1

China’s entry into the

� China an original member of the GATT, but seat was kept by Taiwan from 1949 until the 1970s.

� China was given MFN status under the Jackson-Vanik amendment, but this required an annual review of its human rights record.

� China asked to join WTO in 1986, but entry was consistently opposed due to state pricing, fears of cheap labor. Clinton negotiated admission in 2000.

� China finally admitted into the WTO (with Taiwan), and agreed to open its import, telecommunications, and banking sectors to foreign competition and investment.

� Chinese tariff rates came down dramatically.

Problems

� China is seen by many as dragging its feet, especially in opening banking to foreign competition.

� Concerns about U.S. food exports.

� Trade and investment have nonetheless dramatically expanded.

� Intellectual Property an issue.

Leading Trading Nations, 2009

Country

Exports

Billion $ Share Country

Imports

Billion $ Share

1 China 1,202 9.6% 1 USA 1,605 12.7%

2 Germany 1,126 9.0% 2 China 1,006 7.9%

3 USA 1,056 8.5% 3 Germany 938 7.4%

4 Japan 581 4.6% 4 France 560 4.4%

� China’s trade surplus is mostly with the USA. It usually runs a deficit with the rest of the world.

� China’s trade surplus has been narrowing.

2

China’s Trade

� China is a net importer of agriculture, exporting $41 billion in 2009 and importing $77 billion.

� China’s agricultural exports have risen from 1.5% of world agricultural trade in 1980, to 3.0% in 2000, to 3.5% in 2009. China’s agricultural imports have risen to 6.4%.

� China is a net exporter of manufacturers – the workshop of the world. Exports totaled $1125 billion in 2009, and imports $675 billion.

� China’s manufacturing exports have risen from 0.8% of world manufacturing trade in 1980, to 4.5% in 2000, to 13.5% in 2009. China’s imports have risen from 1.1% in 1980, to 3.5% in 2000, to 7.8% in 2009.

�

Relations with the U.S.

� Taiwan Strait crisis of 1996.

� U.S. bombing of the Chinese embassy in Belgrade in 1999.

� Negotiating admission to the WTO.

� Midair collision between a U.S. reconnaissance aircraft and a Chinese fighter plane in 2001.

� Growing U.S. Trade Deficit, pressure for revaluing or floating RMB (Chinese Yuan).

From 2000 to 2009, China’s exports to U.S. grew from $103 to $412 billion, while U.S. exports to China rose from $21 to $130 billion.

China’s Next Steps

� Jiang Zemin affirmed as core of the leadership in 1997: general secretary, president, chair of standing committee and MAC.

� New policy of “Release the small, retain the large.” Mergers, acquisitions, bankruptcies, share issues, privatization, new groups.

� “Three Represents” policy opened CCP membership to private entrepreneurs, and envisions making party more democratic and representative.

� Chinese SOEs eventually merged into roughly 200 large conglomerates on Chaebol model.

� Zhu Rongji named Premier, and he pushed for rapid turnaround in SOEs.

3

Chinese Corporations

� Many firms are part of over 2500 large business groups, of which 1500 are state-owned and controlled.

� Shanghai Stock Exchange lists 860 firms, with more than $2 trillion market capitalization. World 5th largest.

� Shenzhen Stock Exchange lists 730 firms, with $1 trillion market capitalization.

� Fortune 500 includes 24 Chinese firms. Sinopec is #17, big four SOCBs, etc.

� Forbes Global 2000 includes 89 Chinese firms, with PetroChina as #41.

� NYSE includes 18 Chinese firms, and NASDAQ includes 16 more. Many more are traded OTC.

China’s Labor Force

(Billions in 2010) % Pop

Population 1,341 100%

Rural Population 671 50%

Urban Population 670 50%

Economically Active 784 58%

Employed 761 57%

China’s Urban Labor Force

2010 Millions

% Total

Population

% Total

Employed

% Urban

Employed

Urban Population 670 50%

Urban Employed 347 26% 46% 100%

State-Owned Units 65 5% 9% 19%

LLC+Shareholding Units 36 3% 5% 10%

Private Enterprises 61 5% 8% 18%

Foreign Enterprises 18 1% 2% 5%

Self-Employed 45 3% 6% 13%

Other Urban Employment 122 9% 16% 35%

Urban Unemployed 9 1% 1% 3%

4

Rural Employment

2010 Millions

% Total

Population

% Total

Employed

% Rural

Employed

Rural Population 671 50%

Rural Employed 414 31% 54% 100%

TVE 159 12% 21% 38%

Private & Self 59 4% 8% 14%

Other 196 15% 26% 47%

At what point does China hit Stage III of the Lewis Model?

How Big of a Change?

Millions 1997 2010 Change Annual Rate

Urban Employment 202 347 +145 4.2%

SOEs 110 65 -45 -4.0%

Foreign 6 18 +12 8.8%

Private 7 61 +54 18.1%

All Other Urban 79 203 +124 7.5%

Rural Employment 494 414 -80 -1.3%

TVEs 92 159 +67 4.3%

All Other Rural 402 255 -147 -3.4%

China has moved 80 million people from rural areas, and 45 million from state units. Where do they go?

Population Policy

� Implemented in 1978.

� Promoting late marriage, late childbirth, and several year spacing.

� If first child is a daughter, has a physical disability, mental illness or mental retardation, a second may be allowed.

� Payment of education/maintenance fees.

� Ethnic minorities generally exempted.

� Government decree carried out by local party officials, sometimes brutally.

� The dark side: forced abortions, infantide, abandoned babies at orphanages, foreign adoption, and bribery for permission.

5

The Theory of Population Growth

� Malthusian theory: population limited by resources.� Economic theory: births are a choice, based on benefits

and opportunity costs.� Higher birth rates in rural traditional male-dominated

societies. Lower birth rates when women have power, in urban settings, when retirement/healthcare is provided.

� Genetic lottery: birth rates fall if infant mortality low.� Generational population momentum.� Demographic transition: medical science and

cultural/behavioral change.� In pay-as-you-go systems, high dependency ratio slows

economic growth.

China's Population Distribution in 2009

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1

2

3

4

5

6

0-4 5-9 10-14 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65-69 70-74 75-79 80-84 85-89 90-94 95+

Male Population

Female Population

Born in

1949

Born in

1959Born in

1979

Birth control led to a population reduction of at least 300 million people, and without it China’s population may have been double.

There is also a shortage of 27 million girls under 20.

The Young and Restless

� http://www.pbs.org/wgbh/pages/frontline/youngchina/view/

6

Fourth Generation Leadership(2003-2012)

� Hu Jintao is CCP General Secretary, head of state, and President, National People’s Congress.

� Wen Jiabao is Premier, head of government.

� Other important members of the leadership include Wu Bangguo, Jia Qinglin, Zeng Qinghong, and Li Changchun.

� The Hu-Wen government has made few initiatives during its decade, other than Hu’s “Harmonious Society” ideology: focus on middle class prosperity, stability, and gradual shift from rapid growth model.

Inequality

� Rising GINI coefficient: 0.33 in 1980, 0.46 in 2000 (U.S. 0.41 in 1997, Japan and Sweden 0.25)

� Urban average incomes were 3.5 times rural incomes in 1978, but only 2.6 times in 1999. Rural incomes grew faster, especially near more urban areas.

� Wide gap between richest and poorest provinces: Shanghai’s GDP per capita 12.5 times that of Guizhou (Alaska and Delaware have about twice the real per capita GDP as Mississippi and West Virginia).

� Rising inequality within urban areas.

� Source of public discontent, protest, loss of legitimacy.

� Growing private economy, official corruption.

� Kuznets’ inequality versus impoverishment.

Rural China

� Half of Chinese still live in rural areas, many on less than $2 per day.

� Rural areas continued to have large surplus labor problem:

� Concern about effect of U.S. exports on farm prices.

� Job market has begun to tighten, and labor surplus may be disappearing.

� Reports of protests by farmers over extractive rural leaders.

� Some local elections.

7

Education

Literacy rate is roughly 90%.

China has more than 30 million new high school graduates per year, plus 2.4 million traditional college graduates, 1.9 million returning adult graduates, and 150,000 advanced graduates.

The most popular majors for advanced graduate study are engineering, management, science, medicine, and law.

China’s exports have typically been concentrated in labor-intensive products that used to be produced by other Asian countries, but China is starting to move into more higher-tech areas.

China’s government is making a major investment in its universities, attracting back professors from top-ranked schools in USA and elsewhere. Qinghua, et cetera.

Stock Markets

� Shanghai Exchange created in 1990, Shenzhen in 1991.

� Foreign investors segmented into B shares market (USD in Shanghai, HKD in Shenzhen) – Forex capital transactions are still not convertible.

� Only state’s best performers initially allowed to list, but state still controlled a majority of shares – stocks a way to raise capital from public without privatizing.

� Market capitalization 26% of GDP in 1997, 30% in 2005.

� Market stagnant from 2001-2006, then bubble began.

� Shanghai Composite Index rose 167% in a last year, as Chinese consumers look for higher returns.

� P/E ratios twice as high in Shanghai than HK, for the same firms.

� Cheng argued 70% of listed firms bankrupt, should be delisted.

In 2008, the SSE lost 70% of its value!

Shanghai Composite Index

0

200

400

600

800

1000

1200

1400

1600

1800

Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Nominal Index

Wee

kly

Clo

se

8

The stock bubble looks even bigger if you take a longer view…

Share of GDP

0%

10%

20%

30%

40%

50%

60%

70%

80%

1978 1982 1986 1990 1994 1998 2002 2006 2010

Consumption Investment

Exports Imports

International Trade has risen as a share of GDP Investment (and Savings) is high and rising too!

� China’s urban landscape has been suddenly transformed

9

Not always for the best…

Prices

� From 1997-99, in 2002, and again in 2009, the CPI fell.

� Supply-led deflation versus demand-led deflation. In the latter case, deflation can become self-perpetuating, loans become harder to repay, and the economy spirals downward. The good, bad, and ugly.

� If markets expect inflation and interest rates are near zero, cash becomes more desirable, and money demand rises.

� If banks worry about lending, they switch to other assets and money supply tightens.

� From 1998 to 2005, M2 grew by 16% per year, but inflation only averaged about 1%.

� In 2006, inflation jumped to 7-8% annual rate.

� M2 grew by 20% per year from 2006-2009.

� Inflation is currently under 4% per year.

10

The RMB has appreciated significantly, especially in inflation-adjusted terms…

0.60

1.00

1.40

1.80

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Real Exchange Rates

Chinese RMB and Euro

Against the Dollar

(2000 = 1.00)

Real Chinese RMB Yuan

Real Euro

Will the Currency Keep Appreciating?

� BOP Surplus from trade surplus, FDI inflow.

� RMB rate kept low through massive purchases of U.S. Bonds by People’s Bank of China, which now holds almost $2 trillion of US government debt alone.

� The problem is that these purchases of foreign reserves increase the money supply, and can be inflationary.

� Money supply growth was checked by selling other central bank assets, and money demand grew too.

� Chinese began changing peg after 2006.

� China now facing rising inflation, and faces a choice: either RMB must appreciate more to end BOP surplus, banks will have to tighten lending, or inflation rises.

11

What if the Chinese stop lending?“If you owe the bank $100 that's your problem. If you owe the bank

$100 million, that's the bank's problem.” - J. Paul Getty

If the U.S. owes foreign central banks $1 trillion, then what happens if they think we can’t pay them?

� Debt denominated in Dollars, depreciation hurts Chinese.

� Depreciation of U.S. Dollar will increase exports and value of U.S. FDI in China, but will make U.S. imports expensive.

� Interest rates will rise, along with the U.S. risk premium, increasing budget deficit.

� U.S. Treasuries world’s safest asset. Higher risk could cause a new financial crisis, default a complete meltdown.

� U.S. also loses future seignorage from Dollar’s use.

Fiscal Policy

� Asian Financial Crisis of 1997 slowed China’s exports: offset by increased government investment plan.

� Smaller plan in 2002, after U.S. 9/11 Recession.

� Great Recession led to significant drop in world trade.

� Chinese Economic Stimulus Plan of 2008–2009:

� 4 Trillion RMB spending plan (12% of GDP) to be spent on public investment, a quarter by central government, the rest by local and provincial governments.

� In contrast, Obama spending plan was less than $1 trillion (5% of GDP), a third in form of tax cuts, a third in public infrastructure, and a third to states to offset their budget cuts in education (but state and local governments still cut enough to offset most of federal government spending increase).

� Critics argue that China already overheated, already overinvesting, so fear stimulus will worsen inflation.

� Budget deficit rose from 0.4% to 2.3% in 2009.

12

Effects of China’s Growth

� IEA estimates China is now the world’s largest energy consumer.

� China now buys 10% of world oil exports, a major reason oil prices have been rising. China is also an importer of coal and natural gas.

From 1919 to 1999, real oil prices have been falling (except for the 1973-83 decade).

China’s rapid growth has reversed this.

35

$-

$20

$40

$60

$80

$100

$120

$140

1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Petroleum Price ber Barrel

(Monthly Inflation-Adjusted Data)

An Updated Look at Oil Prices(Cushing WTI, 1976-2012 Monthly Averages)

Effects of China’s Growth

� China is a major importer of copper, zinc, iron ore, lead, aluminum, and other metals, reversing a 150-year trend in falling commodity prices. China is increasingly involved in African source countries.

13

The world’s biggest polluter?

� China is the biggest producer of CO2.

� Only 1% of urban residents breathe air that meets EU standards.

� Most Chinese do not have access to clean water.

� Many rivers are toxic.

� The list goes on and on.

Why?

� Classical socialist economies tend towards ecocide: poor protection of property rights, minimal freedom of press, party control of court system, corruption, excessive focus on growth, popular desire to catch up.

� Most rich countries also produced pollution during their early stages of development: environmental quality may be a “luxury” good.

� China’s extreme population density exacerbates the effect.

Monetary Policy

� Price Level = Money Supply / Real Money Demand

� MS = DEM * MB

� Monetary Base is a liability of the PBC, backed by reserve assets. Money supply depends on lending.

� With a pegged exchange rate, the PBC cannot control the purchase of reserve assets, and must use other tools (e.g., the reserve ratio) to control lending and the Deposit Expansion Multiplier.

� There are two goals of monetary policy that sometimes conflict: price stability, and ensuring there is enough credit to maximize economic growth.

� The PBC can also try to influence the quality and direction of lending, not just the aggregate amount.

14

China’s money demand grew much faster than the economy – this unpredictability made the money supply harder to manage. The ratio of M2/M0 also rose.

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

1978 1981 1984 1987 1990 1993 1996 1999 2002

Rat

io

M0/GDP

M1/GDP

M2/GDP

(M2/M0)/10

Data sources: People's Bank of China; data for 2003 is as of September.

Once China’s price level stopped rising, the discount rate (the internal price of money between banks) came down dramatically.Of course, since the Great Recession, U.S. rates are much lower. But this rate is not the major tool.

Since 1992, M2 Money Supply has continued to grow rapidly.

15

Banks

� The PBC is headed by Zhou Xiaochuan. PBC works with SAFE and CBRC, sets overall policy.

� The big four SOCBs (ICBC, BOC, ABC, CBC) are listed on several stock markets. They are half of China’s banking.

� Asset Management Companies were created to recapitalize SOCBs in 1990s.

� A dozen or so second-tier joint-stock commercial banks are primarily state-owned. Minsheng Bank is private.

� There are also over 100 city commercial banks, generally owned by city governments.

� There are also a host of urban and rural credit cooperatives, investment trusts, policy banks, and even foreign banks.

China’s Banking System (2009)

Assets (% GDP)

Assets(%Total)

Liabilities(%GDP)

SOCBs 116% 51% 110%

JSCBs 34% 15% 33%

CCBs 15% 7% 14%

Other 61% 27% 58%

Total 228% 100% 215%

By comparison, total assets of U.S. commercial banks add up to less than 100% of GDP.

China’s Housing Bubble

� Massive construction of new housing, with privatization and consumer loans (20% or more down). Banks heavily involved in lending to developers.

� Massive migration from rural areas plus urban development, high savings rates and bank deposits.

� Housing in major cities rose to $130/f2.

� Tightening monetary policy, rising interest rates, bubble appears to have peaked.

� Worries of a property price collapse leading to decline in consumer wealth, but financial collapse less likely.

� Chinese public debt low, and reserves very high.

16

Social Safety Net

� Healthcare, disability and pensions were provided by the work unit (danwei). Since reform, these have been dismantled, and remainder tends to be fragmented and inconsistent.

� New voluntary rural pension system is growing, but still covers less than half of rural residents.

� Public sector partially and inconsistently subsidizes healthcare through public hospitals and clinics. Majority of cost is still out-of-pocket.

� Unemployment benefits tied to minimum subsistence, and provided by provinces and municipalities. Very inconsistent.

� Mostly, people save or do without. The aging of the population is a time bomb.

Fifth Generation Leadership

� The CCP will appoint new 5th Generation leaders in Fall 2012 (including Xi Jinping as General Secretary).

� The NPC will appoint new leadership in Spring 2013 (Xi Jinping as President, and either Li Keqiang or Wang Qishanas Premier). Other key figures include Li Yuanchao, Wang Yang, Zhang Gaoli, Liu Yandong, Ma Kai, and Zhang Qingli. Bo Xilai has been removed from power.