China’s economy: Still some way to go

Financial, Fiscal and Enterprise Affairs Directorate (DAF)

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The Chinese economy has come a long way in the past 25 years. Yet more needs to be done to ensure the continuation of rapid growth, including further measures to provide a suitable climate for foreign investment.

China is widely – and correctly – regarded as one of the great economic success stories of the past two decades. The country has moved from an economic system characterised by autarchy and central planning to an increasingly market economy open to international trade and investment, all this while retaining one-party rule. Economic growth has accelerated, and China has become both an important global trading force, ranking sixth worldwide in total trade (exports and imports combined) and one of the world’s largest recipients of foreign direct investment (FDI). Living standards have improved to the extent that consumer goods familiar in OECD countries are now also common in China’s towns and cities.

So impressive has the country’s performance been in a range of areas – absolute size of GDP, real GDP growth rate, export performance, accumulation of foreign-exchange reserves, poverty reduction – that several economists have gone so far as to forecast that China may soon become the world’s largest economy. But the real achievement is the economic transformation of a country that only a generation ago was among the world’s poorest, as well as the most isolated.

There can be little doubt that FDI has played an important role in this transformation. Before 1978, foreign investment had been unwelcome, albeit with a few exceptions, such as those accompanying Soviet assistance in the 1950s. Foreign investors were officially regarded with suspicion and hostility. Multinationals tended to shun China for this reason, but also because of the lack of a sound legal basis to support foreign investment, not to mention the underdeveloped state of the domestic market. Then, incomes were low and 80% of the population lived in rural communes, where income was received largely in kind.

But under the “open door” policy introduced in 1978, China has welcomed foreign investors in ever increasing numbers, attracting them by providing physical and institutional infrastructure, as well as fiscal incentives. And of course there is the lure of a potentially huge emerging market.

Foreign investment policy and legislation are gradually being liberalised. The most recent batch of liberalisation measures resulted from China’s accession to the World Trade Organization (WTO) at the end of 2001, which, among other things, are scheduled to result in the opening up of major services sectors to foreign investment.

FDI inflows rose from US$916 million per year in terms of actually realised investment in 1983 to $3,487 million in 1990. They then accelerated rapidly in the mid-1990s before stabilising by 2000. In fact, China became the world’s largest recipient of FDI in 2002, receiving nearly US$53 billion (see News briefs and OECD Observer No. 237, May 2003).

These achievements are laudable, especially when contrasted with China’s previous economic history or the record of other developing countries of comparable size and stage of development. However, the euphoric claims in recent years that China is becoming an “economic superpower” are premature.

For a start, the pace of China’s economic growth in recent years, while undoubtedly fast, may well have been exaggerated by the official figures. Eagle-eyed economists have, for instance, noted continued discrepancies between the growth rate of industrial output and the much lower growth rates of energy consumption and freight tonnage. On the other hand, growth rates of some items, particularly in the informal economy, may be understated because they are not fully countable.

China’s National Bureau of Statistics (NBS) has adjusted the real national GDP growth rate downwards because it is aware that provincial governments have too frequently exaggerated regional performances. Indeed, in some years the resulting national rate failed to reflect economic reality – notably in 1998, when the NBS reported the economy to be growing at nearly 8% even though anecdotal evidence suggests that it was slowing markedly.

With the help of the OECD, the NBS is now working to improve its methodology, for example, by gradually supplementing or replacing its laborious and error-prone practice of total counting with more efficient sample surveys like those used in OECD countries, which provide a more accurate picture of what is going on in the whole economy.

Needless to say, working methods adopted during decades of central planning will take time to disappear. Already, efforts to translate existing GDP statistics into reasonably accurate estimates of per capita income that can be compared with other countries have floundered on the lack of sufficient information, particularly about price levels, needed to construct a reliable exchange rate on a purchasing power parity (PPP) basis – in other words, comparing like with like by using a currency rate that eliminates the differences in price levels between countries. Also, World Bank estimates of China’s gross national income (GNI) per capita have fluctuated sharply and some experts consider them to be overestimates. Even so, current World Bank figures show China as ranking only 127th out of 208 economies worldwide in terms of per capita GNI in PPP terms.

Similarly, forecasts that the Chinese economy will be the world’s largest have generally been based on unreliable PPP exchange rate estimates. A more realistic assessment is provided by the country’s sixth place ranking in terms of export-import trade, as this is measured in current US dollars, so eliminating exchange rate problems.

China’s official FDI statistics are generally taken at face value by the rest of the world, but here, too, there are grounds for re-examination. As pointed out in a new OECD investment report, Investment Policy Review of China: Progress and Reform Challenges, these statistics are not yet calculated and reported according to the standard procedures recommended by the OECD and the IMF. One indication that the official statistics may overstate China’s FDI absorption is the large gap between FDI flows from OECD member countries into China as reported by China (US$77 billion) and by the OECD countries themselves (US$39.3 billion).

An unknown, but undoubtedly significant, proportion of FDI inflows emanates from China itself in the form of what is known as “round tripping” investment that is routed via Hong Kong, China or other putative sources, like offshore tax havens, to take advantage of incentive measures such as tax holidays. Flows from Hong Kong, China still count as an investment inflow, but in practice, such investment is effectively domestically generated and should be deducted from the FDI total.

Moreover, China’s FDI-attraction record is also much less impressive if population size is taken into account. Inflows of FDI per capita are far lower in China than in almost all OECD countries, much smaller than in the larger Latin American economies, and even below some of the developing countries in south-east Asia, like Malaysia and Thailand, although these are currently complaining of a diversion of FDI to China. China now wants to attract more FDI, especially in the kind of services and high-technology manufacturing sectors in which multinationals in OECD countries are internationally dominant, rather than in the relatively labour-intensive, short-term projects that have flourished in the past.

To help them achieve this, China: Progress and Reform Challenges presents a number of policy options that China’s policymakers may wish to consider. These include items like eliminating remaining elements of local protectionism; streamlining the still cumbersome foreign investment project approval process; and reconsidering remaining foreign ownership restrictions that complicate foreign business activity in sectors as wide-ranging as mining, chemicals and food production. Also, authorities should open China’s capital markets more fully to foreign investors, for example, by allowing more foreign-invested enterprises to list on Chinese stock exchanges and allowing such enterprises to issue corporate bonds, while rendering taxation legislation and regulations more transparent. Competition policy would have to be enhanced, in particular by ensuring level playing fields for businesses.

Another key area for improvement is the legal system. Current efforts to improve its functioning and independence have to be intensified. In particular, the Chinese government is to be encouraged in its efforts to improve the effectiveness and independence of China’s law courts. And property rights, including for intellectual property, would have to be strengthened.

Co-operation with China in the investment and other fields is designed to assist the country in remedying these problems and consolidating progress towards an open, equitable and sustainable economy.

References 

OECD (2003), Investment Policy Review of China: Progress and Reform Challenges, Paris.

Ögütçü, M. and Taube, M. (2002), “Getting China’s regions moving”, in OECD Observer No 231/232, May 2002. See link below.

©OECD Observer No 238, July 2003




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