Stephen Roach on China's Tightening Campaign

by: Stephen Roach

Excerpt from Morgan Stanley economist Stephen Roach's essay today on China's attempt to contain its overheated economy:

Inasmuch as China remains very much a “blended economy” -- a combination of a state- and market-directed system -- the verdict on its current tightening campaign is far from convincing. A shift in monetary policy achieves traction only when the banking system and financial markets are fully developed -- something that is still very much lacking in China today. At the same time, state-owned enterprises -- which continue to account for between 30-40% of the Chinese economy -- behave very differently than private and publicly owned businesses. The former are not motivated by market signals nor influenced by policy actions designed to impact markets. The persistent regionalization of the Chinese economy also complicates any macro tightening campaign, leaving a highly fragmented China largely insensitive to Beijing-directed cooling off measures. Recent punitive actions aimed at regional officials in Inner Mongolia pay lip service to this aspect of the problem but do little to challenge the runaway growth still concentrated in coastal China.

The lack of macro control over a still fragmented Chinese economy is a major glitch in the recent tightening campaign (see my 3 July 2006 essay, “China’s Great Contradiction”). Hyper-growth in eight of China’s 31 provinces has taken on a life of its own. These regions, which collectively contain about 40% of China’s total population, have accounted for 72% of total Chinese GDP growth since 2000. I have been to many of these areas myself and witnessed first hand their explosive growth in infrastructure, urbanization, and capital investment in new plant and equipment. I have also spoken with regional leaders in many of these provinces -- provincial governors, mayors, and bankers who speak of open-ended growth for years to come irrespective of cycles in the national economy. Beijing’s macro policy adjustments have done little to arrest the micro aspects of overheating.