CHINA ECONOMY: MIRACLE OR MIRAGE

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Sagging Growth, Bad Loans Belie Beijing Propaganda

Date: 10/11/99
Author: Paul Sperry
©Copyright 1999 Investors Business Daily, Inc.

It was a sight to behold: Nearly 60 chief executives from Fortune 500 companies last week lined up with party officials in Shanghai to help cheer 50 years of Chinese communism.

Actually, they were just being polite. What they were really cheering is the chance to grab a piece of China's "rapidly developing" economy-or so Beijing terms it.

Leading up to the Fortune Global Forum sponsored by Time Warner Group Inc., the state news organ, Xinhua, blanketed executives with rosy economic reports.

"China has become one of the countries (that's) developing most rapidly, with an annual growth rate of 9.7% on average," crowed one article.

Another Xinhua story blared: "China Continues to be Major Investment Destination."

Indeed, said Fortune spokesman John Needham, "It is China's rapidly developing economy that has attracted the attention of the presidents of the world's great multinationals."

But China's economy is not booming. Nor is it attracting the kind of heavy foreign investment it once did.

Activity has slowed sharply in recent years. And now, after two decades of unbridled growth, "China's economy is effectively in recession," said Gerald Segal, analyst at the International Institute of Strategic Studies In London.

In this month's Foreign Affairs, Segal figures that China's economy is growing at 6%, not the 9% that Beijing reports. And when you back out "useless goods produced to rust in warehouses," "massive government spending on infrastructure" and other illusory gains, you're left with a shrinking economy, he said.

The U.S.-China Business Council expects total foreign direct investment in China to drop as much as 20% by year's end. It stalled out last year at $45.5 billion.

Despite their Shanghai salute, U.S. investors are pulling back, too, data show. Contracts peaked in 1993 at 6,750. By last year they'd plunged to 2,181.

Also, growth in China's exports-the linchpin of its economy-ground to a halt last year and is down this year.

"China faces an unprecedented combination of declining exports, declining foreign direct investment and a decline in the willingness of international banks to lend to it," said Brookings Institution analyst Nicholas Lardy.

Were U.S. executives oversold on China?

No, investors just got the jitters, explains the pro-China business lobby.

Saber-rattling over Taiwan, NATO's errant bombing of the Chinese Embassy in Yugoslavia and other sensitive issues "created a more unstable environment" for investors, says U.S.-China Business Council analyst Jeremy Waterman.

Once the dust settles, and Beijing further eases state controls on the economy, investment in China will pick up, Waterman predicts.

Segal, on the other hand, cites poor returns. China "is overrated as a market," he said. For years CEOs have been "bamboozled" into thinking they can make big money in China.

In recent years several carmakers, complaining of "bureaucratic fatigue," have shut plants in China or scrapped plans for new ones.

Smart CEOs aren't buying the hype.

Only 28% of senior executives at America's fastest-growing companies view China's market as "very important," said a recent poll conducted by Oradell, N.J.-bases TIPP for Investor's Business Daily.

China's consumer spending is growing at an "anemic" 4% to 5% a year, Lardy said, as more Chinese save out of fear of losing their jobs. Joblessness in China has hit a 30-year high "and will probably go higher," he said.

Some say unemployed workers' protests, now a weekly event, have had more to do with the rash of state-security crackdowns than pro-Democracy dissidents.

To prop up sagging growth, Beijing is taking on debt. Lardy says about 80% of all state spending is financed not by taxes but by bond sales.

"Government debt is increasing at a rate that will not be sustainable over time," he said.

Also, China's four largest banks are so saddled with bad real-estate loans that they're reportedly on the brink of failure.

At the Shanghai forum, Chinese President Jiang Zemin boasted of Shanghai's "vibrant business zone, full of high-rise buildings." What he didn't say was those high rises are only about 30% full.

Then there's China's sputtering export engine, now about a quarter of China's economy. In the first five months of this year, China's trade surplus had actually shrunk by about 60% from the same 1998 period, Lardy says.

China's exports should rebound, though, as its Asian trading partners get back on their feet.

But Segal says some 45% of state-run industries are losing money. The profit squeeze has been made worse by 24 straight months of falling prices.

Most executives agree China has opened up its huge market in recent years.

But its 1.2 billion consumers are just potential buyers of U.S. goods. Fact is, about 850 million of them still live in poor, rural areas and don't have a lot to spend. In terms of per-capita income, the average Chinese earned $3,570 a year in 1997, ranking the country alongside Latvia and Jamaica.

At 1.8% of total U.S. exports, sales to China are tiny. We export as much to Belgium.

Even if you can stomach China's high tariffs-which average 35% and range up to 150% on some goods-you still must deal with burdensome rules on imports. Trade officials also grant which firms you can ship to. Most are state monopolies.

Some say setting up shop in China is the better way to go.

Novecon Cos. CEO Richard Rahn met recently with Shanghai's vice mayor and found that "Chinese leaders are not interested in communism so much as control; they're pragmatic."

They now allow the "functional equivalent" of property ownership in China through easily renewable, long-term leases, says Rahn, whose Sterling, Va.-based plant makes advanced computer chips.

But China's courts still aren't independent. They're merely rubber stamps for the Chinese Communist Party. In contract disputes, businesses can't count on a fair hearing. And the appeals process is viewed as a joke.

Top executives polled by IBD cite red tape, weak property laws and corruption as the three biggest hurdles to doing business in China.

"Corruption is a very uncertain, highly destructive tax of its own," Rahn admitted.

For U.S. manufacturers, the most attractive thing about doing business in China is cheap labor. Often, though, cheap labor isn't enough to overcome the cost of bureaucratic barriers.

Take power projects, the hottest area for deals in China. U.S. contractors ticked off one concern after another after a 1995 Energy Department trade trip to China.

"Many believe the rates of return in China are not adequate," the trip report said.

Other drawbacks: "Lack of a strong commercial legal system," "currency convertibility" problems and "laws that prohibit pledging assets of projects as collateral for loans."

Over the past two decades, thanks to the late leader Deng Xiaoping's economic reforms, China's people have gained the right to improve their economic lot.

They can move to another city to find a better job. Before, owning a phone was a big deal. Now they can start a business.

"China in essence has changed from a totalitarian society, where every aspect of life was regulated, to a dictatorship," where regulations apply mostly to politics, said Richard Bernstein and Ross Munro in their book, "The Coming Conflict with China."

But China's economic strategy isn't just to raise living standards.

"It is also aimed at enhancing the acquisition of the most advanced Western technology, including 'dual use' technology that can be used for both civilian and military purposes," Bernstein and Munro said.

In other words, Beijing wants to modernize the People's Liberation Army.

"To continue doing business in China, (an) American company is required not only to transfer advanced manufacturing technology to China, but also to train a Chinese work force, " Bernstein and Munro noted.

They cite McDonnell Douglas Corp., maker of the F-15 fighter jet. In its bid to make money in China, it transferred enough technical data to "fill a library."

China's military-industrial complex, or "PLA Inc.," is run by a huge bureaucracy known as COSTIND-Commission of Science, Technology and industry for National Defense-says Nicholas Eftimiades, author of "Chinese Intelligence Operations."

COSTIND controls PLA arms suppliers like Norinco and Poly Technologies that front as exporters of goods like toys and frozen fish.

But it's really earning the "foreign exchange for its military modernization program," Bernstein and Munro said.

China's foreign-exchange reserves now rival Taiwan's and Japan's.