COVER STORY • Japanese Economy After the Olympic & Paralympic Games Tokyo 2020 • 3

APerspective on the
Chinese Economy in2020

By Long Ke

Six years ago Premier Li Keqiang described the Chinese economy
as the “new normal” – meaning that it does not need to realize 8% to
9% growth – in the Government Activity Report at the National
Congress. Growth of 6% to 7% would be enough. But since then the
Chinese economic growth rate has slowed down to 6% in the third
quarter of 2019, the lowest rate during the past 27 years. It isdifficult for the government to maintain economic growth at the newnormal level. Many economists and professors both in and outside
China recognize that the real growth rate is much lower than theofficial data announced by the government.
Of course, it is easy for Chinese policy makers to explain why the
economy slowed down. One reason could be that the economy has
been damaged by the trade war with the United States. But the Xi
Jinping administration emphasized at the start that China would win
the trade war – meaning that although the trade war could damage
the Chinese economy, it will damage the American economy muchmore. But a year later Chinese political leaders and policy makers
have changed their attitude. It is clear that the trade war has
damaged the Chinese economy seriously, and certainly is damaging
the American economy too. The Chinese government made a
mistake in continuing the trade war with the US. For China, thecorrect decision would be to end the trade war as soon as possible;
otherwise the trade war will damage Chinese social stability.
The second reason to explain the economic decline is the
economic and industrial structure problem. Over the past four
decades China’s economic development model has basicallydepended on cheap labor to produce huge amounts of cheap
products, and most of the products are exported to American andEuropean markets. Its trade surplus helped China to overcome its
shortage of foreign currency, and China used the foreign currency toimport high-tech equipment from developed countries to strengthen
the competitiveness of its domestic manufacturing industries.
China has been reforming its economic system and gradually
opening up the domestic market to foreign companies since 1978. It
took 20 years for the Chinese economy to catch up. Since then China
has come to play an important role as a global manufacturing center,
which not only sustained Chinese economic development itself but
also drove global economic development. Chinese nominal GDP
accounted for 15% of the global economy in 2017. But under thiseconomic development, labor costs increased rapidly. Since 2001 in
big cities like Beijing, Shanghai and Guangzhou minimum labor costs
have increased 10% annually till 2018. The Chinese government has
12 Japan SPOTLIGHT • January / February 2020

Author Long Ke

no option now but to refuse to raise labor costs. The rise in laborcosts is an indicator from the market that China needs to shift fromlow-end industry to high-end industry. To realize this goal, Chinaneeds to deepen reforms of the economic system, especially toprivatize state-owned companies, no matter whether the government
wants to or not. The real reason for the economic decline is thegovernment’s refusal to reform the SOEs. This is the major structuralproblem of the Chinese economy.

Role of the Market vs Role of the Government
Although China’s economic growth rate has declined from 8% to
6%, it doesn’t mean this is due to economic fundamentals.
Compared with other emerging economies, the Chinese education
system from primary school to university is very good. The system
has educated thousands upon thousands of elite students during thepast four decades. The Chinese young generation is much moreaggressive and challenging than those in other emerging countries.
The background to the miracle of economic growth is that the
government has implemented economic liberalization gradually,
although it has refused to reform the political system to create ademocracy in China. Chinese people have enjoyed much more
freedom since 1978 than in Mao Zedong’s era. Nowadays over 150
million people travel abroad every year. There are over 80 million
people who use the Internet in China (Chart 1). The Internet gives
Chinese people many more opportunities to experience and enjoy
freedom. Forty years ago they could only get information from state
media like the People’s Daily and Xinhua news agency. But now
fewer people read the People’s Daily in China. Many young people inuniversities and colleges access the Internet and even use Facebook
by virtual private networks (VPNs). The Internet is changing Chinese
people and Chinese society, even though the government is trying todeny the people access to Facebook and YouTube with firewalls.
It is generally believed that the Chinese government can regulate
the Internet selectively, but cannot stop people using it. People are
expecting to enjoy much more freedom from now on, and thismovement is going to change Chinese society and the economy. Xi
made a speech at the Fourth Conference of the Central Committee ofCommunist Party in October 2019 in which he emphasized
modernizing regulations and rules by law. He didn’t define thesemodernizations, but it is easy to imagine what he meant – to use
information technology and AI to monitor people’s activities. Ever
https://www.jef.or.jp/journal/

COVER STORY 3

Xi & His Economic Policy

CHART 1Chinese netizens & share of total
population
70.0%

90,00080,000

Netizens

70,000Share (right scale)

60,000

60.0%
50.0%

50,00040.0%

40,00030.0%30,00020.0%

20,00010.0%

10,000

0.0%

20

05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18

0
10 thousand
Source: Xinhua net

since Adam Smith, we have all known that a market economy needs
freedom. Only price mechanisms can allocate resources efficiently.
Here the question is how Xi can sustain economic development byusing controls and regulations. Xi believes that allocation by thegovernment can sustain economic development.
So Xi will aim to strengthen the competitiveness of SOEs andmake them larger and stronger. Under socialist ideology the workers
in the state sectors are the infrastructure of the socialist party.
Logically, to strengthen SOEs could help Xi to strengthen the party.
But in some sense this would mean a tradeoff between strengthening
SOEs and sustaining economic development. According to the AllChina Federation of Industry and Commerce, private companies only
last on average four and a half years from establishment tobankruptcy. Most private companies are not allowed to apply for
public infrastructure projects. SOEs always take advantage byapplying for government projects, not only the central government
but also local governments. Only if the project needs technology that
only a private company has can SOEs not compete.
Yet private companies contribute much more to economic growththan SOEs and create more opportunities for employment. A strong
state sector is not enough to drive economic growth. Meanwhile
SOEs get huge amounts of subsidies from the government andborrow huge loans from the state-run commercial banks. The resultof this is that SOEs have a huge over-capacity in equipment and huge
non-performing loans. The Chinese government cannot sustain
economic development without privatizing the SOEs.

China has been playing a role as a global manufacturing center
since the 1990s. In the past decades thousands of multinational
companies have invested in China, attracted by its cheap and highquality workers. Most of the young workers come from the ruralinterior – Sichuan, Hunan, Henan, etc. Their household registrationin their home regions cannot be transferred to the city where theywork, for example Shenzhen, according to the regulations on
registration. China is not a fair market for workers from thecountryside. The supply of cheap and high-quality young workers
has attracted many multinational companies to invest especially incoastal areas. The government has opened the market and sharedpart of it with foreign companies, earning foreign currency andgaining high-technology transfers. The weakness of the Chinese
economy had always been the shortage of foreign currency and thelack of advanced technology, so the solution to catching up with
developed countries was to open its market and liberalize andderegulate the economy.
Historically, Deng Xiaoping decided to open the market to foreigncompanies gradually. Deng not only wanted to attract more foreigncompanies to invest in China, but also to maintain the monopoly
leadership of the Communist Party. The key point in his thinking wasinsistence on the leadership of the Party on the road of socialism andcommunism. But everybody knew Deng gave up this road instead ofmaintaining the leadership of the Party. The current Chinese
economic system is not socialism; it is state capitalism, according tomany Chinese watchers. As a result liberalization and deregulation of
the economy enable China to catch up with developed countries.
Since the 1980s there has been an argument in the central
government about how to reform the SOEs. The liberals, for example
professors and economists in universities and official government
think tanks like the China Social Science Academy, recommend
reforming the ownership of SOEs, privatizing them gradually;otherwise China cannot sustain its economic growth. At the end of
the 1990s Premier Zhu Rongji decided to deepen reform of SOEs. He
aimed to liberalize and sell the small and medium-sized SOEs to theprivate sector. But he maintained state ownership of the big SOEs.
Zhu’s reforms created the infrastructure of the Chinese marketoriented economy, although they remain unfinished.
China experienced a lost decade under the Hu Jingtao
administration (2003-2012). Hu was not a challenging leader, but alucky one. Although he didn’t try to deepen market-oriented reforms,
China succeeded in hosting the Olympic Game in Beijing (2008) andthe Shanghai Expo (2010). The infrastructure investment for these
Japan SPOTLIGHT • January / February 2020

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events definitely contributed to GDP growth much more than
expected.
The current Xi administration has been pushing the Chinese dream
to rebuild a strong China since 2013. Basically Xi himself and his
team are a new generation, different from those in the former Deng,
Jiang Zemin and Hu administrations. Xi’s generation was educatedduring the Mao era. Xi himself was a little red guard when he was in
middle school during the Cultural Revolution (1966-1976). This
experience has made his administration’s policy making moreconservative. At first most China watchers expected that Xi could
improve market reforms dramatically and accept the values of the
global community, and even lead his people to create a democraticsystem in China in order to be integrated into global society. But the
global community misunderstood Xi. He rejected the values of
freedom, human rights and the rule of law. He told his people hewould realize the Chinese dream of a national renaissance. China is
coming to be the new leader in the global community. Xi is not aliberal, he is a nationalist. His economic policy is to reregulate andstrengthen control of the economy. In a word, Xi is taking China backto Mao’s era.

The Weakness of Risk Management
It is clear that Xi respects political power more than Jiang and Hu.
For Xi, politics is power, or power is politics. To strengthen politicalpower Xi is reviving personal dictatorship. The constitutional
provision limiting presidential rule to two terms (10 years) has been
deleted. It seems that Xi has now become to the most powerfulleader in China. Over 2 million politicians and officials have beenarrested under Xi’s administration because of corruption. National
renaissance is the dream that Xi has shown to his people, and torealize it Xi has pushed the “One Belt, One Road” initiative, originallydesigned as a measure against the framework of the Trans-PacificPartnership (TPP).
Chinese diplomatic policy can basically be described as a “three
worlds policy” created by Mao that divided the world into three parts:
developed countries (the US, the United Kingdom, etc.), middle
developed countries (Japan, Australia, etc.), and developing
countries (China and African nations, etc.). The One Belt, One Road
initiative cannot be regarded as an infrastructure project fordeveloping countries only, for it is Chinese diplomatic strategy to aim
at leadership regionally and globally.
Chinese GDP became the second largest in the world in 2010, andis expected to be the largest in the near future. That means China
could replace the US as the leader of global society. To take global
14 Japan SPOTLIGHT • January / February 2020

leadership economic power is important, but it is not enough. HereI’d like to point out the weakness of Xi’s administration. It is the
weakness of risk management about domestic and global problems.
For example, at the beginning the trade war with the US was not so
difficult to solve. President Donald Trump asked the Chinese
government to protect intellectual property rights (IPR) by the rule oflaw, to stop forcing foreign companies to transfer their technology toChinese companies, and to stop paying subsidies to Chinese SOEs,
in order to create a free, fair and global market. This would not only
be profitable to the US but also helpful to China, which cannot
strengthen innovation without protection of IPR.
For Chinese manufacturing industries, the US is the mostimportant market. It is hard to understand why Xi decided tocontinue the trade war with the US. Trump started the war becauseof the imbalance in international trade with China. For China, the best
option is to try to rebalance trade. Of course, the war is damaging
the US and importers of Chinese goods, especially Americanhouseholds. But it is believed the trade war will damage the Chinese
economy and society much more than the US. Global supply chainsand values have been rebuilt since the war began a year and a halfago. More and more foreign companies are moving their factories
from China to other emerging countries, for example Vietnam. As aresult, the unemployment rate in China is rising very rapidly,
although the official statistics will never show the real situation.
Nowadays thousands of workers from the countryside are losing
their jobs in the cities. It will definitely damage Chinese social
stability. Of course, the trade war is not an endless game, but China
cannot expect the multinational companies to move their factories
back to China because labor costs have risen so high. Chinese
manufacturing industries have lost their cost competitivenesscompared to other emerging economies, for example, Vietnam,
Mexico, etc. The way out of this for China is to strengthen
innovation. To realize this goal China must protect IPR by the rule oflaw.

Perspective on the Chinese Economy
It is important for China to rationalize the economic structure andto strengthen the efficiency and the price mechanism and deepen themarket economic reform as Xi mentioned seven years ago in Beijing. But
the Xi administration could not stop the economy’s slowdown (Chart 2).
In the past decades it has been believed that China needs to realize
an 8% growth rate in order to create more employment opportunities
to stabilize society. But in regional areas, the governors of provinces
and cities usually force the state commercial banks to generate much

COVER STORY 3

CHART 2The slowing economy in China
120.00118.00116.00114.00112.00110.00108.00106.00104.00100.00
％

1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Q2/2019102.00Source: Chinese State Statistical Bureau

more liquidity for the SOEs to make investments. It doesn’t matter
whether it is necessary or not. The most serious problem is that insome provinces and cities the macroeconomic data are manipulated
in order to be evaluated by the central government. This hasdamaged the reliability of macroeconomic data, and it is difficult forpolicy makers to pursue a rational and efficient policy mix because
they cannot get the real economic data. And wrong policies will leadthe economy onto the wrong road.
Since 2013 the Xi administration has stopped all market-oriented
economic reforms. Vice Chairman Wang Qishan, whom Xi trusts themost in his administration, made a speech in a closed meeting of theParty and told the audience: “We will not reform anymore. How canthey (people criticizing the administration over economic operations)do anything to us?” Meanwhile, Xi has emphasized again and again
strengthening control of the economy, especially SOEs.
Theoretically a market-oriented economy and price mechanism
will only work efficiently in a liberal market environment. It is
understandable that China’s economic growth rate has dropped so
rapidly. The People’s Bank of China cut the deposit reserve ratio tostimulate investment by companies, especially SOEs, but the policy
has not worked. SOEs have invested too much since 2009, so thatmost of them hold huge amounts of excess equipment. Their debts
are damaging their balance sheets and assets, as well as the state
commercial banks. This is a potential risk to the Chinese economy
and society. The IMF has warned the Chinese government manytimes to address the bad debt issue; otherwise it will lead theChinese economy into a system crisis.

Nowadays few economists in or outside China can present an
optimistic view of the economy. We don’t need to be too pessimistic,
but we need to recognize again the Chinese policy making process to
avoid misunderstanding what will happen in China.
Investments by the private sector, consumption by households
and external trade are the orthodox driving forces of the economy.
But under Xi’s administration the trade war with the US has not only
damaged trade but also encouraged multinational companies torebuild their supply chains and value chains. That means China has
to improve its R&D and innovation in order to upgrade its industrial
structure. In some sense, Trump’s request that China protect IPR is
not only for the benefit of American companies but also for Chinese.
For most Chinese companies, especially private ones, there are no
incentives to research and develop fundamental technologies.
Chinese companies are usually very aggressive in developing
profitable products. External trade, especially exports to the US, haspeaked out obviously, and companies are very careful about
investing in new projects. It is time for China to change its economic
model.
In China the population is declining, and the problem of an aging
society makes households save more money instead of consuming.
The social security system in China has not been establishedperfectly, especially the public insurance system for health care.
Since the Jiang administration, the government has emphasized thenecessity of building a development model dependent on domestic
consumption. This significant policy will help China to change its
economic model, but the problem is how to improve reforms. During
Hu’s era China lost 10 years and few reforms were enforced.
In conclusion, I believe that to sustain economic development
China must reform the current economic system and build a marketoriented one. It needs to privatize SOEs gradually. There is no way tosustain economic development without building a market-oriented
system. China is a country of great diversity and Chinese people arevery aggressive in taking risks to do new business. It will be
impossible to sustain economic development under the frameworkof a centrally planned economic system. The Xi administration isstrengthening control of the economy and society. But Xi has tochange that policy and return to the framework of a free and open
market designed by Deng. Otherwise the Chinese economy will fall
into a serious crisis.

Long Ke is a senior fellow of the Tokyo Foundation for Policy Research, aproject professor at the Global Center for Asian and Regional Research of the
University of Shizuoka and a senior fellow of the Fujitsu Research Institute.

Japan SPOTLIGHT • January / February 202015