Nout Wellink：My Take of China’s Economic Policy

2019-07-28 IMI

Nout Wellink , m ember of IMI International A dvisory B oard , Former Governor of the Dutch Central Bank Introduction The Chinese economy is the second largest in the world. At the same time it ranks 73rd on a GDP per capita basis (IMF, 2018). This results in kind of a quandry: some observers focus on the size, others on the living standard of ordinary people. The legitimate ambition of the Chinese Authorities is to substantially raise these living standards in the next decades. The result will, absent shocks, be an economy that is in absolute terms larger (in the long run much larger) than today’s number 1, the US-economy. As to the long run, if the per capita gdp would be at the level of, e.g., my country (the Netherlands), the Chinese economy would have outgrown the US with a multiple of more than 3. This perspective explains to some extent the fast growing tensions between the US and China, the two most powerful countries in the world. The daunting task in front of us is how to smoothly integrate an economy of the size of China into the global economy. Not only the present and future size of the Chinese economy makes this integration process without precedent in economic history, but also the economic, cultural and political differences that still exist. China is creating a market economy that fully participates in the global economy, but with Chinese characteristics and under the strong leadership of the Party. This sounds anathema to Western observers, but I think that it is important to try and understand this model that is indeed different from the model existing in the Western part of the world. “It makes”, as Andrew Sheng and Xiao Geng wrote, “little sense to view Chinese political developments through a Western lens, especially at a time when the world is shifting from a unipolar to a multipolar system” (1). I agree with this, but that is not to say that there should not be mutual respect for each other’s values and approaches when the two worlds meet in the international arena. Living up by all countries to the internationally agreed-upon trade rules is of paramount importance. The necessity of a smooth, gradual transition and integration process A smooth transition and integration process is in everybody’s interest. An economic disruption would not only hit China hard, but also heavily affect the global economy. Let’s not forget that China nowadays accounts for one-third of global growth. Especially since the beginning of the financial crisis this country has become the locomotive not only for Asia but also for the rest of the world. An important figure in this context: China succeeded in reducing its current account surplus, after an all time high of 11,1% of GDP in December 2006, to less than 2% in 2011, thereby substantially contributing to the growth in other countries. In the subsequent years the surplus hovered around that figure. Without China the financial crisis in the rest of the world would have been much deeper. But it came at a price. China is still suffering from some legacy problems due to its mind-boggling crisis program. For 2019 and 2020 a basically balanced current account is expected. Larry Summers, former US Treasury Secretary, rightly stressed last April in The Financial Times that “today China’s global surpluses are far below past negotiations targets of a few years ago” (2). However, in the coming years current account deficits cannot be excluded. China is aging, young people save less and old people will draw from their savings. The savings ratio already declined from the peak of 52% of GDP in 2008 to 46% in 2017 but is still one of the world’s highest, thereby distorting (or mirroring a distortion of) the economic structure. It seems reasonable to assume that in the years ahead the savings rate will further decline. After all, in a richer country the spending appetite of consumers also increases. This could lead to a current account deficit. On the other hand, the foreseen lower growth rate requires less investment. In addition, if the Chinese government would be successful in reducing what is called by the IMF the “augmented” deficit, the current account might nethertheless end up in positive territory. On balance – barring unforeseen developments – I am rather relaxed about China’s current account perspectives. The same holds for the onshore exchange rate, which has been allowed (since 2015) to move in either direction of a daily trading band midpoint set by the central bank. In real terms, on a weighted basis, the rmb (real broad effective exchange rate; REER) has appreciated substantially since 2007 (index 2010=100; February 2007: 89,65, February 2019: 124,51 (3)). In its 2018 Art.4 Consultation the IMF (4) came to the following conclusion: “While the external position was moderately stronger (with the level consistent with medium-term fundamentals and desirable policies) the rmb in 2017 was broadly in line with fundamentals and desirable policies”. Since then the figures have changed a bit (also due to the US pressure on China). From a level of 130 in 2015 the REER depreciated to around 125 in 2019. but I think it is fair to draw the conclusion that China succeeded in realizing reasonably balanced overall results for its exchange rate and current account. The outlook for the capital account seems to me less certain. There is always the risk of sudden outflows, in spite of capital controls. On the other hand, the gradual further opening of its financial markets (recently China extended for example its Renminbi Qualified Foreign Institutional Investers - RQII - program to the Netherlands) will most certainly attract additional capital from foreign sources. This measure was very much welcomed by investors in my country. Therefore, externally China is contributing to a smooth integration process. However, internally the re-balancing process has not been completed yet. President Trump has a different view with respect to the exchange rate. As to the rmb Trump repeated in June 2019 his now well known song: the Chinese “devalue their currency, they have for years; it’s put them at a tremendous competitive advantage”. His own ministry of finance came in the autumn of 2018 to the conclusion that there was no exchange rate manipulation on the Chinese side. The reasons: the current account surplus of China amounted to less than 3% of GDP and the scale of interventions in the exchange markets, co-determining whether a country is manipulating its currency, were clearly not fulfilled. Compared to the peak in 2015 the real effective exchange rate has indeed declined with 4%, but was still substantially higher than on the eve of the financial crisis and broadly in line with the external position. Therefore it would be more logic for the US to focus on the domestic causes of its persistently high current account deficit than blaming other countries. The reserve currency character of the dollar has made it possible for the Americans to live beyond their means for many years in arow. The Chinese economy: a mammoth tanker See the Chinese economy for a moment as a mammoth tanker, trying to harbour in the world economy, Changing the course of such a tanker into the right direction takes time, but making mistakes during this potentially accident prone change of course could turn out to be very costly. I belong to those who are strongly in favour of a step-by-step approach, thus minimizing the risks involved in this harbouring process. After the fall of the wall in 1989 Russia was ill-advised by those (amongst them prominent US economists) who suggested to liberalize the Russian economy more or less overnight. This is a dangerous approach when the country is large and an adequate institutional, supervisory and legal framework is lacking. As we all know, in Russia it initially ended up in economic and political chaos. In the Russian case, two lines of thinking were behind the suggested approach. A dogmatic one, based on the idea that in a liberalized economy all problems would be solved more or less automattically. The other line of thinking was that only quick and drastic measures would create an irreversible situation. The best approach in the Chinese circumstances is to my mind a step-by-step approach, a controlled, gradual integration in the world economy. The real issue is: what does a step-by-step approach mean. How big should these steps in practice be. And how credible is such an approach. Isn’t a step-by-step policy kind of a trick to hide that you do not really want to change. This credibility issue is at the heart of many discussions between Western countries and China. A lot of people in the Western world unfortunately simply don’t believe the Chinese Authorities when they say, as they do, that structural reforms are high on their priority list. Following closely the economic developments in China, I am convinced that the government wants to live up to its promises, realizing that it is in the country’s best interest to deliver. After all, its own credibility is at stake. Admittedly, the process is sometimes a bit slower than outsiders expect, but this reminds me of a famous fairy tale from my childhood. It is about a running competition between a hare and a turtle. Everybody expects the hare to win the race, but it is the turtle. The hare is always distracted during the race, the turtle is very focussed and, although a much slower runner, the first at the finish. Re-balancing measures The step-by-step approach obscures that in recent years in China important economic measures have been taken. Perhaps these measures haven’t been “sold” sufficiently enough. Far reaching measures were, for example, taken in the following area’s: the liberalization of interest rates,, the granting of foreign majority interests in financial institutions, the exchange rate policy, the approach to overcapacity and the protection of intellectual property rights. Let me dwell a bit further on three set of these areas, so as to clarify my case for a step-by-step approach. It is of course outside the scope of this contribution to deal with all the structural reforms. Interest rates During my term as a Boardmember of BoC, China has liberalized to a very high extent interest rates for deposits and loans, but - admittedly - under certain circumstances the authorities still provide so-called “window guidance”. That happened for example when the Chinese SME’s got into financing problems. I see this kind of guidance as a positive element of the Chinese system, but too much pressure on the banks, resulting in loss-making loans, is of course not a good idea. What is needed, is a balance between the social and financial responsibilities of banks. The liberalization of interest rates took several years. Rightly so, because such an approach almost by definition implies a shrinking of the interest margin and a huge pressure on the profitability of banks. Banks will, therefore, engage in new activities, such as the introduction of (complex) wealth management products. But this introduction requires sufficient knowledge of these new products, clear accounting rules, adequate risk management, strong supervision, etc. Continuing with financial repression wasn’t an option either, because then clients of the bank would move to risky products in the shadow banking sector (as they did). The point I want to make is that decisions on certain steps or on refraining from these steps only can be taken if you have thought through all the implications and have sufficiently prepared yourselve to cope with these implications. Sequencing, patience and endurance are crucial in the context of structural reforms. That takes time, but disregarding these aspects is a recipe for disaster. Intellectual property rights As to intellectual property rights, this issue is now hotly debated, especially between China and the USA. My perception is that China started late, too late, with addressing this issue, but it nowadays has a vested interest in protecting intellectual property rights. The country is in the midst of an innovation boom. It is not surprising that Prime Minister Li Keqiang in 2018 stressed that “enhancing the protection of intellectual property rights is a matter of overall strategic significance, and it is vital for the development of the socialist market economy”. The authorities have indeed taken action. It required new legislation, specialized courts, trained judges, etc. A recent article of William Weidman (5) illustrates convincingly that China is seriously addressing local judicial protection, small damage awards, the process of discovery, and the bias against foreign companies. He quotes an earlier study that found that between 2006 and 2011 foreign companies brought over 10% of infringement cases in China and won over 70% of these cases. According to Weightman, today’s winrates average around 80%. A few months ago I myself spoke to a Dutch entrepeneur who has been working in China for several decades. He had won 3 of the 4 intellectual property infringement cases. The fourth went wrong, but in his view rightly so, because he said he had provided insufficient evidence. That said, there is still room for further improvement. The Chinese Authorities themselves have launched a nationwide campaign in April 2019 to tackle the infringement of intellectual property rights. I am not enough an expert to conclude that the situation is perfect, but it seems to me that much more has been done than is often understood by observers in the West. Protection of foreign investors The same holds for the protection of foreign investors. In addition to measures already taken, a new “Foreign Investment Law” will enter into force on 1 January 2020. This is an important law that offers protection to foreign investors in a number of areas: expropriation rules, transfer of profits to foreign countries, equal treatment of domestic and foreign companies, etc. It is a mystery to me why the progress with respect to these topics is not acknowledged, especially because meanwhile several foreign financial institutions, including from Germany,Taiwan and Korea, have been allowed to set up local subsidiairies in China. A few onther examples. A bank of my own country, ING, was allowed to take a majority stake in a joint venture with the Bank of Beijing, and J.P. Morgan has since taken a majority stake in a Chinese asset manager. All of this, of course, does not mean that suddenly it has become very easy for foreign financial institutions to penetrate deep into the Chinese economy. There are all kinds of obstacles, such as the lack of a branch network, the actual monopoly position of the existing banks, costs, etc. As a result, it remains difficult for foreign parties to compete with domestic counterparts. My feeling is that the Chinese government would like to see this happen. Indeed, these measures not only serve the interests of Western investors, but are also in China’s interest. They are needed to channel savings towards more efficient uses and to slow down the growth of the shadow banking sector. As said before, in the context of this article I cannot deal with all the structural reforms that already have been taken or are in the pipeline, but my conclusion is that quite a lot has happened already and is still happening. Results at the macro level A more balanced growth Where have all these developments led to? Is China successful in transforming its economy. China is no longer an economy with double digit growth figures. The focus nowadays is on the quality of growth. Healthcare, poverty alleviation, social security, pensions, the fight against polution and corruption are getting more attention. This policy change was necessary for social reasons but also because growth rates of 10% or more could only be achieved through a combination of exuberant export growth and financial government incentives that for budgetary reasons could not be sustained. Although the official budget deficit was around 3%, the so-called “augmented” deficit ( a broader notion used by the IMF) is in the order of 10%. My feeling is that the IMF is overdoing the “augmentation” a bit, because the government is not responsible for the whole gap between the two figures. On the contrary, it has taken action to escape from that responsibility. To the extent the gap (the deficit of other sectors than the central government) would disappear, this would have the same impact on the economy as a reduction of the official budget deficit. Also for environmental reasons a double-digit growth rate could not be kept up. The present growth figure of around 6.5% is more sustainable and healthy than the previous double digit growth rates. I interpret this figure as something between a target and a best guess. It is more than just a forecast, because the actual growth figures should fit into the ambition of a doubling of gdp in the period till 2020. The consequences of the slowdown in the growth rate are in absolute terms less dramatic than a lot of people think. Since 2007 a doubling of China’s real GDP has taken place. A growth rate of 6,5% now is in absolute terms comparable with, say, 13% in 2007. The growth rate is not only lower, but in terms of composition also more balanced than in the past: a smaller share of exports, more consumption, less public investment. In 2017 the agricultural sector contributed 7,2% to gdp, the industry 40,7% and services 52,2%, to be compared with 10,73%, 47,5% and 41,82% respectively in 2008. All in all remarkable shifts. The figure for the service sector might even be too low, according to an OECD study, the reason being that in the Chinese statistics companies are assigned to their main activity. If a second activity of a company is in the service sector, it is not reflected in the statistics. The objective of the Chinese government is a service sector of 60% of GDP in 2025. This seems to me a realistic goal and implies a further re-balancing of the Chinese economy. State owned versus private sector companies Prime Minister Liu recently summarized (6) in another way how much the structure of the Chinese economy has changed in recent years and has also come to rely on the private sector: 50% of the tax revenues now stems from the private sector, 60% of GDP, 70% from technological innovation, 80% from urban employment, and 90% from new jobs and new businesses. At first glance Prime Minister Liu’s remarks seem at odds with those of President Xi who has repeatedly emphasized the importance of state-owned companies, but Liu’s remarks are not necessarily contradictory to Xi’s. State-owned companies are in President Xi’s view instrumental in the economic development in China. They are important for vital sectors in the economy. Critics in the Western world of this approach often forget that in the past their countries have followed the same kind of policies. I myself have been – on behalf of the government – in the 70s of the last century a member of the supervisory Board of several state-owned companies I also remember vividly the discussions we had, for example, during those days about the abolishment of subsidies for shipbuilding yards. A government being involved in vital industries seems to me a characteristic of a certain phase in the economic development of a country. That does not mean that state-ownership should be forever or that there are no risks involved. One of them is poor efficiency, showing up for example in low productivity, overcapacity, etc. These companies should also not be used for unfair competition on international markets. Furthermore it is often costly and, therefore, subsidizing them is not always the best use of tax revenues. Overcapacity is a burden for the rest of the world in case of dumping on the international markets. But it is a heavy burden for the country itself with overcapacity industries too. China tries to get rid of overcapacity industries but at a gradual pace. My experience with the Chinese banking system is that these issues are being addressed, but that there is still a long way to go. If possible this process should be accelerated but political and social constraints are phenomena the Western world is familiar with too. Since 2013 several million people have lost their job in the overcapacity industries in China. The privatization in China is gaining track and positively influencing the economy. Nicolas Lardi (7) who has analyzed the period since the late 1970’s, concludes that private companies have contributed significantly more to the rapid growth of the Chinese economy than State-Owned Companies/State Controlled (SOE’s) Companies. The root-cause of this is the much higher productivity- and profit increase in the private. An important role has also played that in recent decades the government gradually removed all kind of obstacles to private entrepeneurship and that the large banks, which in the past mainly focussed on financing SOE’s, have become easier to finance private companies. The challenge now is to also improve further the productivity of the SOE’s. Interesting is that, according to Lardi, the share of private companies in the export of China has increased substantially from zero in the nineties of the last century to 44% in 2015. It is in his view not unlikely that this percentage has increased further in subsequent years. This means that the participation of China in international trade is considerably less government driven than in the past, which fits in the re-balancing process. Increase in wage share The rebalancing of the Chinese economy is also reflected in the distribution of national income. In contrast with developments in the OECD area as a whole, the wage share of GDP has risen sharply in China since 2011. After years of decline (in the period of very unbalanced growth) this share is again at the average level of the OECD countries, but – admittedly - still much lower than in the US or Europe. One of the causes behind the increase in the share of wages is the already mentioned structural shift from industry to the more labour-intensive service sector. An increase in labour shares affect macro-economic aggregates such as cost to enterprises and household consumption, and contributes to the further restructuring of the economy. It goes without saying that the rise in wage share in China has gone hand in hand with an increase in personal consumption. Taken together, developoments at the macro-level are clearly moving into the right direction. The necessary re-balancing of the Chinese economy is underway, but not yet completed. The world (and also China) will have to get used to the fact that the Chinese economy will become gradually more volatile. After all, a market economy is characterized by fewer government interventions. Spearheads of Chinese economic policy Two spearheads of the economic policies of China during the present transition process I find extremely important. These spearheads will underpin a favourable growth climate in the years to come. First of all the so-called “Belt and Road Initiative” (BRI; Silk Road Project) and, secondly, “Made in China 2025” (MIC 2025). Both projects fit into an approach aimed at preventing China to end up in the so-called “middle income trap”. In such a trap a country is too expensive for mass production due to increased wages, but not advanced enough to compete with the most developed countries. To prevent such a situation (with stagnation and social unrest) a country has to re-invent itself. That is what China with these two projects is doing. Of course, there are more important projects but I can only deal with two of them. The Silk and Road project The significance of the Silk Road Project for China but also for the countries through which this route is being constructed is, in my opinion, still underestimated. The project covers an area with 4.6 bln people (60% of the world population). Pakistan’s central bank governor, Yaseen Answar, compared the importance of this project with the importance of the New Deal for the US in the 1930’s. And rightly so. It is indeed a gigantic project that will become a growth engine for a number of countries that untill now, for a variety of reasons, were unable to raise sufficient foreign capital. For example, the port of Piraeus in Greece has developed explosively since the Chinese involvement, numerous new companies have been set up in Africa that can use the Silk Road infrastructure, roads have been built in Pakistan and Kazakhstan, etc. But also China itself will be further opened through this project. Until now most Belt-related loans are for projects in China. These loans focus on electricity, gas, heating, water. I’ve visited bank branches along the Silk Road and was pleasantly surprised by the enthousiastic approach of the bank managers. The US authorities took a shortsighted viewpoint and opposed the establishment of the Asian Infrastructure Investment Bank (AIIB) which is instrumental in the financing of the BRI. China is said to have started this project not only for economic reasons, but also on power political grounds. In this respect today’s world does not differ much from yesterday’s. But let’s not forget that huge investments in public infrastructure are a prerequisite for the development of many of the Silk Road countries, amongst them the countries on the African continent with a rapidly growing population. A positive development of this continent is of paramount importance for many reasons, including the containment of potential future migration flows. I welcome the participation of the Netherlands in the AIIB and I deeply regret that the US stubbornly refused to participate. All this does not mean that the Silk Road Project is without problems. We have seen this, for example, in Malaysia, Pakistan and Sri Lanka. Some of the projects are too large for a country and the same holds for some of the loans. Many, amongst them the World Bank, have expressed concerns about a possible future African debt crisis. Unfortunately, there is sometimes a lot of uncertainty about the size and the conditions under which Chinese loans have been granted. More transparancy is indeed required. If receiving countries run into problems and recourse to the IMF is inevitable, the Fund must first determine the so-called “debt sustainability position” before it can come to the rescue of the country. That is difficult if there is a lack of transparancy about the debt position. China is not a member of the Paris restructuring club, although it has participated on an ad hoc basis. It would be helpful if China would become a full member of this club, taking into account that China is financially involved in an increasing number of countries. Positive developments During a symposium in Beijing at the end of April 2019 Christine Lagarde, Managing Director of the IMF, quoted an old proverb regarding the Silk Road Project: “It’s easy to start a venture, the more difficult challenge is what comes next”. Madame Lagarde is positive about the second Phase of the project, the reason being that the Chinese authorities have committed themselves to more transparancy and enhanced cooperation with the international community – the official as well as the private sector. Furthermore the Chinese Authorities have put high on their agenda water management, the circular economy, the fight against corruption, debt sustainability and green sustainability (the importance of the environment). The communique issued after the Second Silk Road Conference at the end of April 2019 contains many encouraging sentences. There is no reason to doubt the intentions expressed. In the words of President Xi: “Chinese people value a promise as much as gold”. If the intentions and expectations of the Silk Route Project come true, this project will be seen in the future as one of the most important economic endeavours of our time. Made in China 2025 Technology is also a priority on the Chinese policy agenda. Since the future is highly technology dependent the logic of this choice is compelling. China is aiming at a leadership role in, amongst others, robotica, transport, information technology, etc. The country is of course fully entitled to have this ambition. Unlike many other countries China has a clearly defined long-term strategy, and wants to become less dependent on other countries. Whatever the outcome of the Huawei discussions with the USA, the mere fact that overnight one of its most important industries can be put on a black list, will only strengthen the self-reliance tendencies. Therefore, even if the Presidents Trump and Xi succeed in finding a compromise, irreversable damage has already been done. Ambitious goals ”Made in China 2025” is inspired by Germany’s “Industry-4-Plan”, but it is more encompassing. The Germans have “the internet of things” in mind, the Chinese government is targeting a total upgrade of the quality of the production capacity, with an emphasis on technological innovation. At the same time - and that seems in the eyes of Western countries a bit contradictory - MIC 2025 calls for the use of market institutions, the strengthening of intellectual property rights, the introduction of international standards, etc. It seems a dual-track policy with build-in fields of tensions due to a lack of understanding of the progress made by China in these areas. Scale and central management have proven to be successful keywords in the past and again form the core of the policy approach. The targets pursued, in particular with respect to the percentage of Chinese companies and production components in high-tech industries, are aimed at a high self-sufficiency rate. The Chinese plans have led to much nervousness, especially in the USA, partly because they would be accompanied by a forced transfer of technology by companies operating in China or wishing to operate in this country. From the Chinese side this is always denied resp. trivialized. Yet the Americans have suddenly been shot in a kind of cramp. That cramp is now spreading across the Western world. Increasingly, current developments are seen as a serious threat to the economic and political power of the West. It is true, the ambitions are high and the Chinese commitment is unprecedented. The US Administration is trying to slow down technological developments (including artificial intelligence) in China, using “national security” as an argument. To what extent it will be successful I don’t know, but it seems clear to me that China will and can not change its ambitions and will eventually overcome the hurdles. A game changer Kai-Fu Lee (8) makes convincingly clear that China’s leading role in artificial intelligence is linked to deeply rooted characteristics of the Chinese economy: Chinese entrepreneurship that is the fruit of tremendous hard work, killing domestic competition, the unimaginable amount of data and the high priority given by the government to AI. Lee quotes an estimate of PwC with regard to the contribution of AI to the world wide GDP. This estimate amounts to 15.7 trillion dollar, of which 7 trillion comes from China and 3.7 from the US. Whatever the accuracy of the figures, it is clear that in PwC’s opinion China is going to take the lead. Let me quote again Lee: “The dawn of AI in China will be like the harnessing of electricity: a gamechanger that supercharges industries across the board”, and: “If AI is the new electricity, big data is the oil that powers the generators”. I think Lee is right. Risks The present and future is selfevidently not risk free. I see actual risks in the real estate sector, the industry, the wholesale- and retailsector. Eventually, I think, China can cope with these problems. The problems in the industry are by no means negigible, especially in the overcapacity industry. The writing off of non-performing loans and the restructuring and sometimes closing of the companies involved will continue in the years to come, but seem manageable to me. The major banks can gradually absorb their losses, also according to the IMF. My observation is that the banks address the bad assets problems in a very structured way, using different instruments. To my mind the greatest risks are in the inevitable liberalization process, the many interdependencies in the Chinese economy (a.o. formal and informal guarantee chains) and the high and difficult to control debt level of the corporate sector and the local governments. Looking at the banking sector I think that the many small and medium-sized banks are the most risky. These banks are local and/or regional players and extremely important for the economic development in their direct environment. For an outsider it is difficult to come to grips with the quality of the assets on the balance sheets of these banks, their capital buffers, their risk management, governance, etc. In May 2019 one of these smaller banks, Baoshang Bank, ran into serious problems and the Authorities immediately took action, involving China Construction Bank, an approach we also in the Netherlands followed when in the past a small bank had to be rescued. There was always a big brother that solved the problem. That was the past, but is not anymore the case. As to the 4 big banks in China, they are well capitalized, although the capital and other requirements of the regulators and supervisors sometimes look like moving targets, becoming more and more demanding. As to the Bazel III Accord, the systemically relevant Chinese banks have implemented the new rules of the game conscientiously (sometimes under the pressure of the supervisor) and at the agreed upon speed. I think this is very important because the Chinese big four are really big. In this regard the international landscape has changed fundamentally. Before the outburst of the financial crisis, in 2007, the three biggest banks in the world - using Tier-1 capital as a benchmark - were American banks, followed by three European banks. Nowadays 4 chinese banks are at the top of the list, followed by two American banks. The increased importance of the Chinese banks entails increased responsibilities, at home and abroad. The most serious short term risk The most serious risk for the Chinese economy in the short run relates to the trade war with the Americans. This trade war holds the key to the outlook for the world economy in the coming years and will, if tensions persist, raise doubts on the projected recovery path. A trade war is fighting fire with fire. If the Americans keep down that path, everyone will burn including the Americans themselves. The US is using tariffs partly as a weapon for the realization of trade-unrelated goals. It is seeking far-reaching changes in China, including an end to forced technology transfers and the theft of intellectual property secrets, seemingly disregarding the measures already taken and/or already announced. The tariff war between China and the US (and also between the US and other countries) is spreading to other areas. A few examples. Top universities in the US are, regrettably, reconsidering their partnerships with Chinese counterparts, and in June 2018 Senator Rubio started to question the global index provider MSCI Inc. about why the company had included certain Chinese stocks in its emerging market index (“What MSCI is doing is allowing the Chinese Communist Party controlled market … to access a critical source of capital and clothe itself in a facade of legitimacy”). The trade war is not only hurting the Americans and the Chinese. The US Administration is misleading the US citizens by saying that it is only the Chinese who bear the burden of the tariffs. A tariff is a tax and its consequences are borne by providers and buyers of a product. The providers of Chinese products include foreign companies in China and all those in other countries that are part of the supply chain. I’ve seen calculations that estimate the share of foreign content in China’s export at 40 to 50%. Relatively sophisticated sectors such as computer- and electronic products have a much higher foreign content. The implication is that in today’s world the direct impact of tariffs is spread over a number of (often neighbouring) countries. Probably the main impact of a trade war is through the damage to the confidence. Financial markets react heavily to news about a trade war. Losses in these markets are often a multiple of the direct effects of (announced) tariffs. But (the danger of) a trade war also influences the behaviour of investors and consumers. The tensions between the US and China have already put pressure on the growth of consumption in China, a pressure the government tries to counteract, among other things, through tax cuts. The victims of a trade war The question “Who will suffer most: the US of China?”, is discussed frequently. To my mind this is not very productive. That said, the potential for tariff measures is bigger on the American side since the Chinese exports to the US are much larger than those of America to China. Moreover, the American economy is very strong and growing fast. Mid-2019 the US-economy will have experienced the longest expansion in recorded history and unemployment is at levels not seen in half a century. So, this economy can take a beating, at least for the time being. On the other hand, Trump’s position is potentially fragile. Support for his policy can fade away quickly if the business cycle would change (the clouds in the sky seem to become darker). More importantly, the Chinese government still has effective instruments at its disposal. During the financial crisis the government has shown that it can mobilize these instruments massively and at very short notice: monetary policy instruments (interest rates, reserve requirements), further tax reductions, public infrastructure, etc. Unfortunately, there is no such thing as a free lunch. Such a policy comes at a price: a delay in structural reforms, an end to the deleveraging process. This is in nobody’s interest. It adds to the conclusion that a trade war only has losers. In summary According to the “2018 Report to Congress on China’s WTO Compliance” China’s record of compliance with WTO is poor. The country is said to have failed to comply with the expectations and “has moved further away from open market oriented policies …… has used the benefits of WTO membership to become WTO’s largest trader, while resisting calls for further liberalization of its trade regime by claiming to be a “developing” country”. In the beginning of this article I pointed to a quandry: being a large country and at the same time not high enough on the per capita income list. China is in several aspects indeed still a developing country, whatever the precise definition, and in spite of the “upper middle income” ranking by the Worldbank. According the the World Bank the country has lifted around 850 million people out of poverty. That is more than impressive and should be taken into account in the assessment of the policies pursued by the government. But at this very moment there are still more people in China below the “upper middle income line” than citizens in the US. It is the ambition of the government to eliminate absolute poverty and create “a moderately prosperous society” by 2020/2022. Step-by-step China is realizing its goals, trying to balance internal needs and external requirements. It is in its own way moving to a market-based economy and has made much more progress in many areas than is being realized. Nevertheless, a further re-balancing remains necessary to ensure sustainable growth. Differences of opinion about the methods used and the balance between internal needs and external requirements should be discussed and not fought through a trade war.

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Nout Wellink：My Take of China’s Economic Policy

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