What must China do in 2020? Key challenges for the China economy

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I came across this keynote speech by Wei Jie recently, a famous economist in China.

In his speech, he very clearly identifies the core issues facing the China economy, and then goes on to make 4 key predictions on what China must do in 2020 to address these issues.

It was such a good speech that I’ve translated the key portions of the speech below for Financial Horse readers.

China is at a very key moment in its development, as it transitions from a credit fuelled economy (growth from manufacturing and real estate) to a higher value added economy. In traditional economist speak, what it will do in the coming years will determine whether it will be able to escape the middle income trap.

Enjoy!


Prediction 1: 2020 is the peak of debt repayment

In Mr Wei’s opinion, 2018-2020 is the peak period of debt repayment in China. In his view, the growth rate of wealth production and money production this year is balanced. This ensures a stable capital supply which is crucial to prevent financial risks. In the next year, China should continue to maintain this balance.

To maintain this balance, he encourages the stabilization of the stock market and exchange rate. As long as the stock market is stabilized, there will be no major problems for capital supply. Further, if the local currency is stable, the capital supply will be stable. Mr Wei suggests to scale down overseas merger and acquisitions and individual overseas investments as otherwise, foreign exchange demand will be too large which will affect the supply of foreign exchange. At present, the government has begun to prohibit individual overseas real estate investment and overseas securities investment, and prohibit investment insurance. In addition, China must find a way to stabilize the foreign exchange supply in “one belt and one road” investments. In May this year, China encouraged RMB investment in the “one belt and one road” project. From data in September, foreign exchange reserves are $1.09 trillion, down from $3.1 trillion to $1 trillion. Mr Wei is especially cautious about this issue and reiterates that foreign exchange supply needs to be stabilized.

Mr Wei also thinks that China needs to find ways to stabilize the financial order. Recently, China has begun to tackle this by addressing problems of illegal lending, and regulating Internet financial companies.

Mr Wei also highlight that in recent years, there have been two worrying phenomena in the real estate industry. One is that financial institutions throw a lot of funds into real estate. The other is that people do not buy houses to live in but to invest. If this trend is allowed to develop, it will cause real estate to become a bottomless hole. If the real estate continues to absorb such a large amount of funds, then there will be problems in the capital supply next year, so China needs to solve the problems in the real estate industry quickly.

In general, next year will be a peak period of debt repayment. China should focus on ensuring a stable capital supply by targeting the aforementioned issues.

Prediction 2: 2020 will be a key period of industrial structural adjustment

Next year is still a critical period for China’s industrial restructuring, and the three major industries supporting China’s economic development will continue to be in the adjustment and contraction stage.

The traditional manufacturing industry, construction industry and real estate industry will continue to be adjusted and contracted next year. Particularly, for the real estate industry, there will be a contraction as in the past, its growth rate was more than 20% per year.

China must find ways to promote the development of emerging industries. First, in strategic emerging industries, including new energy, new materials, life bioengineering, information technology, new energy technology, energy conservation and environmental protection, new energy vehicles, artificial intelligence, etc.  Second, the service industry, including consumer service industry, business service industry and production service industry. Next year, China should further deregulate the service industry. Third, the modern manufacturing industry, including spacecraft manufacturing and aircraft manufacturing, high-speed rail equipment manufacturing, machine tool manufacturing, nuclear power equipment manufacturing, ultra-high voltage power transmission and transformation equipment manufacturing, and modern ship manufacturing and marine equipment manufacturing.

Next year is still a critical period for economic restructuring, and the three supporting industries (traditional manufacturing industry, construction industry and real estate industry) continue to be in the stage of adjustment and contraction. If China wants to maintain growth next year, China must give full impetus to emerging industries and strive to make breakthroughs. Otherwise, there will be great downward pressure on the economy.

Prediction 3: Great downward pressure on China’s economy

There still a lot of downward pressure on the economy next year. From the data of the third quarter of this year, China had 6.0% GDP growth. For next year, the downward pressure will remain high.

In order to alleviate the pressure of economic downturn, China must do two things. The State Council is right to introduce regulations to promote business relations. If it does not adjust and further liberalize enterprises, the pressure on enterprises will be even greater. The second thing is to continue to reduce taxes and fees. VAT was reduced this year for the manufacturing industry. Another key point is to raise the starting point of value-added tax for SMEs. This is equivalent to the elimination of value-added tax for micro enterprises. These tax cuts are useful for companies that are facing difficulties because of rising costs.

The amount of tax reduction this year is about 500 billion yuan, and the sum of tax reduction and fee reduction this year is about 2 trillion yuan. It should be helpful for the operation of enterprises, but Mr Wei doesn’t think it is enough and suggests cutting more taxes and fees next year.

Prediction 4: China will continue the adjustment of its “opening up” reforms

The Sino-US trade war in 2017 led to the readjustment of China’s opening up reforms. Regardless of the outcome of the trade negotiations, China’s opening up will continue to adjust.

Mr Wei has three suggestions. The first is to continue to strengthen China’s advantages. There are two advantages for China: one is manufacturing, the other is market. These two are our main advantages and will continue to be strengthened.

Because we are a manufacturing power, the United States has to consider China’s interests in negotiations. Because no other country can meet the market demand of the United States.

China is a manufacturing country, but not a manufacturing power. We have certain limitations, for instance material technology, aviation manufacturing, medicine, CNC machine tools and hardware and chips in the information technology industry.

If China can solve these limitations to become a manufacturing power, China will have more bargaining power.

China has a huge market advantage and a considerable proportion of the middle class, but if we want to develop the market advantage, we need to open up the market.

Next year, we will continue to open three markets, the market for goods and products, the service industry, and the market for investment. These three markets should be fully opened to build China markets. When Chinese markets become big enough, the fate of other countries will be connected with China, making it less likely for them to unite with the United States to curb China’s rise.

The second thing China needs to do is to make up for the lack of technology as soon as possible. This issue was evidenced in the Sino-US trade war. Huawei is one of China’s best technological innovation enterprises, but once the United States cut off its supply, it encountered many difficulties.

China must strive for big changes in its technological capability within three to five years. To achieve this goal, China needs to increase investment in technology, to build foundations for innovation (e.g. Science City) and the third is to modify the intellectual property system, to encourage innovation by allowing individuals to obtain the economic benefits brought by invention.

In the past, intellectual property rights were owned by the state and institutions. Now, intellectual property will belong to individuals, and this will spur on innovation. Previously, China grew rich from manufacturing, this time, China will be rich from technology.

While opening up, China should also to reduce its dependence on the US market. The “one belt one road” initiative (OBOR) can help to reduce dependency on the US. It is precisely because of the “one belt and one road” that China is resilient in the Sino-US trade war, because China has found new investment places and new markets.

In the past 6 years, the value of Chinese goods and materials in “one belt and one road” has been above 6 trillion. By contrast, the United States has become China’s third largest trading partner, the first largest partner being the European Union, and the second largest partner is ASEAN. So next year, China will continue to manage “one belt and one road” so as to reduce dependence on the United States. Within “one belt one road”, China must do a good job in financial services, infrastructure services and legal services.  Only by doing these three kinds of services well, can China’s products and services truly go global, and China will have more leverage and bargaining power in the world.

To sum up, next year will still be a year for adjustments of China’s “opening-up” reforms.

Since 2008, investment has been the main driving force for China’s growth, but since last year, consumption has replaced investment as the first factor to drive growth. For the next step, China should continue to adjust the pattern of opening up and steadily promote economic development.

To recap, there are 4 key points:

First, next year will still fall within the peak period of debt repayment. China must ensure stable capital supply by stabilizing the stock markets, financial order, real estate markets and exchange rate, so as not to default on too much debt and trigger the risk of financial crisis.

Second, next year is a critical period for industrial restructuring. The three major industries (traditional manufacturing industry, construction industry and real estate industry) that used to support the economy will continue to adjust and contract, so China needs to find ways to jumpstart emerging industries.

Third, next year is still a year of relatively great downward pressure on the economy. China must find ways to improve business relations and continue to reduce taxes and fees.

Fourth, next year will continue to be a period of adjustment of the opening up reforms as influenced by trade wars. China must continue to do 3 things – strengthen strengths, improve shortcomings and further develop the “one belt and one road” imitative so as to ensure economic development and growth next year.


Is this an accurate summary of what China must do in 2020? Share your comments below!

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