China Dream hits the wall
May 8, 2005 12:00 AM (GMT)

CHINA'S explosive growth is testing the managerial competence of the relatively new leadership in Beijing.

Some of the problems are the result of poor planning; others stem from the mainland's expansion rate, which, despite attempts to cool it, still tops 9%.

The population is ageing, the number over 65 rising by 35m in the past decade. When the working population peaks at 950m in 2020, the number of over-65s is expected to be 170m. By the middle of the century, they will make up a quarter of the population.

But there is little pension provision and the government will have to launch a big scheme - probably enlisting foreign and Chinese insurance companies - to fund part of pension provision privately.

One result of a decline in the working population is competition for labour. Some factories in the south and on the east coast are already finding it harder to recruit the right workers for increasingly sophisticated plants. Workers are becoming better organised and wages are rising - sometimes as the result of riots or of dissatisfied workers walking out.

Factories have been able to cope with increased wages by improving productivity, but as the economy moves into more sophisticated products China will not be able to rely on cheaper labour when in export competition with poorer Asian countries such as Vietnam.

Instead of focusing on the coastal regions that have fuelled growth, the Chinese government is encouraging firms to re-locate to the interior, where the economy is often rural-based, services are rudimentary and living standards are low.

Rural revolts over taxes, corruption and heavy-handed officials have shown the political danger of not catering to the countryside. But because Chinese industry was focused on the coastal development zones in the 1990s, it will take decades to reverse the trend - and any change will risk slowing down overall growth.

The latest figures show that gross domestic product (GDP) in coastal areas is 79% above the national average. In the interior regions, which include big cities as well as farm areas, it is 23% below.

Coastal regions account for 90% of China's trade and attract 85% of foreign investment. The prospect is that poor inland regions will be dependent on state funds, representing a burden on the central budget. In some provinces, up to half the workers have been reduced to poverty by ill health and lack of treatment. This is creating a rural underclass that could pose a threat to the regime.

But China's health problem stretches to the cities, too. One report puts the number of people diagnosed with a chronic illness at 160m, 12% of the population. Economic losses stemming from "health poverty" may be equivalent to 7% of GDP.

At the same time, air pollution is taking its toll, particularly among urban workers. As a developing economy, China will not be bound by the Kyoto Protocol until 2010. China has taken over from the United States as the largest emitter of sulphur dioxide. Its cities are among the most polluted in the world, particularly in high development zones. Ecological damage is put at $13bn a year. Lung diseases are reckoned to cause a quarter of deaths. Acid rain is damaging farm land on a significant scale.

Yet the race for growth means that no improvement is in sight. China's huge energy needs have led it to launch a programme to build hundreds of new coal-fired power stations.

These will increase air pollution and associated illnesses. They will also encourage wildcat coal mining which kills thousands of miners each year and has caused hundreds of thousands to become victims of lung disease. The polluting coal industry is set to grow well beyond the current output of 1.8bn tonnes.

The new crash programme for power stations is not only a factor of high growth. It also reflects a failure of central planners, who failed to anticipate energy needs and the attractions of China's abundant and cheap coal supplies. The movement of so much coal causes transport bottlenecks, particularly on the railways, while ports cannot handle imports of gas and oil.

Overcapacity may be looming in two fast-developing sectors: steel and cars. Chinese provinces have been racing to build steel plants. Though Chinese demand has sent prices through the roof, some analysts believe that, from next year, the trend could be reversed. With enough domestic production capacity from new plants, China would become an exporter of steel, threatening to bring down world prices.

Though motor car sales rose by 15% to 2.3m last year, this was far below the doubling of purchases in 2003. Industry analysts expects car sales in 2005 to increase by 10%; top-of-the range vehicles are particularly under pressure. BMW sales in the Greater China market of the mainland, Hong Kong and Taiwan fell by 10% in 2004.

The slowdown in the car market has been accentuated by a government campaign to slow lending as part of a bid to reduce the bad debts of China's state-owned banks.

The bad debts of companies outweigh private debts. Though the government has pumped $60bn into state banks in six months, they need more. Analysts put the requirement at anywhere from $160bn to double that if the banks are to get their balance sheets in shape for flotations.