Larry Hsien Ping Lang: How to Survive the Economic Downturn

Born in Taiwan, Larry Hsien Ping Lang is currently a Chair Professor of Finance at The Chinese University of Hong Kong. He is known in China for his provocative critiques of the SOE (The State-Owned Enterprises) reform process. The following excerpts are from his recent speech to a group of Chinese entrepreneurs in Shandong province, translated by CDT:

Date: Oct 12, 2008
Place: Golden Bay Hotel, Golden Palace Conference Hall, Yan Tai
Topic: Perspectives in Current Economic Hot Issues by Professor Lang

…Please consider this question, how did we achieve 10% growth in the economy each year? Many stock investors asked me: “Professor Lang, our economy has been doing so well, growing at 10% every year! However, the stock market seems not to reflect the strong growth in our economy. I told them they were wrong. The Chinese stock market faithfully mirrors the fundamental problems in our economy. Even the 10% growth rate is problematic. Where is the problem? It’s our development model. Which method did we use to boost economy? We encouraged large-scale consumption of steel and cement to boost our economy. If you travel around China, you will see local governments spent heavily on building greenways, bridges, etc. This is the real driving force of our economy. What proportion does such expenditure take up of overall GDP? It takes up about 30% of total economic activities. In other words, participants in GDP-related projects that are undertaken by local governments are the major players that lead economic growth, and they are the overheated sectors.

What about other private manufacturing sectors? Generally they are sluggish businesses. Then what about the (players in the overheated) sectors that account for 30% of economic activities, what are they? Take last year for example; it included real estate companies, companies involved in achievement projects and government-image projects, large state-owned enterprises, financial banks and security firms etc. Do you know their growth rate last year? They achieved more than a 30% growth rate last year. In other words, companies that generated 30% of total economic activities achieved the 30% growth rate. This translates into a 10% overall growth rate for the whole economy. Now you could understand that the contribution to overall economic growth from the private manufacturing sector is very slim.

Because we spent large amounts of resources on infrastructure development, the infrastructure construction, the so-called “GDP project,” is the real engine of our economic growth over the past 10 years. It may look very encouraging that we achieved such amazing GDP growth. However, we are paying a huge price for it. Let me walk you through the price we paid. Such an economic development model results in very unhealthy and abnormal compositions of GDP. When we compared our GDP compositions with those of European countries, Japan and so on, the major composition of GDP (in other countries) is domestic consumption. It means manufacturers will manufacture bottled water when I want to drink bottled water, pianos when I want to play the piano, cell phones when I want to use a cell phone. These are consumption-driven production and they are very common. Therefore, 70% of their GDP is from consumption in this category. We, on the contrary, have 35% in (regular) consumption, about half of other countries. What is our GDP composition then? The major part is the steel and cement (consumption) you see (above). Such expenditure on infrastructure construction takes up more than 50% of our GDP, while being less than 20% in western countries.

Do you understand the real consequence of such an economic structure? Due to the limited domestic consumption, the problem of overcapacity (in our manufacturing industries) prevails. That means we created more than we can consume. What caused this overcapacity? We sacrifice our environment, deplete our resources, and exploit our workers to expand manufacturing capacity. How far does it expand? It expands to an extent that we manufacture so many products that our people cannot consume them all. Since we only have 30% GDP in consumption, we have to sell the extra products overseas, to export the goods generated by overcapacity. It sounds appealing that we earned large export revenue, however, it in fact planted a time bomb that exploded in 2008. Why is it a bomb? Please think about this: we only consumed 30% of GDP, yet we have large production capacity. The production capacity is so large that we have to export the surplus goods to other countries for consumption. As a return, we earned large amount of foreign reserves at the expense of our environment and labor. One trillion in 06, 1.5 trillion in 07, 1.8 trillion in 08, now we are advancing towards 1.9 trillion. It will be 1.9 trillion after my speech. The huge influx of foreign exchange is the price we pay for this unhealthy export-oriented economy. Because of this (trade surplus), RMB has to be appreciated. Once it appreciates, it hurts the private sectors that heavily rely on exports.

As a result, the dualistic economic structure emerged. What does “dualistic economic structure” mean? It is a phenomenon that those sectors involved in governmental GDP projects leading the growth of our economy are overheated; yet the private manufacturing sectors are being largely neglected (having trouble attracting investment). As the exchange rate goes up, it sends an alarming signal to the private manufacturing sectors, which dominate 70% of the manufacturing industry. They are facing a deteriorating investment environment that is further depressing the sluggish private (manufacturing) sectors while fueling the already overheated sectors. At this critical moment, as the cost goes up due to the effect of RMB appreciation (the cost of imported inputs increased), private manufacturing sector is facing an even greater challenge to attract capital.