What is Asian development going to look like in the near future? Given that China remains the region’s leading giant, and one of its fastest-growing economies, the challenges for the new Chinese leadership have became the focal point of recent discussions on this topic.
What could be the most adequate real-life example of the fictional, fantastical Pixar movie “Up?” — China’s land–use rights saga! In “Up,” Mr. Frederickson’s entire life and all his cherished memories are threatened when real estate developers want to usurp his home and his land. Through constant harassment, the developers finally force Mr. Frederickson to give up everything he owns – or so they think. To everyone’s surprise, Mr. Frederickson uses thousands of helium balloons to carry his home to the mystical place of his childhood dream: Paradise Falls. In reality, the battle between Mr. Frederickson and the real estate developers reflects the heartaches of many Chinese rural villagers, and unfortunately, the Chinese villagers cannot fly their homes to Paradise Falls.
When I learned about China’s land-use rights system — that all land is owned by the government, and the citizens receive “rights” to use the land — I felt even more fortunate to live in a free country where people are entitled to own private land and personal properties. In recent years, land-use rights in China have been put to the test as corruption among the local government and real estate developers worsens. China’s rapid urbanization and the local governments’ need for additional revenue created a ferocious phenomenon of illegal land seizures. Farmers suffer from losing their land-use rights, and the compensation from the local government often barely makes up the loss.
Customers at a supermarket in China. (Photo: BusinessForum China)
Over the past thirty years, China’s GDP has soared from $140 billion to nearly $6 trillion. This phenomenal growth has been sustained at double-digit rates largely through a reliance on exports from heavy industry. Recently however, slow growth in the US and a renewed crisis in Euro zone countries have shown China that it cannot count on exports forever. The new leadership, headed by Xi Jinping, must now oversee a transition to an economy that relies on domestic consumption over export based industrial production.
With the world’s largest population one would think domestic consumption should not be difficult to achieve. Wang Shiling, who runs a mall in Linyi, perhaps put it best when he said, “people still need to consume living necessities. Toothpaste, notebooks, basins, you name it. Don’t forget that China has 1.3 billion people!” Even with such a large population though, domestic consumption only constitutes about 37% of China’s economy (the rate in developed countries is closer to 70%).
Economic indicators also suggest that China is on the path to rebalancing the economy. Since 2009, wages have been on the rise while government stimulus packages have focused on infrastructure and construction, which not only employ workers but aid the movement of goods and services throughout the country.
For all this though, China still faces many barriers to growing domestic consumption. The average Chinese may be earning more than before and stringent restrictions on the financial sector have recently been (ever so slightly) relaxed, but rebalancing the economy is about more than salaries and interest rates. In order to spur wider consumption, the government must reform current policies to encourage citizens to spend more and local businesses to expand productivity.
(Photo: China Daily)
The effects of the global economic crises of 2008 are still being felt in the United States and Europe, in the form of persistent unemployment, sovereign debt crises, and stagnant demand. Now, the fallout from the slowdown could begin to affect the unique economic relationship between China and Africa.
Over the last three decades, the Chinese Communist Party has ensured its political dominance by delivering consistent economic growth and development. China’s economic model is a turbo-charged version of the authoritarian approach developed in Singapore under Prime Minister Lee Kuan Yew. The essence of this model is state-directed heavy investments in labor-intensive economic sectors, leveraging China’s comparative advantage in low unit cost of production (cheap labor) in order to establish a strong export-based economy.
However, the global economic slowdown – especially the economic challenges facing the United States and Europe – coupled with rapidly rising wages in China, implies ever less demand for Chinese exports. A decrease in economic growth and economic development will call the legitimacy of the Chinese Communist Party into question. To avert such political fallout, the Chinese state will need to shift its economic model from being reliant to exports to one that is based on consumption by a large and increasingly wealthy domestic market. This means adopting structural economic reforms that will make domestic consumption a greater part of economic output.
China is Africa’s biggest trading partner and one of its biggest sources of foreign direct investment (FDI). Chinese FDI to and trade with Africa, as well as other nations, focuses mainly on the natural resource sector. This gives China particular leverage in Africa, where governments and economic elites are often financed primarily by the exploitation of primary commodities such as oil and gas, minerals, cocoa, cotton, and other cash crops. But a Chinese economy that is less reliant on massive exports is also one that needs to import less raw materials and primary commodities for its manufacturing sector. This has significant implications for Africa.
In the case of Nigeria, for example, oil and gas play a disproportionately important role in the financial system and government finances, accounting for over 90 percent of exports and government revenues, but only thirteen percent of economic output. Many other countries in Africa share similar structural economic distortions. The inherent risk is that the economic challenges facing some of the world’s biggest economies– the United States, the European Union, and China – will lead to less trade with and FDI flow into Africa. Should such a possibility become manifest, then the political consequences for African political elites would be dire.
Africa, in general, has many of the requisite elements for high economic growth. Demographically, its population is young and growing – on average, sixty percent of the continent’s population is below the age of thirty. This promises a bountiful long-term supply of labor. Though infrastructure is sorely lacking due to decades of poor maintenance and graft, there are vast swaths of unexploited arable land that would form the foundation for a vibrant agro-industrial economy.
To leverage these favorable factors, and deliver sustainable economic growth and development to their populations, African governments depend on inflows of FDI – which bring not only much-needed capital, but also technology and expertise. In the last decade, an increase in FDI inflows to Africa accounts for the robust positive economic growth trends that the region has experienced. As proof, the African middle class is now 350 million strong, spending about $700 billion annually. At current trends, the African middle class is expected to grow to one billion people by the year 2050.
But with the economic headwinds facing the European Union and the United States, along with impending structural adjustments to China’s economy, FDI flows to Africa are projected to slow. This is prompting increasing competition among African states over a shrinking pool of investment capital. To achieve competitive advantage in attracting investment capital, many African nations are now embarking on structural economic reforms to improve the investment climate in their economies. Reforms such as better fiscal consolidation, privatization of state-owned enterprises, power sector deregulation, legal and judiciary reforms, and legislative initiatives such as Freedom of Information Acts are becoming more commonplace throughout Africa.
The prevailing wisdom is that an entrepreneurial market economy is the best solution for the swelling youthful populations of Africa. The importance of FDI to achieving this objective is widely recognized among African political elites. The contest for FDI is prompting transformational economic reforms across the continent.
The increasing economic pressures on African political elites make them more disposed to political reforms that are required for an enabling business environment. These changes would also make Africa a more desirable target for US business investment beyond the natural resources sector, including consumer products and services, infrastructure (telecoms, power, transportation, real estate), the budding financial sector (insurance, banking), and agriculture (agro value-chains). For US corporations, opportunities abound and the time is right.
Villagers protesting in Wukan in 2011. (Photo: AP)
Recent data suggests that in countries which have made the transition from “Not Free” or “Partly Free” to “Free” (according to Freedom House) the average rate of GDP growth increased from just over 6% to over 14%. Countries categorized as “Free” also seem to draw more overseas investment: while the total level of US foreign direct investment (FDI) in “Free” countries is well over $250 billion a year, FDI in “Not Free” countries remains under $20 billion.
For some, though, China’s recent success stands as a counterpoint to the idea that democracy is better for business and economic development. Multinational corporations as well as local companies have fared extremely well over the course of China’s last 30 years of economic development, which was accomplished under an autocratic regime. China’s economic triumphs indeed deserve recognition, but weak rule of law seems likely to inhibit continued growth.
By most accounts, more than 90,000 protests occur in China every year, a manifestation of popular discontent with corruption and other instances of officials disregarding the rule of law. The villager revolt in Wukan at the end of 2011, for example, highlighted the role that corruption plays in issues such as income inequality and access to capital. In Wenzhou last summer, a high-speed train crash that killed at least 40 people can be traced to improper implementation of safety protocols. Instead of investigating the incident and punishing those responsible for the lapse, officials attempted to cover up the wreckage, literally. And while local officials deny it, the practice of police abducting “suspects” without due course is reportedly widespread. Add to this numerous labor strikes, and many companies are naturally concerned about their ability to maintain the productivity of their workforce.
Issues surrounding intellectual property (IP) rights are also a major threat to many companies. This goes beyond pirated movies and fake Puma sneakers (or “Pumba” sneakers as I have seen in local shops). When foreign companies do business in China, they often run the risk of having their patented technology copied, reproduced with minor alterations, and then re-patented. This naturally leads to a loss in competitiveness resulting in reduced revenues. Foreign companies have often invested in Chinese projects only to be shoved out by local competitors who have managed to replicate proprietary information. Such behavior has led to some major losses and many businesses rethinking whether or not it is worth it to do business in China.
Foreign investment is not the only victim of lax regulation regarding intellectual property. A recent article exploring the topic suggests that the value of a Chinese start-up’s IP is generally discounted by between 33 percent and 50 percent. Weak institutions for protecting property deter investment in new ideas and reduce the drive to innovate. Why spend time, energy, and resources to engage in productive innovation when there is no guarantee of being able to profit from it?
Such disregard for laws and regulations has a direct impact on investors, both foreign and domestic, who fear their money may be squandered. The general consensus is that China must now transition away from its export-based model and foster a more robust domestic market. However, would-be entrepreneurs — the agents of growth and development — are effectively denied the ability to convert their assets into capital, and so are unable to turn ideas into reality. Domestic companies and start-ups are also hindered by regulations put in place to prop up the state champions that have driven growth over the past three decades.
Unlike China, democracies are built on institutions that help to foster an environment conducive to enterprise, where citizens and businesses are able to voice their opinions and contribute to the development and enforcement of laws and regulations. Democratic societies are also more transparent, allowing for greater accountability and more effective and fair enforcement of the law. When officials are accountable to the public, they have a larger stake in tackling issues such as corruption that inhibit economic growth. Additionally, wider access to information helps to arm businesses with the knowledge they need to make important decisions and conduct effective strategic planning.
Recently, questions have arisen about whether or not China can maintain its high rate of growth. In a recent discussion at the Carnegie Endowment for International Peace, Justin Lin of the World Bank stated that he is confident that China has the potential to continue growing at rates of over 8 percent for at least 20 more years. However, in order to do so, the reforms that Deng Xiaoping initiated in 1978 must be completed. This process includes the removal of market distortions that support state-owned champions, the development of a reformed financial system that allows local entrepreneurs to access capital, and much stronger rule of law. Without such reforms, growth may falter in the face of problems related to the rule of law and corruption.
Professor Mao Yushi. (Photo: NED)
CIPE recently had the honor of inviting Professor Mao Yushi, the winner of the Milton Friedman Prize for Advancing Liberty awarded by the CATO institute, to share his valuable insight on the current events in China. Professor Mao is the founder of Beijing Unirule Institute of Economics and is one of the ten most influential economists in China. In his opening remarks, Mao declared that China’s dramatic improvements to individual freedom are visible through its citizens’ abilities to travel and study abroad, to purchase foreign goods and services, and to invest in real estate properties and gold, which have all increased since 1978. He further stated that over 300 million Chinese citizens no longer live in extreme poverty, which is a great improvement when compared to other developing countries in Asia.
Despite these improvements, Prof. Mao also pointed out several major issues that act as stumbling blocks to China’s economic development, among them, income disparity between the rich and the poor, and between coastal and the rural areas, is becoming a significant problem in China. Furthermore, Mao suggested that the enormous amount of money invested in newly built and unoccupied real estate represents an incipient housing bubble; fewer than 30% of high-rises in big cities are occupied. Mao also stressed that the failure of the high-speed railways to turn a profit is especially detrimental to the economy – without profits, the huge loans that financed construction of the railways cannot be repaid on time, and may have to be written off.
Mao also argued that the low fertility rate and distorted gender ratio in China will hinder the country’s ability to stabilize its labor force over the next 5 to 10 years. He stated that the environmental issues caused by the rapid economic growth are neglected and that there is a lack of motivation to address them, noting d that all the lakes and the air in China are heavily polluted. Similar to Justin Lin‘s point of view in his newly published book, “Demystifying the Chinese Economy,” Mao believes that in order to continue the country’s remarkable economic growth, the Chinese government must address the above issues more aggressively.
When asked whether China 2030—a recent report by The World Bank that called for more private sector reforms in China – would have any impact on Chinese policy, Mao held that the real issues lie within state-owned-enterprises (SOEs). Prof. Mao stressed that the SOEs hold privileges over large amount of resources, as well as political power. SOEs often receive much lower interest rates on loans and also enjoy tax exemption privileges. Mao said that economic and political reform would be difficult if such privileges continue. In his view, should a major financial crisis occur in the future, the Chinese government must help pay off the debts of SOEs with state resources.
In his overall opinion on the last several decades economic development in China, Professor Mao acknowledged remarkable improvements in terms of both individual freedom and poverty levels in China. Nevertheless, he also demonstrated several major issues that could hinder China’s ability to continue with its high economic growth rate. These concerns included income disparity between the rich and the poor, the housing bubble in major cities, the bad loans invested in unprofitable high-speed railways, potential future labor shortages, and the environmental issues caused by the rapid growth rate in China. Mao’s unique outlook on China’s economic development and the future of SOEs provided a well-rounded conclusion for his visit at CIPE.
For another perspective on the forces driving China’s economic ‘miracle’ — and the reforms that will need to happen for it to continue — read the latest Economic Reform Feature Service article by Xingyuan Feng, Christer Ljungwall, and Sujian Guo, Re-Interpreting the ‘Chinese Miracle’: A Multi-Dimensional Framework.
Hernando de Soto famously asked: although cities across the developing world are teeming with entrepreneurs, why do those countries seem unable to become prosperous market economies? The answer, he argues, is that they hold “resources in defective forms: houses built on land whose ownership rights are not adequately recorded, unincorporated businesses with undefined liability, industries located where financiers and investors cannot see them.”
CIPE and partners Association for Foreign Investment and Cooperation in Armenia, Unirule Institute of Economics in China, Institute of Economic Affairs in Kenya, Institute for Solidarity in Asia in the Philippines, and Saratov Chamber of Commerce and Industry in Russia set out to explore this crucial question in more detail, identifying the barriers small entrepreneurs face in urban property markets using the International Property Markets Scorecard.
The Scorecard provides a methodology for property market system analysis to investigate the six core elements necessary for sustainable market development: property rights laws and enforcement, access to credit by small businesses, efficiency of governance, rational dispute resolution, financial transparency, and appropriate regulations. This approach not only illustrates the linkages between property market elements but also helps identify gaps and advocacy priorities where some of those important institutions remain weak, either due to a lack of proper legal and regulatory framework or its weak implementation.
Following an in-depth analysis of the available secondary data such as international indices and national statistics, CIPE partners conducted fieldwork in two select cities to localize the results. This work was tailored in each country through a mix of focus groups and interviews to obtain the most accurate snapshot of the conditions entrepreneurs face in dealing with the government, banks, and professional services providers in the property sector. These views from small businesses have a unique power to illustrate key problem areas because of the real, personal experiences they reflect.
Property markets are multi-dimensional institutional frameworks that touch upon issues key for all citizens but particularly vital for small businesses. As such, property markets are a microcosm reflecting the state of a country’s institutions that build democracies and market economies alike.
This Feature Service article summarizes key findings – both shared and country specific – as well as reform recommendations for the next advocacy-oriented stage of our efforts. You can also read full country reports here (China coming soon): Armenia, Kenya, and the Philippines.
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Tagged armenia, china, kenya, Philippines, property markets, property rights, russia
The CIPE Development Blog provides coverage of the Center for International Private Enterprise and its partner network at work -- highlighting successes, drawing out lessons from failure, and exploring the broader issues of political and economic development. For more information visit CIPE.org.
