Natural disasters

The two natural disasters that preceded the Olympics revealed China as a big economy, but not a strong one. The snow storm left millions of travelers and families shivering and stranded; and a large part of the country in shambles, its people exposed to the vagaries of nature.

The deadly 8.0 M Sichuan earthquake on 12 May, claiming almost 100,000 lives, also exposed the fragility of Chinese infrastructure – despite the worldwide admiration of China’s rescue efforts and the formidable courage and compassion of the Chinese people at its epicentre. During the first couple of days, no contact was possible with the outside world from the earthquake zone and many lives were lost because of poor rescue equipment and the collapse of low-quality buildings.

Milk scandal

The melamine milk scandal broke in July and by November China reported an estimated 300,000 victims: many infants died from kidney stones and other kidney damage. The World Health Organization referred to the event as one of the largest food safety events it has had to deal with in recent years.

The milk scandal exposed a host of problems: poor governmental supervision, inadequate law enforcement, and the power of special interests amongst them. The milk scandal also exposed a more general problem of food safety in China, and China has moved to adopt stricter measures to ensure the food safety. After all, GDP is only part of the story of development: people’s lives, protection and living standards are the ultimate purpose of economic development.

Olympics, China and the world

With the Olympics, China moved to centre stage in living rooms around the world.

As China stepped up onto the international stage, the inevitable question was how should China seek to understand the world, and how should the world seek to understand China. The Beijing Olympics was a good first test in examining this question.

As the Chinese people were preparing to show their hospitality to the world, the torch relay was met by violent protests in some western countries about a range of political issues. Some western politicians even called for a boycott of the opening ceremony. This caused many Chinese people to rethink the relationship between China and the west.

Eventually, China hosted an ‘exceptional’ Olympics with a spectacular opening ceremony, and efficient organization, involving thousands of dedicated volunteers. The Olympics saw many western people change their view of China after experiencing the reality in China and seeing Chinese people up close. Thanks to the Olympics, China has also become a more open and tolerant, as well as a more tolerated, society.

Reforms in 2008

In 2008, China restructured government through the creation of ‘mega-departments’. The number of ministries was reduced from 31 to 27. The target is to establish a service-oriented government and improve governance efficiency through streamlining the overlapped functions of different government departments.

An important milestone event in 2008 was the land reform at the 3rd plenum of central committee of CPC. The duration of farmer’s land use right was extended from 30 years to ‘long term’, and farmer’s interests and rights are to be strictly protected under new laws. Though the transaction of land use rights is not the focus, the door is now open for transaction in land and for capitalist agriculture.

Other major reforms included: value-added tax reform to eliminate the overlapping taxes and encourage equipment investment, and fuel tax reform to abolish the road maintenance fees and other charges.

Tacking and jibing economic policy

This was a year to test the ability of China’s economic team in tackling new and complex economic problems. Though these tests were huge and are ongoing, 30 years of experience in policy development has created, it is fair to say, a considerable legacy in policy management skills within the leadership team.

At the beginning of last year, the priority of macroeconomic policy was to control inflation and prevent overheating of the economy (so-called two ‘prevents’). The Chinese boom was driven by export-oriented growth and related investment spending. Two interdependent steps were required: one to balance China’s trade surplus through RMB appreciation, reducing export-tax rebate, and other trade policies; the other to transform China’s economy from export-oriented to domestic market based growth. If it hadn’t been for the financial crisis, the expectation was that this might be achieved smoothly within 3 to 5 years.

Mid-year, there were already signs that overheating was no longer a serious problem, and China’s economic growth was about to slow. The central government promptly adjusted the policy from ‘two prevents’ to ‘ensure stable economic growth and control inflation’. Monetary and fiscal policies were relaxed accordingly.

In the fourth quarter, the world economic crisis deteriorated rapidly and China’s downturn was worse than expected. The central government initiated 4 trillion yuan economic stimulus package in November and introduced measures to stimulate consumption and exports.

The estimated 9 per cent growth in 2008 is not bad, but many investors suffered in the stock market collapse as the Shanghai Composite Index plummeted by 65.5 per cent. The ups and downs of international commodity market also had a negative impact on the Chinese economy and taught Chinese investors a serious lesson on market risk.

The challenges ahead

The most immediate challenge is to tackle the current economic crisis and hold growth up at around 8 per cent in 2009. The medium and long term challenge is how to improve China’s market system and political institutions.

This year is the 60th anniversary of the foundation of the People’s Republic of China. The economic blueprint for 2009 was outlined at the three-day Central Economic Work Conference at the end of 2008. The primary goals are ‘ensuring high growth, expanding domestic demand, and upgrading the economic structure’.

The growth target in 2009 is set at 8 per cent. Though 8 per cent would be the lowest growth rate in China since 1997, it would be a relatively high growth in the context world recession. The biggest uncertainty for China’s own performance is where the world crisis heads in 2009.

The inflation target is 4 per cent. If exports continue to drop, there could be deflation but the proposed reforms in resources sector could be inflationary. The acceleration in government spending could also translate into inflation.

Though China’s trade surplus in November 2008 reached a record high, the overall contribution of the trade surplus to its GDP growth is likely to have been negative or zero in 2008. Though the transformation of China’s economic growth pattern requires balanced trade, trying to achieve trade balance through the financial crisis would have a negative effect on the economy. In 2009, China will try every effort to stimulate its export.

The biggest challenge is employment. China needs to create about 10 million new jobs each year to absorb labor growth. A sizable proportion of the unemployed are migrant workers who have land in their hometowns. This is one reason why China is very cautious in dealing with the issue of land privatization. Access to land plays a role in security for migrant workers.

Chance for reform

The 4 trillion yuan stimulus package ushered in an ‘active fiscal policy and appropriately easy monetary policy’. Government and government-related investment is growing quickly, but private investment remains in the doldrums. A major problem for China’s economic growth is how to stimulate private investment (a core element in growth in the past) and private consumption.

The key will be further reform. The recession actually provides the chance to wind up the momentum of reform in 2009. Expanding the domestic market and upgrading industrial production requires reforms in line with ‘liberalization, deregulation and decentralization’. These reforms are necessary to make the market system work better.

To stimulate private investment, China needs to get rid of barriers to entry barriers in sectors that are monopolized (such as telecommunications, transport, urban utilities, financial sectors, healthcare, education), and reform its investment system. To expand domestic consumption, social security and healthcare system must be reformed. As inflationary pressure is alleviated, energy and resource price reforms can also be introduced.

Building soft power

If economic power can be called hard power, then what China most needs to improve is its ‘soft power’ through strengthening institutions and instigating a cultural renaissance. China is a country with 5,000 years of civilization. It was one of the most prosperous countries in the world until industrial revolution in the 18th century. The economic success in the past 30 years has imbued the Chinese people with a strong sense of optimism and confidence in the future. A civilization that has survived 5,000 years, can now build a culture compatible with the pillars of modern civilization in a globalised world: a strong market economic system and democracy.

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Yongsheng Zhang is Senior Research Fellow at the Development Research Center of the State Council (DRC), PRC and Professor of Economics at Renmin University, Beijing.

This is part of the special feature: Reflections on developments in Asia in 2008 and the year ahead