Xu Xiaonian: Time to face reality, and regain common sense

Published 23rd September, 2015 23:55 HKT

Being a patriot is not just about saluting with the left hand, but pointing mistakes out with the right. Chinese economists have over the past five years criticised government policy, but under the Xi administration, these criticisms were carefully dialled down. Depressingly, many essays felt obliged to namecheck Xi Jinping, and the unoriginal ‘new normal’ slogan. But perhaps the government’s mishandling of the stock market, and lack of meaningful reform to counter past policy errors, have inspired economists to once again speak their mind. Dr. Xiaonian Xu is Professor of Economics and Finance at CEIBS, and previously Head of Research at CICC. Below are the key takeaways from his speech yesterday.


Economy

  • According to a report, the Finance Minister recently said in a meeting that the current malaise in the Chinese economy could last another 5 years. With respect the Finance Minister’s estimation, I agree.
  • The difficulties of structural adjustment will determine how long the economy remains in the new normal. But this time round the reality is the government will not, and cannot afford to resort to massive stimulus.
  • The ‘China Model’ should really be split into two. During the first model from 1978 to 1990, the economy relied on unleashing market forces to increase efficiency, and enjoy productivity gains. In the second model from 1990 onwards, the government has allocated resources and growth has been reliant on credit: Government spending, the central bank printing money, and bank loans. The difference between the two models is that the second model is unsustainable. (Chinese economists tended to limit criticism to the current model as unsustainable, rather than arguing in fact the government has taken retrograde steps since 1990).

Statistics

  • How sharp is the slowdown? 7%, 6% or 5%, it’s hard to tell. Because there’s a big discrepancy between the official statistics and what we’re seeing on the ground. If I was pressed to come up with a number, I still couldn’t give you one. Some of the international media are clearly puzzled by the discrepancy between official macro figures, and the underlying data. Therefore with respect to macroeconomic data, it’s not for me to comment. (Clearly Chinese economists also question the official data, but cannot articulate this directly).



Debt

  • This is the hidden danger in China’s economy. The 4 trillion yuan stimulus package in 2009 has left the problems of local government debt, and bad bank loans. Unless this debt is cleared, the economy will not boom again. It seems unlikely these problems will be solved in the short term, so everyone should prepare for the long haul.
  • The local government debt for bond swap program was initially set by the government at 1 trillion yuan at the beginning of the year, but is now already at 3 trillion yuan. Which means the problem of local government debts was underestimated.  

Reform

  • There are two preconditions for rejuvenating the economy: i.) deleverage. ii.) reform. The economy must leave behind the government led demand model, and revert to the 1978-1990 model of unleashing market forces to generate economic growth. Until these two conditions are met, then we are still in the new normal. (This point appears to challenge the government’s official line, by implying it’s the government that created the mess, and without reform of the government’s role, there will be no improvements. A reminder of one of the policy goals set out in the Third Plenum).



Industry

  • Another reality is the falling prices in the industries suffering from oversupply reveals a problem of a lack of investment opportunities, not a lack of money.
  • This problem is compounded by labour and capital costs which have proved resilient, not falling with the slowdown in economic growth. The problem is especially acute for businesses that in the past relied on low costs to expand. Now with profit margins squeezed, this traditional business model must adapt to the market.

Business

  • In the meantime, Chinese businesses must adapt to the new normal. Chinese businesses mistakenly believe that the key to success is obtaining government connections and bank loans. Traditional businesses must adapt to the new market environment, and innovate.
  • Chinese businesses lack original thinking. For too long they have copied instead of innovated. This problem stems from traditional Chinese culture, which does not encourage independent thought, but instead hopes everyone follows the written, and unwritten rules.
  • Another criticism is that once one Chinese business is successful, other Chinese businesses rush in and copy, which creates industry oversupply, and reduces prices. 

Value Creation

  • The central bank printing more money does not add value. Reducing reserve requirement ratios or interest rates does not add value. Trading stocks does not add value.
  • There are two ways to create value. i.) design new products or services ii.) find new ways to produce existing products or services at a lower cost.
  • Chinese businesses should instead focus on core competitiveness. This means producing a product or service that cannot easily be copied. You can take an Apple iPhone apart and copy the components, but you cannot figure out its software, which is derived from in-house R&D. Whereas a Xiaomi phone is simple and easy to copy, everyone knows how it works.

Internet

  • The internet is a tool, it should not be elevated to a way of thinking. For example the invention of the steam engine was a big step for the development of mankind, which led to other breakthroughs. But you’ve never heard anyone talk about ‘steam engine thinking’.
  • Time for some common sense. You can take a VC’s money and use it to subsidise consumers, and grow a large consumer base. But how can you make money from them? Where’s the added value?
  • P2P does not create value, it just links lenders with borrowers. It does not solve the problem of credit risk assessment. Only the likes of Alibaba and Tencent, who have access to big data, can attempt at doing this. But honestly speaking, the quality of this data is poor. They need other data to estimate more accurately borrowers’ risks.
  • I’m not against ‘internet +’, but we need to think more originally how to apply this to business, and improve efficiency. Really it should be the other way round, ‘+ internet’. The ‘electronic brain’ (Chinese word for computer), cannot replace the human brain. (‘Internet +’ is a policy which the government is promoting as a way to transform the economy, but which Xu implies is a substitute for real reform).

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2 comments

  1. […] 7. Xu Xiaonian: Time to face reality, and regain common sense | chiecon Being a patriot is not just about saluting with the left hand, but pointing mistakes out with the right. Chinese economists have over the past five years criticised government policy, but under the Xi administration, these criticisms were carefully dialled down. Depressingly, many essays felt obliged to namecheck Xi Jinping, and the unoriginal ‘new normal’ slogan. But perhaps the government’s mishandling of the stock market, and lack of meaningful reform to counter past policy errors, have inspired economists to once again speak their mind. Dr. Xiaonian Xu is Professor of Economics and Finance at CEIBS, and previously Head of Research at CICC. Below are the key takeaways from his speech yesterday. […]

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