China’s SOEs Hampering Domestic Consumption?

Professor Horst Loechel

To help CEIBS Alumni assess their business strategy for this year, the school’s alumni magazine TheLINK interviews a top economist.

TheLINK: What do you expect for China’s economic development in the short term?
Prof Horst Loechel: I am not expecting a much higher growth-rate for China in 2010 than what we saw in 2009. China’s economy is performing much better than the rest of the world, but China’s economy still depends very heavily on the world economy. The U.S. and Europe will certainly face more problems in 2010 as they will begin their exit strategies from the fiscal and monetary stimulus packages. This exit will cause a slowdown in economic growth worldwide, which will bounce back to China.

In the long term, in 25 to 30 years, China will overtake the U.S. as world’s biggest economy, in absolute value. In terms of GDP per capita, it will take a much longer time for China to match the U.S., Germany, and Japan.

TheLINK: How can China shift from exports to domestic consumption?
Prof Horst Loechel: Looking at exports, it is most important that China shift to a higher value-added for export products. China’s per capita income level is still low compared to the U.S., the EU or Japan. One reason is that the value-added in the export industry is low. A higher value added leads to higher income and in turn to higher consumption.

Regarding the change of the growth model from export to domestic consumption-driven, this is difficult. One reason for the difficulties is because of China’s SOEs. Today, China’s SOEs still control about 40 percent of the economy and make the nation’s biggest profits; they do not have to pay dividends but accumulate all their profits. If the SOEs paid dividends to the state, then the government could use the funds for an improvement of China’s social security system or for a reduction in individual income tax. Alternatively, dividends can be paid to private shareholders after privatisation. Either way would result in boosting private consumption by increasing incomes. 

TheLINK: Besides domestic consumption, what other factors will drive China’s economic development?
Horst Loechel: In the short run, China needs a stabilized macro economic environment – relatively low inflation, moderate growth, and a controlled transition to a more flexible exchange rate. Otherwise Shanghai cannot develop into an international financial centre. In the long run, China needs proper deregulation and further privatization. That means keeping the momentum going towards a market economy, with Chinese characteristics.

Another key factor in economic development is China’s SMEs. SMEs are a driving force of innovation and are bringing a lot of employment and new income. But one bottleneck for the development of SMEs in China – and not only here - is funding and finance. It is very difficult, for instance, for SMEs to get loans. Also, the capital market is still immature particularly with regards to the bond market.  This is a problem because SMEs are engines for growth and innovation.

The LINK: What are the key threats to China’s economic growth?
Prof Horst Loechel: The biggest risk for the Chinese economy is the world economy. It will be very difficult for the Chinese economy to move ahead without the support of the world economy. Also, China cannot be the locomotive of the world economy as the U.S. was in the past. For a developing country, this is not possible.

There are not too many internal threats to China’s economic growth, but the environment is one. In the past, most countries – including China – did not pay much attention to this issue. For a developing country, rising pollution is nearly unavoidable. However, I agree with the efforts of China to take the environmental challenge seriously.

[Reprinted with permission from The China Europe International Business School.]