Speed Bumps for Chinese Miracle

China's economic vigor, for years the envy of the world, is increasingly being questioned. For the past six months, a flood of negative news has poured out of China, one of the world's growth locomotives and its largest importer of bulk plastics. The reports paint a picture of a country that is plagued by shortages, on the verge of a possibly severe economic downturn.

Yet business executives worldwide remain bullish about investing in China. An annual survey completed last month by management consulting firm A. T. Kearney found that, for the third year in a row, China ranks ahead of the U.S. as the world's most attractive investment destination. Is their optimism wrongly placed?

Being right about the Chinese economy is important for managers in the chemical industry. Chemical plants are expensive to build, and if China is heading for a major economic slowdown, it may not make financial sense to go ahead with a significant investment in the country now. But if the Chinese economy is facing nothing more than a temporary slip, managers can't afford to delay lest the competition establish a foothold in the meantime.

The news from China is worrysome. For the past 20 years, much of Chinese growth was powered by its export-oriented manufacturing sector. Now, it seems as if the sector is in a stranglehold. Since summer--and probably for the next two years--China has been facing power shortages that have had an impact on chemical companies in the country (C&EN, Sept. 27, page 16).

Throughout China this year, manufacturers had difficulty acquiring raw materials such as coal, coke, and steel, and basic petrochemicals like styrene and benzene. Owing to shortages of coke and electricity, much of China's once hyper-competitive phosphate chemicals industry has turned uncompetitive (C&EN, May 31, page 14). The shortage of steel is bad enough that small-time hustlers have taken to stealing manhole covers and selling them to scrap yards.

Most amazing for a country that has been promoting its practically limitless labor pool, factories in China's coastal regions have been unable to fill job openings. For the past few months, factory managers in coastal industrial towns such as Dongguan and Shangyu have complained that it is difficult for them to find operators. Higher wages would attract more workers but would erode China's advantage as a country endowed with low-cost labor.

Meanwhile, the economy keeps growing at a mad clip. The central government in Beijing is striving to cool it down through administrative measures such as restrictions on corporate bank loans. And late last month, China also raised its one-year benchmark lending rate to 5.58%, a 0.27% increase. An official in Nanjing tells C&EN that Beijing has also severely tightened the allocation of land to new business ventures.

PLAGUED WITH this many problems, the Chinese economy would seem to be headed for derailment. And yet, so far there are hardly any visible signs that it is slowing. Copper producers in the Asia-Pacific region said last month that they expect strong demand from China to endure. Air pollution and traffic jams in China are worse than ever. And wealthy Chinese are traveling the world in ever-greater numbers, pushing up real estate prices in cities such as Hong Kong.

David S. Jiang, the chairman of Sinodata Consulting, a Beijing-based firm advising companies in the chemical and energy fields, gives high marks to China's top technocrats for cracking down on extravagant investment projects planned by companies and government organizations. He estimates that the central authorities have succeeded in stalling about $100 billion worth of investment projects.

Yet there are actually few restrictions in sectors, such as petrochemicals, that are promoted by the central government in Beijing. China Petroleum & Chemical Corp. (Sinopec) and PetroChina both want to build world-scale petrochemical complexes, and Beijing will approve them, Jiang believes. Zhenhai Refining & Chemical recently received the green light for a 1 million-metric-ton ethylene cracker and petrochemical complex.

In general, investment in fixed assets in China has on the whole been growing too fast, from $360 billion in 1997 to more than $650 billion last year. This is the main cause for China's overheating, Jiang says. A large share of this money has been wasted in ill-conceived business ventures--unnecessary government office towers and excessive expansions in the cement, steel, and aluminum industries. One of Jiang's examples is calcium carbide, used to produce acetylene. Capital has poured into the sector, he says, but the plants that are built pollute and consume too much of the electricity that is in short supply in China.

The reports of labor shortages are atypical of the situation in most of the country, Jiang says. Chinese universities graduate 3.5 million students annually, he points out, and foreign-invested joint ventures are able to hire them as operators for as little as $200 per month. Government leaders in Beijing still express more concern for China's unemployment problem than for an apparent shortage of operators in coastal cities.

A collapse in the Chinese banking sector could undermine the Chinese economy. Bad loans at Chinese banks officially amount to 13% of total loans but are widely believed to be much higher. Banking crises in Asia, as Japan demonstrated in the 1990s, have a tendency to be solved slowly and to lead to long economic downturns. According to a recent report by the Asian Development Bank (ADB), the China Banking Regulatory Commission acquired more power last December. Since then, three major banks have been restructured. ADB warns, however, that "the task of reducing nonperforming loans further remains challenging."

The Chinese economy has been growing at a furious pace ever since the 1997–98 Asian financial crisis. The central government in Beijing is forcing a much-needed slowdown from the top, despite protests from other levels of government throughout China. Beijing could overdo it, reducing growth in gross domestic product to 3 to 4% rather than the 7 to 8% it is aiming for. In any case, the result will be an economy prepared for sustainable growth. The evidence that China is in for a prolonged downturn is not convincing.