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Global Inside the China Debate Japan March Tankan Preview View GEF Archive

Stephen Roach (from Beijing)

Global

This is always my favorite week of the year to be in China.   It’s the time when the China debate goes from the inside to the outside, as the National People’s Congress segues directly into the China Development Forum.  The latter is a relatively small gathering of senior Chinese officials and a group of so-called outside experts, originally conceived by former Premier Zhu Rongji in 2000.  I have been privileged to have participated in this conference for six of the past seven years.  It offers a great opportunity to jump right into the heart of the macro and policy debate in China.  This year was no exception -- especially coming in the immediate aftermath of the NPC’s passage of China’s 11th Five-Year Plan.  But little did I know how this debate would finally play out. 

The End of the Central Planning Era?

China chose the occasion to announce a critical transition point on the road to reform.  For the first time since the Communist Revolution in 1949, the old numerical targeting and sectoral allocation conventions of central planning have all but been eliminated from the multi-year framework.  Only broad aggregate growth guidelines remain -- 7.5% average gains in real GDP through 2010 -- but they were presented as more of a forecast than a top-down edict.   In effect, the Chinese leadership is telling us that the dawn of a new market-based approach to macro policy management is at hand.  The rest of the China story needs to be set in the context of this critical transition to the post-central-planning era. 

At this point in time, however, the transition is more in theory than in practice.   China basically has only one leg in the Promised Land of the market system -- the other remains planted firmly in the old framework of centrally-directed controls.  While Chinese ownership conventions are shifting away from state-owned to private-sector enterprises, the transformation to market-based pricing continues to lag.  That’s certainly true of the legacy system of administered pricing of many goods and services that still exists for utilities, public transport, coal, natural gas, oil, gasoline, and indirectly for food due to state-sponsored agricultural inventory management programs.  But it is also true of the prices on a variety of financial instruments -- namely, interest rates, the currency, bank credit lines, and bond prices.  These prices are still tightly controlled by leadership decisions made at the highest levels of the Chinese power structure.  As financial sector reforms continue apace, I have no doubt that market-based pricing will spread into these areas as well.  But for now, that is far from the case. 

The resulting hybrid system is not without some serious problems.  The combination of private ownership and administered pricing may well be predisposed toward a misallocation of resources.  In effect, a nation with a 50% national saving rate is attempting to intermediate a massive reservoir of funds back into the real economy without relying on the invisible hand of a market-based cost of capital.  The Chinese leadership understands the potential pitfalls of this transitional arrangement but views them as the ongoing sunk costs of a key element of the reform process -- the overriding desire to maintain stability in economic, social, and political terms.  China evidently does not yet feel that the institutional conventions of its newly reformed system are strong enough to withstand the full-blown pressures of market-driven forces.

Chinese Rebalancing

This underscores one of the great ironies of the new China: As a reflection of this deep-rooted and understandable caution, the central planners remain very much in charge in China.   As has been the case over the past couple of years, Ma Kai, Chairman of the National Development and Reform Commission -- the modern-day counterpart of the old central planning agency -- took the lead in laying out the macro strategy at the China Development Forum.  While other major economies empower their head central banker, Minister of Finance, or Secretary of Treasury to assume that role, in China it still lies in the portfolio of the senior central planner.  Chairman Ma is a very impressive figure.  Not only does he have a firm grasp on the magnitude of China’s problems and challenges, but he is brilliant on his feet in fielding tough questions from the crowd.  The main thrust of his presentation at this year’s CDF was to hammer home the critical point that China needs to tilt its macro structure away from a growth dynamic that has become overly reliant on exports and fixed asset investment.  Instead, China will focus increasingly on boosting its support from domestic demand -- especially private consumption. 

This was music to my ears.  If China can successfully execute this important shift in the mix of its GDP, it will go a long way down the road of its own rebalancing.  The Chinese leadership is, in effect, conceding a very critical point on the sustainability of its all-powerful growth machine -- that it has pushed the export- and investment-led growth paradigm to the limit.  It fully recognizes the potentially destabilizing consequences of staying with this formula for too long -- trade frictions and protectionism from open-ended export growth and excess capacity and deflation from open-ended investment spending.  Without the solid underpinnings of internal consumer demand, China’s supply-side growth model poses mounting sustainability risks of its own.  A major rebalancing is the only answer -- and one that China’s senior leadership now endorses wholeheartedly.

Consumer-Led Chinese Growth

At the China Development Forum, I challenged Chairman Ma on the execution of this strategy, asking him point blank how China expects to spark a dynamic consumer culture in the face of a daunting sense of job and income insecurity that appear to be unavoidable outgrowths of ongoing reforms.   My question: “Don’t the massive headcount reductions brought on by the continuing dismantling of a state-owned system make it very difficult for China to count on a pro-consumption growth dynamic?”  Chairman Ma’s response was both candid and very wise.  He stressed four keys to success for China’s shift to an increasingly consumer-led growth dynamic: (1) Income support -- always the main driver of consumption -- will be directed at the lower end of the pay distribution, especially in rural and agricultural China.  (2) The safety net will be emphasized as the means to cope with consumer insecurity and the related excesses of precautionary saving; this implies heightened emphasis on social security, educational, and healthcare reforms.  (3) Emphasis will be placed on improving the retail distribution network; this is a physical infrastructure issue (i.e., roads and rail) but also a commitment to expanding China’s retail and wholesale trade establishments -- part of a broader set of services-based growth initiatives.  (4)  Improving the quality of the Chinese consumption experience is also a major focus; this includes initiatives on land-price reform, enforcement of hazardous product regulations, and tilting export growth away from the low-labor-cost production model. 

Chairman Ma’s response hit the nail on the head, in my view.  It was a great exposition of the macro and micro considerations of spurring the shift to a consumer-led growth dynamic.  He left us with one critical point: The emergence of a Chinese consumer culture will take time -- and possibly a good deal of it.  This is a key point on the coming rebalancing of the Chinese economy.  For 50 years, the state provided the people everything from cradle to grave -- from jobs and income to shelter, medical care, education, and retirement stipends.  As the state-owned enterprise system gets dismantled, so, too, does that umbrella of all-inclusive support.  This is as profound a shock as any nation has to face -- unleashing a powerful surge of precautionary saving to compensate for the Chinese life-style that has been turned inside out.  It may well take a new generation of Chinese consumers to overcome that shock.  That has important implications for the Chinese growth dynamic as the sources of support shift away from exports and investment toward private consumption.  Aggregate economic growth could well slow as the consumption impetus lags the more immediate deceleration of investment and exports.  In that context, the 7.5% growth forecast of the 11th Five-Year Plan -- a distinct slowing from 9.5% average growth of the past 25 years -- makes a good deal of sense.

Audience with Premier Wen

For me, the highlight of the annual China Development Forum always comes at the end of the gathering -- the traditional meeting with the Premier.  Sometimes this exchange is tightly scripted, but at other times, it offers considerable food for thought.  This was one of the latter examples.  In a free-wheeling response to intense questioning from the assembled group of outside experts, Premier Wen Jiabao left little doubt of the strong resolve of the Chinese leadership in facing a series of daunting challenges in the years ahead.  There were three key messages that struck me as especially important this year: First, the Premier highlighted the critically important role of rapid economic growth.  In his words, “Growth is still a very high priority in order to deal with the inevitable dislocations brought about by reforms.”  That tells me there are clear limits as to how much of a transitional slowing China will tolerate in aggregate activity as it shifts to more of a consumer-led growth model.  Second, he upped the ante on emphasizing quality over quantity in assessing growth objectives; this is an old theme in reform-minded China but with a much stronger emphasis than I had heard in the past.  Environmental concerns, income disparities, the social safety net, and the productivity imperative are all viewed as increasingly important aspects of the quality dimension to Chinese growth objectives.

The third message was the show-stopper, for my money.  It came in response to a question I raised on the growing and worrisome risks to the US-China trade relationship -- a topic that I had just spoken on in the formal proceedings of the China Development Forum (see my 20 March 2006 Special Economic Study, “Globalization and Mistrust: The US-China Relationship at Risk”).  The time was late, and we were all tired after two days of intense discussions.  This was the last question of the meeting -- and the final word from the Chinese leadership at this year’s China Development Forum.  The Premier was especially animated and intense in framing his response.  “China views this relationship as very important,” he said, “and takes these risks very seriously.”  He implied that efforts will be made to further expand Chinese imports from the US as well as deal with the all-important concerns over intellectual property rights.  He was emphatic in re-emphasizing the limited role that foreign exchange policy could play in tempering the US saving shortfall and related trade imbalance -- in effect, implying no major change in the RMB exchange rate.  At the end of his discourse, he leaned forward, looked me straight in the eye, and stated with great emphasis, “You can take this message back to the American people: It is unfair to make China a scapegoat for structural problems facing the US economy.”

Three Senators in Beijing

The next morning, as luck would have it, I had the opportunity over breakfast to run Premier Wen’s comment by three US politicians who just happened to be in town -- Senators Schumer, Graham, and Coburn.  As they put it, the liberal, the moderate, and the conservative, respectively, had come to China in a rare moment of solidarity to demonstrate both the breadth and depth of bipartisan political support to bring the US-China trade issue to a head once and for all.  Schumer and Graham, of course, are co-sponsors of a bill (S. 295) that would impose 27.5% tariffs on all Chinese imports into the US unless there was an RMB currency revaluation of a like amount.  They were steeped with confidence that this bill had overwhelming support in the Senate and most likely comparable support in the House.  And since it played to the angst of middle-class US wage earners, they did not expect the first veto of a politically-weakened President Bush to be exercised on this issue. 

Chuck Schumer is a very smart and savvy man.  He is using the bully pulpit of a prominent politician to put so much pressure on China that it will have no choice other than to give.  Nor does he have much doubt that this approach will work.  “This is exactly what I did in Japan in 1986,” he said -- apparently the last time he was in Asia.  “It worked in Japan and it will work in China.”  Senator Schumer is not Reed Smoot -- Utah’s protectionist senator who co-sponsored the Smoot-Hawley Tariff Act of 1930 that led to the Great Depression.  In the end, Schumer doesn’t want tariffs -- he wants to go down in history as the man who made China blink.  But he is perfectly prepared to play high-stakes political poker in order to achieve this objective.  So is the rest of the US Congress.  The big risk is that China calls Washington’s bluff and the two parties start to stumble down the very slippery slope of trade frictions and protectionism.

While the senators claimed they were there to listen and learn, my guess is that this was a classic window-dressing sojourn.   As I probed them on the issues, they had all the answers down pat -- their minds were made up.  Schumer actually conceded the point on the structural macro linkage between the trade deficit and the national saving problem -- a first for a major China basher.  This, of course, has been a major leg of my own macro stool for longer than I care to remember.  “I agree with you,” he said, “America doesn’t save enough and we consume too much.”  Fine to that point, but then he turned the logic inside out: “I care deeply about the loss of US manufacturing jobs to China.  If I am successful in cutting our trade deficit with the Chinese, not only will those jobs come back home but I will have succeeded in boosting US saving and cutting excess consumption.  My bill can do all that and more.”  I am rarely speechless, but at that point, I started to choke on a huge bite of watermelon.  “Let me get this straight,” I gasped, “tariffs will boost saving?”  Too late -- he was already off to face the ever-present battery of cameras and microphones. 

In a short span of 24 hours, I had heard it all on both sides of the China debate.  The Chinese leadership was amazingly transparent in expressing their own hopes and concerns at a critical juncture on the nation’s extraordinary journey.  And then the Washington crowd blitzed into Beijing with an agenda of its own.  What was missing was a willingness to bend -- for both sides to come together in the best interests of the collective whole.  The great paradox of globalization never seemed more vivid -- our economies may be global but our politics remain decidedly local.  Unless we resolve that paradox, I am afraid the win-win dreams of globalization advocates could remain fleeting.

Japan
March Tankan Preview
Mar 22, 2006

Takehiro Sato (Tokyo)

March Tankan Preview 

Takehiro Sato (Tokyo)

Japan 

Tankan may accentuate BoJ’s bullish stance

We expect the March Tankan survey results to indicate genuine improvement in corporate sentiment and a positive approach to F2006 on the part of businesses.   Large companies are steadily absorbing the impact of sharply higher energy and materials prices, and with revenue and profit rising for four consecutive years, we expect the current lag in capex to give way to an outburst of pent-up demand between F2H05 and the end of F2006.   We continue to favor our most bullish scenario for the economic outlook, and we expect continued improvements in Tankan headline readings in and after June.   Furthermore, we think the BoJ is likely to make another upgrade to its economic view on the basis of the Tankan findings, and we think both the Bank’s Monthly Report (due out on April 11) and the Outlook report (April 28) will once again underscore the bullishness of the central bank’s stance.   In the Outlook report in particular, we expect the bank to ready itself to jettison ZIRP and lift policy interest rates to a neutral level.   We think expectations of higher market interest rates are far more likely to strengthen than to retreat significantly.

Forecasts for business conditions DIs

We foresee a current DI for business conditions at large manufacturing enterprises of +24 points, a +3 point improvement on the December survey.   For large non-manufacturers we also anticipate a +1 point improvement, to +18 points.

We expect to find evidence of a slightly accelerated rate of improvement in manufacturers’ sentiment, fuelled by firm trends in both domestic and overseas demand and companies’ increasing ability to operate profitably (despite sharply higher energy and primary commodity prices and consequent variable cost growth), thanks to lower breakeven points following restructuring efforts that have reduced fixed costs, as well as by depreciation of the yen in real and effective terms, and the stock market gains we have also seen to date.   For non-manufacturers, too, we anticipate real improvement albeit in small steps, reflecting strong movement in domestic demand as a whole.

As the business conditions DI moves up, there is a tendency for forward projections to turn weaker.   However, while we expect this pattern to be evident in the Tankan for March as well (we expect to see +22 points for forecasts by large manufacturers), we do not think this should have particularly negative implications.

Forecasts for management plans in F2005-06

Sales and profit targets: We think the main point here is new plans for F2006 rather than the status of revisions to management plans for F2H05.   Despite the prevailing negatives of elevated energy and materials prices, the tone of both domestic and overseas demand is robust.   We also anticipate some impact from yen weakness and the wealth effect from high stock prices, and so we expect management targets for both sales and profit in F2006 to reveal a positive stance by companies.

At the same time, for F2H05, responses to the December Tankan survey pointed to corporate expectations for weaker profit margins and rising personnel costs, resulting in fairly cautious expectations for profit targets.   In addition, forex rate assumptions on which management targets were based were considerably more cautious than actual levels, being at or around the ¥108/$1 level for 2H.   Consequently, we think that there is potential for substantial upside in targets for export sales and recurring profit, and that some of this is likely to be reflected in upward revisions of forecast profit levels in earnings estimates for F2H05.

Capex plans: Here too we think newly drafted plans for F2006 are likely to hold more significance than revisions to F2005 budgets.  Even so, this does not mean that we are unreservedly upbeat on the outlook for F2006.   In manufacturing, capex in F2005 has mainly been driven by transportation machinery (motor vehicles), but at the moment there is no particular standout as a likely key driver for F2006.   On the other hand, in non-manufacturing, budgets have been augmented significantly during F2005, especially in infrastructure-related areas such as communications and energy.   In this context, the actual tone of capex has been unexpectedly dull.

We think this is probably due to an inability to implement capex plans on schedule because of impediments including capital goods supply restrictions.   Assuming that has indeed been the case, we think the period from F2H05 through F2006 could see a surge in demand that has been pent up until now.

Going forward, we expect momentum for change in capex to be brisker in the non-manufacturing segment than in manufacturing.   Among non-manufacturers, we expect firms in a broad range of fields — led by electric power/gas utilities, which have been restraining fresh investment up to now, but also extending to others including communications, real estate and leasing — to come up with ambitious plans.   Given that non-manufacturing spending accounts for 70% of total corporate capex, we think a genuine revival in this segment should have no small effect.

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