Economy needs more than just speed-breakers
Zhang Xiaogang
2004-05-26

It's useless to argue whether the mainland economy is once again growing too fast, or overheating.

When investment in fixed assets grew (our sources in Beijing didn't cite the specific amount), 53 per cent in the January-February period compared with the same period last year and hit a peak since 1994; and when the supply of energy and raw materials are under their worst strains, hardly anyone can have the confidence not to say the economy is overheating.

China is overheating. There is no question about it. And the central government has been trying various tactics to cool it down beginning with the corporate finance regulations for real estate developers issued by the People's Bank of China last year. But apparently, just a few attempts at intervention didn't suffice.

Some industries, which may have only short-term profits and are not encouraged by national development planners, consumed more capital than others. Investment in new steel works, for example, surged more than 170 per cent from a year ago.

As dangerous signs (not just high investment, but also inflation) were popping up here and there, Beijing was forced to take even stronger measures. Many big-tick investment projects, started without going through proper approval procedures, were suspended on the direct orders of central government officials.

For the first quarter, fixed asset investment amounted to 879.9 billion yuan (US$106 billion), an annualized growth of 43 per cent. April's fixed asset investment was 399 billion yuan, with annualized growth brought down to 35 per cent, almost 20 percentage points lower than the first two months.

Effective tactics

Now, with more encouraging macro-economic reports at hand, we have confidence to say that the central government tactics are at last proving effective. These are important to help maintain the state of health of one of the world's largest powerhouses of economic growth.

But can we be confident enough to claim that the economy is being sufficiently cooled down, and there is a guarantee of a "soft landing," or its return to growth at a normal speed? No. It looks that China still has to do a lot more work to reach that point.

The mainland economy is different from the past in that many of the big investors are from the private sector whether in public infrastructure or in such capital-intensive industries as steel works and cement mills. This is why some analysts say the economy's overheating this time may be a good sign, or at least have a good side that the private sector is for the first time in China's history becoming the main investor in society.

However, no matter the investors are from the private sector or from government institutions, they all rely on the same banking services. There's only one financial system in the nation. Squandering by investors, no matter who they are, would inevitably affect the financial system, already notorious for its chronic inefficiency and bad loans.

But if the banks' big lending projects are all wasteful projects, which are later suspended by the central government, how can they avoid incurring new bad loans?

Beijing's emergency measures of economic intervention have so far only helped the economy cool down. They are still far from enough to help the investors choose more sensible projects. A lot more work is to be done to prevent the economy from overheating time and again.

Regional reforms

A careful look into wasteful investment projects reveals the fact that many of them are, directly or indirectly, endorsed by the local governments. Private-sectors investors would hardly be able to embark on bold projects without support from their friends in the government.

Nothing can be done to prevent this from happening. It is because, by definition, local officials' portfolio would include creating new jobs, building new industries and new cities, and generating greater incomes for their constituencies.

The only realistic option for China, therefore, is to make the local officials plan viable and worthy investment projects rather than wasteful ones. That would call for a series of actions other than simply interfering with the speed of the economy, most importantly a reform of the regional public finance system, or how a local government sponsors and finances regional development projects.

To ensure regional public finance reforms are carried out, a number of decision-making standards and best practices should be recommended by the central government. This is the only way to eradicate the cause of the economy's cyclic overheating processes.

 
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