China's Great Adjustment

Yu Yongding, Scholl Fellow, Senior Fellow, Institute of World Economics and Politics, Chinese Academy of Social Sciences. Introduced by Michael H. Moskow.

Dr. Scholl Foundation Lecture on US-China Relations: China's Great Adjustment

Event Summary by Richard C. Longworth

The Chinese economy is distorted by over-investment and over-reliance on exports, Chinese economist Yu Yongding told The Chicago Council Monday evening. Fixing these problems will be hard, even dangerous, he said, but cannot be postponed.

Yu acknowledged China’s astonishing economic growth over the past 30 years, based on its investment-driven and export-driven model.

“Now,” he said, “this once successful growth model has run out of steam. Faced with choking smog, ubiquitous waste, lackluster foreign demand, and fast decline in capital efficiency, China has no choice but to change its growth pattern.

“The government has to strike all sorts of balances and walk a tightrope.”

Can it succeed? Yu didn’t say. In an earlier article, he wrote that “China has faced much worse on numerous occasions: each time, it muddled through.” But he didn’t give his Chicago audience this comfort.

Yu, one of China’s leading economists, is the Dr. Scholl Foundation Visiting Fellow at The Chicago Council. He is academician and senior fellow at the Chinese Institute of World Economics and Politics, a former advisor to China’s central bank, and a former member of the UN monetary and financial reform committee. In a Council speech two weeks ago, Financial Times columnist Martin Wolf called Yu "the wisest and most honest Chinese economist."

Yu bluntly catalogued the challenges facing Chinese policy-makers. But he started by debunking two frequent predictions – that China’s economy is an unstoppable force that will soon overtake the US economy or, conversely, that it faces “impending collapse” because of labor unrest, housing bubbles, and other problems.

“In my view, neither side is right,” Yu said. “The truth is that, after 30 years of breakneck growth, China has reached a new stage of growth. The Chinese economic juggernaut has to slow.”

China’s growth rests on an investment rate nearly equal to 50 percent of gross domestic product, by far the world’s highest. This investment has targeted three areas – real estate, infrastructure, and manufacturing. All, he said, are unsustainable.

First, China’s real estate investment accounts for 10-13 percent of GDP, also the world’s highest, Yu said. The result is a housing bubble, with high demand producing soaring prices, leading to more demand and more construction. This “vicious circle” has lasted 15 years, he said. The result: prices so high that they create “growing resentment among ordinary people” who cannot afford even a modest apartment, plus a surplus of skyscrapers and five-star hotels.

“China’s banking system is quite heavily protected,” Yu said, so an American-style housing crash is unlikely. The real problem, he said, is a “misallocation of resources.”

“Sustainable growth cannot be based on steel, cement, and glass – period,” he said.

Second, much of China’s new infrastructure is admirable, Yu said, but “infrastructure investment is also hitting a wall – a financial wall.”

“There is still room for more investment in infrastructure, especially in areas such as environmental protection, city infrastructures, social infrastructure, and so on,” he said. “But due to the financial constraints, China has to treat infrastructure investment in a more measured and cautious manner.”

Third, over-investment in manufacturing has led to unused capacity and plunging profits, Yu said. China’s steel capacity is half the global total, he said, but those mills operate at barely 70 percent of capacity. “Due to such serious overcapacity, the steel industry’s profitability was merely four-hundreds of one percent,” he said. “The profit on two tons of steel was just enough to buy a lollipop.”

The upshot, Yu said, is that China must cut investment. But this will curtail growth “and may even cause a hard landing.” At the least, it “will lead to an increase in unemployment and social tension” – the economic/political “tightrope” that he mentioned.

Yu said the solution is a shift from investment-driven growth to “encouraging household consumption” – in other words, consumer spending. Such spending is constrained now by inadequate government pensions, medical insurance, and other forms of social insurance, which leads Chinese to save their money instead of spending it.

This could be cured with higher wages and more equitable income distribution, plus government spending on education, hospitals, retirement homes, and the like, he said.

Finally, Yu urged China to pare its huge trade and foreign currency surpluses. These surpluses, he said, are the mirror image of America’s trade and budget deficits and cause as many problems. One example: much of China’s foreign currency is invested in dollar-denominated securities earning “very low returns.”

A good start, he said, would be a currency reform, allowing the yuan to rise against foreign currencies. This would enable Chinese consumers to spend more on imported goods, while reducing the twin surpluses.

Yu acknowledged that lower exports would hurt the trade sector’s 100 million workers. This means that “China has to bear very large costs of adjustment, including human costs. But they cannot be postponed any further…The longer the delay, the higher the cost of adjustment will be.”

Speaker Bio



Yu Yongding, “China’s New Inflation Constraint,” Project Syndicate, 7/31/13

Yu Yongding, “China’s Narrowing Policy Horizons,” Project Syndicate, 1/31/13

Yu Yongding, “China’s Rebalancing Act,” Project Syndicate, 9/26/12

Read more of Yu Yongding’s recent writings for Project Syndicate here 

Additional Information

The Dr. Scholl Foundation Lecture on US-China Relations seeks to bring to Chicago one high-level American or Chinese policymaker, government official, or thought leader to deliver a major public lecture on key policy issues facing US-China relations.