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It's Worse Than You Think In China


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It's Worse Than You Think in China

This is China's year of living dangerously (page 48). It is in a deflationary spiral that is choking economic growth and raising the political temperature. Unemployment is rising. Consumers are hoarding cash. Reform is on hold. Efforts to clamp down on corruption are discouraging investment. Foreign investors are being squeezed. Imports of Boeing jets are on hold, deepening the U.S. trade deficit with China. Premier Zhu Rongji's attempt to keep the economy growing as he shuts down state factories, curbs the bureaucracy, and attacks corruption is in trouble. What comes next is hard to say.

U.S., European, and Japanese investment is already beginning to fall, depriving China of needed capital, technology, and management expertise. In an attempt to help state enterprises, Beijing is going protectionist. The operations of foreign telecoms are being curbed, and a "buy local" campaign is under way. Distribution channels are drying up for foreign companies, and profits, never hefty, are disappearing.

The worst of it is the return of heavy-handed centralized control. In a lauded attempt to stop the smuggling of foreign exchange abroad, Beijing reinstituted the old tools of central planning. When state authorities discovered that the dozens of "ITICs," provincial investment corporations, were exposed to billions of dollars in foreign loans which could not be paid back, they cracked down hard. But now paperwork needed to buy dollars or yen takes weeks, discouraging investment. And foreign banks, who thought the government would be the lender of last resort to the ITICs, are left holding the bag.

Zhu is making progress in turning China into a market-driven economy. He's reforming the banks, passing securities legislation, privatizing property, and getting the military out of business. But the problems are enormous, and the remedies often harmful. Many foreign companies are asking whether they should pass China by for the next five or 10 years while things get sorted out. Only Beijing can answer them.


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