Why Taming the China Dragon Is Tricky

Slowing down China's high-speed economy is devilishly hard to do, and may even be beyond Beijing's control

by Brian Bremner

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It's a problem a lot of developing countries would die for. Yet Beijing faces a policy quandary of the highest order. China's $2.6 trillion economy, which blew away market expectations and clocked 11.1% growth in the first quarter, is rushing along like some blisteringly fast, runaway maglev train. Chinese President Hu Jintao's economic team in Beijing has been trying to tap the brakes to avoid a reprise of the painful boom-and-bust scenario that hit the country in the mid-1990s, yet hasn't managed to do so despite three years of effort.

China's seemingly unstoppable surge was a big topic on the podiums and in the hallways at the 2007 Boao Forum for Asia, a gathering of regional leaders and executives held in the southern province and resort island of Hainan on Apr. 20-21. Another prime subject: the global economic risks of a China that might jump the rails.

While China's restrictive currency policy that has kept the yuan relatively cheap gets much of the blame, Beijing is having trouble wrestling with this economic beast for lots of reasons that cut to the basic structure of China's economy. Among them is a massive savings glut in the corporate sector, the globalization of manufacturing networks, and the still vast developmental needs of an economy that must generate 15 million-plus jobs annually to avoid widespread joblessness and social unrest. Here is a quick guide to some of the issues:

Just how strong is the Chinese economy right now?

The world has never seen such a sudden and sustained rise of an economy that was so desperately poor just three decades ago. China has averaged 9.6% growth rates for 30 years and is now the fourth-biggest economy in the world—and likely will overtake Germany as No. 3 in the next year or so. It's the third-biggest trading nation: Two-way trade between China and the rest of the world hit $1.76 trillion last year.

China's nearly $1.2 trillion stockpile of foreign currency is the biggest on the planet, a reflection of the mainland's role as the biggest creditor economy and massive capital power. Lured by cheap labor and a white-hot Chinese domestic economy, foreign companies pumped about $60 billion in direct investment last year, and the country's global trade surplus came in at a record $177 billion. "No nation has moved as fast as China in establishing a global footprint," marveled Pakistani Prime Minister Shaukat Aziz at the Boao gathering.

Sounds like party time. Why are Chinese leaders worried?

Lost in all the breathless talk about China's overall economic performance is the cold, hard reality that the country's per capita gross domestic product is only $2,000 per person. There are huge income imbalances between China's big-city and rural provinces, years of rapid development have ravaged the environment, and the pressure to create fresh jobs and provide adequate social welfare policies is awesome in a country that is home to 1.3 billion people, about one-fifth of humanity.

"China remains a developing economy that has a long way to go before it can achieve modernization," says Wu Bangguo, chairman of China's National People's Congress standing committee. A big runup in inflation or an economic bubble that bursts would be absolutely catastrophic for hundreds of millions of Chinese families barely making ends meet—not to mention for Hu and his comrades running the show in China's one-party Communist regime.

Why doesn't Beijing just ratchet up interest rates to cool things off?

China did so in March, when the People's Bank of China increased a key benchmark, the one-year interest rate, by 27 basis points, to 6.39%. The one-year deposit rate was nudged up by the same amount, to 2.79%. It was the third such interest-rate hike in the past 12 months—and one or two more credit tightening moves are likely in 2007.

Yet here's the thing: China needs to slow down investment in factories and public works projects, which drive 40% of overall gross domestic product growth.