ASEAN-China Relations: Realities and Prospects

18. China's Business Environment: A Macro Economic Perspective

260 Yuwa Hedrick-Wong 18 China’s Business Environment: A Macro Economic Perspective Yuwa Hedrick-Wong A macro perspective on China’s business environment is important because business executives and investors need to understand what is driving China’s growth in terms of both cyclical and structural factors, so that they can plan and manage with better market insights that are anchored in a broader and longer-term perspective. Accordingly, this chapter seeks to answer three key questions, covering both the short and the long term, which could help develop such insights. These questions are: (i) What is the outlook in terms of the “hard” and “soft” landing debate and what is really driving China’s growth? (ii) What are some of the real bottlenecks to growth? (iii) What are some of the most critical challenges to China’s longer term growth prospects? OUTLOOK IN TERMS OF THE “HARD” AND “SOFT” LANDING DEBATE AND WHAT IS REALLY DRIVING CHINA’S GROWTH The whole debate over “hard” and “soft” landing is completely misguided. The primary distinguishing feature of the current economic expansion in 18 ASEAN-China Relations Ch 18 5/8/05, 9:06 AM 260 China’s Business Environment: A Macro Economic Perspective 261 China is that it is led by the private sector. This marks it as completely different from all previous cycles of expansion since the 1978 opening of the economy. The private sector in China today is driven almost entirely by business profitability, which is in turn dependent on buoyant demand. They have had little access to bank financing, and because they invested with their own funds, they are insensitive to either bank credit tightening or higher interest rates. As long as they are enjoying high returns, which they are, they will continue to expand, and there is little the government can do about it. China’s private sector entrepreneurs live and die by their profits, and hence are closely tuned to changes in the market. So what is the big fuss about the government bringing in new measures to curb investment and to “cool” down economic growth? The fact is that the government acted earlier this year in a proactive way to curb excessive investment in the public sector, primarily the state-owned enterprises. This is a reflection of how much the Chinese leadership has taken to heart the lessons learned from the last boom-bust cycle of 1993–94. At that time, the surge in growth was almost exclusively led by massive investment made by state-owned enterprises, with loans from the large state banks. Much of the investment was ill-conceived. Many state-owned enterprises made the investment not because there was a business case to justify it, but just because they could secure the loans to do so. Many managers in the stateowned enterprises treated bank loans as “free” money that they could spend in any way they liked to expand their operations, very often in areas completely unrelated to their core businesses. Thus, government ministries opened hotels, enterprises in heavy industries operated department stores, and construction companies ran restaurants. This inevitably led to overinvestment and poor returns, and, worse, accelerating inflation. As the government attempted to rein in inflation by ordering the state banks to tighten credit, it quickly led to an economic downturn. Not surprisingly, many state-owned enterprises defaulted in servicing the bank loans as their investment went sour. In the process, record high non-performing loans resulted in China’s banking sector — a legacy that is still haunting the large state banks today. This time around, the government is determined to prevent a repeat of such colossal mistakes, and hence the measures introduced in early 2004 to scrutinize the large loans lent to state-owned enterprises, and instructions to state bank management to curb lending to certain sectors, such as steel, that has experienced rapid increase in production capacity. These are measures aimed proactively to prevent a repeat of the boom-bust cycle of the past, and not to curb growth in general. 18 ASEAN-China Relations Ch 18 5/8/05, 9:06 AM 261 262 Yuwa Hedrick-Wong So it is the private sector that is driving real growth in China today. The expansion of the private sector is a result of a series of reforms in recent years, which have created a much more welcoming environment to China’s private entrepreneurs. The recognition of...