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The beginnings of a disintegrating China - Part I

By David DuByne - posted Monday, 24 November 2008


The Olympics have come and gone, and the promises by Ministry of Finance government spokesmen, that the Chinese economy was set to grow healthily and steadily after the summer Olympic Games and that a post-Olympic economic downturn was highly unlikely, need to rethink their official statements. Even today after the $500 billion rescue package from the Chinese government the National Bureau of Statistics (NBS) reiterated: “China's economy is in good shape despite the changing economic environment, and it will remain stable with relatively fast growth. We should be confident about the country's economic outlook."

Rosy scenarios now fly around the daily news that even in the worst of global economic times China will be minimally affected. The fundamentals of China's economy are sound, the central government is in total control and if a problem occurs, the solution is already unfolding. The National Development and Reform Commission will continue efforts to expand domestic consumption amid the global economic uncertainty and People's Bank of China says “there is still room to tap more domestic consumption”.

The Ministry of Finance reiterated that “A high savings ratio can stimulate demand when economic recession occurs. China's economy is therefore cushioned against the worst of the disaster.”

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With all of this positive news, who should be worried? My answer: anyone that understands the ripple effect, that’s who! The leaders say one thing to pacify the people while on the streets another world exists. I want to delve into the beginnings of a disintegrating China.

I sat in disbelief reading a recent Shenzhen local paper stating that “Some 9,000 of the 45,000 factories in the cities of Guangzhou, Dongguan and Shenzhen are expected to close down in the next three months according to the Dongguan City Association of Enterprises with Foreign Investment estimates. Those closures would see up to 2.7 million jobs cut as overseas demand for consumer goods and clothes fades.” That’s more than 50,000 a day if you believe official figures, which I do not, and I believe the number is actually higher.

The association says that, by end of January, demand will shrink by 30 per cent, and these are just mainland factories. The Federation of Hong Kong Industries said that about 25 per cent of the 70,000 Hong Kong-owned companies in southern China "could go to the wall by the end of January". Yet on the very next page I read an article quoting the Ministry of Commerce as stating, “Although it is likely to cause a decline in China's external demand, our stock market and financial system will not be fundamentally affected”.

I can understand the flip-flopping stories as a means to keep a population from panicking; after all the Shanghai A-shares have declined more than 60 per cent from their bubbly peak at the beginning of the year. The Hang Sang in Hong Kong and the Shenzhen indices are not doing much better. Real estate prices have slipped 20 per cent in the last six months, all of the recent factory closings with many more to come and this is just the beginning of a prolonged feedback loop.

The central government's plan to reverse a foreign trade decline is to increase domestic consumption, restructure industry and boost innovation to change its economic development mode; that’s fine but first you need to have an expanding domestic economy to do that.

Priority number one

Number one on the priority list is domestic unrest caused by factory closures and owners declaring bankruptcy, thereby avoiding the troublesome task of paying their employees. In the last three weeks Dongguan Weixu Shoe Company collapsed and laid off 2,000, Chong Yik Toy Company shut leaving 1,000 without pay. The largest, Smart Union, locked its gates on 7,600 workers. Protesters descended on government buildings in Dongguan where hundreds of police were called out to quell violence.

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Local public funds have been used to cover the back pay owed to workers, $7.6 million so far. This was to cover three factory closures. Imagine the bill when factories close across China in the tens of thousands. By the time you read the article “Govt foots collapsed shoe firm's wage bill”, from Xinhua News Agency many more factories will have closed along the east coast.

“Big deal”, you say. “The workers are paid and will return to the countryside where they can grow vegetables.” That is true, but the few thousand RMB in their pockets will run out after a few months and with very few other opportunities to secure an income, China’s stability is in question. These workers originally came to the city to support the family by sending back money every month, now they are returning to the countryside by the tens of millions across China. My question is, "When the money runs out what will they do?" I’m sure crime and violence will skyrocket - to what degree I can only guess - but most importantly to what degree can security be guaranteed by the central authorities outside the cities?

If there is a repeat of anything like the Great Leap Forward, where 40 million starved to death, or the Cultural Revolution, which ended barely two decades ago, it will become a society restructuring event. China today is quite a different place compared to the 1950s: the current pollution problems have made 98 per cent of water sources above ground unusable and the amount of arable land has shrunk dramatically as factories and cities now cover what was once farmland.

These bankruptcies and massive layoffs are not just single events in isolated locations, it is beginning to happen countrywide. The lag time between the events of the western banking system and the fallout here in China is approximately two months. With that said more trouble is on the way. If there is no contingency plan by the communist party for the global downturn within their own society, and if they are reacting to each event rather than planning for such events, then the China we have seen during the last 10 years will be an entirely different place in another two.

Second tier

The second order of business will be restructuring to a non-export driven economy for the next three years until the world works itself out of this financial mess. The only one to speak out so far against the grain of positive news is Fu Ziying, Vice Minister of Commerce, who with some common sense said “It would be more difficult to maintain stable export growth next year because of the global financial turmoil”. As I stated before, most of the fixes for the slowdown seem to revolve around expanding domestic demand, which is the catch 22; demand for exports slows, so if citizens have no job and less money, selling them goods and getting them to spend won’t work. These pipe dreams of China's economic flexibility and macro-control guaranteeing economic stability are exactly that, a dream.

I think a message is beginning to get through with this unfathomable event requiring Government Agency spending be frozen in 2009, halting the average annual 5 per cent increase of the past five years. The Ministry of Finance said last week: "The budgets for next year should be capped at the same amount as this year's and every project would be looked at."

Agency spending includes staff salaries, lavish gatherings and official state business. Expense budgets of all 107 central government agencies will be analysed and related departments asked to tighten their budgets.

Wang Chaocai, vice-president of the ministry's research institute for fiscal science, said “The spending freeze will be achieved by reducing the number of meetings and conferences, reception activities and business trips, and by cutting transport costs”. This is truly astonishing in the land of showing off wealth and status; that’s like asking the Emperor to reduce the party and banquet budget during the Tang Dynasty - unthinkable, unless there is a crisis.

The way I understand it, each department is compartmentalised and deals with that departments business only - the idea of ripple effect is not widely understood in China even at the highest ministry levels. It is widely understood that exports directly affect factory production and workers lose their jobs.

Trying to explain that the copper mine in Jiangxi will need fewer workers and that leads to lower need for rail transport, which leads to a reduction of rail cars and that industry, plus the maintenance crews and repair parts involved to keep it all running; this is a more difficult task. How about the food vendors at the factory gate, the nearby stores and delivery drivers who drive fewer miles and buy fewer tires? There is less vehicle maintenance, which requires far fewer mechanics and spare parts to keep the transportation network by road moving, which is also its own separate industry. This example filters right through ports, construction, real estate, logistics and so on, and it’s all based on producing or transporting something for manufacturing, export and indirectly imports.

Power generation is one of the biggest industries in China, and according to the China Electricity Council “power demand in August fell 5.8 per cent from the slowdown in export-oriented consumption along coastal areas”. This directly connects to China’s largest steelmaker, Baoshan Iron and Steel and the nation’s biggest aluminium producer Aluminium Corp of China, which cut prices for December by as much as 20 per cent in a bid to attract more orders amid a slowing economy (and is considering further cuts because of falling metal prices and weak domestic demand).

Premier Wen Jiabao said on Saturday that fiscal revenue in the fourth quarter of this year will continue to drop after falling from more than 33 per cent in the first half to 10.5 per cent in the third quarter. The World Bank followed with a downward revision for China’s GDP growth next year at 7.8 per cent or lower on reduced spending in consumer markets.

As many areas of the world enter a recession 7.8 per cent sounds great, but in China the working age population is still growing, China needs at least 8 per cent growth to maintain the current employment rate. Where will the three million new college graduates find work this year, after all they are fighting with the surplus of five million diploma holders that still have not found work in the last two years.

The third obstacle

The third obstacle will be restoring confidence in the average citizen’s mind. As the cycle of distrust between employee, supplier and factories intensifies, factories may close because workers leave for fear of not being paid; suppliers will not deliver unless paid cash on the spot at delivery, no more credit. This cycle will lead to an exodus of workers from coastal provinces. I believe that Shenzhen, a city of somewhere between 10-14 million will shrink by maybe half by the end of next year

In a reactive approach as situations occur around the mainland, there have been several new laws introduced. The Communist Party of China (CPC) issued a landmark policy document on October 20 allowing farmers to: "lease their contracted farmland or transfer their land use right to boost the scale of operation for farm production and provide funds for them to start new businesses.” This is the first firm confirmation that tens of millions are going back to the countryside.

The Ministry of Finance shortly thereafter announced that the property contract tax had been lowered to 1 per cent from 3 per cent, on purchases of properties that are smaller than 90 square metres. Also, the down payment requirements will be lowered to 20 per cent, from 30 per cent. Real estate was where a lot of “new” money came from in the last ten years. Spending was up because property values were up, just as in the US from 2000 to 2007.

Starting from November 1, the Ministry of Finance said in a statement, “The government will raise export tax rebates for 3,486 products including textiles, clothing, furniture and toys. The tax rebate was raised from 11 to 14 per cent to help exporters cope with lower demand”. This is a stealthy way to boost container loading, since cargo volumes are down 20-50 per cent depending on the port.

These measures are like a doctor treating the symptoms of a patient, not treating the cause of the disease. The trend of shrinking foreign demand is unlikely to reverse, and the new policies are to create domestic consumption and encourage spending. Disposable income from the real estate and manufacturing sectors has dried up in the country. You cannot spend something that you do not have.

Continued here.

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First published in Language Matters on November 13, 2008.



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About the Author

David DuByne is Chief Editor of Oilseedcrops.org and a consultant for companies distributing products into Myanmar as well as a sourcing agent for Myanmar agri exports. He can be reached through ddubyne (at) oilseedcrops.org.

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