The China I Know

I'm a bull on China. I was bullish in 1980 in the early days of reform, I was bullish during the depths of the SARS crisis and during the global meltdown four years ago. During the last year of distant observers bemoaning negative signals out of China, I have remained a long-term optimist.

The reason is simple. All the fundamental drivers remain in place to continue moving the Chinese economy forward. And as it drives forward, China will be a major consumer of just about anything competitive companies anywhere, including North America, produce.

This is for China, however, a particularly interesting time. We have indeed seen a marked slowdown over the last year. There are structural reasons for this, and equally compelling reasons it has already started to reverse. We are also at an inflection point in the political evolution of modern China, with the recent 18th party Congress behind us and a new leadership team emerging.

Both economic restructuring and political change are slow burns in China. The new set of leaders was named to the party in mid-November and will not take up their government roles until next March at the National Peoples' Congress. But make no mistake, there will be a different crew running China, and I believe we can expect some real changes.

Most people have noticed the third quarter figures came out at 7.4 percent, a slowdown from 7.6 percent in the second quarter, and 8.1 percent in the first. The slowdown has been induced by three factors. First, a collapse in the export market, most importantly Europe, which for most of the last decade, was China's largest market. Second a policy-induced brake on the real estate sector to lower the cost of housing. Finally, there was a reduction in the infrastructure spending initiated in 2009.

But in the economy as a whole, I see strength. Industrial production growth is running well above 9 percent. Exports have been growing markedly above the pace of GDP over the last couple of months, and in September grew at 9.9 percent. Interestingly, exports to the United States are quite robust. Internal freight shipments expanding, and the PMI is moving up. Overtime has started to increase in manufacturing, services, and even construction. We are watching real estate percolate again and the government has taken measures to stimulate the economy.

But the most important indicator is sustained growth in retail sales. Retail spending has been up between 13 to 15 percent throughout 2012. While overall growth may be lower, the growth there is has been driven more by consumption than ever before. Over the past four years, consumption has gone from 35 percent of the economy to 39 percent of the economy today. If you think of China as a $7.3 trillion economy right now -- in nominal, not purchasing parity terms -- domestic consumption represents over $3 trillion in economic activity, roughly the size of the entire German economy.

The commentators and pundits who talk about not enough consumption in China are talking through their hats. Consumption is growing more rapidly than any other part of the economy, and it is a very substantial driver for the whole economy.

In 2002, China grew at 10 percent and added about $130 billion of aggregate consumption. In 2007, it grew at 12 percent and added about $370 billion to the overall consumption figure. This year, if China grows at 7.5 percent, it will add over $500 billion in new consumption and will constitute something approximating 25 percent of incremental global growth. Looking forward, there is no reason to suspect domestic consumption will not continue to grow

As if by stealth, China has slowly but substantially begun to re-balance its economy away from exports and fixed asset investment. The restructuring of the Chinese economy so many have been clamoring for is well underway.

But nothing happening in China is divorced from politics. More than at any time since 1989, we have seen extensive intrigue within the halls of power with scandals, corruption, murder, the unheard of return of long-retired party bosses, and an almost open power struggle among rival camps. In spite of the recent bare-knuckle politics, the ranks have appeared to close.

So who is this new band of seven leaders who will take the world's most populous country forward for the next ten years?

First, we have never before had a team with such a strong track record in economic management. Xi Jinping, the new Party Secretary who will become president next March, has experience in some of the poorest and wealthiest provinces. Li Keqiang, who will become Premier, has overseen provinces in central China and one of the most dynamic northeastern provinces. According to my count, among the seven are former senior officials or party secretaries of Guangdong, Fujian, Zhejiang, Shaanxi, Henan and Liaoning. Others have been mayors or party bosses of the major cities of Shanghai, Qingdao, Tianjin, Beijing and, briefly, Chongqing. One, the former mayor and later party leader of Beijing, was intimately involved in the creation of China's stock exchanges and has a deep appreciation for capital markets and global financial issues. Many speak English, have children who are or have studied abroad. And all but one of the seven had extensive dealings with foreign business leaders.

This extraordinary group of experienced, talented leaders have, through an orderly transition, taken over the party and will soon take over the government. What's important for the West to do is prepare for changes at the granular as well as policy level.

At the granular level when the leadership in China changes every ten years, almost everybody changes. It is "musical chairs" en masse. Almost every governor of every province, every party secretary, every mayor changes when new leadership takes over.

In terms of policy changes, I expect we will see an acceleration economic reform. This encompasses financial reform, which will likely advance more quickly, resulting in the liberalization of interest rates, more participation in the financial sector by private players, further liberalization of the renminbi, and probably a move to full convertibility in the next few years.

We will almost certainly see state-owned enterprise (SOE) reform begin. This kind of reform was a huge initiative during the leadership of Jiang Zemin and Zhu Rongji until ten years ago. There are thousands of municipal and provincial SOEs and I expect the government will launch a program to see them sold off.

I think we'll still see a sustained, if not advanced encouragement of outbound foreign direct investment and continued encouragement of inbound direct investment. Some of the commitments that China made towards openness that were not energetically addressed, such as foreign participation in the credit card market and related payment systems, will probably be put back on the table.

With the new leadership, we're also likely to see a focus on the middle class. Underemployment of young people is a source of worry for the leadership. The university system is creating a huge number of graduates, but the economy has not done as well absorbing them into middle class employment.

As for political reform, the two additional putative leaders expected to be part of a politburo of nine and who were left off the smaller team of seven, were both viewed as strong advocates for getting structural political adjustment moving again, an area of change completely frozen over the last ten years. The leadership is quite aware of the public level of intolerance for abuses of power. Here I can vest my hope in the worldiness of the leadership, of my knowledge of how politically searing the Bo Xilai affair was, and the increasingly doubtful public with respect to the responsiveness of government to the concerns of the governed. Perhaps we will, after ten quiet years, see the resumption of quiet experimentation and political reform.

Diplomatically, we're going to see a tough regional player. We're going to see a country that will not get pushed around on trade matters. When the United States or Europe take action, China is going to do the same in retaliation.

It's going to be a very, very interesting China over the next few years. The group coming to power is among the toughest in years. But they are a very smart, very international group of leaders, and I think we're going to see a very different China when we look back ten years from now.

I retired as the Canadian ambassador to China 11 years ago. On the day of 9/11, I was flying from Beijing through Vancouver to Washington and New York, where I was giving speeches on China, and my working title was "Don't Make China An Enemy." While these speeches were never given, their catalyst was my perception that consensus was developing among Americans that China was emerging as a threat to the United States.

As the aftermath of the 9/11 attacks unfolded, China-as-America's-principle-perceived-threat went away. However, it is my observation that America, which always needs an enemy, is beginning again to decide that China fills that bill. If so, we may all be in for a very rough ride. For better or worse, China is now big enough, tough enough and resilient enough to be a formidable foe.

If, on the other hand, we recognize the people running China are, in fact, open and internationalist, we will see this as a regime with which America and others can deal with. Moreover, it's going to be a regime critical to helping solve some of the economic problems that America and the rest of the world face. The choice is ours to make.

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