China Attempts to Leverage Its Private Sector to Increase Its Military Might

The People’s Liberation Army (PLA) is racing to develop command, control, communication, computerization, information, surveillance and recognition (C4ISR) capabilities.  China’s defense budget, currently $115 billion, has increased at a double-digit rate for the past 15 years.2  However, China is facing three key challenges in modernizing its military.  First, China’s policy-makers are seeking to remove historical barriers between civilian and military industries.  Technologies that can be used for both civilian and defense economies, known as “dual use” technology, are at the heart of this effort.  Second, China is employing market-driven management concepts in their modernization program.   Since the late 1970s, China’s industrial sector, both civilian and military, has been structured into rigid hierarchical organizations.  Such vertically-structured silos largely or entirely restrict the flow of information within the organization to up-down lines of control, inhibiting or preventing cross-organizational communication and thus cross-fertilization and sharing.  Finally, China is struggling to develop environments that enable innovation.  The lack of both cross-fertilization and a competitive contract environment has a deleterious effect on innovation, including integration of technologies into increasingly large, complex, information-based systems.

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A Shenyang J-15 fighter takes off from the Liaoning aircraft carrier.

Military-Civilian Barriers

At the 18th Party Congress in October 2012, China’s leaders continued to promote “military-civilian integration” as a core component of the country’s military development strategy.  China’s leaders believe this integration will help China continue its rapid defense modernization without creating too great a drag on its economy.Deeply-rooted barriers, redundancies, and incompatibilities between the military and civilian sectors have yet to be resolved before this integration can occur.

The EU Council on Foreign Relations reports that, “Since the Cultural Revolution, the People’s Liberation Army (PLA) has acquired civilian industries, which it has helped to protect in stormy times, and which have become a source of profits for the military.” However, “Beginning in the 1980s, streamlining the arms industry entailed converting some military firms to civilian production.  Dual use development  has provided an indirect way to acquire foreign technologies, which could eventually be transferred to weapons production.”1 Dual use technologies include information technology, microelectronics, aerospace, and other commercial technologies that can be adopted for military purposes.

Technological trade with China, however, presents significant security risks for China’s advanced trading partners, such as the U.S., Japan and Europe.  Adam Segal of the Council for Foreign Relations has stated that the U.S. Defense Department also relies “increasingly on the U.S. commercial advanced technology sector to push the technological envelope and enable the Department to ‘run faster’ than its competitors.”  Thus U.S. national security is also tied “to the same global process of innovation through global competition and integration that indirectly contributes to the improvement of Chinese military capabilities.”2


Traditionally, the Chinese defense sector has been afflicted with some of the worst pathologies of the state-owned, centrally-planned economy:  low productivity, overcapacity, a lack of understanding of final markets, a dearth of management skills, and technological backwardness.2  China’s industrial sector has always been, from its socialist origins, a collection of vertical silos that do not allow for systems integration and competitive management. This is especially true of the defense industries.  Chinese leaders now believe that the barriers between industry sectors will need to be broken down to fulfil the need for informatised defense.  China has eleven industrial conglomerates in this model. They are “huge, vertically integrated behemoths that have a near monopoly control of the domestic defense market.”3  They also have a diverse set of strengths and weaknesses. Their strengths are that they have enormous experience and expertise in conducting defense work, they have strong ties to the military, and they have a well-established R&D base. Weaknesses, however, include an uneven track record of technological success, institutional cultures that are rooted in central planning and an “overwhelming focus on industrial era practices and processes” (e.g. heavy industry) that are not suited to developing or manufacturing information age military products.3


China does not have a robust system for indigenous innovation that could give it a competitive advantage in defense technology.  It lacks incentives for communication and cooperation between civilian and defense industries.  Even though a market economy now exists in China, its defense sector remains sheltered from market pressures.  Innovation requires competition and competition can be more effectively employed by a market economy.

In his book, “Fortifying China: The Struggle to Build a Modern Defense Economy” 3, Tai Ming Cheung, director of the Institute on Global Conflict and Cooperation (IGCC) at UC San Diego, poses the following question as to whether technological innovation can flourish in an authoritarian system:  “Is there a fundamental incompatibility between China’s efforts to be a world leader in technological innovation and its maintenance of a restrictive, authoritarian political system?” In particular, Cheung wonders if “the absence of a robust and independent legal system, highly controlled flows of information and knowledge within society and lack of encouragement of pluralism that would allow for greater autonomy and self-governance with the Science and Technology community” would doom this strategy from the outset.


The Chinese government has prioritized military-civilian integration, but implementation remains a work in progress.  Integration is hampered by China’s closed, vertically integrated military model that has limited potential for achieving major gains in its efforts to modernize its military.  China must overcome additional hurdles with respect to international dual use trade restrictions, as well as with its rigid management structures and lack of an effective environment to foster indigenous innovation.  Given the challenges it faces, it is reasonable to expect that the pace of innovation will be gradual at best.  Such a slow pace could provide additional incentives for China to steal the intellectual property of other countries.  China is the world’s largest source of IP theft.4  In addition to hundreds of billions of dollars of loss to the IP owners, theft of intellectual property is undermining both the means and the incentive for entrepreneurs to innovate, which will slow the development of new inventions and industries that can further expand the world economy and continue to raise the prosperity and quality of life for everyone.


  1. Godement, Francois, Kratz, Agatha, Lafferty, Brian, Puig, Emmanuel.  “The Reform of China’s Defence Economy.” EU Council on Foreign Relations.
  2. Segal, Adam. “New China Worries.” International Economy Magazine, Fall 2007.
  3. Cheung, Tai Ming. “Fortifying China: The Struggle to Build a Modern Defense Economy”, Cornell University Press, August 2013.
  4. “The IP Commission Report.” 2013.


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China: Quo Vadis?

China today is at a crossroads. There are many forces at play, both internally and externally. In both the economic and geopolitical realms, China is a country of dual  identities. Economically, China is in transition from a relationship-based system, exemplified by its large number of State-Owned Enterprises (SOEs), to a market-based system, as seen in the massive growth of private companies. Although China has made notable strides in moving from relationship-based to market-based approaches and institutions, its economy today remains a hybrid, with growing market-oriented sectors co-existing with a shrinking, yet still powerful, state sector.

In the geopolitical realm, China also has two identities. On the one hand, it is a world power with the potential to be a catalyst for global growth and integration, backed up by a track record of record-breaking development and a powerful cultural history. On the other hand, China has the potential to assert itself as an authoritarian force, backed up by a substantial military.

These dual identities are interacting in different ways — they are merging in some places and are at odds in other places. This is influencing how China is interacting with the rest of the world. Alternatively, it is also influencing how the world interacts with and views China.

Economic Duality and Transformation

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A replica of Wall Street’s charging bull on the Bund in Shanghai.  AGENCE FRANCE-PRESSE/GETTY IMAGES

In 1998, one year after the Asian Financial Crisis led to regional contagion of currency and stock market declines, reduced import revenues and government upheaval throughout South Asia, University of Chicago professors Raghuram Rajan and Luigi Zingales wrote on the implosion of relationship-based financial systems in the crisis and the limitations that would be overcome through completing the transition to an arms-length system.6

Relationship-based systems are commonly seen in developing countries. In this system, return is ensured for the lender by “granting power over the firm being financed, e.g., through ownership or through retaining a role such as main lender, supplier or customer.”6 The lender ensures return by retaining some form of monopoly over the firm being financed. “As with every monopoly, this requires some barriers to entry”6 that substantially raise cost of entry to potential competitors, e.g. due to regulation or lack of transparency. In an arms-length system, the lender is protected by explicit contracts. Contracts and associated prices determine transactions that are undertaken. “As a result, institutional relationships matter less and the market becomes a more important medium for directing/governing terms of transactions.”6

In China today, both systems are functioning in parallel as it continues to develop and integrate with its global markets. The role of the market and private business in China’s rapid ascent has been profound. Private companies now account for more than two-thirds of China’s economic output, up from zero when reform began in 1978, in an economy that has expanded 25 times in real terms. Private companies also account for almost all jobs growth in the same period and are leading contributors to export growth.3

In addition, China has endeavored in recent years to promote positive, business-driven relationships with free-market economies, further reflecting China’s own internal development towards a market economy and its desire to be at the forefront of international trade. Specifically, China is continuing to integrate with the global financial markets. In November 2014, China launched the Hong Kong – Shanghai share link, providing global investors direct access to China’s capital markets. Also in November, plans to build a Canadian Renmimbi hub were announced, making currency transactions simpler and cheaper.

In addition to the rise of the market, relationship-based systems can still be seen clearly in China. The largest examples of this are China’s State-Owned Enterprises (SOEs). SOEs fall into three groups: industrial SOEs, of which there are about 145,000, virtually all of which report to provincial and local governments; banking and financial companies; and media and entertainment companies. Thirty years ago, SOEs were owned and controlled entirely by the government. The government determined what and how much to produce, where to invest, who to sell to, how to price and where to get financing SOEs had no right to hire and fire, and profits were handed over to the government. SOEs acted like mini-societies, providing life-time employment and basic social services, such as clinics and schools. SOEs also benefited from cheaper financing from state-owned banks, favoritism from local governments in land sales and fewer demands from regulators.

By the early to mid-1990s, SOEs were in financial crisis. They were hampered by rigid internal management structures and uncompetitive compared with more nimble, market-oriented, non-state firms. The government began an incremental, protracted, privatization program, which is still underway. This program included modernization of SOE governance, management and legal structures, all of which increased their “contractibility”5 quotient significantly, a key prerequisite for a market-based system. The low productivity and low returns of SOEs (less than half that of private companies in China) are a drag on the economy that cannot be afforded, especially in the face of a structural slowdown associated with a declining working-age population and the fading benefits of past economic reforms. China’s leaders agree that growth must increasingly come from productivity gains driven by improved resource allocation, rather than through simply agglomerating large amounts of capital and labor.5 Jian Chang of Barclays says that improving SOEs is “the most critical reform area for China in the coming decade.”

Geo-Political Hegemony Duality: Leadership through Growth and Influence or Control through Military Intervention?

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Chinese President Xi Jinping, right, is seen toasting with Macau Chief Executive Fernando Chui Sai-On in this handout photo in Macau to celebrate the 15th anniversary of its handover in December.2

In addition to its two economic identities, China has two geopolitical identities. It is a world power with the potential to be an important catalyst for global growth, integration and peace, as well as an authoritarian state with the potential to assert itself through force.

As a catalyst for growth, China is working vigorously to expand its international markets and trade, key elements of its future economic performance and, therefore, its internal stability. Over the past two years, China’s President Xi Jinping and Premier Li Keqiang have embarked on a frenetic diplomatic offensive, making at least 17 visits to 50+ countries on five continents and racking up close to 500 meetings with foreign heads of state and government.2 Wang Yi, the foreign minister, said proudly that Messrs. Xi and Li have created “a ‘Chinese whirlwind’ in the world.”

Recognizing that its regional and global growth rests on well-developed infrastructure, China is also continuing its decades-long efforts to develop what Beijing has coined as “comprehensive connectivity,” the end result of which is a networked Asia with China at its heart. Since 1978, Chinese national investment has been targeted toward regional container ports, industrial parks, high-speed railways, and highways that crisscross the Asian mainland, energy pipelines, and other infrastructure. China is now bringing economic development further west and south, creating additional trade and markets. At the November 2014 Asia-Pacific Economic Conference (APEC), China announced the establishment of an Asian Infrastructure Bank and a Silk Road Fund to finance regional development projects.4 This includes $40 billion in loans to help create a 21st-century version of the ancient Silk Road in the South China Sea region.4 It remains an open question as to whether this will result in an ASEAN block with closer economic ties to China or if China will ultimately use its economic and military weight to repress and control the region.

As a global geopolitical leader, China is engaging in activities to promote regional stability. During 2014, China has engaged with Afghanistan as the US prepared to leave the region. China shares a small but strategic border with Afghanistan from Xinjiang province and has an interest in the stability of the region. China has pledged $325 million and has promised to help train 3,000 Afghan professionals and to assist in training and equipping the Afghan National Security Forces.3 The Central Asia region has great possibilities for economic development, but also contains the potential for conflict among nuclear-armed neighbors. China has an opportunity and a difficult task to help ensure that the region becomes an engine for growth, not for conflict.7

China has built global credibility for its economic transformations and accomplishments, which have lifted 500 million people out of poverty. It is now in a position to leverage these successes to further benefit both itself and all of Asia through trade and economic development. At the same time, it has the potential to incite regional instability over territorial disputes and military brinksmanship. Recent territorial incidents include the dispute over the Senkaku (Diaoyu) Islands with Japan, the South China Sea with the Philippines, and unilaterally placing an oil-drilling rig in waters 120 miles from Vietnam’s coast. China is also in danger of smothering some of the key contributors to its success in Hong Kong and Taiwan, rather than recognizing and promoting them, as Deng Xiaoping did with successes such as the Household Responsibility System.9 Any or all of these possibilities risk its economic and geopolitical future. Will China dominate the region through force or will it help lead the region to increased profitability and peace?


China’s current economic diversity can be traced to two incomplete transitions: first, the development away from bureaucratic socialism towards a market economy; and second, China’s ongoing industrialization and its evolution from a rural to an urban society. These two transitions affect every aspect of the economy, society and culture, and are both far from complete. China has made notable strides in moving from relationship-based to market-based approaches and institutions, but its economy today remains a hybrid.

China’s economic and political aggressiveness is occurring at a time when its current economy faces notable risks of a significant downturn. Its leaders are working vigorously and globally to promote economic growth. While this aggressiveness could be beneficial to both China and the Asian region, it can also be threatening, given its demonstrated propensity for using force to impose its will. Going forward, China’s standard of living and the rights of its citizens will be influenced by how it reconciles these systems and approaches. China today carries with it a complex mix of the traditional, the socialist, the modern, and the market, bundled in a pragmatic mindset to solve problems with any and all tools and opportunities at its disposal. It is too early to know with reasonable certainty how these forces will ultimately play out. Quo vadis – where are you going – is an especially apt question for China. China’s evolution and accomplishments since 1978 are awe-inspiring and unprecedented. Will its people and its leaders continue to build mutually beneficial relationships and systems domestically and with the rest of the world? If yes, this well could define the 21st century as a golden era of peace, prosperity and civilization.


1. “Quo Vadis.” (Where are you going?)
2. Browne, Andrew. Wall Street Journal. “Expect No Easing of ‘Chinese Whirlwind’. Beijing Softens its Bluster, but Ambition Remains Unchanged.” January 6, 2015.
3. Lardy, Nicholas. Peterson Institute for International Economics. “China’s Rise Is a Credit to Private Enterprise Not State Control.” Op-ed in the Financial Times. September 15, 2014.
4. Economist Intelligence Unit – Country Report – China. 12-14-14.
5. Zhang, Dong and Freestone, Owen. “China’s Unfinished State-Owned Enterprise Reforms.”
6. Rajan, Raghuram and Zingales, Luigi. University of Chicago “Which Capitalism? Lessons from the East Asian Crisis.” Journal of Applied Corporate Finance, Vol. 11, No. 3, Fall 1998.
7. Cotter, Michael W., US Ambassador (ret).
8. Naughton, Barry J.. The Chinese Economy: Transitions and Growth. Cambridge, MA: MIT Press, 2007. Kindle Edition.
9. Kennedy, Robert E. and Marquis, Katherine. “China: To Get Rich is Glorious.” 2006 (revised 2013). HBS case no. 9-707-022.

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China, South Korea reach on FTA

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South Korea and China started negotiations on the FTA in May 2012 and have held 14 rounds of negotiations since then, finally wrapped up 30 months of negotiations on a free trade pact on November 10th, a deal expected to open a new chapter in the economic cooperation between the two countries.

FTA is the agreement between the two countries in trade that the two countries have decided not to impose taxes each one, is brought up the market expansion effects.

Korea-China FTA included the steel, petrochemical, industrial, and food sectors, such as tying the duties and services and investment, most of the non-tariff areas in the agreement details. However, the two areas are reluctant to market opening has been excluded from the agreement targets. The conclusion of the Korea-China FTA is expected to bring a number of changes in the market economy.

First, South Korea’s government is expected Korea-China FTA is raising the growth of our economy, the expanding investment of the United States, European companies in South Korea and simultaneously South Korea and China will be in relations with strategic cooperative partnership to induce North Korea’s opening up through the deepening of reform and to bring the safety and unity in Korean peninsula.

The company will stand a chance to be in the world market and a large increase in profits by the price competitiveness of expensive tariffs. In addition, increases increasing production and exports of large industries will lead the sales of small businesses; export, production, and employment are expected to increase at the same time. . The forecast for consumer is that prices will be stable and extended to the width of choices. Korea-China FTA sector that suffers a benefit to the conclusion referred to areas such as automotive, machinery, cosmetics, and medical.


PRC Korea FTA 반대 2

Despite these claims of some government, the voice of opposition raises to the Korea-China FTA. Opposition insists that due to the Korea-China FTA, agricultural sector will be suffering damage and the agricultural population will be reduced significantly. Also the bow of a small business is degenerate accordingly put forward the claim that national unemployment rate would be increased. Because most small businesses are maintained by contractors of large enterprises, collapsing SMEs is causing the higher production costs of large enterprises. Also

They are concerned that the low-wage labor market policy in China would be encroaching on the Korean domestic market accordingly job losses and wage growth reduction. In addition, lower competitive industry will be hard to survive with that of a Korea-China FTA partners settlement will be hard to survive, and the FTA tariff elimination will lead the influx of Chinese low-cost domestic agricultural products, even though the Korea-China FTA agreement exclude the agriculture.

The Korean government, fearing the extreme opposite of these farmers, exclude of rice and rice-related products excluded from the agreement target (all agricultural products (1,611 pieces) 581 pieces of ultra-sensitive items for the Korea-China FTA agreement. After the entry into Korea-China FTA, the current tariff rates continue to maintain and customs of agricultural season or Safe Guide (ASG) were introduced, but FTA agreement was suspended for tariff elimination for sensitive products.

Meanwhile, China were excluded automobile, but Korea were excluded the enrichment fisheries from agreement targets. China is to eliminate a blow to the Chinese automotive market and Korea is to eliminate the possibility of a recession concentrated fisheries. The finished car was not included, however duties of 6-10% on auto parts will be gone in 20 years, and industrial tariffs for commodities such as the refrigerator, a washing machine and cooker will be repealed within 10 years.

Proportion of the general public import and export trade is only 29.1% occupied. Considering the status of trade tariffs between the two countries, Korea is rather high in commodities. Accordingly, the effect of increasing exports to China by tariff reductions is likely to be limited. Lack of domestic institutions in China, South Korea has the difficulty of the actual enforcement to lead the negotiations to problems.

PRC Korea FTA 2

I guess that cause of FTA between South Korea and PRC, South Korea’s GAP will grow 2.4~ 3.1%, because PRC is first target export country (26.1% in total export of South Korea) to South Korea (based on 145,837 mil. USD (2013) (source: trading economics, Oct, 2014).

Utilizing the experience of comprehensive FTA with Korea-US, or Korea- the EU, South Korea must strive to best negotiation for the best results in these areas. Also South Korea converges from requirements of the export industry and enterprise to yield concrete benefits.



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World’s Most Unaffordable Housing

For the fourth consecutive year, Hong Kong has won the title of world’s No.1 most unaffordable housing — and in very convincing fashion. The median cost of a flat in Hong Kong is HK $4.02 million (US $515,000), 14.9 times median annual household income of HK $270,000 (US $34,600). In contrast to that of other developed Asian countries, this “median multiple” in Singapore and Tokyo-Yokohama are just a mere 5.1 and 4.4 respectively. This 14.9 multiple is even more shocking according to the World Bank and United Nation guidelines for affordability — from 3 to 5 the categories are rated as moderate (3.1 to 4.0), serious (4.1 to 5.0) and severe unaffordability (5.1 and over). Faced with monolithic problem, the Hong Kong government has not done nearly enough to ease the burden for its citizens.

To date, 3.4 million or 48.8 percent of the population of Hong Kong live in government housing or government subsidized housing. On the surface, it seems a successful public housing program has facilitated upward social mobility and also rapid development of now-thriving new towns. However Hong Kong is still entrenched in a looming housing crisis that does not square with its economic affluence, as evidenced by a severe undersupply and high property prices and rents beyond the affordability of the general population. The number of applicants awaiting public housing at the end of June was a whopping 255,800 with an average wait time of seven years. Of these people, 130,000 were singles under the age of 60 – quadruple the equivalent figure of 30,000 applicants in 2005.

So where do these low-income individuals result to living during their wait for public housing? Well the “lucky” ones are trapped living with their parents and relatives in tiny Hong Kong flats. Wong Yik Mo, a 35 year old warehouse worker with a monthly income of HK $14,000, lives tryingly in a 500 sq ft apartment with five adults — his wife, older brother and parents. Seeing that his salary was above the HK $9,670 cap to qualify for single housing, he has undergone drastic action by forfeiting his job in order to escape. Such stories are increasingly common amid the acute shortage of low-cost housing and escalating property prices.

The even lesser fortunate of the less fortunate low-income individuals result to living in even tougher conditions. Mak, 72, has lived in a four-walled “coffin home” for the better part of a decade. Despite working hard 14 hour shifts as a janitor, he has been stuck in a purgatory of incredibly low income and a long waiting list for better public housing. Another coffin home resident said to a reporter, “I’m not even dead yet, but I’m already living in my coffin.” Nicknamed “coffin-home” or “cage homes” for their physical similarities, some 200,000 people live in this underbelly of Hong Kong. Through Mak’s eyes, there are two distinct Hong Kongs: “the one seen through his only window, personified by the glitz and glamour the city is famous for. And on the inside, that has allowed less fortunate citizens to fall through the cracks.”

A typical cage home with barely room to sit up straight                      Source: The Globe and Mail

The problem of affordable housing is just one of many that represent a much larger issue of an extreme wealth gap. Monthly wages have only increased 30% in the past 10 years which pales in comparison to a 60% jump in Hong Kong GDP and a shocking 140% increase in housing prices over the same time period. Younger generations are gravely discontented because they don’t see any prospects of affording a home. The attempt to tackle housing affordability is noble, but the Hong Kong government is side stepping the root of the problem that lies within a structural inequality for property sector tycoons. Three companies account for 72% of the residential property market in Hong Kong – without greater market competition, the “tycoons are seen as gaming an unfair system in their favor.”


Housing Prices in the past decade (Source: Money CNN)

Underlying the recent demonstrations in Hong Kong is a voice that says strongly – despite the growth and development that the business elite have brought to Hong Kong, the process has created a very unequal society. The public dissatisfaction stems from a lack of voice in the city state for the typical Hong Kong citizen and the people are demanding a bigger say in what affects their lives. The Hong Kong government needs to tackle this problem and show the Hong Kong people that they care about not only the rich, but all the citizens regardless of status. As one Hong Kong citizen puts simply, “It’s not that the H.K. government can’t help people like me who are part of the low-income society and need help, it’s that they don’t want to help people like us and solve problems like this.”


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People’s Bank of China Cuts Interest Rates Sharply -Insights into Chinese Economics

Surprisingly, the Chinese central bank declared a sharp interest rate cut by 40 basis points on Friday, 21th Nov 2014. With the release of this news, a debate began over the prospects this might bring for the second largest economy. Theoretically, the government takes this action to reduce the cost of financing and to increase the liquidity within the market. However, behind the story, many believe that this is a clear signal that the Chinese economy is suffering from economic slow down after a decade of fast development.


The Current Problems with China’s Economy

Recent policy changes on interest rates and lending volumes show a clear indication of when the Chinese economy experienced difficulties. As is well known, economies are subject to highly cyclical evolvement. Together with the world economy, the most recent economic growth cycle started for China in 2003, a year after Hu Jintao became president. The lending volume increased sharply by 23% in 2003, while GDP began double-digit growth. When the financial crisis struck the world in 2008, the Chinese government launched a 4 trillion RMB economic stimulation plan to react to the negative impact from foreign markets. However, due to the incomplete financing system, most of the funds flew into infrastructure and real estate segments, which were mostly on a one-time basis that cannot be repeated. Since 2011, three years after the 4-trillion-plan, the effect of this stimulus has gradually diminished and the challenge of keeping up growth has emerged.


Three pillars support the growth of China’s economy: Export, Consumption, and Investment. By analyzing the current status of these three pillars, we can clearly understand the problems China faces:

  • Export

Similar to the path of many other Asian countries, China’s economic growth is greatly driven by exports. Under the background of “deindustrialization” in US and Western Europe, China gradually took over most low and medium-end manufacturing and became the “World’s factory.” However, this form of development was to some extent unsustainable because China has relied too heavily on low-income human labor and high environmental degradation. Recently, this has led to serious social problems.

Given the financial crisis in 2008 and the European crisis in the past two years, China’s export industry has struggled due to a decrease in external consumption. Another issue has been the gradual appreciation of Chinese RMB, which has appreciated from 8.6187 (to 1 USD) in 1994 to 6.1432 (to 1 USD). This appreciation has hurt the comparative advantage of Chinese manufacturing. As the statistics reveal, China has just experienced an exports slowdown in the third-quarter of this year. This slowdown has led to third-quarter GDP growth of around 7%, which fell behind the annual target of 7.5%.

  • Consumption

After the last financial crisis, changing the GDP growth pattern is the key strategy of the Chinese government. The government has clearly stated that pushing up the internal consumption rate is a top priority. With this clear goal in mind, the Chinese government has constructed many new economic policies, including an agricultural subsidiary, a medical care system reform, a agriculture tax cut, and a salary increase program. However, it takes time to observe how efficient these new policies will be. According to statistical data, the percentage of residential consumption to GDP was 46.4% in the year 2000. The number decreased to 33.8% in 2010 and then stayed in the range of 34%-35% for the following years. This data is telling us that if China wants to expand its domestic market, a reform in industrial structure will be required, and this is difficult accomplishment to make in short period of time. In addition, the country is now lagged by serious corruption and unbalance of income. There is still a long journey ahead for the government to solve all these issues, and push up the consumption.

  • Investment

Since the improvements of these other two pillars are difficult and time consuming, a quicker method of economic growth must be adopted. Investment in China is just that. More than 80% of economic scale is contributed by government related industry, which ensures the government’s ability of raising capital and investing into specific fields. In fact, this investment has been a vital part of China’s economy, especially in the last few years.  To better understand this investment, we divide the government’s investment activities into three main categories: manufacturing investment, infrastructure investment, and real estate investment.

Manufacturing Investment

Beginning in the late 90s with the reformation of state-owned companies, led by Prime Minister Zhu Rongji, China kept investing in the manufacturing industry as a result of demographic benefits. After the big boom for the past 10 years, the entire manufacturing industry is in a situation of overcapacity. The average facility utilization rate among all industries is only 70%. Take the steel industry as an example; the profit margin for each ton of production is only several pennies. It would be difficult to further increase investment in manufacturing.

Infrastructure Investment

As with the practice of the 4 trillion-plan, most of the infrastructure investments depend on government funding. However, the local governments are not money machines with unlimited capacity. In order to meet the huge capital needs for infrastructure investment, the local governments usually rely on issuing a variety of bonds in different forms. Funding the infrastructure investment through government credit seems practical in a short period of time, but it is unsustainable and risky in the long-term. On one hand, the general infrastructure projects, like railways and stadiums, are one-time investments and most of the major facilities have been built so far. Even if a need for infrastructure still exists in second-line or third-line cities, the scale of the investment will not be comparable to previous construction. On the other hand, the government’s credits vary from province to province. Actually, only several local governments like Beijing and Shanghai, which own deep pockets and political priorities, have good credit ratings. However, things seem different within other provinces. The local government of Shanxi Province defaulted earlier this year. The event clearly indicated that even for the government, credit is not unlimited. In conclusion, infrastructure investment seems to be an available way to drive GDP growth, but it is not as powerful as previous years have shown. Also, it is not sustainable enough for the long-term, and brings problems to government finance.

Real Estate Investment

Real estate investment used to be the key engine for China’s GDP growth in the past 5 years. However, this flourishing situation has disappeared. According to a recent industry report, the price of residential houses fell in 67 cities out of 70 in October. The slowdown in real estate has leads to many problems. First, many bank loans are backed with house property pledges. When real estate prices decrease, the bank will tighten the loan policy and decrease the lending. When capital supply decreases, the cost for company financing will increase, which leads to a further depress in industrial business. Second, government revenue will shrink sharply if the real estate industry goes into recession, because there are large portions of government revenue that come from real estate related taxes and land selling. Considering the large amount of the government debt all over the country at this time, if the real estate bubble someday collapses, the government would go bankrupt due to a incapability to accumulate consumption.

Conclusions and the Effect of Cutting Interest Rates

In conclusion, China is facing accumulated problems from exports, consumption, and investment. These difficulties will keep challenging the growth of China’s economy. However, it is still too early to conclude that China’s economy has fell into a predicament. After all, China is still the World’s fastest growing economic power with larger influence in global affairs. There are still many advantages that China could take to overcome these difficulties and lead to further and better development. First, the global crude oil prices keep falling, which China could benefit from by hedging with the increase in human costs. Second, some geographic political incidents that happened earlier this year provided China another choice of investment: resources. In May 2014, China signed a contract with Russia on the trade of natural gas, and the value of this contract was estimated to be nearly $400 billion USD. New input of resources will play a vital role in China’s industrial upgrade. Third, the new Chinese government, led by President Xi Jinping, has declared a war against corruption and dedicated to push the reformation in Chinese society. By optimizing social structure, upgrading the manufacturing industry, and encouraging technological innovation, there is still much confidence for the future development of the Chinese economy.

Though promising, there is still current issues that need to be dealt with. Cutting interest rates will have following positive impacts to the economy and help China to maintain its annual GDP growth target of 7.5%, but more must be done.

  • Restrain RMB appreciation and subsidy export. The value of RMB to dollar depreciated by 200 bp in one day after the announcement. In the long run, if the RMB keeps depreciation, it will definitely benefit the export industry and release pressure to those struggling in export enterprises.
  • Reduce borrowing cost for industrial companies. This is the most direct influence to the economy. With the interest cut, it will partially solve the problem of high borrowing costs to private business sectors and encourage the industrial investment.
  • Incentives for the real estate industry. Lower interest is definitely positive news to the real estate industry. A real estate site transaction achieved a deal at the highest price in local history in Guangzhou soon after the announcement published.



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Abe: to raise the consumption tax to 10% in 2017?

After the government lifted the consumption tax in Japan from 5% to 8% in this April, sign of Japanese economic recovery was about to be lost. Prime Minister Shinzo Abe postponed his original plan of increasing the consumption tax from 8% to 10% in 2015. While he claimed later that the consumption tax hike would be carried on in April 2017 regardless of the economic assessment at the time.

Why increasing the consumption tax?

Mr. Abe’s purpose is to solve the primary problem of budget deficit as a percentage of gross domestic product by fiscal 2015. And those who support hiking the consumption tax think it is a matter of “international credibility ”. If Japan doesn’t recover from its debts soon, Japan will lose its credibility internationally.

Situation after lifting the tax from 5% to 8%

With the effect of depreciation of Japanese Yen, imports such as grain and natural gas became more expensive in Japan. For Japanese people, the price of foods, electricity and gas increased largely, while wages didn’t. A “bad inflation” is taking place in Japan.


Shoppers cross a road in the Ginza district of Tokyo.           Source: Bloomberg

In 1997, Japan has experienced a similar situation. The consumption tax was increased to 5% from 3%, and since then Japanese economy was back to a recession from a recovering economy. This time, the impact of increased tax is even greater than in 1997. After the first round of increasing consumption tax, the fall in nominal consumer spending has been even more severe than in 1997, and we can observe a sign of recession is again.


Increasing consumption tax: a mistake?

With a growing aging population, the problem called “fiscal child abuse” is also seen in Japan. In order to protect senior citizens, the government is paying huge amount of money on them in terms of social security and public service. While because of the fiscal problem in Japan, it is the young generation that who are going to pay for it. With postponing second round of lifting the consumption tax, issuing more domestic loans may be inevitable. If so, this “fiscal child abuse” problem may get worse because next generation will be paying back these loans.

A Japanese TV program interviewed Japanese people, asking their opinions on increasing the consumption tax. Almost all the people being interviewed showed negative attitude on this issue.

In addition, some Japanese people are also afraid that increasing the consumption tax may decrease the tax income. In 1995, when Japan increased its consumption tax to 5% from 3%, because of deflation and getting-worse economy, enterprises’ revenue decreased. In total, tax income also decreased. 20 years later, Japan is facing the same situation this time. In 2020, the Olympics will be held in Tokyo. There are a good amount of projects for this event going on now. Because of the influence of increased consumption tax, these projects may also get negatively impacted.

Speaking of the consumption tax hike, one hundred consequences may be thought of. But only one of them is positive. One WSJ article on this topic ended with a comment like this,” Please, Mr. Prime Minister, apply the same fortitude you used on the Bank of Japan to overcome tax-and-spend orthodoxy.”


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Mr. Abe: increase women workers in Japanese workplace

Aging population and low fertility rate has been one of the most severe problems in Japan. In 2014, 25.9% of the population in Japan are senior people more than 65 years old. According to Statistical Handbook of Japan, the rate will increase to 33% in 2030. Because of dwindling workforce, Japan is looking to women for solution.

Situation of women in Japanese workplace

While Japanese women are better educated than nearly any other countries in the world, female participation in the labor force is 63%, much lower than in other developed countries. It is common in this place that women leave their jobs when getting married or having their first child born. They stop working for decades or more. Data shows that 70% of those who leave their jobs even for good. Partly because of the leaving problem, the rate of leadership roles in Japanese company is only 10%, quite low compared to 31% in Singapore, 38% in Germany and 43% in the U.S.

Women workforce in Abenomics

Due to this problem in Japan, the government is making effort on raising the participation of women in the workforce. On Oct. 17, the cabinet approved a bill that big companies (with 301 employees or more) to increase the rate of women in management positions. These companies are required to make and announce their plans on this.

To develop the economy in Japan, Prime Minister Shinzo Abe put this issue in one of the most important ones in his Abenomics. His goal is to increase the rate of women leaders in Japan to 30% by 2020.


In addition, we can see there are five women ministers in his new cabinet. By doing this, the female representation jumped to 26% from 10%. Mr. Abe’s action was to make an example for the society. “I believe that the hard work of the women in the cabinet will bring on social change,” Mr. Abe said.


Will it work?

Before arguing if Mr. Abe’s effort will make an effect, it may be important to look at the reasons first why most Japanese women quit their jobs.

One study compared the reasons why Japanese and American college graduates leave their jobs. The result shows that child-care and looking after elderly relations are the main factors for American women. While Japanese women are dissatisfied with their jobs and they have a feeling of being put into “dead-end” roles. In Japan, men usually work for long hours and hence don’t have much time taking care of children. This makes Japanese women feel that they need to be at home. Furthermore, women in wealthy places in Japan, like Tokyo, simply do not want to work.

With fact above, will the issue of women workforce in Japan be easily changed?

According to Yoko Yajima, a diversity consultant at Mitsubishi UFJ Research and Consulting, “It’s about work-life balance, worker productivity, training female employees, diversifying work styles—issues that companies have been trying to address for about 20 years.”

The situation that there are less women in Japanese workplace than in other rich places in the world is not only simply caused by the policy. Changing Japanese women’s mind may be another important aspect for Mr. Abe to achieve his goal.


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