Tour the factories along China's busy southern coast and nothing at first seems amiss. Companies great and small are still making the dolls, T-shirts, and computer peripherals that have flooded the world and helped fuel China's booming economy. China, in fact, has defied the global slowdown and offered practically the only good economic news on the planet. But talk to the workers and bosses, and you'll get at a more disturbing truth. Orders are less brisk. Prices are falling. Inventories are piling up. Says the manager of a toy factory near Guangzhou: "Everybody here is anxious."
China is slowing down. That was happening even before the terrorist attacks on the U.S. Now, with the global economy experiencing yet more stress, Beijing will be hard-pressed to sustain the growth. That has serious implications for a nation already bracing for a flood of imports and competition as it prepares at long last to join the World Trade Organization.
WEAKER PUNCH. In recent years, the Chinese government has helped keep the economy humming. Since 1998, Beijing has issued $43 billion in Treasury bonds, pumping the proceeds into public works and higher official salaries. That, in turn, has helped sustain the spending power of the nation's 80 million middle-class consumers, whose purchase of everything from TVs to automobiles to cell phones accounts for nearly half of gross domestic product.
Now, it appears, Beijing's pump-priming is losing its punch. In recent months, consumer prices had been rising as demand stayed strong, reversing stubborn deflation that had persisted for nearly three years. But last month, the consumer price index rose 1% year-on-year, the lowest growth in five months. "The government is spending lots of money in hopes the external environment will pick up," says Yiping Huang, an economist at Salomon Smith Barney in Hong Kong. "The efficiency of that spending is declining quite quickly."
One key problem is the widening chasm between China's cities and countryside. With more than 800 million rural residents earning barely a third of what their urban counterparts take in, Beijing's efforts to boost consumer demand beyond the cities is not working. While most urban residents have already bought their color TVs, air conditioners, and refrigerators, rural residents, who earn an average of $270 a year, can't afford such purchases, says Beijing University economist Song Guoqing. "The gap between rural and urban sectors is growing at an unsustainable speed," he says.
Another drag on consumer spending is the sharp drop in China's stock markets, which are down as much as 19% this year. The selloff is being fueled in part by Beijing's necessary, but confidence-sapping, crackdown on market manipulation. Some 65 million Chinese own stocks, and their decline has created a reverse wealth effect by making people feel poorer. That helps explain why retail sales growth slowed, year-on-year, to 9.6% in August, compared with 10.3% for the first half.
In addition, China's export sector--which equals about 20% of GDP--is facing huge new challenges as the world economy goes into recession. While exports grew a robust 27.8% in 2000, analysts predict they will tread water this year. Take the toy industry. Last year, it exported $5.6 billion worth of product, with more than 60% going to the U.S. In the first half of this year, toy exports from Guangdong province, where most of China's toy factories are located, were off almost 20%. "Originally, we expected that bad situation to be reversed in the second half of this year, with all the holidays coming up," says Li Danming, deputy chairman of the Guangdong Toy Assn. "Now that looks very unlikely."
The decline in global demand also is hurting industries that only recently switched to an export strategy. Facing a saturated market at home, Shenzhen television maker Konka has opened factories in India, Indonesia, and, most recently, Mexico, to supply North America, where half of its international sales go. Last year, Konka sold $100 million worth of color sets, making it China's largest TV exporter. But with global demand steadily declining, the company reported a $23 million loss in the first half, its first ever. Faced with even bleaker prospects for overseas growth, Chen Deqing, general manager of Konka's overseas marketing center, reckons exports will increase only "a little bit" this year.
As export markets dry up, glutted inventories are expected to get much bigger. Indeed, one reason China's TV sector looked abroad in the first place was to escape a brutal price war at home. Share prices of China's major electronics companies have fallen by an average of 20% over the last 12 months. Things are so bad that the Ministry of Information Industry (MII) says the industry may collapse.
Falling prices are hurting other industries, too. Many expect the ongoing price war among mainland PC makers to continue until at least yearend. Baoshan Iron & Steel Co. and Angang New Steel Co. say a worldwide glut in steel will keep prices low for the foreseeable future. Diversification into other businesses is not always an answer either. MII has started limiting the number of licenses to produce mobile phones, for instance, because most of China's top TV makers have moved into that industry, sparking a price war.
STILL ATTRACTIVE. To be sure, China is in better shape than many of its Asian counterparts. Foreign investment is up 20.39% so far this year. And some believe that the mainland's cheap labor and huge domestic market will still attract investors. At the same time, the Chinese government intends to keep priming the pump. Earlier this month, Beijing pledged to issue an additional $18 billion in Treasury bonds next year. That money will pay for a 15% rise in civil servant salaries, the third such hike in two years, as well as continued infrastructure spending. And as it prepares to host the 2008 Olympics, Beijing aims to spend $22 billion in the coming years on stadiums, roads, railways, and sewage treatment plants.
Trouble is, all that spending is putting pressure on government finances. Beijing insists the deficit is running at an acceptable 2.7% of GDP. But that figure rises to 50%, says Beijing University's Song, if one factors in the estimated $250 billion worth of bad loans held by state-owned banks as well as Beijing's pension liabilities. "If the government keeps up this spending," says Song, "we're on the road to danger."
With the world bracing for a period of uncertainty, boosting domestic demand seems like China's only option. And with rural regions falling further behind the prosperous coastal cities, that is even more crucial. The last thing China needs is the sort of social unrest that could wreck its great free-market experiment.
By Dexter Roberts in Beijing, with Mark L. Clifford in Hong Kong
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