The international community, and particularly policy makers in the United States, put great expectations on the contribution that China can make to global economic recovery by rebalancing its economy through promoting consumption growth.

The Chinese authorities broadly accept this priority and have put in place a number of policy measures that aim to achieve it.

Piecing together a complete picture of Chinese consumption by drawing on both official and unofficial data reveals some interesting detail about how far China is along the way to boosting domestic consumption.

China’s consumption share of GDP was probably underestimated by an average of 3.1 percentage points during the past decade, as it declined steadily from 64 per cent in 2000 to 50 per cent in 2008, in line with official statistics, but recovered afterwards to 54 per cent in 2010.

These figures could mean that China’s long-awaited economic rebalancing has already begun, especially if the sharp decline in the country’s trade surplus from 7.5 per cent of GDP in 2007 to 2.1 per cent in 2011 is taken into account. If these changes continue, the Chinese economy may transition from an economic ‘miracle’ toward more normal development, as growth slows, inflation rises, industrial upgrading accelerates and economic cycles become more dramatic.

Boosting China’s domestic consumption has been a key government policy in trying to rebalance the economy. But according to official statistics, the consumption share of GDP declined persistently from 62 per cent in 2000 to 47 per cent in 2010, highlighting a serious policy failure.

Even more surprising is the widening gap between retail sales growth and total consumption growth in recent years. The fact that consumption-related retail sales grew increasingly faster than total consumption indicates the relative weakness of components of consumption unrelated to retail sales. This weakness is mainly in China’s services sector. But this is at odds with common sense, as normally the income elasticity of demand for service goods is much higher than that for other consumer goods.

The Chinese National Bureau of Statistics derives consumption data from household survey data. If household income was significantly underreported, as various studies have suggested, then it is quite possible that household consumption was also grossly underestimated, and likewise for consumption growth rates in general.

A re-estimation of China’s consumption share of GDP, taking into account these distortions, suggests that China’s consumption share of GDP actually declined from 64 per cent (with official statistics recording only 62 per cent) in 2000 to 50 per cent (officially 48.4 per cent) in 2008, but then recovered to 54 per cent (officially 47 per cent) in 2010.

What could have driven the improvement?

There is a strong argument that both China’s ‘growth miracle’ and its economic imbalances during the country’s reform period are attributable to widespread distortions in factor markets. These distortions generally repress factor costs and, therefore, are like subsidies to producers, investors and exporters. At the same time, they also tax households. This explains both the increasing dominance of investment and exports in Chinese growth and weakening consumption during the past decade. This implies that the key to rebalancing China’s economy lies in further liberalising its factor markets and removing cost distortions.

Anecdotal evidence suggests that the climate for increased consumption has started to improve in recent years. This seems to have been mainly triggered by changes in factor costs and returns, but more importantly, the changes are by and large natural market responses, instead of deliberate policy adjustments. The government certainly took steps to reform pricing mechanisms for factor markets, most clearly in energy prices and exchange rates. But a rapid growth in wages and the increased role of market-based interest rates were still the most significant changes.

While the People’s Bank of China has not taken concrete steps to liberalise interest rates, those that are market-based have started to play an increasingly important role in China’s financial intermediation. Changes in both labour and capital markets are also positively impacting on consumption in at least two ways. First, they increase household income, while also reducing ‘subsidies’ to Chinese enterprises. And second, rising wages and interest income advantage low-income households, and should help improve income distribution.

This analysis has encountered both disbelief and scepticism.

Some critics have argued that retail sales are a poor proxy for consumer demand, since China’s figures must incorporate wholesale business, and government and business procurement. But Chinese retail sales figures do not include wholesale business, and the analysis does not use retail sales as a proxy for consumption.

Others object to the analysis because China’s undervalued currency, relatively low wage growth and repressed interest rates show little sign of reversal — and these are crucial factors in repressing household income growth.

But with a decreasing trade surplus, declining foreign exchange reserves and even occasional expectations of a currency depreciation, estimates of the renminbi’s undervaluation have been significantly re-evaluated downwards. Wages have in fact grown rapidly, and while regulated interest rates did not change much, the proportion of financial intermediation subject to market-based interest rates has risen sharply. These are exactly the types of changes that are driving a rebalancing of the Chinese economy and recovery of consumption.

Reports of China’s declining consumption share are exaggerated, and the official statistics are partly to blame. Rather, the opposite appears to be true, with China’s consumption share already starting to expand.

Yiping Huang is Professor of Economics at Peking University and Professor at the China Economy Program, the Australian National University. He is also Chief Economist for Asia at Barclays Bank, Hong Kong and co-authored the report The Great Wave of Consumption Upgrading (January, 2012).

1. Rebalancing China’s economic structure
2. Sustaining economic growth in China
3. Malaysia’s New Economic Model as a rebalancing strategy

China’s vice president, Xi Jinping, is set to make a hugely important visit to the US next week, prior to succeeding President Hu Jintao as China’s next president later this year.

The visit will set the stage for interaction between the next generation of Chinese leaders and American political leadership and help to shape how the most important bilateral relationship in the world will be managed over the medium-term future.

In recent times, the political-security dimension of the Sino-American relationship has received increasing attention, as the US ‘pivots’ toward Asia. But core and immediate challenges concern the economic relationship and how rapid change in the Chinese economy plays into US and global interests. These matters will be at the forefront of Mr Xi’s meetings when he visits Washington.

In a recent interview in the Wall Street Journal Nick Lardy argues that ‘if China does not accelerate the pace of reforms that support rebalancing, when global growth resumes a more normal pace, China’s external surplus likely would expand again. That would mean that China again would be subtracting from economic growth in the rest of the world, including the United States. That would make it more difficult for the United States to reduce its budget deficit to put its government debt on a more sustainable path’.

Lardy’s lead essay this week reflects the view set out in his new book that correcting the numerous imbalances is necessary to propel China toward a new and sustainable growth path.

Among the problems, Lardy says, are: a low share of private consumption expenditure and a super-elevated share of investment in GDP; an outsized manufacturing sector and a diminutive service sector; an unprecedentedly large hoard of official holdings of foreign exchange; and an increasingly high and probably unsustainable rate of investment in residential property. Mitigating these imbalances will require fundamental market-oriented reforms. The pace of reform will need to be accelerated to achieve sustainable, domestically driven growth and harmonious relationships in the international economy, notably with the United States.

Chinese economists, such as Yiping Huang at Peking University, have made the same point about the distortions in Chinese markets that need to be addressed to correct imbalances in the economy.

Lardy worries about the tardy pace of reform in China. ‘Market-oriented interest rate liberalisation, eliminating the under-pricing of energy and other factor inputs used predominantly in manufacturing, greater flexibility of the exchange rate and an even more rapid expansion of the social safety net are essential to moving China onto a consumption-driven growth path. Many of these reforms have been on the agenda for a decade or more’, he says, ‘yet with the exception of increased social expenditures, progress has been painfully slow’.

According to Lardy, the explanation is that financial repression, the undervaluation of the currency, and factor price distortions advantage some sectors and regions of China at the expense of others. The benefits of unbalanced growth flow to export- and import-competing industries (which enjoy elevated profits at the expense of firms in the service sector), coastal provinces (which have enjoyed supercharged economic growth at the expense of inland regions), the real estate and construction industries (which have benefitted from interest rate policies that have made residential property a preferred asset class), and China’s banks (which enjoy lofty profits that come with the high spread between deposit and lending rates set by the central bank) who have acquired disproportionate influence over economic policy. And to date they have been able to block much-needed policy reforms. These reforms are necessary if China is to move toward a more balanced, sustainable growth path.

Lardy also argues that there are immediate dangers to strong growth in China from excessive investment in housing and real estate. The share of residential investment in GDP has doubled to more than 10 per cent between 2003 and 2010, a share far higher than that in countries with comparable per capita incomes. This was induced, Lardy argues, in part by households channelling their savings into housing in the face of negative real deposit rates in the state-owned banking system.

While Huang sees less immediate risk of collapse in the housing market, residential housing has become the single most important driver of China’s economic growth since the middle of the last decade. Lardy is right in observing that this cannot last indefinitely, although how long it lasts is a very important question.

Peter Drysdale is Editor of the East Asia Forum.

1. Sustaining economic growth in China
2. Reform in China: Experience with economic system reform
3. Chinese economic risks

China’s 2009-10 stimulus program was quite successful: growth ticked down only slightly in 2009 while the rest of the world suffered its sharpest decline in 60 years.

But the stimulus program was not intended to address the longer-term structural problems that in 2007 led China’s premier, Wen Jiabao, to characterise the country’s growth as ‘unsteady, imbalanced, uncoordinated and unsustainable’.

Numerous imbalances have emerged in the Chinese economy in recent years: a low share of private consumption expenditure and a super-elevated share of investment in GDP; an outsized manufacturing sector and a diminutive service sector; an unprecedentedly large hoard of official holdings of foreign exchange; and an increasingly high and probably unsustainable rate of investment in residential property. Mitigating these imbalances will require fundamental market-oriented reforms. Continuing the modest, incremental reforms of recent years will not be sufficient to propel China toward a new growth path.

Perhaps the most important source of China’s economic imbalances is financial repression, most apparent in the negative average real return on one-year deposits in Chinese banks since 2003. This is in sharp contrast with the years 1997-2003 when the average real rate was 3 per cent. Negative real deposit rates have had a double-barrelled adverse effect on private consumption expenditures. First, negative rates have depressed the growth of household income, leading to lower consumption. Second, in response to sustained negative real deposit rates, households have sharply increased the share of their after-tax income that goes to savings, further depressing the share of private consumption expenditure in China’s GDP.

Also in response to negative deposit rates, households have increasingly funnelled their savings into alternative investments, notably housing. Since 2003, returns from owning property have far exceeded the interest rate on bank deposits. Housing investment accounted for 5 per cent of GDP in 2003; by 2010 that share had doubled to 10 per cent. This is far in excess of the average share of residential housing investment in other countries with a comparable level of per capita income. This sharp rise accounts for nearly half of the increased share of investment in GDP between 1997-2003 and 2004-10. In short, residential housing has become the single most important driver of China’s economic growth since the middle of the last decade.

But this is not likely to continue indefinitely. First, the share of household wealth held in the form of property has doubled over the past decade; at some point households are likely to seek greater diversification. Second, bank exposure to property, in the form of mortgages to individuals and loans to property developers, has roughly doubled in the past five years. At some point China’s banks may decide the risk of extending even more property loans exceeds the potential returns. Third, household debt relative to income has doubled in the past few years. Household indebtedness in China as a share of GDP is again half as great as households in countries at comparable levels of economic development. With real estate prices now falling, Chinese households may soon decide the risk of incurring even more debt outweighs the potential returns from additional investments in housing. Any of these developments would lead to a slowdown in the pace of property investment, which could potentially have a negative impact on China’s economic growth.

Market-oriented interest rate liberalisation, eliminating the under-pricing of energy and other factor inputs used predominantly in manufacturing, greater flexibility of the exchange rate and an even more rapid expansion of the social safety net are essential to moving China onto a consumption-driven growth path. Many of these reforms have been on the agenda for a decade or more, yet with the exception of increased social expenditures, progress has been painfully slow. The explanation is that financial repression, the undervaluation of the currency, and factor price distortions advantage some sectors and regions of China at the expense of others.

The beneficiaries of imbalanced growth — including export- and import-competing industries (which enjoy elevated profits at the expense of firms in the service sector), coastal provinces (which have enjoyed supercharged economic growth at the expense of inland regions), the real estate and construction industries (which have benefitted from interest rate policies that have made residential property a preferred asset class), and China’s banks (which enjoy lofty profits that come with the high spreads between deposit and lending rates set by the central bank) — have acquired disproportionate influence over economic policy. And to date they have been able to block much-needed policy reforms. But these reforms are necessary if China is to ever move toward a more balanced, sustainable growth path.

Nicholas Lardy is Anthony M. Solomon Senior Fellow at the Peterson Institute for International Economics. He is the author of Sustaining Economic Growth in China after the Global Financial Crisis.

1. Chinese economic reform, full front and centre
2. India: sustaining high growth needs new reform momentum
3. Low-consumption China needs serious reforms

Since the fourth quarter of 2010, the global economy has faced serious uncertainty and a turbulent outlook.

Both the US and Europe have gloomy growth prospects due to a lack of credible medium-term plans for debt reduction in the US and the sovereign debt crisis in southern Europe.

Against the downside risk to growth in the West, Asia’s recovery and growth in the past three years has been exceptional. China and India recorded the highest growth rates in the world with 10.3 and 10.1 per cent in 2010, respectively, while Indonesia, Thailand, Malaysia, the Philippines and Vietnam (ASEAN-5) grew 6.9 per cent. Asia, with a solid global market and a large pool of foreign exchange reserves, has proven to be the shining light of the world economy.

Asia’s future prospects are likely to be affected by the West, yet ‘rising Asia’ also appears able to help save the sinking world economy. Even with weaker demand from the West, Asian growth in 2012 is expected to remain strong on the back of solid domestic demand. But for robust, sustainable and balanced world growth, Asia needs to shift from its conventional extra-regional export orientation to intra-regional demand as a way to help advanced economies recover and to ensure its growth sustainability.

How can Asian governments accomplish these twin objectives amid the current global turbulence? First, they must continue to shift to more domestic demand-based growth in the short and medium term and accelerate ongoing regional economic integration to allow freer intra-regional trade and more cross-border investment. This policy shift will result in two things: greater self-propelled growth and more imports from Western economies, especially the US, which would help correct chronic trade imbalances and raise the growth potential of America and Europe.

Second, Asian governments must minimise external financial contagion and expand intra-regional FTAs to spur sustainable economic growth.

How can they do this? One effective means would be to create a cross-border free trade regime in East Asia. At present, there is a relatively low degree of intra-regional trade share in East Asia. Intra-regional trade among ASEAN+3 countries has increased steadily since 1998, when the Asian financial crisis was subsiding, but slowed a little after 2005. In 2008, the East Asian intra-regional trade ratio, at about 37 per cent, was lower than that of the North American Free Trade Agreement (NAFTA), and far lower than the euro zone’s ratio, with 60 per cent. Considering that the euro zone and NAFTA are free trade blocs, it seems plausible that East Asia could find significant growth sources from its own regional domestic demand if it established an East Asia-wide FTA.

Given the ongoing hub-and-spoke issues around intra-regional FTAs, East Asia should adopt a strategy of ‘doing easy things first’. A good example of such an approach is the Chiang Mai Initiative, which is already under way. The Asian Bond Market Initiative could also be accelerated to provide a viable cross-border financing scheme to small and medium enterprises. In this regard, a cross-border regional cooperation mechanism among sub-regions and mega-cities such as the Pan-Yellow Sea Circle and Greater Mekong Sub-Region could be a starting point.

Northeast Asian integration has great potential to build a robust regional community of peace and prosperity. It is encouraging that China, Japan and Korea in May 2010 agreed to establish a secretariat office in Seoul to address trilateral regional issues. Apart from FTA talks in Northeast Asia, Asian governments in ASEAN+6 need to pay attention to many proposals in cultivating diverse ‘public goods’ such as cross-border oil and gas pipelines and railways to enhance connectivity. Dynamic benefits resulting from a cross-border, bottom-up approach could also be derived from establishing common standards for production technology, product regulations, distribution and after-sales services.

By accumulating success stories for open Asian regionalism, major Asia Pacific economies can work together toward an Asia Pacific Economic Community, which the APEC forum has long addressed. Though it may take time to nurture mutual trust and confidence, Asia should be eager to establish open regionalism which a variety of external stakeholders, including the US, India, Canada, Australia and New Zealand, can join. Asian open regionalism needs to be translated into an Asia Pacific Economic Community to ensure it will be a building block toward viable multilateralism, not a stumbling block.

At this critical juncture of the world economy, East Asian integration must be pursued to increase its own growth momentum internally. Asia must move aggressively to shift its focus to the region’s 3.5 billion consumers so that its intra-regional demand-led growth can contribute to balanced and sustainable global growth. The Greek debt crisis clearly showed that no country can overcome the emerging economic malaise without a strong manufacturing base. Consequently, Asian economies need to strengthen the already existing global ‘manufacturing house’ through intra-regional trading. But Asia is diverse and still not free from historical rivalries. For both its own growth and the good of the global economy, Asia needs visionary political leadership to put historical legacies behind and look toward a long-term vision for an Asia Pacific Economic Community.

Choong Yong Ahn is Distinguished Professor at the Graduate School of International Studies, Chung-Ang University, Seoul.

This is an abridged version of an article that originally appeared here in Global Asia.

1. The DPJ: Sacrificing the economy to ‘save’ agriculture
2. World economy not quite out of the woods yet
3. Economic integration: Will Asia go regional?

The World Bank recently published a valuable research paper (World Bank Policy Research Working Paper 5940 by Justin Yifu Lin and Doerte Doemeland) which presents the evidence needed to justify a globally coordinated initiative in carefully selected infrastructure investment.

A G20 initiative in 2012 could make this happen. G20 leaders have the opportunity to launch a concerted effort to remove the policy and market failures causing serious infrastructure bottlenecks to growth, especially in developing economies. The prospect of a new sustainable source of effective demand could counter the current drift toward a ‘lost decade’ — an extended period of high unemployment, high risks and low returns on investment leading to continued weak growth,high unemployment and debt.

There is no prospect of repeating the coordinated 2009 Keynesian stimulus of increased government spending. Some countries have run out of fiscal space, while others have opted for needless short-term austerity. Consequently, the World Bank paper advocates a new form of fiscal stimulus that is not simply a boost to public consumption, but an investment in future productivity.This form of stimulus would catalyse parallel private investment and serve as a globally coordinated investment initiative, rather than an attempt to stimulate individual economies.

Such a global Keynesian initiative would remove constraints to growth in developing economies, and create new demand in developed economies suffering from high unemployment and excess capacity. Investment in infrastructure can thus generate a virtuous cycle of higher demand, productivity and growth that isconsistent with long-term deleveraging.

The proposal, based on extensive research, argues for the need to find a way out of the current situation, when monetary stimulus is proving inadequate, and when structural adjustment can only be expected to gain traction when demand is revived. Governments need to support demand and employment without adding further to debt levels in the medium run. Providing capital for potentially self-financing infrastructure investment to remove logistic and other constraints to growth would be the best way of doing this.

The report also cites evidence that such a stimulus does not risk crowding out private spending, but can be expected to contribute significantly to employment and growth. The authors demonstrate the potential for profitable infrastructure investment in all economies, while noting that the highest needs and potential returns are in developing economies.

By learning from experience, including the disappointing experience of Japan in the 1990s, it is possible to select the right kind of investment in infrastructure. The paper draws attention to initiatives that support good project selection and design, such as the Infrastructure Action Plan — drawn up in 2011 as part of the G20’s contribution to the development of low-income countries — and the Infrastructure Finance Center of Excellence, which aims at leveraging Singapore’s expertise in urban development and financing.

The G20’s ongoing effort to improve infrastructure in low-income economies should be extended to all economies. Recent estimates of annual requirements for investment and available financing for infrastructure identify a financing gap in the range of US$400 billion to US$650 billion per year. Narrowing this gap would have a significant global macroeconomic effect. The paper discusses numerous options for mobilising additional finance, ranging from domestic revenue raising to local and international bond issuance, and public-private partnerships. These are just some of the ways to steer more of the available global savings toward productivity-boosting infrastructure.

The potential contribution of infrastructure investment to promoting global economic recovery has been discussed for a while. And at a time of deficient global demand, the huge savings of emerging economies — most of which are generated in Asia — are intermediated chiefly in the financial markets of New York and London. Rather than financing productive infrastructure, much of the world’s savings are financing the deficits of already heavily indebted developed economies. The time has come to deal with this massive global financial market failure. Asian members of the G20 have put the infrastructure opportunity on the G20’s growth agenda. This well-researched World Bank paper should ensure it rises to the top of that agenda.

It will take time and creative thinking to meet the financing needs for infrastructure.  A High-Level Panel on Infrastructure appointed by G20 leaders delivered a useful report at the 2011 Cannes Summit. That report contains recommendations for improving the institutional and enabling environment for investment in infrastructure, and ideas for financing infrastructure projects with significant but delayed returns to investors and how to manage project risks.  But the Panel focused only on much-needed infrastructure in the world’s most difficult investment environments, especially sub-Saharan Africa.

The issues of institutional capacity, innovative financing and risk management need attention everywhere and need to be addressed if investment in infrastructure is to provide a globally significant boost to effective demand.  G20 leaders should now challenge their officials, financial-sector managers, and international financial institutions to find ways to intermediate savings to finance more investment in infrastructure.  These ideas can be directed to financing both public and private investment in commercially-viable investment in infrastructure wherever it is needed.  A high-level conference of the world’s leading experts on these issues, which might be organised by the World Bank could be a useful first step in that direction.

Dr Andrew Elek is Research Associate at the Crawford School of Economics and Government, Australian National University. He was the inaugural Chair of APEC Senior Officials in 1989.

1. How can Asia help fix the global economy?
2. Global imbalances and the paradox of thrift
3. APEC’s new ‘financial inclusion’ initiative

There is a widespread belief among Thais that immigrants reduce local workers’ job opportunities and depress wages.

This is evident from an opinion survey study conducted in late 2010 by the International Labour Organisation (ILO) Triangle Project on public attitudes to migration and migrant workers. An alarming 89 per cent of respondents agreed with the statement that ‘Government policies to admit migrants should be more restrictive’, while only 40 per cent believed that migrant workers make a net contribution to the economy. The results echo previous findings from another ILO/UN Women-commissioned study conducted by Assumption University in late 2006, which found that most respondents believed that migrant workers should not be able to apply for any job, and that Thailand did not need migrant workers to sustain its manufacturing and agricultural industries.

The negative attitudes revealed by that survey were fuelled by concerns over the sharp increase in the number of migrant workers, which nearly doubled from 2004 to 2007. As of 2007, immigrants represented around 5 per cent of the country’s workforce of 36 million. Most migrant workers in Thailand come from the Greater Mekong sub-region; approximately 75 per cent come from Myanmar and 12 per cent each from Cambodia and the Lao People’s Democratic Republic. These immigrants are largely young and low-skilled, and around three-quarters are unregistered or undocumented.

The fact that an increasing number of migrant workers — documented or undocumented — are demanded in key industries such as agriculture, fisheries and construction indicates that these industries now depend on foreign labour. Clearly, restricting migrant workers’ ability to work in these industries would adversely affect the Thai economy. Recent estimates by Martin and Pholphirul suggest that the contribution of migrant workers to Thailand’s real GDP is approximately 1 per cent per annum. Given that migrant workers constitute 5 per cent of the country’s total workforce, their disproportionately low contribution to GDP reflects their lopsided presence in low-productivity industries.

The Thai economy is characterised by the coexistence of a capital-intensive formal sector and a large labour-intensive informal sector which employs mostly low-skilled and temporary workers. Employers in this sector usually offer lower wages without benefits or job security to their workers. The Thai labour force’s rapidly increasing education levels mean that younger Thais are now turning away from informal so-called ‘3D’ (dirty, dangerous and demeaning) jobs. This growing void has been filled by incoming foreign workers, the majority of whom have attained less than a lower primary education.

Greater inward migration over the three-year period from 2004 to 2007 caused only minor adverse effects on the least-skilled local workers’ job opportunities. Even in the presence of a large number of migrant workers, the Thai labour market continued to tighten and the unemployment rate for the least-skilled workers declined further over the following three years to 0.35 per cent in 2010. The aggregate unemployment rate was also at a very low level, at roughly 1 per cent. A tightening labour market at the low end of the skill distribution is also evident in the large increases of hourly wages for workers at the bottom end of the wage percentile which were observed over the period from 2007 to 2010. It is clear that the availability of migrant workers is buying firms in the less-productive industries more time to adopt labour-saving technologies or to relocate if required.

Consistent with previous studies, there appears in fact to be a small negative impact of 0.69 per cent on local workers’ average wages, the wages of those who have at most a primary education. The wage effect of new migrants on existing migrant workers is larger by comparison, at roughly negative 2 per cent. Due to their complementarity in production, the inflows of low-skilled immigrants are found to raise the productivity and hence average hourly wages of native workers with a high school or college education by 0.56 per cent and 0.57 per cent, respectively. Due to the larger share of high school- and college-educated workers in the Thai labour force, and the higher wages commanded relative to the less-educated groups, it is clear that there is a net gain in the wages of local workers from immigration. The positive effects on the wages of skilled workers (high school and college graduates) outweigh the negative effects on the wages of native low-skilled workers.

Dilaka Lathapipat is a recent PhD graduate in economics at the Australian National University, and is now Research Specialist at the Thailand Development Research Institute, Bangkok.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Where is Thailand Headed?’.

1. Why labour market flexibility in Japan is so difficult
2. A tale of two cities: Chinese labor market performance in 2009 and reform priority in 2010
3. Moving together to liberalise labour in East Asia

Joining the WTO in 2012 marks the culmination of a long period of transformation for Russia, which first applied for membership in June 1993, and finally had its terms of entry accepted on 16 December.

To join the WTO, Russia has had to overhaul its national laws to bring them into conformity with the global trade regime, and work out bilateral market-opening deals with all other members. Russia has agreed to slash tariffs, get rid of industrial subsidies and allow foreign companies greater access to its domestic market. The most important of these concessions is market access for foreign service-sector companies and banks, which was eagerly sought by European Union states.

WTO membership will offer Russia some of the tools needed to rebalance its economy, which relies heavily on selling the nation’s oil. As a major oil exporter, over 50 per cent of its foreign trade is already tariff free. But the metallurgy and chemicals industries stand to gain from increased market access and protection from anti-dumping measures. In time, other industries will benefit from restructuring and increased productivity stimulated by increased competition.

Russia needs foreign capital in order to modernise, and is aware of the need to project a more positive investment image. The largest gains from WTO membership will come from increased foreign investment in the Russian market for services. Clearly, WTO membership alone will not convince cautious investors — but opening the Russian economy to international practices can only have positive benefits for the business climate. Russian citizens will also benefit from WTO membership, not just because they will obtain access to cheaper goods, but also because greater infrastructure will be created to support local industries. WTO membership will ultimately mean a more predictable trade market in Russia, which is very important given the current global financial situation.

Yet it presents challenges, too. While membership promises increased market access for Russian exports, Moscow will have to open the country to foreign imports. Agreements will need to be implemented as a means to attract investment, stimulate trade and increase competition.

The challenges of membership are not limited to economic policy — they also undermine the political model that has come to define Russia since 2000. Under Putin, Russian citizens accepted reduced political freedoms in exchange for stability and economic growth. As a WTO member, Moscow will have fewer means to support inefficient industries against competition from abroad. This could cause problems for the many towns that rely on one factory or industry for jobs and public utilities.

In the short run, reducing tariffs and other protective measures for import-sensitive industries, such as cars and aircraft, and opening up key financial service industries — banking and insurance — to foreign competition could lead to the loss of jobs in those areas. As such, the Russian government may need to provide unemployment insurance and other adjustment assistance. But globally competitive industries, such as the raw-material producers, could see international markets opening up and an increase in foreign investment as accession forces Russia to restructure its economy.

In the long run, evidence from economies that have gone through similar transitions suggests that trade liberalisation will lead to a more efficient Russian economy and better living standards for the average Russian citizen. New industries will probably emerge over time, helping to diversify the Russian economy.

Until now, Russia has been the largest and most populous country not party to the WTO. Russia’s accession will significantly expand the geographical coverage of WTO rules to all major economies, bringing a larger degree of stability and transparency to the international trading system. At the same time, Russia’s entry into the WTO would continue a trend in which, as the WTO becomes larger and more diverse, it becomes more difficult for that membership to reach a consensus on important issues. In addition, trade disputes between Russia and its trading partners will be brought to the WTO for resolution rather than being addressed bilaterally, adding to the WTO’s ever-growing caseload.

Still, to become a truly open economy, Russia will need to use WTO membership as a springboard for wider economic change. It still looks likely that Putin will be the one to face the tough realities of implementing WTO commitments, but he leads an elite that has long favoured protectionism and subsidy over serious reform. The long-term benefits of membership should nevertheless outweigh its initial costs. Russia will have to make courageous decisions on which industries are truly sustainable, and take measures to protect the population from the costs of adjustment.

Abdur Chowdhury is Professor and Chair at the Department of Economics, Marquette University, Milwaukee. 

1. Russia debates the impact of WTO membership
2. Russia and APEC 2012: imaginary engagement?
3. China’s development since WTO accession

India’s food price inflation has been a major driving factor behind the country’s accelerating inflation over the past few years.

In particular, agricultural food prices rose sharply during 2011. The price of vegetables increased by 18 per cent; pulses by 14 per cent; milk by 10 per cent; and eggs, meat and fish by 12 per cent. Fruit and cereal prices also increased, albeit by a smaller margin of 5 per cent and 3 per cent, respectively.

These price escalations are largely due to an inefficient supply chain in agriculture. Some factors which affect agricultural supply and help raise food prices include poor agricultural productivity, a lack of corporate involvement in agriculture, ceilings on landholding size, the existence of middlemen, hoarding, and, more importantly, insufficient cold storage facilities and transportation infrastructure. Around 50 per cent of fresh produce in India rots and goes to waste between the farm gate and the market because of inadequate cold storage facilities and a poor distribution network.

Controlling food price inflation has become an urgent policy objective for the Indian government because of the regressive tax that inflation imposes on Indian consumers. Moreover, persistent and spiralling food inflation threatens the country’s macroeconomic stability and its potential for high and sustained economic growth in the future. Consequently, the Indian Cabinet approved 51 per cent FDI in multi-brand retail on 24 November after intense deliberations at different levels that extended over a year, although these reforms have since stalled. With the clear objective of curbing inflation, the policy came with some riders to protect the interests of neighbourhood stores, farmers, and small- and medium-sized enterprises.

If effectively implemented, allowing FDI has the potential to streamline and modernise the sector through a number of ways. First, the development would bring in foreign capital, technology and the managerial expertise of big international retailers. Second, it would‬ develop an efficient linkage between the back-end supply chain and the front-end via capital investment and technological inputs,‬ creating a proper farm-to-fork infrastructure through direct purchase from farmers and the resultant control of intermediaries. This will also ‬bring about efficient movement of produce through the reduction of transit costs. Third, it would ‬minimise the prevailing wastage of fresh produce by improving upon the country’s existing cold-storage facilities, transport infrastructure, warehousing technology and food-processing facilities. Fourth, FDI should‬ help raise farm productivity through the application of contract farming, increase agricultural production, reduce intermediate costs, render remunerative prices to farmers for their produce and eventually lower final ‬food prices to consumers, thus integrating retailers into the value chain. And fifth, it would create employment in small- and medium-sized industries and back-end infrastructure.

Despite regulatory provisions to ensure domestic competition and protect the domestic retail industry and farmers, the policy received stiff opposition. Concerns included the possibility of foreign entrants’ monopoly power over both farmers and consumers; predatory pricing strategies by the new entrants; manipulation of prices for the entrants’ own benefit and a fall in income, employment and the eventual destruction of the unorganised indigenous retail sector, which is dominated by small family-run outlets.

But it is important to remember that other countries like Argentina, Brazil, Chile, China, Indonesia, Malaysia, Russia, Singapore and Thailand have allowed 100 per cent FDI in multi-brand retail since the 1990s, with encouraging experiences. China, for one, permitted FDI in retail as early as 1992. It has since attracted huge investments in the retail sector without affecting either small retailers or domestic retail chains. Since 2004, the number of small outlets has increased from 1.9 million to over 2.5 million in China. Employment in the retail and wholesale sectors also increased from 28 million to 54 million from 1992 to 2001. And in Indonesia, even after 10 years of opening up to FDI in multi-brand retail, 90 per cent of business remains with small traders.

The favourable experiences of other emerging markets suggest the appropriate implementation of FDI in multi-brand food retailing, with effective checks designed to protect indigenous small- and medium-sized enterprises, will eventually alleviate the supply-side impediments to agricultural production. It will transform the way perishable agricultural produce is acquired, stored, preserved and marketed — and thus help control India’s persistent food inflation.

Nandita Dasgupta teaches economics at the University of Maryland, Baltimore County. She is also Visiting Faculty at Johns Hopkins University. A version of this article was first published here in Columbia FDI Perspectives. 

1. Indian food stocks, prices and the exchange rate
2. Beating back India’s retail Luddites
3. The Indian Budget: Give it the benefit of doubt

India’s economy was one of the earliest to stage a turnaround after the global financial crisis.

The decisions taken in early 2008 to increase public-sector wages, forgive loans for farmers who had borrowed from the banks, and massively expand the rural-employment guarantee scheme assisted the economy before the global financial crisis unfolded in the last quarter of the year. Not surprisingly, India staged its recovery within two quarters of the crisis striking, as economic growth accelerated from 6.7 per cent in 2008–09 to 7.2 per cent in 2009–10 and 7.5 per cent in 2010–11. Most forecasts for 2011–12 predicted over 8 per cent growth. But the economy has shown significant signs of slowing down. With the economy growing at about 6.9 per cent in the second quarter of 2011, and the November estimates of industrial production showing over 5 per cent decline, it is now expected that the growth rate for 2011 may even fall below 7 per cent.

The moderation in India’s economic growth rate was not the only matter for concern in 2011. The economy possesses a number of structural imbalances, and no effective mechanisms have been put in place to correct them. The government has not been able to control fiscal deficits at the budgeted levels and it is now expected that the central government’s fiscal deficit will be about 5.5 per cent of GDP and the consolidated fiscal deficit around 8 per cent. With the annual losses of state electric utilities amounting to 1 per cent of GDP, the government’s overall fiscal situation is not much different than it was at the beginning of the decade. Providing for additional expenditure commitments in education, healthcare and food security will be a daunting challenge over the coming year — especially when combined with the political difficulty of phasing out ill-targeted subsidies and achieving fiscal consolidation in the medium term.

There are worries on the balance-of-payments and inflationary fronts as well. The virtual stagnation of the global economy has resulted in stagnating exports for India, and as crude oil prices remained elevated throughout 2011, a high growth in imports also continued. With exports even slowing in the services sector, India’s current account deficit is likely to touch 3 per cent of GDP. In normal times, this could have been managed with capital inflows, but, with foreign institutional investors shying away from India, financing a deficit of this order will pose problems. Not surprisingly, the value of the rupee plummeted by over 20 per cent in the last few weeks, and even with the Reserve Bank of India in possession of reserves surpassing US$300 billion, a significant depreciation of the rupee could not be prevented. In the next six months, India will have to repay foreign loans of over US$140 billion, but problems may arise if the lenders refuse to roll over the credit. In addition, the inflation rate for 2011 is likely to be close to 10 per cent, and the rupee’s falling value has not helped matters.

The major concern for 2012 is the government’s apparent inability to forge political consensus and enact reforms which could bring in FDI and institutional investment. The last few months have raised serious questions about the government’s ability to carry forward much-needed reforms. These issues of governance — teamed with the inability to phase out subsidies or achieve fiscal consolidation — and India’s ‘policy paralysis’ in several areas are serious cause for worry. But crisis is the mother of reform, and the difficult situation should force the Indian government to act. The government has an 18-month window to carry out reforms before electoral politics overtake policy making. Hopefully, it will muster enough support by forging consensus on important economic reform policies, remedy the structural imbalances and revive the economy to reach the trend growth rate of over 8 per cent.

M. Govinda Rao is Director at the National Institute of Public Finance and Policy, New Delhi, and a member of the Economic Advisory Council to the Indian Prime Minister.

This article is part of a special feature: 2011 in review and the year ahead.

1. The Eurozone crisis and prospects for India
2. India: The discipline of liberalisation
3. Incredible India? Complicated India

Consensus-based policy making is a salient feature of Vietnam, where important decisions are collectively made.

Consensus is needed not only for the formulation of a reform vision but also for the elaboration and implementation of this vision. Doi Moi, the most successful economic reform to date, would certainly not have occurred in 1986 if no consensus were reached at the VI Party Congress.

A series of events in 2011 indicate that a vital consensus for the acceleration of economic reforms has been attained. Vietnam’s first major economic event for 2011 was the Communist Party Congress held in January, which set out Vietnam’s development strategy for the next 10 years. Like its predecessor, the 2011–2020 Strategy adopted at the Congress places great emphasis on rapid economic growth, with a target of 7–8 per cent average annual GDP growth over the next decade. The strategy puts increased attention on the quality of growth, including targets on macroeconomic stability and requirements for clarifying the role of the state in a market economy. Nevertheless, the ambitious quantitative growth target suggests a continuation rather than a fundamental break with previous strategies.

But events took a significant turn just a few weeks after the Congress. In late February the government issued Resolution 11, aiming to restore Vietnam’s macroeconomic stability and cool down an overheated economy. Specifically, the resolution sought to address high levels of inflation, tension in the foreign exchange market, high nominal interest rates and declining foreign exchange reserves. The implementation of Resolution 11 remained a top priority in the government’s agenda throughout 2011, and reviews of its implementation continue to take place regularly. Resolution 11 represents a decisive switch from growth to stability. For the first time, there is an official government policy document that completely neglects the term ‘growth’ in its targets. Its longevity signals a significant change in the mindset of Vietnam’s policy makers.

Signs of a radical shift in economic strategy became more evident when the new administration came into power in July. Several workshops and focus group discussions were held to facilitate policy dialogues regarding the restructuring of Vietnam’s economy to improve efficiency and competitiveness. From this process, consensus was reached on Vietnam’s strategic development priorities, identifying major areas for reform in the coming years. This consensus argues for radical transformation in three areas: state-owned enterprises (SOEs), the financial sector and public investment. The need for reform was also officially documented in the Socio-Economic Development Plan (SEDP) for the period 2011–2015, which was approved by the National Assembly in November.

Following these events, Vietnam recorded good economic growth in 2011, with an estimated rate of GDP growth at 5.8 per cent. Exports performed very well, increasing by 33 per cent despite a significant decline in global demand. This robust GDP and export growth prevailed over a significant contraction in fiscal and monetary policy, and Vietnam’s strong export performance contributed notably to the reduction of trade deficits and the foreign exchange market’s stabilisation. The rate of inflation also slowed in the last four months, largely due to the implementation of Resolution 11.

The adoption of Resolution 11 and the SEDP in particular indicate that Vietnam has achieved consensus on accelerating market-based reforms in ‘difficult’ reform areas, namely SOEs, the financial sector and public investment. The recent release of an ambitious proposal for SOE reform through to 2020, developed by the National Steering Committee for Enterprise Reform and Development, provides further evidence of this consensus. According to the proposal, about 44 per cent of the remaining 1300 full SOEs will be equitised in the next four years.

In this context, 2012 will be a very challenging year for Vietnam. The country still has to deal with an overheating economy, and inflationary pressures remain a genuine threat to the country’s economic stability. The banking sector is vulnerable, with a rising share of non-performing loans resulting from a long period of extraordinary credit growth. Challenges also lie in transforming the SEDP’s vision into specific actions. The plan calls for a fundamental restructuring of the economy, and while many agree on the vision of the reform, the formulation of a feasible action plan will take time, owing to the likelihood of resistance from economically strong interest groups.

The Vietnamese government is developing a detailed action plan for its ambitious restructuring strategy. It is expected that this plan will be approved by the end of the first quarter of 2012. The timeframe looks very ambitious as consensus for detailed actions still needs to be built. But there is a significant factor which may speed up the implementation process: while the market economy was an unfamiliar concept in previous times, it now receives strong support from the vast majority of Vietnamese people.

Dr Doan Hong Quang is a Senior Economist at the Poverty Reduction and Economic Management Unit, World Bank, Vietnam. This is part of a special feature: 2011 in review and the year ahead.

1. Malaysia’s economic transformation
2. Managing the risk of inflation during economic recovery – the case of Vietnam
3. Vietnam sails through the crisis but needs reform to sustain the growth