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Social Enterprise News

March 21, 2005

Spring Newsletter - Net Impact - China: Is the Economic Boom Sustainable?

After more than a quarter-century of growth averaging nine percent annually, the Chinese economy faces a host of new challenges. Can it keep up with the pace? Legal and financial experts weigh in.

China's economy has been expanding at an average annual rate of nine percent for nearly three decades. This growth is beginning to take a toll not only on the world economic system, but also on China itself. It is exerting pressure on China's limited supply of natural resources, on raw materials and on international commodity prices, thereby compressing profits for China's own manufacturing firms. As the country opens its capital markets, which it has promised to do, it will be harder to maintain control of its exchange-rate policy. And many are now wondering whether China's unprecedented economic boom can be sustained.

That was the question posed to three distinguished legal and financial experts on a panel moderated by Charles Calomiris, professor of finance and economics at Columbia Business School, director of the Chazen Institute of International Business and director of CIBER, the Center for International Business Education and Research, at this year's 14th annual Net Impact Conference, "Business Leaders Building a Better World." The panelists answer: Yes, if:

Yes, if China continues to reform laws affecting the business and investment climate, further adresses the problems and concerns of those left behind and manages to enforce these laws, said Benjamin Liebman, director of the Center for Chinese Legal Studies at Columbia Law School.

Yes, if China deals with the issue of corruption, said Lawrence Delson, principal of Delson International, Inc., and assistant professor of financial management in the Department of Law, Taxation and Finance at NYU.

Yes, if - and only if - it can cooperate and find win-win situations with Japan, said Nancy Yao, vice president and director of policy research at Goldman, Sachs & Co., who just finished researching this topic from a base in Tokyo under a Council on Foreign Relations - Hitachi International Affairs Fellowship.

China is a country of contradictions and its success depends on their resolution, the panelists agreed. The freedom in China's economy contrasts with the lack of freedom in its political process; for its economic success to continue, China will have to show political pragmatism and enable a transition to some kind of democracy in the near term. China's banking system, capital allocation process and large amounts of bad debt resemble the flaws of the Southeast Asian economies in the 1990s; a better outcome of sustainable growth rather than financial collapse will depend on China's efficient use of foreign direct investment (FDI) and increasing technological know-how. China has an enormously elastic supply of labor that it can draw on for the foreseeable future and ambitious involvement in joint ventures abroad. But it must reform its legal system, deal with corruption and cooperate with its neighbors if China is to sustain its growth.

Since 1978, China's legal system has undergone rapid reform that both facilitated its economic growth and contributed to increased social dislocation. Most legal reforms to date have been concerned with creating a framework for economic rather than social development. Legislation in the 1980s focused mainly on attracting FDI. In the 1990s, China began to draft and enact securities laws and market reforms vital to domestic as well as foreign investors. It wasn't until recently that the legal system began to shift from economic development to social concerns. But the past 26 years of economic growth have left many behind.

"The increasing social dislocation in Chinese society, and the growing difficulties of the state in addressing such problems, are as great a threat to long-term development as are problems with the financial sector or in the investment regimes," Liebman said. "The next set of reforms needs to go very far beyond simply laws governing the financial sector, the investment regime or the economy. Continued economic success depends on the ability of the legal system to address a range of new issues, both social and economic."

In recent years, China has begun to devote significant resources to addressing women's and children's rights, labor issues and environmental problems. "There is now a wide range of legislation on the books, but enforcement remains weak and the problems remain staggering," Liebman said. "The problem of lack of enforcement is often tied up with issues of lack of confidence in local authorities, local protectionism and corruption."

Illustrating this point, Delson told of Chinese truck drivers who recently construed new weight limit regulations on the roads not as a safety precaution or an attempt to improve roads, but rather as another attempt by the municipal government to extract taxes to raise additional revenue for local officials. Whether China can deal with the issue of corruption will have a lasting impact on sustaining the growth, Delson said.

Fundamental misperceptions, misunderstandings and miscommunications also haunt China's relationship with Japan, Yao said. Japanese businesses increasingly resent what she calls the "trickle-down problem" in China: when corrupt provincial leaders fail to implement the regulations written in Beijing. Japanese FDI in China remains substantial, but Japanese companies are hedging the risk and looking at Southeast Asia and Latin America as well. China is reaping a lot of the benefits of Japan's overseas development assistance, but Japan is beginning to reduce that. Furthermore, negative perceptions affect government relations. "Those are the two most powerful countries in the Asian region and, in many ways, globally," Yao said. "And they're not talking. Lack of sovereign-to-sovereign relations affects the economic area."

"Japan can really complement a lot of China's deficiencies," she added, especially in environmental technology. Japan's refining process and technology base are strong complements to China's low-end manufacturing base. Japanese fuel-cell vehicles complement China's environmental demand. "Japan is the closest and the most developed and the most sophisticated economy within China's reach," Yao said. "That is really a critical relationship."

Nearly 1,400 MBA students, professionals and sponsors attended the 2004 Net Impact Conference, "Business Leaders Building a Better World," of which this panel was part. The sold-out conference was held November 11 to 14 and drew participants from 80 business schools, 167 companies and 11 countries. Hosted by a different business school each year, Net Impact's annual conference is one of the largest and best-known gatherings of socially minded business leaders in the world.


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