubtedly a more politically and economically liberal place than five years ago, but now it is stalled on its road to greater market liberalization.

 It has made impressive progress, creating more than 30 million private businesses and $208 billion worth of shareholding companies since 1979. And the decentralization of economic decision-making empowers local entrepreneurs. But the 20 years of reform makes it both harder and more dangerous to stop, even if Asia's economic crisis is giving Chinese leaders second thoughts about the virtues of capitalism.

 China's current economic woes are a lethal mix of a Japan-like bubble and a Russia-like rusting state sector. GDP growth is officially put at an annual rate of 7 percent, after adjustment for inflation, but it is falling, and Chinese officials privately admit that the economy is effectively in recession.

 GDP growth of 3 to 4 percent is necessary simply to absorb new entrants to the labor market. A further 4 percent of GDP is accounted for by unsalable products of state-owned industries. China is not a haven of economic prosperity in the regional storm.

 In fact, it has a banking system on the verge of bankruptcy. A best-selling book in China by He Qinglian suggests that some 60 percent of bank loans are nonperforming. Half the personal savings of Chinese has been lost by banks in unrecoverable loans to state-owned firms.

 In what Mr. He calls ''marketization of power,'' a small elite is siphoning off so much domestic and foreign capital that since 1992 China has exported more funds than it has imported. No wonder it announced new controls on the export of foreign currency on Aug. 20.

 The deflationary pressures are enormous. Inventories rotting in warehouses are worth $360 billion. Some 70 percent of new real estate is empty; the Pudong district of Shanghai has both the world's largest office tower and the biggest vacancy rate. Industry is running at only half of capacity. Price deflation reached 3 percent in August and gathers pace.

 As Mr. He explains, with the disparity between rich and poor greater in China than in the United States since 1994, there are far fewer people with a stake in the current partial capitalist system as China enters a time of dangerous crisis.

 Hence the official call in mid-September for a fiscal stimulus to the 70 percent of Chinese who live in the rural economy and have been neglected in the last 10 years of reform.

 The fact that such devastating economic data are freely available is testimony both to the more open political environment and to the extent to which President Jiang Zemin is trying to distance himself from the economic policies attributed to Deng Xiaoping.

 Mr. Jiang has tried several new strategies, most notably the much ballyhooed spring reforms by Prime Minister Zhu Rongji. But Mr. Zhu's attempt to slash the government bureaucracy by half has been headed off by powerful vested interests and those worried about rising unemployment and social unrest in a deflating economy.

 The sell-off and restructuring of state firms has been halted. Far from cutting bank lending to the state sector, the order went out in July to increase spending, thereby worsening the banking crisis. The announced sell-off of government-owned housing has been suspended; so have plans to liberalize grain sales.

 Mr. Zhu's failures have led Mr. Jiang to try another way to de-marketize power by selling off the moneymaking enterprises of the armed forces. This, too, is unlikely to work.

 It is heartening that China's leadership seems to know what must be done to eliminate these systemic problems, but the failures in Japan and Russia to tackle their versions of similar crises are evidence that good intentions are not enough.

 When observers worried that China's post-Deng leadership was weak, it was not so much that they doubted that Mr. Jiang could consolidate his Communist Party position against rivals, but rather that he might not have the power and authority to undertake difficult reforms.

 China is in no state to be a serious threat to the outside world economically, militarily or in any other way. In fact, a China that loses its reforming nerve is merely a threat to itself.

The writer is director of studies at the International Institute for Strategic Studies in London and director of the Britain's Pacific Asia Program. He contributed this comment to the International Herald Tribune.