September 15,2009

A High Price Will Be Paid for the New Economic Imbalances the Stimulus Creates

By Scott Zhou

A variety of statistics show that China's economy is rebounding quickly, and China likes to see itself as playing a leading role in helping the global economy out of its morass. On the other hand, China's economy is also moving into ever greater imbalances, intensified by the "driving out of private firms and promoting of state-owned enterprises (SOEs)" through the government's oceanic intervention.


During the economic crisis, the government has issued stimulus policies to avoid in the short term business closures and layoffs, but the side effects of this "medicine" are becoming apparent as market mechanisms have not been allowed to play a role and resources have flowed into inefficient sectors.


Both the government's 4 trillion yuan stimulus package and the banks' first half 7.4 trillion yuan lending splurge have been feasts for SOEs in the economic winter. With serious production surpluses in industries controlled by central firms, investment can not effectively increase employment. Central enterprises "capture" ministry spokesmen to save them through industrial policy, purchasing and storage, and protectionism, and use the vast amounts they have borrowed or been granted for speculation in the stock and real estate markets, becoming a major force in driving up a round of asset bubbles.

Local governments support SOEs, which they own or which are their area's largest single employers, while even regions such as Zhejiang with well-developed private enterprises find that increasing the state-owned element is a short cut to higher GDP and growth in the short run.


Flush SOEs are turning their attention to high profit areas where the private economy is relatively active, such as real estate and mining and steel, and getting involved. Central firms bid for "Land Kings," private coal mines in Shanxi Province are being snatched up by SOEs, reconstruction in the private steel sector has stopped while loss-making, laggard, and inefficient state-owned steel firms are helping themselves to private iron and steel companies with government assistance.


But in fields truly representing China's competitiveness and sustainable development, it is the private enterprises that are breaking new ground. In such industries as new energy, which the government is making great efforts to develop, private enterprises are performing best, BYD, for example, in the field of electric cars, Suntech in solar energy, and ENN in the development of clean coal use. Huawei, ZTE, Zoomlion, and EVOC are enterprises successfully going global in technology, products, services, marketing and strategy. After more than a decade of OEM, equipment manufacturers are entering and succeeding in international markets. SOEs mainly rely on the country's huge foreign reserves to acquire overseas resources.


SOE profits have dropped like a stone. A main component in the volatility China's economy is its large numbers of SOEs.


The government's current massive intervention program is forming a pattern of interests whose shortcomings will be more and more obvious in the long term. The price paid for sustainable growth in the short-term to handle the crisis may well exceed the benefits. The longer it goes on, the greater the cost.

FDI in China has continuously declined over the past year, while the market dominance by and protection of SOEs are strengthening. With less dependence on international markets and foreign capital, China is feeding an illusory sense of superiority, ignoring the true challenges it faces in a rush to return to an old and failed system.

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