Insights
Author: Hu Zheng, Invited Researcher of CDI, Director of China Merchants Group, and Chief Representative of China Merchants Group in Central Asian and Baltic Region
Editor’s Note: The implementation of the Belt and Road Initiative (BRI) shall be closely combined with the reform and opening up, top-level design, shared development, sustainability. Construction of overseas industrial parks is the highlight of BRI. In the new era, the emphasis of BRI is to properly deal with the relationship between “Going Out” and “Bringing In”.
The implementation of BRI deepens China’s reform and opening up and they are closely integrated with each other. In the course of reform and opening up that started since 1978, the most prominent feature is “Bringing In”. The establishment of special economic zones, high-tech parks, bonded logistics parks, free trade zones and the introduction of capital and technology have directly driven the leapfrog development of China’s economy and have also exerted significant impact on the world.
Under the context of the reform and opening up and with the advancement of BRI, the “Going Out” is endowed with new characteristics. First is the support of national strategies and policies. Second, we should focus on addressing top-level design issues such as policy coordination, infrastructure connectivity, trade, currency and people. Third, we should uphold the concept of shared development. Fourth, we should aim at sustainable development. Chinese enterprises should innovate and create a new model of Going Out.
Construction of overseas industrial parks is the highlight of BRI and has gained high recognition from countries along BRI. The construction of parks will not only drive local economic development and promote local employability, but also facilitate the transformation and upgrading of production capacity. Overseas industrial parks have become the strategic pillar of BRI and provided Chinese enterprises with a new platform of win-win cooperation.
In the new era, the implementation of BRI should be promoted with the spirit of reform and opening up. In this process, we should adhere to the concept of win-win cooperation, properly handle the relationship between “Going Out” and “Bringing In”. That means China should export its own development experience and learn from others at the same time, which will greatly enrich the connotation of BRI. In addition, we should value sustainable development and share mutual benefits while implementing BRI.
Author: Fan Gang, President of CDI
Editor’s Note: Eventually, China and the United States will need to sit down at the negotiating table to solve trade frictions.
Trump would sooner or later impose trade sanctions on China, but no one had expected such a big move. China’s exports to the United States amounts to over 400 billion U.S. dollars, while Trump is now seeking to impose tariffs on up to $60 billion of Chinese imports. Such a big move on trade shows that the United States treats China as its primary rival in trade. The action also illustrates that such superpower like United States can be brutal sometimes, adopting measures without any evidence or reasonable analysis and ignore rulings by the WTO.
American consumers will be the victims of trade war between the US and China. The trade war will also harm China as the consumer product prices could rise. It is necessary for China to consider the price elasticity of demand when deciding how much to export. Generally speaking, the trade war will impact on United States as much as China. There is the fear that if you want to fight this trade war and I do not fight back, you would probably be even less reasonable tomorrow. Thus, China will certainly take countermeasures.
Keep a level head in face of US-China trade war
As a rising middle-income country, China needs to be prepared for the possible suspicion, antagonism and even aversion from others. These reactions must be taken care of proactively but also with a cool head. This is not the first time for China to meet with oppositions from other countries, nor will it be the last. China shall keep a level head in face of the cacophony of voices as it rises.
Those who in the past believed the China’s growth depended on low-end manufacturing have now discovered that China is able to innovate and has even become a leader in certain high-tech industries. The western world now feels threatened as China becomes a stronger competitor. And the trade war is highly interconnected with the rise of rise since Trump has declared that the trade sanctions on China are to protect US interests.
China has worked hard for its own success. Chinese have lower per capita income but are increasingly capable of innovation. Most exporters in China are private companies not subsidized by the government. There are many foreign-funded products and services among Chinese exports as well, for example, products that are manufactured in China by American businesses, which also count as Chinese exports to the US when calculating the US trade deficit with China.
Structural conflicts exist in Sino-US trade
The Sino-US trade frictions is not simply caused by trade deficit but more fundamental structural challenges existing in the two kinds of economies. Initially, the US alleged that the deficit due to China’s low foreign exchange rate. However, trade deficit has persisted after China raised RMB’s exchange rate against the US dollar. Even after US conducted the 301 Investigation against China, trade deficit still stayed on the same level.
China is not only highly competitive in a wide range of industries and also benefits from low cost and high efficiency in many fields. Even though, the competitivity in high-tech industries still needs to improve. Structural problems exist in Sino-US trade in the sense that China is not allowed to import the desired products as it exports its products to the US.
Stand up to US-China trade war
First, China needs to have reciprocal countermeasures. China will probably raise tariffs in response to the imposed higher tariff, which is something that China is capable of doing. Second, crisis management consciousness is crucial to preventing potential risks from developing into full-fledged crises. China needs to negotiate and defuse tensions where possible to avoid a completely hostile situation. Third, China-US trade only accounts for just 16-17% percent of global trade, and trade with Europe, another 16-17%. China also has the option to develop trade relations with emerging countries, including countries in Latin America, Middle East and Africa.
China’s core concern is still development. China welcomes foreign investment not just for the sake of attracting capital, but also creating jobs and bringing in advanced technologies and management. We observe how foreign-funded businesses operate and learn their experience in management. This is not stealing, as this kind of knowledge or expertise is universally shared. It is a common practice among all countries to model on existing products and come up with similar products on their own, not just in China. China is committed to staying open and will not shut its door for foreign businesses even though its own businesses are denied entry into a foreign country.
Globalization will not stop
Globalization was started by American capital and multinationals in the first place. American workers did not take it seriously at the beginning, but globalization has indeed spurred the development of China. As farmers leave villages to work in cities, China has seen a steady increase in per capita income, fast development of technologies and larger exports. Naturally, discontent in the US rises as local workers lose jobs to their foreign counterparts. In a sense, reversals and relapses in the process of globalization are inevitable. It is therefore important to anticipate challenges and be prepared.
However, globalization will not stop. Multinationals from developed countries now continue to promote globalization as they are still establishing their presence across the world today to maximize their gains. Two new forces have also joined to promote globalization nowadays, one being low-income countries which have discovered the benefits of attracting foreign investments for their own development from the experience of China and India, the other being middle-income countries like China.
China, as a middle-income country, needs globalization in the process of bringing in foreign capital and encouraging its businesses to go global. Going global is a must for China in view of its domestic excess of capital. Despite a moderate level of income in China, the high savings rate has resulted in a huge amount of capital, which will lead to overcapacity if invested within the country. Many Chinese businesses have also come to realize the importance of seizing the opportunity to develop abroad as China restructures its economy, thus starting to allocate global resources.
Despite opposing voices, globalization will continue in the long run. It is natural that the US wants to get some of its businesses back to accommodate the interest of domestic workers, as all governments wish to see more investment within their own borders. While there are many reasonable ways to do this - reducing interest rate in particular - fighting a trade war, however, is a bit of reversal of globalization.
Author: Liu Muyun, Invited Researcher of CDI and President of Beike Biotechnology
Editor’s Note: Zero tariffs alone cannot address the root cause of exorbitant prices of imported anticancer drugs and much more should be done to expand market access to quality anticancer drugs.
When he held a news conference at the end of the two sessions, Premier Li Keqiang said that tariffs on drugs will be slashed, while the much-needed anticancer drugs might phase in zero tariffs. However, zero tariffs alone cannot address the root cause of exorbitant prices of imported anticancer drugs.
It can achieve a scale effect for international pharmaceutical companies to concentrate the large market demand of China, negotiate directly with the producers via a national channel and purchase anticancer drugs in bulk. National procurement does not only mean lower prices, but also quality assurance. It is feasible to set up a centralized procurement platform at the national level with a new state administration on medical insurance to be put into place according to the State Council institutional reform plan of 2018.
We should give play to the role of Internet, establish an evaluation database for anticancer drugs, a catalogue of much-needed clinical drugs, a database to optimize catalogue and price negotiations of the centralized procurement.
In addition to scientific and technological innovation, mechanism innovation is also needed. We should reform the management of clinical tests, speed up the review and approval system for innovative drugs, accelerate application and marketization of research results, improve the business environment generic drugs, and combine technological innovation with clinical diagnosis and treatment.
The key role of medical service in the treatment of complicated diseases should also get enough attention. Innovative drugs, surgery and therapy are all clinical diagnosis and treatment tools; however, people who use these tools efficiently and economically also matters. Health practitioners deserve recognition and respect from the society.
Author: Fan Gang, President of CDI
Editor’s Note: “As an economist, I am very proud of achievements of China’s economy. However, it is crucial to keep a realistic and sober amidst the chorus of praise. There will be something wrong if we do not address problems facing China’s economy,” said Prof. Fan Gang.
Recently, especially since the beginning of 2018, public opinions in domestic and abroad have seen a great change from the previous decries to the current praises. The cover story in Time was titled “China won” and domestic opinion leaders also started to applaud the rise of China. It is however crucial to keep a realistic and sober amidst this chorus of praise.
Indeed, China has made great strides, especially in manufacturing. A short documentary made by KJ VIDS, a British media company, mentioned that by 2005, the construction area of China in every two weeks is as big as today’s Rome. Moreover, the production value was able to create one Greece every 16 weeks and one Israel every 25 weeks. Despite these great achievements, we need to be aware of the existing problems. For example, China’s per capita GDP in 2017 was 9600 US dollars, making China rightfully a middle-income country. However, it was less than 20% of that of the United States. Problems will arise without a sober mind towards addressing our weaknesses.
One neglected achievement is that China’s economy has maintained high growth rate in 40 years with no crises, which is unprecedented in the world. Developed countries, in the early years of rapid development, saw economic crises every 10 years or so. China’s economy also has its cycles, with highs at around 14% and lows at 6%. What has made China’s economy unique in the world is that it has never experienced major economic crises or recessions. This is partly due to lessons learned from the bursting of bubbles and financial crises experienced by developed countries over the past four decades.
Economic landscape and growth of China
China’s economy went through a cycle in the 1990s, got over-heated from 1992 to 1994, experienced a five-year downturn from 1995 to 1999 and remained mired in a soft patch from 2000 to 2002 until finally recovering after the SARS outbreak in 2003. The second overheating came in 2005 and lasted till 2007. China went through a self-imposed restructuring as the world was hit by a financial crisis in 2008, and saw a periodic peak between 2009 and 2010 due to economic stimulus. Another downturn was experienced from 2011 onwards until the economy touched the bottom in 2016 and started to warm up slightly in 2017; however, the economy was not bouncing back and would still stumble at the bottom for a while with certain unsolved issue.
In the short term, China’s economy will maintain a 6.5-7% growth rate with a neutral macroeconomic policy without either stimulus or tightening, which will facilitate ongoing reform and restructuring before entering the next round of growth. It is thus important to see economic growth from a periodic point of view, and regard economic downturns as fluctuations. One thing that is worth noting is that it takes longer for China’s economy to complete the process of soft landing than to restructure during crises. In the long term, we should be fully aware of the challenges facing China’s economy, including rising labor and environmental cost, a widening income gap and a global landscape under newly emerged risks.
Potential is huge too, with per capita GDP at only 9000 US dollars, industrialization rate less than 70% and 30% of the labor force living primarily on agricultural income. Only 55% of Chinese people lives in cities and 70% of the population are low-income people, half of whom being farmers and half being migrant workers. Overall, China has low levels of consumption and high savings rate, with family consumption representing a mere 30% of the GDP. We shall have confidence in exploring this potential.
Changes in global landscape
External environment is a major source of uncertainties at present. Positively, developed countries have seen strong recovery driving China’s exports. The Federal Reserve has raised interest rates and then China introduced a combination of policies by raising interest rate and lowering required reserve ratio, which remained neutral.
The “Trump effect” has indeed contributed to the rise of protectionism. What Trump does remind governments around the world of the need to reduce tax burdens on businesses, which is good. He deems that Chinese government has been correct in taking advantage of other countries for the interest of Chinese people, while the US government has failed to do so for the interest of its people, which is why he tries to make up for this gap. In future, he is likely to take measures in trade.
Does this mean a retreat of globalization? At first, globalization was advocated by developed countries. Their governments represented the interest of multinationals and domestic capital to promote globalization around the world. After realizing that globalization was against their interest, their domestic workers protested against this trend. However, at present, multinationals with global presence are still playing a crucial role in allocating resources worldwide as the drivers of globalization. A decade ago, developing countries had reservations about globalization, as they feared over the prospect of being dominated by multinationals and losing opportunities for job growth. Later on, however, as they found globalization actually contributed to their economy, they, including China, turned to be advocates of globalization.
China wishes to continue to attract foreign capital to gain know-how for its own development and many policies recently rolled out by the Chinese government encourage foreign capital to enter China by improving business environment. At the same time, China has also entered the stage of going global. High savings rate over the past two decades has accumulated a significant amount of capital, which will only lead to excess capacity if invested in the domestic market. Therefore, Chinese businesses should now compete in the world market and utilize global resources to seek new growth engines. China benefits from and advocates globalization, which will certainly continue to grow despite such setbacks as the rise of trade protectionism and short-term retreat.
New growth momentum
First, business environment. China’s policies are increasingly pro-innovation and pro-entrepreneurship, with more tolerance of problems that might arise from innovation. For instance, the messy outcome of bike sharing is unimaginable in many countries, but is treated with tolerance in China. In China, new things get a chance to survive, and when there is a problem, supervision follows. In the next few years, a big share of China’s growth will come from innovation and entrepreneurship.
Second, the development of financial systems, especially direct financing mechanisms. In the past, businesses took out loans from banks, but now they have more options, such as venture capital, PE, or selling equities. Finance plays a fundamental role in spurring innovation and entrepreneurship and the development of the financial system will come as an engine for economic growth in future.
Third, consumption growth. In the past, people born in the 1980s and 1990s used to be the main force of consumers, while retirees, who had little disposable income, spent very little. Things are different today. The wealthier generation begins to retire, and with both time and money, starts to consume more, transforming the country’s consumption pattern.
Fourth, manufacturing development. The improved quality of some Chinese manufacturers will contribute to a stronger image of “made in China”, instead of being a synonym for shoddy products. With improved consumer confidence in our products, the manufacturing sector will embrace a new round of growth.
Industrial development
First, that all industries have potential for growth does not mean all enterprises enjoy the same prospects, as they would experience constant mergers and restructuring. In the end, big enterprises will become even bigger and small enterprises will get merged into bigger ones. Enterprises shall fully consider how they would be merged so as to improve their production and innovation capacity. Research on the overcapacity in the steel industry in the American history suggests that the cause is vicious competition for resources among private enterprises during rail construction. J.P. Morgan played a dominant role in the mergers of the US steel companies with over 700 companies organized the steel industry and 200-300 companies out of business, which is a classic example of mergers. Trump once said that he enjoyed economic slumps when is a good time for mergers. Mergers and acquisitions are the destiny of many businesses. This is a good thing, as businesses can channel the return on investment into new undertakings.
Second, the manufacturing sector still has huge potential. In the 1980s, Korea was concerned about the industrial hollowing-out effect, worried that it would experience recession when industries move to China. However, the Korean economy has proved otherwise, gradually advancing to high-end growth. This rule also applies to China. We will be able to move forward as our manufacturing sector continues to climb the value chain.
Third, application of new technologies, and in particular, the internet. The internet is a public technology and serves every individual, company and industry, which makes it crucial for industries to keep pace with the information trend.
Fourth, professionalism and dedication. Successful companies are invariably those that are dedicated to their businesses and persevere for a long time, a quality that is indispensable in pursuing craftsmanship and an upgraded version of “made in China”.
Author: Guo Wanda, Executive Vice President of CDI
Editor’s Note: Cross-regional coordination mechanism and legal arrangements under the “one country, two systems” framework have great significance in boosting the development of the Guangdong-Hong Kong-Macao Greater Bay Area, in which Shenzhen as a transportation hub and innovation engine will play an instrumental role.
The Greater Bay Area has gone beyond administrative divisions, and its development needs the support of the central government and the coordinated and collaborative development of cities in different regions. In this sense, it is crucial to have top design plus regional coordination and institutional arrangements in the Greater Bay Area. First, the general planning of the Greater Bay Area is a public good, and shall thus be dominated by the government. Second, the future industrial development in the Bay Area shall be driven by the market and businesses, leveraging the force of both government and market.
At the same time, legal arrangements under the framework of “one country, two systems” have great significance for promoting an integrated market of the Guangdong-Hong Kong-Macao Greater Bay Area. As the Greater Bay Area involves Hong Kong and Macao with different customs territories and legal systems, the authorities of Guangdong, Hong Kong and Macao can refer to the EU system in building a common legal framework under which all regulations can be implemented, so as to facilitate the flow of people, goods, capital and information, etc., within the Bay Area.
Shenzhen is uniquely positioned and plays a very important role in the future development of the Greater Bay Area. On the one hand, Shenzhen shall continue to enhance transportation infrastructure, such as the “Bay Area Loop Line” to extend the influence of Shenzhen across the region; on the other, Shenzhen shall encourage its industries to capitalize on the premium higher education resources of Hong Kong so as to give full play to the Hong Kong-Shenzhen Metropolitan Area as an engine for innovation.
Author: Fan Gang, President, CDI
Editor’s Note: The 15th "China Reform Forum" was hosted by the China Society of Economic Reform in Beijing on December 2, 2017. The theme of the forum was "to learn from and implement the spirit of the 19th CPC Congress, study and make breakthroughs in the reform of key areas". Professor Fan systematically analyzed the necessity of the property long-term mechanism at the conference.
Despite that short-term policy may work under certain conditions, ultimately long-term mechanism must be established to stabilize the market. As seen in the current huge demand for properties, housing demand is far from exhaustion. The high rate of property ownership in China only reflects the underdeveloped rental market, not the exhausted demand. In addition to residential needs, there are also non-residential needs. Problem arises when people invest in property with small intent for letting, which is resulted from the bubble in the property market and the pursuit of value appreciation in properties. In the absence of a mechanism to increase the cost of property ownership, such demand has not been curbed. Therefore, the most important long-term mechanism on the demand side is property tax.
Property tax has three functions. First, it will increase the cost of ownership, and reduce investment demand. Second, it is the internal stabilizer of price fluctuations. Given the same tax rate, the tax on the property will vary based on the current value of the house. When housing price skyrockets, some people will choose to withdraw from the market or switch to smaller ones due to higher tax. This is fully reflected in other countries’ mechanisms. Third, currently, taxes paid upon purchasing the property included future public services such as environmental conservation and transportation maintenance. With the increase in land price and labor cost, the costs of these public services will also increase along with the economic development. Therefore, the current lump-sum tax upon purchase is unreasonable.
Property tax policy must be implemented rationally with a transitional period. For example, for the properties that have paid lump-sum tax upon purchase, property tax should be collected after a ten to twenty-year transitional period when the lump-sum is discounted to present value. Meanwhile low-income property tax deduction can be integrated into construction tax, or grants for suitable personnel which is similar to the minimum living security.
On the supply side, in terms of inhabitable area, China faces severe scarcity of land and its habitable area per person is one third of the world average, combined with other human factors such as regime, strategies, and policies, causing short supply of land and houses. Such circumstance is mainly reflected in the following four aspects. First, the current plot ratio in China is too low. More buildings should be constructed on the limited land to improve efficiency. Second, some local governments should be held responsible for failure to supply land when housing prices rise and its aftermath. Third, property developers acquire land at high prices while housing price is the derivatives of land premium. Four, the rental market is underdeveloped as the result of insufficient supply of affordable rental properties and inadequate legal system that protects the interest of both landlord and tenant.
Last but not least, land allocation system, specifically allocation between major and small cities, is a problem of divergence of urbanization strategy. In the past, the development of small cities was given priority. Small cities were granted large quantity of land while the supply of land to major cities was restricted. However, the majority of people migrated to major cities while middle-sized and small cities, especially third and fourth tier cities, are where the population outflows. Recently, China Development Institute conducted a study on industrial transfer. The central government had policies in place to encourage industrial transfer and identified over 60 cities to be the industrial transfer destinations. For over ten years, 87% of the transfer was to provincial capitals but barely to small cities. Since better services, infrastructure, human resources and logistics services are only available in major cities due to the agglomeration effect and cluster effect, various industries are brought into major cities along with numerous employment opportunities. Therefore, to pursue a better life, people have to migrate to major cities.
To improve the property system, market-oriented strategy is necessary. First, market based resource allocation should take effect, instead of government undertaking. Second, stabilized market does not entail fixed price. Growth of income and predetermined land supply indicates that the relative price of land is basically GDP. If GDP increases constantly, the land price will increase and then the housing price. As such, what truly needs to be stabilized is the proportion of income to housing price. Measures should be taken on both sides of supply and demand while long-term mechanism should be established to gradually achieve long-term market stability of supply and demand.
Author: Fan Gang, President, CDI
Editor’s Note: At the Belt and Road: Seize the Next Wave of Growth in Eurasia forum on November 23 in Venice jointly held by China Development Institute and The European House – Ambrosetti, Professor Fan talked on the economic rationale of Belt and Road. Here are excerpts from his speech:
There are lots of questions about how China will benefit from the Belt and Road Initiative (BRI). The usual analysis is from international diplomacy and geopolitics point of view, which states that by improving infrastructures and connectivity, China gains a bigger market, resulting in more investment in neighboring countries and the world. This is undeniable.
But as an economist, I would like to stress the importance of the economic rationale of BRI. People may wonder why China has the money to finance BRI since China is still poor – GDP per capita is quite low comparing with developed countries. But after 20 years of high savings, China accumulated wealth. The question lays in how to use this saving. If invested in domestic economy, over capacity is inevitable. Currently the surplus goes to foreign exchange reserves, which goes to US treasury bonds. But why not invest in concrete projects that can facilitate other countries’ development, strengthen connectivity with China, and also build our community for future prosperity? Therefore, economically speaking, BRI is a better way for China to utilize its national saving.
However, BRI can only be fulfilled by a joint effort by China and other countries. Although the main focus is infrastructure investment, we should not only calculate cost and benefit in terms of direct return or short-term returns, but also the future, the return to public good, and the economic prosperity of the region.
Nonetheless, it is still investment which requires us to consider carefully about financing and selecting the projects, compatibility with local country’s economic development strategy, effectiveness and efficiency of the projects, which essentially amounts to how to succeed and benefit the people in the future. These are the questions we bear for the Belt and Road: Seize the Next Wave of Growth in Eurasia which is also why I think holding this forum is important.
Author: Wang Jianye, Managing Director, Silk Road Fund; Professor of Economics and Director of the Volatility Institute at NYU Shanghai; recently has been selected as Rotating Secretary General of the International Working Group on Export Credits (2020-2023).
Editor’s Note: At the Belt and Road: Seize the Next Wave of Growth in Eurasia forum on November 23 in Venice jointly held by China Development Institute and The European House – Ambrosetti, Professor Wang talked on the financial issues and challenges that Belt and Road Initiative faces.
Over the three years since the launching of Belt and Road Initiative (BRI), from an investment and financing perspective, what have happened? What have we learned? What are the key challenges going forward?
What have happened?
It has almost become a cliché that the vast landmass in the Eurasia continent, with growing population and markets, has great growth potential. Investment to increase connectivity in this not well-connected region would expand the market, creating effective demand and growth. However, while officially-supported institutions increased their financing, we have not yet seen large capital flows into the developing countries in this region. Why?
A recent World Bank research is telling.1 Their data show that per capita investment growth in emerging market and developing economies has been falling rapidly since 2010, with non-BRICS commodity exporters from roughly 7 percent in 2010 to 0.1 percent in 2016. This is in contrast to the partial recovery in developed economies. By 2014, investment growth there had returned to its long-term average rate, about 2 percent. Their research points out that sluggish investment and growth in developing countries, notwithstanding record-low external borrowing costs and large unmet internal investment needs, can be attributable largely to domestic problems – worsening business environment, rapid buildup of enterprises debt, and policy uncertainty – while external factors such as major countries’ economic slowdown also played a part.
Against this background, let’s look at data from China. Three developments are worth noting from China’s international investment flow data of the last few years:
First, outward direct investment (ODI) increased dramatically in 2015-2016, driven largely by private enterprises. ODI since the global financial crisis could be divided into two periods: 2008-2013, 2014-2017. Data compiled by government and market sources indicate that private sector drove the recent outflow acceleration. ODI relative to GDP rose from 1.1 percent in 2014 to 1.5 percent in 2015 and 1.9 percent in 2016.
Second, destination markets also shifted from emerging and developing economies to developed countries. It should be noted that ODI by disclosed value and number of deals in the Belt and Road developing countries have also increased, admittedly from a very low basis. In conjunction with the rise of the private enterprises, ODI target industries experienced a shift, from primary commodities to services, high value-added manufacturing, and consumption related sectors.
Third, the recent surge in capital outflows especially in 2015-2016 reflects to certain extent masked capital flight. Unusually large and rapid buildup of foreign assets by some domestic entities through M&A or purchases in real estate and unrelated businesses became a source of concern. Some entities including in the financial industry accumulated large domestic liabilities in support their foreign spending spree, increasing balance sheet mismatches. “Errors and omissions” in the balance of payments were also indicative of such a flight, which increased from -0.6 percent of GDP in 2013-14 to about -2 percent of GDP in 2015-16.
The regulatory authorities responded by strengthening the enforcement of capital flow regulations and domestic financial prudential requirements. Starting from November 2016, irregular ODI has subsided. Recent BOP data suggest that net direct investment, which turned deficit in 2016, returned to small surplus in the first three quarters of this year.
What have we learned?
Financing the development of the Belt and Road has to be on market principles. Multiple factors affect China’s capital flows, but primarily market forces in the international arena. Our analysis points to three types – cyclical, structural, and governance drivers. Cyclical forces stem from changing expectations on domestic vs. foreign interest rates and exchange rate movements. Structural forces result from rising domestic costs—wages, land prices, tightening of environment regulations, etc. Governance factor affects SOE investment through corporate governance; it also affects private investment through its impact on uncertainty regarding taxation, regulatory treatment, and property rights protection. In opening up its financial account, China faces domestic financial stability constraint.
The principles of sharing are very important for BRI financing sustainability. The BRI is not a “Marshall Plan,” and cannot be a one-actor show. To achieve “win-win” outcomes, in May 2017 finance ministries of 26 countries endorsed the Guiding Principle on Financing the Development of the Belt and Road, highlighting “equal-footed participation, mutual benefits, and risk sharing.”
Challenges going forward.
First, the leadership challenges to state-owned enterprises. As the Chinese economy is in transition, SOEs still play dominant role in some sectors and significant in others. SOEs’ return on assets and investment return have been falling in recent years, and significantly below that of private enterprises. According to the IMF, adjusted for implicit support through the use of land and natural resources, and lower implicit financing cost, SOEs’ return on equity is estimated to have become negative since 2012.2 In the industrial sector, SOEs account for more than half of corporate debt and 40 percent of industrial assets but less than 20 percent of industrial value added.
Returns on SOE overseas investments are likely to be much lower on average than private enterprises. These companies, especially their leadership, are facing daunting challenges to increase efficiency and profitability. For cross-border M&A, more important is post-acquisition restructuring and management. Strategic vision, efficient decision making and high-quality execution are vital, which require sound corporate governance, market consistent incentives and market-driven corporate culture to attract and retain talents. All are leadership demanding.
Second, the challenges for direct investment in developing economies in the Belt and Road. Many countries are low-income, small size, placing viability limit on projects that require larger market. Red tape and rent-seeking also add to the hidden costs of doing business there. Moreover, counterparty risks are high. It is often difficult to find local corporate partners with solid balance sheet and performance track record. Payment capacity is typically a concern with high risks over the longer term. Few countries or companies there are in investable credit rating. Many are vulnerable to global and commodity cycles.
Coping with these risks would require our enterprises operate on market principles, thoroughly understand local conditions, and on that basis match investors of various preferences for risks and returns with the right projects and other partners. Special attention should also be paid to social responsibilities and environmental protection. Building alliance with local stakeholders and going green would help achieve commercial success in the relatively risky segments of the market.
Third, the challenge of expanding the use of RMB in overseas direct investment. In the last several years, large ODI and other capital outflows have led to a decline in China’s foreign exchange reserves from nearly $4 trillion to slightly over $3 trillion. At this stage, maintaining a sizable official reserves before the RMB exchange rate can be freely floating is important for financial stability. Expanding ODI thus would entail the use of RMB. Although the RMB has become a composite currency of the SDR, its share in World foreign exchange transactions is still smaller than several currencies that are not in the SDR basket.
The challenges are to progressively develop the relevant infrastructure, reduce RMB funding and holding costs, build up so-called “network externality” (i.e., a greater number of users increases the value to each). Of course, international use of a currency depends ultimately on market acceptance, which could be a long process. Stable currency value and the rule-of-law institutions and governance are therefore fundamental.
Finally, the challenge to modernize governance at home in face of increasingly free cross-border mobility of capital and talents. Public sector reforms are particularly relevant in this regard. Exposing the SOEs fully to market competition through opening up protected sectors and removing implicit subsidies would force restructuring, increase efficiency, and contribute to leveling the play field for all enterprises.
Fiscal reforms to make public spending accountable, reduce uncertainty in taxation, and realign central-local fiscal relations will go a long way in instilling confidence and reducing capital flight. Reform to make the tax system more progressive will not only help alleviate income inequality, but also put the public finances on a more sustainable footing, good for internationalization of the RMB.
The recent State Council Opinion reiterated that effective protection of property rights is a cornerstone of our society. The challenge is not just in implementation, but in the difficult institutional and cultural transformation to a “rule-of-law” society.
The BRI calls for “opening-up” of the countries in the Eurasian continent. In doing so, it also creates the conditions for institutional and governance modernization in these countries. Real progress in these reforms will not only transform the business community but also the relevant society, benefiting people along the Belt and Road, creating truly “win-win” outcomes.
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1 Ayhan Kose, Franziska Ohnsorge, and Lei Sandy Ye, 2017. “Weakness in Investment Growth: Causes, Implications, and Policy Response.” Policy Research Working Paper 7990, World Bank, Washington DC.
2 International Monetary Fund, Staff Report for 2017 Article IV Consultation, paragraphs 18-19, http//www.imf.org.
Author: Mark Yeandle, Associate Director, Z/Yen Group Limited
Editor’s Note: At the China Industrial Finance Forum 2017 on November 17 in Jinan held by CDI, Mr. Mark Yeandle shared his views on the experience of London financial centre. Here are excerpts from his speech:
Firstly, was the city of London constructed or did it grow? What keeps it as an important center? Secondly, is there any lesson we can learn from the development of Canary Wharf from scratch? Thirdly, if there is any lesson for China’s financial centres?
London was not planned as a financial centre. It developed as a trading centre of a very successful empire. The British people always had a long history of international trading. Then we had the industrial revolution and the building of financing as an industry which had a massive impact on the country. It became a very logical sequence if you carry on building financial centres. Big bang in 1980s was a deregulation of financial services which freed up the market and allowed the UK and London in particular to grow and thrive. The invention of modern finance, the industrial revolution and the Big Bang are the three great steps of innovation.
Obviously, London is a big city in terms of the size and population. Interestingly, long-term decline of sterling actually helped Britain more international. Investment managers could make good returns in investing purely in UK instruments simply because the value of sterling was dropping. Constant innovation, the development of institutions over the years, being one important centre in the European time zone which enables London to speak to Asia and America in the same working day, English language, skilled people, general reputation of trustworthiness, all sort of things all helped London develop.
Why does London stay on top? Time zone and English language are still important. Liquidities of market are now so strong. London has become a leading centre for stocks, shares, bonds, foreign exchanges, derivatives, insurance, etc. It got all the intuitions like the Lloyds insurance market and the Baltic Exchange. Innovation, like Fintech, also helps London stay on top.
How on earth did Canary Wharf come about? It is now a leading financial area and 30 years ago it was still part of the London Docklands. The London Docklands actually died in the earlier part of this century. Thames were tidal so you always got ships up and down. The harbours basically died because long ships were just too big and deep for the city. So, we ended up with Canary Wharf as an industrial wasteland very close to the City of London. The City of London is one square mile and it is just contained within the old Roman Walls, so it is very limited in space. The old financial development tried to take place there but there was simply not enough room in the City. The buildings were very old and unsuitable and quality of office environment in London was poor. So, the Docklands development organizations went to the City of London and asked: “are you happy with your office premises or do you see the need to do something dramatic?” The answer is that we have to do something dramatic.
Canary Wharf was not planned. It was there because it was demand. I have been to many financial centres where premises have been built early in the process. They have very lovely glass towers, very shining and impressive. Unless you plan early on how to fill them, they will become embarrassment when you leave them empty there. Canary Wharf was filled basically before it was built, because there was so much demand there. The development worked very closely with London about transport links because Canary Wharf is still far away from the City. They spent huge amount of money on transport, like Jubilee Line, City Airport, Docklands Light Railway, London River Services and Helipad.
What perhaps China’s financial centres can learn from this? Building a financial centre, you start with business environment and sufficient infrastructure. Only when you get those two things, skilled people want to move in and financial sectors begin to develop here. Eventually, it will lead to the reputation as a strong financial centre. The generalities of financial centres also give some advice. You cannot be an international centre without international people. Successful people want to live in successful cities. People want to live in cosmopolitan places and gravitate to cluster of their industries. Reputation of the centre is vital because it takes 20 years to build a reputation and five minutes to ruin it. Trust is the glue that holds all relationships together. People will not come to and invest in the city, unless they trust that they will be treated fairly no matter where they come from.
Author: Peter Bofinger, Professor for Monetary and International Economics, Würzburg University, and a Member of the German Council of Economic Experts
Editor’s Note: At the China Industrial Finance Forum 2017 on November 17 in Jinan, Professor Peter Bofinger shared his views on the successful experience of the German Economy. Here are excerpts from his speech:
Germany is among the top ten economies in the Global Competitiveness Report provided each year by the World Economic Forum. In this ranking, Germany is especially high in terms of innovation and business sophistication. Germany has one the lowest unemployment rate among the OECD countries and sound public finances compared with other advanced economies.
Why is the German economy so successful? Germany has a specific economic model which was shaped by Ludwid Erhard, the father of Germany’s market economy, after the WWⅡ. His concept can be labeled in his motto that is “prosperity for all”. The idea was that in order for a country to prosper it means that growth has to be shared by all. Growth is important, but growth has to be widely shared.
How can the concept be translated into the German economic system? What really matters when you decide an economy is the relationship of government influence and market force. For example, the Anglo-Saxon countries have low government influence and strong market influence, and in the Scandinavian countries, market influence is relatively small compared with government. Germany is in the middle, not too much government, not too much market, and it is a very balanced approach. It explains why Germany is so successful.
The approach also explains the success of a German model that provides workers with relatively high security. Unemployment protection of workers in Germany is rather high. Good protection of workers is not something negative for growth and it is a positive feature. Workers and employers see themselves as partners; there is no confrontation but cooperation between them. It is really helpful for Germany. The intuitional framework is called co-determination which means the boards of large companies compose of 50 percent of workers’ representatives and 50 percent of shareholders’ representatives. It is important for the solid environment of the German economy, especially in recessions.
Germany also has a special industrial landscape which is rooted in the German history. Until the beginning of 19th century, Germany was composed of independent small states, so Germany is a much decentralized country. It is also reflected in the industrial structure. Germany has many companies spread across the country. Some of them are even global leaders but they are in the countryside. Why can these family companies adjust themselves over time and still remain successful? The family model is very helpful, because they have long-term perspective. They do not depend on short-term capital market, but they have their long-term vision of how to be successful.
What is the financial system for this decentralized structure of Germany? It is called a three-pillar system which is very robust in times of crisis. One pillar is private banks. The second one is savings banks which are owned by the local authorities and spread all over the country. This decentralized banking system really helps small enterprises get the money. In addition, we have corporative banks which are owned by small investors and mainly exist in major cities. Both saving banks and cooperative banks are not listed on the stock exchange. The three pillars make up a stable system, because it is diversified and it is on the local basis that money is provided for the local companies.
Is Germany really so good? The biggest test for the German economy is the German unification in 1990. When the Berlin Wall came down, we suddenly have 60 million East Germans with an economy that was extremely not completive, while the West German economy was really able to provide social security and infrastructure investment. The unification has been successfully managed, which is a sign of strength of the German economy.
The German economy’s strength is obvious if you look at how we manage the globalization. Germany has benefited from the rapid process of globalization because we have the right products that are needed for industrialization. Compared with other advanced economies, the German economy is very open and has successfully managed the challenge of globalization, which shows the strength of our economy.
Germany has been able to retain the manufacturing base and it is still one of the very strong manufacturing economies. Manufacturing matters.
We have also realized the potential of digitalization. We are one of the economies which intensively use industrial robots. Digitalization is not something afraid of and it does not destroy jobs but provide new opportunities.
What are the lessons for China?
Social protection is a blessing not a curse, because it provides motivation for workers. Good labor relations matter for the performance of firms.
Small can be beautiful. Small and medium-sized companies are successful because they are more flexible and transparent and have low transaction and information costs.
Stock markets are good, but we must be careful. What matters for successful economies is long-term vision, while dependence on stock markets nurtures short-termism.
Globalization and digitalization are beneficial for the wealth of nations, but they do not generate prosperity for all. We need government to use them in the right way so as to produce prosperity for all.
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Author: Fan Gang, President, CDI
Editor’s Note: Internet finance, while injecting new vitality into economic development, has also brought with it inevitable risks, which calls for new models of internet finance regulation.
Online shopping, internet finance and telecommunication technologies have brought various benefits to the Chinese economy, such as fueling the development of the manufacturing sector, providing financial support for small and medium enterprises, and promoting consumer finance. Compared to developed countries, China’s internet finance is developing well. There are several reasons for this. First, the relative backwardness of China’s commercial and financial industries in the past created a huge space for the emergence of internet finance. Second, Chinese consumers’ awareness of privacy protection is not as high as their counterparts in western countries. Third, the Chinese government has adopted a tolerant stance towards innovation, entrepreneurship, the application of new technologies, as well as new business patterns and models, facilitating the growth of internet finance. In addition, China’s vast consumer market has provided excellent opportunities for growth.
The development of internet finance has pros and cons, which, while creating benefits, has also brought negative impacts such as phishing and fraudulent activities, etc., all of which have made regulation on internet finance highly relevant. We need to adopt a mixed supervision system which can penetrate into different industries related to internet finance. Moreover, the partnership between governments and enterprises shall also be encouraged. Moderate and effective regulation by the government will help businesses develop better. As the regulator and the regulated share common interests, their partnership and collaboration will contribute to forming a self-disciplined regulation mechanism, which is in the interest of the long-term sound development of China’s internet, e-commerce, and electronic finance, etc.
Author: Guo Wanda, Executive Vice President, CDI
Editor’s Note: In the Guangdong-Hong Kong-Macao Greater Bay Area, Shenzhen has a unique advantage of innovation. Shenzhen shall give a leading role to innovation and strive to build a new regional innovation system.
Shenzhen is a metropolis featured with openness and innovation. Shenzhen is home to a large number of highly competitive private businesses which focus on innovative and creative industries. Moreover, the high efficiency of Shenzhen’s government, favorable business environment, large numbers of talents have all contributed to Shenzhen’s vigorous economy. Shenzhen shall give a leading role to innovation for a better spill-over effect in promoting the shared development for other cities in the greater bay area. The following measures shall be taken: first, to build a regional innovation system featuring industry-academia collaboration research; second, to put in place an industrial chain incorporating venture capital, innovative technologies, and talents for innovation; third, to facilitate the aggregation of industries, talents and capital.
In the greater bay area, Shenzhen can foster benign competitive relationships with other core cities like Guangzhou, Hong Kong and Macao in the greater bay area. Open and pragmatic cooperation will be carried out between Shenzhen and Guangzhou, in particular the establishment of the Guangzhou-Shenzhen Science and Technology Innovation Corridor. Hong Kong is an international hub for finance, trade and shipping with sound basis for cooperation with Shenzhen in industries, talents and technology, etc. Macao is a global center for tourism and leisure, as well as a well-functioning platform for one-stop MICE services. To achieve mutually complementary cooperation, Macao should combine these strengths with Shenzhen’s strengths in internationalization.
Moreover, integrated industrial chains have been formed among Shenzhen, Dongguan and Huizhou, and the collaborative development capitalizing on the advantages of the three cities is sure to exert positive influence on the growth of the greater bay area as a whole. The division of city functions among the three cities, together with close collaboration and partnership among industries, will help promote the Shenzhen-Dongguan-Huizhou city group. Differences in cost have made them highly complementary to each other in industrial division and city functions. A better coordination mechanism among Shenzhen, Dongguan and Huizhou will serve as an role model for other cities in the greater bay area. With the further improvement of transportation networks in the Guangdong-Hong Kong-Macao Greater Bay Area, there will be higher mobility of different economic factors, enabling Shenzhen to reach out further in the overall development of the greater bay area as a regional growth engine.
Author: Fan Gang, President, CDI
Editor’s Note: China still has huge potential for economic growth, as the domestic supply side reform and growth in consumption further promote the development of China’s economy. Enterprises will also meet new opportunities in the period of economic transformation.
During the period from 2011 to 2016, China faced rather strong downward pressure on its economy. Stimulated by the supply side reform and domestic demand, however, the prospect of China’s economy remains encouraging. In the next round of economic growth, there will be more high-tech innovation elements, and China’s economy will embrace growth with a better quality. At the same time, the domestic supply side reform and growth in consumption will continue to fuel China’s economy.
The report of the 19th National Congress of the CPC put forward the supply side structural reform as a central task in facilitating economic development towards better quality and higher efficiency, while industrial restructuring and transformation is a major challenge for the supply side reform. In the future, industries will continue to climb the value chain towards the middle and high end of it. In addition, the future of China’s economic structure will witness a shift to consumption as a new driver, with consumption of services also expecting faster growth. At the same time, other drivers for consumption growth are also gradually coming into play, including the steady growth of national income, continuous improvement of social security, sustained development of consumer credit, and increasingly diverse consumer needs.
However, we should also be concerned about the overheating of the Chinese economy. The overheated economy is because of technological progress and institutional change. When the economy becomes overheated, we often encounter periodic problems such as overcapacity, stock backlog, debts, etc. Two conditions must be met if the Chinese economy wants to ensure a soft landing: first, when inflation happens, the national government shall take timely measures to suppress excessive bubbles; second, economic and administrative measures shall be adopted as two pillars to control economic growth within a proper range. For enterprises, how to adapt to national economic transformation and restructuring by adopting appropriate business strategies is important if they are to have sustainable development.
Editor’s Note: CDI experts gave suggestions to the development approach for Shenzhen after the 19th CPC National Congress.
Housing Should Be for Living in, not for Speculation
Land shall be used for housing construction. To solve the housing problem, we should trace back to the factor of land. What Shenzhen needs is a residential land supply regime instead of improved housing construction ability. Therefore, Shenzhen shall make a series of adjustments to its land management regime by establishing a residential land supply regime that can meet the housing needs of Shenzhen residents.
To Introduce Shenzhen Special Economic Zone Model along the Belt and Road
The Belt and Road Initiative has been well-received by many developing countries. These countries believe that the successful development model of Shenzhen Special Economic Zone is duplicable and helpful to transplant. When opening up to the countries along the Belt and Road, Shenzhen needs to share its success story of the Special Economic Zone model to the world.
To Achieve Development in Fundamental Scientific Research
Despite of its high ranking in terms of science and technology innovation, Shenzhen should clearly recognize that innovation does not only refer to technology industrialization but also basic research. Therefore, there is still plenty of room for improvement in terms of basic theoretical research and disruptive innovation. Four Nobel Prize winners have established their laboratories in Shenzhen with remarkable achievements.
To Contribute to China’s Opening-up
Shenzhen should seek for service trade-driven development and integrate its service trade into the global service sector. Shenzhen should also accelerate research on and implementation of projects such as free trade ports and cross-border cooperation zones What’s more, Shenzhen should provide excellent public services, maintain market rules and mechanism, and create a world-class business environment and attract high-quality business resources across the world.
