Amongst all the political upheaval in the Middle East and North Africa, with people rising against dictatorial regimes in Tunisia, Egypt, Libya, Yemen and elsewhere, this week China embarked on its annual legislative session. The legislative session of the National People’s Congress, which officially enacts legislation, will rubber-stamp the government’s 12th Five-Year-Plan (2011-2015), which was decided at the Communist Party meeting in October, 2010.
Details won’t be made public until the conclusion of the legislative session (which usually lasts 10-14 days), but some elements of China’s next five-year economic plan have been made public. The three elements worth highlighting are a lower growth rate and a more balanced/sustainable economic model, meaningful reductions of pollution through better energy conservation, and a more aggressive fight against inflation.
A New Growth Model:
New Energy Priorities:
Fighting Inflation:
Analyst are already predicting that this Five-Year-Plan will be the most significant in China’s modern history, marking the moment that China finally decided to abandon its fast export-led growth strategy in favor for a more sustainable growth model. However, this new effort by China to rebalance its economy in not addressing the root cause of its monetary problem (inflation), and will not facilitate the rebalancing of global trade, which has been so critical to the overall world recovery.
The root cause of China’s inflation is its weak-currency policy, which is feeding an artificially large trade surplus. This policy hurts both China by producing an overheated, inflation-prone economy, and the rest of the world by increasing unemployment in many other countries.
Theoretically, inflation is the market’s way of undoing currency manipulation. According to Paul Krugman, China has been using a weak currency to keep its wages and prices low in dollar terms; market forces have responded by pushing those wages and prices up, eroding that artificial competitive advantage.
China’s leaders are trying to prevent this outcome, to protect exporters’ interest, and because inflation is even more unpopular in China than it is elsewhere. Don’t forget that it was inflation that fueled public discontent with the government, bore the 1989 protests in Tiananmen Square.
China is already hurting its citizens through financial controls. For example, interest rates on bank deposits are limited to just 2.75 percent, which is below the official inflation rate of 4.9%. Rapidly rising prices, even if matched by wage increases, are making the situation much worse for Chinese consumers.
Unfortunately, Beijing is not willing to deal with the root cause and let the RMB rise. Instead, they are trying to control inflation by raising interest rates and restricting credit. This is destructive for China, because credit limits are proving hard to enforce and are being further undermined by inflows of hot money from abroad. With efforts to cool the economy falling short, China has been trying to limit inflation with price controls, which also rarely work.
Furthermore, this is destructive from a global point of view as well: with much of the world economy still depressed, the last thing the world needs is major players pursuing tight-money policies. The solution to China’s monetary problem (and to the global recovery) is to let the currency rise!
But, any rebalancing efforts will face serious opposition from special interests domestically, primarily the State Owned Enterprises and regional and local officials. The SOE’s benefit from lax environmental regulations, cheep energy and government subsidies, and an overall export led growth strategy. On the other hand, local officials are not always willing to change, have old ideas about growth and tend to favor pet projects that need massive investments. Couple that with China’s one-party state that refuses to do anything that looks like giving in to U.S. demands, and you have a recipe for certain continuation of the status-quo.
The focus of the new Five-Year-Plan is promising, but its success is questionable.