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The State Advances, the Private Sector Retreats - Crisis Economic Policy in China

GG 2020 - 14th May 2010

By A. Gabriel von Roda

The mantra that China’s leadership has repeated to the international community, like a monk with his prayer wheel, has been the request that the WTO and the West recognize China as a full-fledged market economy. However, with the recent financial crisis, one hears the Chinese phrase guo jin min tui – the state advances, the private sector retreats - with increased frequency in China. This marks a trend that has made it harder for China to convincingly make its case for recognition as a market economy.

With the largest economic stimulus in history (USD 540 billion) - its adequacy questioned by many observers - China’s state-sector has as a result seen itself bloat with “cheap” capital.

China’s state-owned firms, flush with stimulus money, have pushed private business aside. Examples of this can be found across many sectors. For example Rizhao Steel, a profitable private steel company, was swallowed via an aggressive M&A by state-owned Shandong Steel Group. Noteworthy here is that Shandong Steel Group was only a year old at the time of take-over and many of the group’s companies were making significant losses.

It is no secret that China’s state-owned firms are also the ones that are favored when it comes to the handing out of large-scale infrastructure projects in railways, highways and airports. About one third of China's infrastructure-heavy stimulus was delivered directly through an increase in government spending, with the rest financed by bank loans.

The real-estate sector has received special attention from state-owned companies. In 2009 state-owned developers purchased 60 percent of the 10-most expensive plots that were on sale. For example, a site in central Beijing was auctioned for nearly 4 billion yuan (USD580 million) making it the most expensive plot in the capital and across the country. The winning bidder was a property subsidiary of state-owned Sinochem Group, blowing all privately-owned heavy-hitters out of the water. A week later another lot in Beijing's outskirts was sold for more than 3 billion yuan (circa USD440 million) to Greenland Group, a real estate company owned by the Shanghai municipal government.

The list of examples of China’s state-capitalists’ march back into the private economy further extends into the airline industry, coal mining, among other sectors. Although for the purpose of this article the point is made: China’s central and local government has dramatically increased its intervention in the economy. However, the question that remains is how China can gain the much wanted recognition as a market economy with such heavy state involvement in economic affairs? And in what fiscal environment China finds herself in the post-heavy-spending period?

Many suggest that government spending will grow much more slowly in 2010; total stimulus program spending would slow to 11% growth from 21% growth in 2009. What will be harder to downscale is the renewed state involvement in the economy. After years of reform and privatization the state is back and reversing this may be harder than many think, especially when one looks at how this comeback in state intervention was financed and what obligations come with it.

Local governments’ race to spend stimulus money has left them with massive debts. Central Bank and China Banking Regulatory Commission (CBRC) surveys found that local governments and development agencies had borrowed up to RMB6 trillion (USD870 billion) by the end of September of 2009, with nearly 90% of total stimulus projects tied to bank loans. Their surveys also found that these loans amounted to 240% of local government revenues.

Further, inflationary pressures are arising from the spending spree and low interest rates, this sees the Consumer Price Index (CPI) at 2.7% year over year. Food prices are up 6.2% year over year, real estate prices rose at a record 10.7% in February 2010, while equity prices are up over 45% in the last 12 months.

This picture will have China’s policy makers on their feet in the next two years trying to fight creeping inflation, high local debt levels and a looming real estate bumble. China would be wise to reconsider its heavy-handed state intervention in the economy. If so, long aspirations to become recognized as a full-fledged market economy may get real attention from the international community.

A. Gabriel von Roda is a GG2020 fellow currently researching in China for his PhD and a co-author of the book ‘The Rise of the Dragon: Inward and Outward Investment in China in the Reform Period’.