Sunday, April 15, 2001

Individual investors keep an eye on the Shanghai and
Shenzhen exchanges in a Shanghai brokerage office.

China must
make leap to a
new economy

Restructuring China's tourism
firms could present opportunities
to Hawaii businesses

By Christopher McNally
East-West Center

Although China's mammoth market is tempting to foreign investors, the country is far from completing the necessary structural reforms to become an open economy. With 30 percent of its production still dependent on state-owned enterprises, it will be difficult for China to open its markets even after it joins the World Trade Organization. Virtually all of China's tourism companies are state-owned, and restructuring them could open many opportunities for Hawaii businesses. Still, investors need to take a cautious and long-term view.

The rise of China, some would say, is the most stunning economic event of the last century. Its economy grew five times in the last 20 years, personal income quadrupled, and 207 million Chinese were lifted out of poverty. By the year 2015, if annual growth continues at 8-9 percent, China will match the current U.S. economy. But throwing out the last vestiges of central planning will not be easy.

State-owned enterprises continue to dominate sectors vital to the economy such as petroleum, telecommunications and mining. Sixty percent of all domestic loans in 1997 went to the state sector but in that year the sector contributed minus 1.5 percent to the growth of industrial output. In other words, state enterprises were gobbling up resources but contributing nothing.

By 2000, China declared victory in its Three-Year Plan to reform state-owned enterprises. The government claimed that 62 percent of the 6,599 large and medium-sized enterprises that made losses in 1997 saw a profit. But were they humming or crumbling? Much of this "victory" was due to lower interest rates, strong companies taking over weak ones, huge layoffs of 24.3 million workers over three years, and debt restructuring. A total of 400 billion yuan, or about $50 billion, of state enterprise debts were swapped into equity held by four asset management corporations. This relieved some state enterprises of debt repayments and threw them a new lifeline.

But much more needs to be done: little has improved in the areas of corporate governance and corruption; another 27.5 million redundant workers probably must go; and there's massive overcapacity in state factories. For example, 80 percent of production capacity in the car industry is sitting idle and products can't be sold.

China must move quickly in privatizing its economy. At the same time the government must establish a safety net for workers who lose jobs. Now they only receive about $20 a month in benefits, with the meager safety nets going bankrupt. Laid off workers who are in the 45-60 age range have difficulty finding new jobs. Chinese are facing greater poverty in their golden years.

The relationship of the party and state with the economy must also fundamentally change. For example, judges are appointed by Beijing but they need autonomy. The legal system is politicized, especially at the local level. There must be transparency at all levels of government, and the press must become freer to report on economic crimes and corruption.

WTO membership will be a yardstick to force politicians, especially local ones, to implement reforms. But these changes must have bite, and the question is: Will leaders have the political will to face the costs of reform and social unrest?

China is sitting at an economic precipice. It must now jump.

Christopher McNally is an East-West Center
specialist on China's industrial and financial reform.
He can be reached at 944-7241 or

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