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The Twilight of 'Chimerica'? China and the Collapse of the American Model

"Chimerica" illustrates the interactions between a Chinese model of high savings, over-investment and export-led growth and the us model of leveraged investment, credit consumption and finance-led growth. The collapse of the us model, linked with the unregulated derivatives market, has driven China to redirect its growth towards domestic consumption, despite the strengthening of regionalisation in east Asia. Yet, China's stimulus plan, based on investment, is limited by both income disparities and the underdevelopment of social protection. Land reform, or the collective redistribution of the remaining state assets, could stimulate domestic consumption. But the first solution deprives the local state of financial resources, and the second solution collides with the interests of the state-party system. However, stronger social movements could lead to a better income distribution. Like two faces of the same coin, credit consumption and a high savings rate reflect the crisis of a global accumulation regime, tailored for a financial oligarchy in the us, or for a party-state oligarchy in China.


The Twilight of ‘Chimerica’? China and the Collapse of the American Model

Guilhem Fabre

“Chimerica” illustrates the interactions between a Chinese model of high savings, over-investment and export-led growth and the US model of leveraged investment, credit consumption and finance-led growth. The collapse of the US model, linked with the unregulated derivatives market, has driven China to redirect its growth towards domestic consumption, despite the strengthening of regionalisation in east Asia. Yet, China’s stimulus plan, based on investment, is limited by both income disparities and the underdevelopment of social protection. Land reform, or the collective redistribution of the remaining state assets, could stimulate domestic consumption. But the first solution deprives the local state of financial resources, and the second solution collides with the interests of the state-party system. However, stronger social movements could lead to a better income distribution. Like two faces of the same coin, credit consumption and a high savings rate reflect the crisis of a global accumulation regime, tailored for a financial oligarchy in the US, or for a party-state oligarchy in China.

The author is grateful to Victor Rodwin, New York University, who gave useful comments and revisions on this text.

Guilhem Fabre ( is at the Universite du Havre, France.

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he rise of China and its impact on the world economy, e specially its relationship with the US, have played a major role in the present global crisis. The early years of the 21st century have seen the development of a close interdependence between the American model of finance-led growth and the C hinese model of export-led growth.

1 Finance-led Growth

The progressive deregulation and globalisation of financial markets since the 1980s created an unusual situation where global savings were financing the credit consumption of one of the richest countries in the world, the US, because of the supremacy of the US dollar. As the winner of the cold war, the US set the tune with its low inflation and easy money policy, which allowed financial operators in their quest for profit maximisation to create asset bubbles, that is, the Internet bubble of 1998-2001, the housing bubble between 2001 and 2007, and the primary commodity bubble in 2007-08, which created another surge of global inflationary trends. The collapse of this neo-capitalist model in September 2008 also signalled the transformation of what Moritz Schularick at Berlin’s Free University and Niall Ferguson at Harvard University have called “Chimerica”, to illustrate the symbiotic relationship between the two giants which were responsible for more than half the world’s economic growth in the years 2002 to 2008. “One half did the saving and the other half did the spending”, as China’s accumulated international reserves (estimated at $2 trillion) served to finance the US current account deficit as well as keep Chinese exports affordable. They are two faces of the same coin: from the end of 2001, which marked the access of China to the World Trade Organisation, to 2008, A mericans’ personal accumulated debts exceeded the sum of their debts in the previous 40 years, US savings having declined from more than 5% to less than 0 of gross national income, while Chinese savings rose from less than 30% to more than 45%.

This relationship was of course not limited to these two countries as the rest of Asia was also export-driven, trade deficits and household indebtedness had also increased in Europe, and e nergy exporters were recycling their petrodollars in western countries. But as Ferguson rightly puts it, “Chimerica was the real engine of the world economy”.1 Thus, as the roots of the present crisis are inseparable from its consequences and the m utations it may g enerate, it is useful to analyse them from a “Chimerica” perspective.

First of all, we may underline that the market booms of 1998 to 2008 were based on rational expectations. The digital revolution, comparable in its impact to the invention of printing, explains the Internet boom. Oil prices have risen more than fivefold between 2000 and 2007 because of strong demand from China and India, accompanied by depreciation of the US dollar, which pushed commodity exporters to raise their prices. But as Thomas Palley has shown, “there is a documented change in the character of oil trading, with speculators (that is, financial institutions and hedge funds) now accounting for 70% of trades, up from 37% seven years ago”.2 Thus, the accumulation of pro-cyclical risks, based on easily obtainable banking credit,3 led to irrational expectations. In this respect, the collective culpability of central bankers and fiscal authorities, especially in the US and Europe, is overwhelming: they voluntarily let the highest range of financial g lobalisation develop with minimum national (not to mention i nternational) regulation. Focusing on the prices of goods and services, they neglected the follow-ups of asset inflation (real e state and stocks) and of financial innovations, which were supposed to reduce risk as also “designed to circumvent regulation or taxation”,4 and finally spread risk to unprecedented levels.

The market for derivatives or credit risk transfers (CRTs), which has grown more than a thousand times since the beginning of the 1980s, to insure operators against commodity prices, interest rates or currency exchange fluctuations, was extended to credit default swaps (CDSs). A CDS is a contract under which the seller, for a fee, agrees to make a payment to the protection buyer if the referenced security, usually some kind of bond, experiences v arious “credit events”, such as bankruptcy, default or reorganisation of the bond issuer. In 2000, President Bill Clinton signed the Commodities Futures Modernisation Act exempting certain derivative transactions on commodities and swap agreements, including CDSs, from regulation. As CDSs were not subject to state laws or control, the way was cleared for the growth of a market where deals were privately made between two parties, without standards for the solvency of the parties. “The buyer does not know how much risk the seller is taking on. And there are no r equirements for the seller to hold reserves of capital against the risks it is taking on selling swaps.”5 CDSs were massively used to insure against mortgage default risks and created the illusion of a low-risk environment accepted by the regulators of the US F ederal Reserve.6

This unregulated market, whose notional value stood at $54.6 trillion in mid-2008, was a principal cause of the near collapse of the US financial system. CDSs played a major role in American I nternational Group’s, Bear Stearns’ and Lehman’s financial problems. Lehman Brothers was one of the largest over-the-counter (OTC) derivative dealers. AIG Financial Products, a subsidiary of AIG active in the derivative market, did not routinely hold reserves of capital or collateral for the risks it was taking. It issued transactions covering more than $440 billion in bonds with obligations that it could not cover. The head of AIG Financial Products, M Joseph Cassano, apparently made $280 million in the eight years up to 2008, and after leaving the company, in February 2008, got a consultancy contract with AIG for $1 million a month.7 The Bank of International Settlements noted as early as 2002 that this market had given rise to a concentration of risk in financial operators less capitalised and less governed by r egulation,8 such as the hedge funds, two-thirds of which are located in offshore locations, with a predilection for the Cayman Islands, but which are mostly funded (86%) in the US.9

Hedge funds, with their progressive institutionalisation after 2000, have played a key role in financial innovation and risktransfer techniques, especially securitisation, which was at the origin of the sub-prime crisis. They were responsible for 58% of the US credit derivatives market by volume and 45% of its emerging markets bonds in 2005. They represented 40% and 50% r espectively of the New York stock exchange and London stock exchange transactions on the eve of the 2008 crisis. Apart from hedge funds, the new surge of private equity funds, “ranging from start-up venture finance to leverage buyouts to vulture or distressed asset funds”, according to the International Monetary Fund (IMF), increased the use of risk-taking and leverage to u nprecedented levels, with implications for the operation of r estructured or acquired firms. Cross-border mergers and acquisitions by private-equity firms and hedge funds reached more than $100 billion per annum after 2003, and represented more than a quarter, on average, of global foreign direct investment (FDI) flows between 2003 and 2007.10 The Carlyle Capital Corporation, a subsidiary of the US-based Carlyle Group, particularly active in defence industry contracts in Iraq, was leveraged up to 32 times, or $1 of capital for $32 of liabilities before adverse m arket developments led to its liquidation in March 2008, with a $16 billion debt.11

Far from effective supervision, the growing impact of offshore financial centres in all continents, which represented half the a ctivity of international banks and a third of the total of outward foreign direct investments, have also strong fiscal implications since they cost $350 billion, 10% of the fiscal receipts in the US, and would represent from 1.7% to 3% of gross domestic p roduct (GDP) in France, or an equivalent of the annual fiscal deficit.12 As wealthy individuals in the developing world evade more than $100 billion worth of taxes in their home countries each year,13 these fiscal issues are a perfect reflection of the c urrent political order.

The crisis which extended to the whole world with the fall of Lehman Brothers investment bank in September 2008, prompted exceptional bail-out plans in the US and Europe. Rising deficits mobilised governments in the US and Europe to support banks and insurance companies. This assistance, which may represent 12% of GDP in the US and 8% in the United Kingdom for 2009, raises again the question of this fiscal evasion which has become systemic, creating a kind of “illegal legality” and exacerbating the speculative tendencies responsible for local and regional financial crises since the end of the cold war.14 As Jeffrey Sachs underlined, “the boom in housing and stock market prices i ncreased US households’ net wealth by around $18 trillion during 1996-2006. The rise in consumption based on this wealth,” which fed global growth, notably in China, “in turn raised house prices further, convincing households and lenders to ratchet up the b ubble another notch”.15

Jacques Sapir has clearly shown that the gains of growth due to the “wealth effect” of the mortgage credit (in the form of the Home Equity Extraction) explain the growth performance of the

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US economy between 2002 and 2007. Without the Home Equity Extraction contribution, US growth would have been comparable to the Eurozone and even less important.16

In short, the US model of finance-led growth succeeded in resolving by way of deregulation and mathematical formulations one of the issues which dominated the 10 years after the Asian crisis of 1997-98: how to give to the 1% richest people, particularly active in the financial sphere, rent-seeking incomes comparable to the beginning of the 20th century, while lending to the poor and letting them realise their dream of security by buying homes. Finance-led growth, built on an easy availability of credit, led to a high concentration of wealth and income gains in the hands of a few: 40% of US corporate profits in 2006 went to the financial sector, while the share of income going to the top 1% of the population doubled.17 Behind all the magic of this financial alchemy, the “shadow banking system” created, according to Nouriel Roubini, “a housing bubble, a mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble, and a hedge fund bubble, which are all now bursting simultaneously”.18

Whatever the political consequences of this systemic crisis, which will certainly come with the socialisation of losses by the public authorities, it is clear that it will redesign the post-cold war geo-economic balance, perhaps in favour of Europe, but c ertainly in favour of east Asia, mainly China. Despite the likelihood of a lasting recession in the UK, Ireland and Spain, due to the size of their housing recessions, the state’s redistributive t radition in Europe, which was being more and more discredited in Brussels as it is on the other side of the Atlantic as the main symptom of euro-sclerosis, is better suited to face the current economic crisis. Moreover, the existence of the euro, in a zone whose intra-regional trade represents 31% of global trade, and whose inter-regional trade, mainly directed towards Asia and North America, represents another 20% of global trade, will c ertainly raise its global status as a reserve currency, despite the lack of political integration in Europe. Official reserves held in euro are 27% of the 2008 world total, up from 18% a decade ago, while the US d ollar share has fallen to 63% from 71% in the same period.19

2 Export-led Growth

But the rise of the economic power of east Asia, especially China, will be the main consequence of this global crisis for a few reasons. First of all, China, with 6% of the global GDP, and Japan, with 10%, are two of the four large economies with huge export surpluses, along with Germany and Saudi Arabia. China and J apan are in a position to lend to other countries, to demand a bigger share of decision-making in international organisations such as the IMF, or to create their own Asian Monetary Fund with an $80 billion reserve. The idea for the fund, first launched during the Asian crisis of 1997-98, was revived during the fall of 2008. They are also in a position to diversify their portfolios with the fall of commodity and asset prices, which is offering new business opportunities in strategic sectors corresponding to their long-term priorities such as energy, minerals, transport, environment and health.

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China has bypassed Japan for the first time to become the largest holder of US Treasury securities, with $652 billion in October 2008, compared with Japan’s $573 billion. China’s State Administration of Foreign Exchange (SAFE) and commercial banks held $370 billion in debt issued by the then struggling US mortgage giants Fannie Mae and Freddie Mac.20 With the decrease of interest rates, it will be less profitable or even loss making for China to invest in US Treasury bonds, given the gap between their lowyield and the 20% appreciation of the renminbi to the US dollar since 2005. But it will be more lucrative to buy back Chinese e nterprises’ shares held by the US, and to diversify its business portfolio. China Investment Corp, the sovereign wealth fund, has incurred large unrealised losses, of the order of several billion US dollars, on its stakes in US private equity firms Blackstone Group and Morgan Stanley. It does not intend to take the steps of J apanese banks and securities firms, which are acquiring stakes in beleaguered US financial institutions. But firms such as KBC, AIG and HSBC Holdings are competing with 30 other financial institutions for a share of China’s $263 billion asset management industry. More and more countries such as Canada, which owns important oil reserves, welcome Chinese investments.21 However, securing adequate returns on the $2 trillion of foreign c urrency reserves has become a daunting task for China as the US has become its main banker, and there are plans for the renminbi to join other international currencies to be used for foreign e xchange reserves. The Chinese government has decided to allow in the next two years the renminbi to be used for settlements with Hong Kong and Macao, and has signed settlement agreements with Russia, Mongolia, and Association of South-East Asian Nations (ASEAN) countries, to use the renminbi in bilateral trade. This progressive regional convertibility is the first step to realise the full convertibility of the currency to counterbalance the likely depreciation of the US dollar in the coming years, which would be the more convenient way for the US government to d ecrease its foreign debt.22

Second, they are signs that the economic integration of east Asia, which was mainly designed to increase the export competitiveness of the region, may turn out to be more self-centred, and thus stronger, as in the case of Europe. The economic regionalisation of east Asia was the unexpected result of the G-7 Plaza Agreement in 1985, whereby the forced revaluation of the yen, and then the Korean won and the Taiwan dollar, were seen as a appropriate monetary response to the trade surpluses of these countries vis-à-vis the US and European markets. Facing strong reductions in export competitiveness, Japan and the four dragons (South Korea, Taiwan, Hong Kong and Singapore) delocalised massively towards south-east Asia and China, which were then opening up. They began with the manufacturing of their labourintensive and low-added value products (toys, clothing and consumer electronics), while moving into capital-intensive and higher added-value sectors such as automobiles, information and communication technologies (ICTs) and, finance. This process accelerated after 1994, with the de facto fixed exchange rate of the renminbi to the US dollar and the strong non-inflationary growth of China, which attracted multinational corporations (MNCs). China became not only the axis of the intra-Asian division of l abour, but also the world’s factory, producing practically everything, except big aircraft. It survived the Asian crisis, which destabilised for a certain period of time south-east Asia, by a djusting its internal economy through cost cutting, the transfer of state social welfare to households, and by launching a huge programme of highway construction, which now covers the e ntire nation.

With its accession to the WTO in 2001, a quarter of China’s growth was generated by exports and investments linked to exports. But this proportion, based on national figures, is much more important if we take into account the concentration of most of the FDI and exports in the high-growth and relatively rich coastal regions, and its effects on the construction industry, s ervices, and on inland regions, through commodities demand, outsourcing in small and medium firms, employment and labour migration. If we add that underground lending, mainly based in coastal regions, is equivalent to almost a third of the loans e xtended through the banking system,23 we may reasonably e stimate that during the early years of the 2000s at least 40% of China’s growth was directly or indirectly dependent on e xternal demand.

From 2001 to 2007, Chinese exports, growing at an unprecedented yearly average of 28%, more than quadrupled while its imports more than tripled. About 45% of its trade receipts came from Asia in 2007 while Europe and North America each contributed 21%. This dynamic of regional integration is even stronger in the case of Japan. More than half its exports and nearly half its imports are to and from Asian countries and China became its main supplier in the early 2000s, with more than 20% of its market share.24 So, despite an expected sharp decline of Chinese exports to Europe and North America, and to the new emerging markets of commodity exporters that it gained in the early 2000s, such as South America ($39 billion of exports in 2007), Africa ($37 billion), the Middle East ($44 billion) or the Commonwealth of Independent States ($48 billion), which are suffering from the fall of commodity prices, China has the scope to keep or develop its export status of low-cost products in Asia, especially in Japan, South Korea, Taiwan, Indonesia, Thailand and India, and to appear more and more as an importer’s market for equipment, transport goods and other technology-intensive products from the US and Europe.

Since the globalisation of the crisis in September 2008, China has renewed and strengthened relations with the heavyweights of the Asian region, such as Japan and South Korea, and addressed itself to liquidity problems in South Korea, which has seen its currency plunge as foreign investors have fled from the country’s financial markets amid the worldwide credit crunch.25 Following an agreement between the three central banks, Seoul can obtain a combined $46 billion from Tokyo and Beijing in case of necessity. An Asian monetary fund with an $80 billion reserve available to fight a regional financial crisis is also de facto taking shape. What is more, China has taken decisive steps towards T aiwan with the historic agreement of November 2008, expanding cross-straits air services to more than 20 Chinese towns, a llowing direct shipping and postal links, as well as setting up a reporting mechanism on food safety to enforce its quality control after the melamine scandal. This agreement represents a “giant step in cross-strait relations” according to Taiwanese business leaders who are eager to enhance financial cooperation with China and to set up a mutual mechanism to manage the strong foreign exchange reserves of the mainland, Taiwan and Hong Kong. In the trade field, there is ample scope for further cooperation between the two complementary economies, since 40% of Taiwan exports are shipped to China, especially in the form of processing trade for the ICTs, while China represents only 12% of Taiwan imports. Two-way trade was $130 billion in 2007, a lthough the traders had to go through a third territory, usually Hong Kong. The same restrictions were limiting Taiwanese investment in the mainland until the new President of Taiwan, Ma Ying-jeou, lifted most of them during the summer of 2008. Around 80% of Taiwan’s FDI is directed to China, especially in the ICT sector (computers, telecom and audio-video equipment), which became the driving force of Chinese exports in the early 2000s. Since the late 1980s, Taiwanese companies have pumped in at least $100 billion in China, about a fifth of the realised FDI stock. Four hundred thousand Taiwanese officially work in China, mainly in the Shanghai (Kunshan district), Fujian and Guangdong regions, but most observers estimate there may be at least twice that number. In 2008, Taiwan-based large banks and stocks and securities firms opened representative offices in Beijing, Shanghai, Kunshan and Shenzhen and hope to engage quickly in meaningful business opportunities “to overcome the negative e ffects of the ongoing financial tumult, which is not going to end anytime soon”.26

In short, the general concentration on China of Taiwanese businesses eager to overcome the reduction in their export m arkets, may lead to the emergence of a real common market of Greater China (China, Hong Kong and Taiwan), which will have tremendous consequences on the global economic order, as well as delicate consequences on China’s internal political system, which has always been based on a monopolistic approach.

3 China and the Global Crisis

This does not mean that China will not suffer from the global crisis. First of all, the general climate of increased living standards, similar to the one prevailing on the other side of the Pacific, began to deteriorate in October 2007, two months after the subprime crisis, with the continuous fall of the Chinese stock market, by almost two-thirds in the following year. This has reduced the savings of the 60 million middle class, who tended to favour investment funds and stocks instead of low-yield bank deposits in an inflationary context. And the real estate boom, which represented around 15% of overall investment and an important part of local authorities’ revenues, began to decline after exceptional gains in 2007. A weakness in the building industry in turn caused a slowdown in upstream industries and services, such as steel, cement, electricity, and freight.27

Second, falling demand for exports, higher material costs, stricter labour laws adopted in 2008, and a strong appreciation of 23% of the renminbi to the euro between July and October 2008 have combined to reduce China’s growth in the last quarter of 2008. The greatest impact was on the labour-intensive, small and

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medium-sized, export-oriented enterprises situated in the coastal areas, which are vulnerable to market changes. These are major employers, absorbing 70% of the 20 million new jobs every year.28 In the first half of 2008, 67,000 such companies, each with an a nnual turnover exceeding 5 million renminbi ($735,000) closed and lay off more than 20 million employees, according to the N ational Development and Reform Commission.29 Two-thirds of the toy exporters, mainly small-sized businesses in Guangdong province, shutdown in the first nine months of 2008, according to Chinese customs officials. The flow of migrant workers from inland provinces to coastal areas is reversing. Statistics from the Ministry of Human Resources and Social Security showed 10 million of China’s total 130 million migrant workers went back j obless to their rural place of origin in 2008.30

But these developments, which have strong social implications in terms of employment, concern labour-intensive exports and low added-value industries, mainly based in Guangdong or in other coastal provinces (toys, shoes, clothing, textiles, accessories, furniture and so on) which were already migrating to C ambodia, V ietnam or Bangladesh in search of lower wages. Things are less dramatic for the higher added-value sectors, such as machinery, equipment and ITC, which have been slowing with the reduction of external demand since mid-2008. As d uring the Asian crisis of 1997-98, national authorities will openly use this opportunity to restructure the economy, this time in favour of higher added-value and technology-intensive sectors, and to o rganise the return of m igrant workers to their original provinces in order to participate in the development of the p oorest regions.31

4 Domestic Consumption-led Growth?

In the wake of the global financial crisis, the Chinese leadership realised that it could no longer rely on exports as the engine of economic growth, and that it was urgently needed, not only at the level of rhetoric, to boost domestic demand. This necessity, underlined long ago, became more pressing as the export-led growth strategy was undermining the balance of Chimerica, and more recently Sino-European trade.32 As half of this trade is linked to FDI and outsourcing by foreign corporations in the quest of low labour costs, Chinese export competitiveness has long been based on the capacity to discipline its workers, especially migrants, by prohibiting workers unions, and violating routinely the international agreements on civil rights it has agreed to u nder the United Nations (UN). As US and European businesses, not to speak of the developed Asian ones, were largely benefiting from this situation, the US and Europe never really raised this i ssue, which could have had strong repercussions on a more equal income distribution in China. They preferred to focus on the question of exchange rates, and accused China of “monetary dumping”, which was just the r esult of severe restrictions on workers’ salaries and workers’ rights. As Palley has underlined, “unions have historically been especially important since they engage in decentralised wage bargaining that tie wages to firms’ producti vity”, they are in a position to “expand markets in deve loping countries, which means tackling income inequality and getting income into the right hands”.33

The Chinese leadership has chosen rural policy as the main leverage of domestic demand. Rural consumption represents

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about a third of total consumption, although 60% of the population still live in the countryside. On 12 October 2008, at the 30th anniversary of the historic plenum which launched Chinese r eform in 1978, the Chinese Communist Party Central Committee adopted a new reform extending farmers’ leases on land from the current 30-year term to an open-ended one, and protecting land-use rights, including the right of land transfer. As land works as a rural safety net for 250 million farm households, this new policy, which may allow farmers to use their land as collateral to access credit, or to rent it when they migrate, may develop rural incomes, narrow the gap between the rural and the urban sectors, stimulate urbanisation on a sound basis, and raise productivity growth. In recent years, much farmland was abandoned or was under-cultivated as 130 million migrants flocked to the cities to work in factories or on construction sites. A report from Qinghua University revealed that at least 120 million farmers needed loans but only 60% of them were able to obtain financing.34 The recent injection of 130 billion renminbi ($19 billion) into the Agricultural Bank of China, China’s third largest bank, enables it to sell shares to strategic investors and the general public with the aim of developing an effective agricultural lending network, through its 24,000 outlets nationwide.35

The new rural land reform was launched as early as 2006 by a four-year joint project of the United Nations Development Programme and the Chinese government, covering eight pilot provinces.36 Throughout Chinese history, land has always been a strategic resource as it is the main factor of production in a densely populated territory. Today the economic potential of the transfer of land use is considerable, as land assets value is greater than industrial assets: 119,000 state-owned enterprises have a book value of around $4 trillion while state-owned land is valued at more than $7 trillion.37 Official statistics show that revenue from the transfer of land amounted in 2005 to 550.5 billion renminbi ($68.8 billion), accounting for one-third of the revenue of local governments, and 3% of GDP. But as “two-thirds of land is transferred far from public scrutiny”,38 the potential value of such deals may be at least twice that number ($137 billion) or 6% of GDP, a figure that may be compared to the share of agriculture in GDP at the same time, around 15%.

Thus the importance of land requisition or of this grey market, which has developed in a context of quick urbanisation, is considerable in terms of resource transfer and rent seeking. They are the source of millions of complaints and hundreds of violent i ncidents, which have erupted in the period 2000 to 2008. Land requisition, housing demolition and resettlement were the top source of social conflict in China, opposing land grabbers (real estate developers) in collusion with local government officials to peasants or local residents. Official figures show that more than 40 million farmers had used their farmland partially or wholly for non-farming purposes while only six million of them, who became landless in land requisitions, have been covered by the basic living or old age security programmes.39 Other estimates are much higher: between 80 and 100 million of rural residents, out of a total of 730 million, are landless or do not have access to enough land for subsistence.40 The real estate boom and land rush in the context of quick urbanisation contributed significantly to social polarisation, as 10% of the richest Chinese families now own more than 40% of total wealth, while the poorest 10% share less than 2%.41 According to the newspaper columnist Yao Z hongqiu, “land acquisition, infrastructure and real estate development contribute profits as well as astonishing economic growth, to bolster the political career of officials. A government’s social responsibilities are relegated to a minor place when c ompared to making profit.”42

The economic potential of the transfer of land use, which may raise peasants’ income and productivity through a better allocation of land, largely depends on the local authorities. In the a bsence of any independent judiciary system, they are responsible for implementing laws and policies, fixing the value of land, and providing appropriate documentation ensuring the rights of peasants to a piece of land. That is apparently the case for only half the peasants.43 And the paradox of this policy of noncompliance is that it will deprive the local governments of a part of their land revenues, which represents at least a third of their income, not to mention the hidden commissions they are used to receiving for commercial development.44

The same logic applies to the stimulus plan, which was a nnounced with great fanfare before the November 2008 G-20 summit in Washington. According to this two-year, four-trillion renminbi ($585.76 billion) plan, 45% will go to the construction of 17,000 km of new railways lines, and to new highways, airports and power grids, 25% will go to reconstruction following the snowstorms and the Sichuan earthquake of 2008, 10% will go to rural development and infrastructure, and the environment and housing will get roughly 7% to 8% each. The remaining 5% includes spending on health, education and innovation. This stimulus package is expected to improve the infrastructure of the country and to create employment, especially for railway construction, and may create six million new jobs.45 However, most beneficiaries of the infrastructure spending are state-owned enterprises rather than small and medium-sized enterprises that contribute the biggest share of industrial output and more than 70% of jobs.46 The progressive acceptance of the informal banking market, which has been tried out in Wenzhou, Zhejiang, may help these labour-intensive companies if the authorities carefully control the liabilities of these financial actors and the interest they can charge.47 As for the stimulus spending, the central government will apparently just provide less than 30% of it (1.180 trillion renminbi or $173 billion), while local governments and state companies will supply the rest. Provincial authorities have begun to compete to get a share of the pie by drawing up investment plans that total 10 trillion renminbi ($1.5 trillion), the largest being that of Yunnan province which has drawn up an annual investment plan of 600 billion renminbi over the next five years, more than its actual GDP. Behind such unrealistic expectations, there are open worries about the corruption that may develop and ritual calls for strict control of local cadres, who were r esponsible for large-scale mass incidents in 2008.48

This plan is forecasted to contribute over 4 percentage points to GDP growth in 2009, and about 1.5 percentage points more than in 2007.49 Other measures such as the increase in tax rebates for labour-intensive exports, or the successive large cuts in the interest rates and reserve requirement ratios by the People’s Bank of China, will improve the growth record in 2009 and 2010, but they do not provide an answer to the structural problems of the Chinese economy. While the central as well as local authorities are focused on strong investment to create economic growth and social mobility in the context of urbanisation and expansion of export markets, household consumption continued to fall to a low level of 35.3% of GDP in 2007. This low propensity to spend can be viewed in conjunction with the high savings rate, which represents 25% of disposable income and 45% of GDP, and which feeds the trend for overinvestment through the state banking s ystem. The restructuring of the state sector in the 1990s under vice premier and premier Zhu Rongji led to the progressive transfer of health, education, welfare, pensions and housing costs to urban households, whose motivation to save has become precautionary in nature, that is, for retirement, illness, education of children, and unemployment. Health expenses are the highest of these costs.

Hu Angang, an economist from Qinghua University, has estimated the extent of what he calls “health poverty”. Between 1995 and 2005, the number of people suffering from illness increased by 16.5% while those without social medical insurance coverage rose from 900 million to one billion, which is more than 80% of the population.50 In 2004, a think tank of China’s Ministry of Health established that AIDS and Hepatitis B infection caused by unsafe injections had caused 390,000 premature deaths and 6.89 million Disability Adjustment Life Year Losses. Statistics showed that 30% of immune injections and 50% of therapeutic ones were unsafe, and in western rural areas, more than 70% of disposable syringes for single use were reused.51 Of China’s total medical fees, the government’s input only accounted for 15% and patients paid 60% in 2005. As hospital treatment is too expensive for C hinese citizens and only about half of the urban population is covered by basic health insurance, the other half choose not to go to hospital when ill, and about a third give up hospitalisation b ecause of expensive medical fees.52 The medical coverage n etwork has progressed since with a medicare system covering more than 91% of China’s rural families who have joined the new rural cooperatives.53 Yet 11.8% of household expenditure goes to healthcare, while 8% of urban household expenditure goes to education.54

As lower income people have a higher propensity to consume than to save, any policy aiming to increase domestic demand should relieve healthcare and education costs which decrease private consumption, not only for the masses of peasants but also for urban dwellers. But despite recent efforts in these fields, these expenses are only a small part of the stimulus plan. Healthcare, social security, and unemployment welfare programmes were just about 15% of the 2007 budget and 2.4% of GDP, far below the percentage of other developing nations.55

Besides, the situation varies greatly as more than 90% of these public expenses are managed by local authorities.56 In reality, boosting domestic demand requires more than investment plans, as overinvestment has been a recurrent trend of China’s economy in the 2000s. Otherwise, China may face the situation of p ost-bubble Japan in the 1990s, when 10 years of public s pending

June 27, 2009 vol xliv nos 26 & 27

in infrastructure created a “liquidity trap”, unable to boost private demand. The widening income gap is responsible for the low domestic consumption rate, as most of the savings are concentrated in the hands of the urban middle class and the few hundred thousand millionaires, who will certainly benefit from the recent opening of a subsidiary of the Bank of China in Geneva, specialising in non-resident Chinese wealth management.57 Thus, any realistic plan should address the question of income redistribution, not only by way of public goods such as health and education, but also a bold, immediate initiative that will be able to electrify the population and reverse the adverse current situation.

Chen Zhiwu, from the Yale School of Management, suggests distributing the remaining state assets equally to China’s 1.3 billion citizens by putting these assets into national wealth funds and distributing the fund’s share to citizens at no cost. He also adds opening up the state budgeting process through public hearings in the national legislature and public participation via the media, to reorient public spending towards people’s needs.58 This would certainly be the best plan to boost domestic demand, when one considers the institutional difficulties of land reform, but it would be a far cry from the dynamic of “transition”, which has been until now characterised by the conversion of the power of decision of the nomenklatura into a power of appropriation of public assets, in industry, commerce and land. One of the main advisers of former party chief Zhao Ziyang and former premier Zhu Rongji, the economist Wu Jinglian, popularly known as “Mr Market”, has recently underlined these institutional d ifficulties. As corruption has infected crucial party organs, i ncluding the police and the judiciary, “if the mainland is to b ecome fully modernised”, he declared, “it must introduce three principles: democracy, constitutionalism and the rule of law”.59 That is word for word what the young Wei Jingsheng, who was sentenced to 14 years in prison, wrote in 1979 on the Beijing democracy wall, in his famous wall poster “the fifth modernisation: democracy”.

Whatever the future of Chen Zhiwu’s proposition, it is certain that the stimulus plan, based on investment, will not be able to contain the dramatic reversal of the flows which have funded China’s growth since the end of the Asian crisis 10 years ago, and which are demonstrated in the return of migrant workers to the countryside.

Anyway, if the government sticks to its proposal and neglects the importance of social safety, people, especially the lowerincome group, will react negatively. In fact, they are already r eacting. There are numerous signs that China is now entering a new phase, which has already been passed through by Taiwan and South Korea after 1986, with the revaluation of their currency, and the end of their old fears and anti-communist martial laws, a phase of strong labour unrest in favour of a better income distribution. In Qingdao, for instance, the main port of S handong, which is the largest economic province in terms of GDP after Guangdong, they were more than 7,800 cases of labour disputes in 2008, up 140% from 2007. Half of these dispute cases were about wages and a third involved social insurance and welfare.60 Unlike in 1989, this unrest will not be limited to the towns, as in the case of the September and October 2008 strikes of cab drivers

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June 27, 2009 vol xliv nos 26 & 27

in 11 cities demanding a cut in the monthly fee they pay to their employers and a limit to the number of licences issued. In October 2008, the CCP central committee decided to enrol for regular training the weakest link of party management, the 2000 countylevel party secretaries. The week-long programme was widely interpreted as one of the latest moves to improve the performance of local officials, who “were extensively taught on how to deal with mass incidents such as protests and strikes”.61

In such circumstances, it is unrealistic to wait for China to b ecome a source of the world’s “growth”. Chimerica is not going to collapse, as China needs to recycle its huge foreign exchange reserves and to make its exports to the US affordable by buying US Treasury bonds. But Chinese officials, who have an asset portfolio estimated at $1,100 billion in the US, are rightly worried about the sustainability of these assets. The US model of financeled growth nearly collapsed along with the shadow banking system, and its rescue added a soaring public deficit to the private debt, some $7,800 billion of loans, investments and guarantees, compared to a pre-crisis Federal debt of around $10,000 billion. As Ferguson has underlined, the Treasury may have to issue $2,200 billion in new debt in 2009, and it is not surprising that the cost of insuring against a US government default has risen 25-fold in little over a year.62

5 The Two Faces of the Same Coin

The problem is not reducible to an adjustment between American “overconsumption” and Chinese “oversaving”, which will take years to take shape.63 As noted in 2005 by The Economist, the entry of China’s vast army of cheap labour to the global system of production and trade has modified the relative prices of labour, capital, goods and assets. It has increased the worldwide return on capital: in 2004, US corporate profits after tax rose to their highest level as a proportion of GDP in 75 years, while the shares of profit in Japan and the Eurozone were close to their highest in 25 years. It has reduced the price of many consumer goods, but also the bargaining power of workers in developed economies, threatened as they are by offshore production. In this sense, the east Asian economies and China have exported wage deflation (the disconnection between growth, wages and productivity), which was largely responsible for households running into debt.64 And China has also held down interest rates in rich economies by recycling its foreign exchange reserves in Treasury bonds, indirectly creating a global liquidity bubble, which did not translate into goods inflation (thanks to its cheap products) but into asset inflation (real estate and stocks).65

Thus credit consumption in the west largely reflects the longterm fall of wages in the sharing of profits, as well as widening income disparities. In the US particularly, asset inflation (real e state and stocks), combined with the privatisation of what is still known as public goods in most of the Eurozone, that is, health and education. Health insurance costs and education fees inflation accelerated the decline of savings and the demand for credit.66 Average household debt rose from 75% of annual disposable income in 1990 to nearly 130% in 2008.

It is striking to see how this picture looks similar to what we have observed in the case of China, where savings, and not credit, in the hands of the urban middle class, mainly finance the rectifica-in the case of China, and credit consumption and leverage tion of the failure of public goods supply, such as health and educa-i nvestment in the case of the US, are two faces of the same coin. tion, which have been largely privatised. But apart from the obvi-They reflect the crisis of an accumulation model tailored for a ous developmental levels of the two countries, there is a difference financial, entrepreneurial or party-state oligarchy, which crein the process of accumulation, which may influence future eco-ated an unsustainable model of “growth with inequity”. The nomic policies. In the US as well as in the Eurozone, the big win-remedies adopted up to now in the west, which tended to add ners of the last 30 years have been a small financial and entrepre-excessive leverage in the public sector to excessive leverage in neurial oligarchy, which, with the help of the political elite, have the private sector,68 may have controlled the fire, but not the accumulated incomes completely disproportionate to their pro-embers, which may burst forth again if the structural question ductivity levels. Whereas in China, the dynamics of a ccumulation of wage deflation and the sharing of profits, which has strong have been largely under control of the party-state oligarchy, under social and fiscal implications, is not addressed. Chimerica has the form of a decentralised state capitalism. Chen Zhiwu has calcu-been basically built on an international division of labour and lated that from 1995 to 2007, “inflation- adjusted government fiscal capital that is no longer sustainable. On the one side, the revenue increased 5.7 times. In contrast, over the same period, the finance-led growth model has been built on the monetary cumulative increase was 1.6 times for urban residents’ per capita s upremacy of the US dollar, which has created an addiction to disposable income and 1.2 times for rural peasants’ per capita in-debt to sustain a consumerist mode of living. On the other side, come.” So, China’s “socialism with Chinese characteristics” is an the export-led growth model has pushed the gigantic capacities economy where an increasing share of national income goes to the of production,69 invested in by developed Asian nations and state.67 Here again, the dis connection between growth, wages and MNCs in China, to flood the world. In this sense, the vessel of the level of wealth re distribution is responsible for under consump-Chimerica may be heading towards twilight, but certainly not, tion, and over investment, as the savings are massively reallocated its twilight, as these capacities of production will remain, and through the state banking system. China, whatever its political and social tribulations, will climb

Finally, the macroeconomic imbalances on the two sides of the up the ladder of technology to become more and more competi-Pacific, which are translated by oversaving and overinvestment tive in a more and more interdependent world.


1 Geopolitical Consequences of the Credit Crunch, 30 September 2008. 2 “Speculators at the Pumps”,, 2008. 3 Robert Boyer, Mario Dehove et Dominique Plihon,

Les crises financières, Rapport au Conseil d’Analyse Economique, La Documentation Française, 2004,

112. 4 Hannes Androsch, Former Finance Minister and Vice-Chancellor of Austria, “Europe’s Financial Vulnerability”,; The fact that regulators are always running behind private-sector innovation, does not explain the neglect of asset inflation, which has been underlined by economists such as Patrick Artus: Les incendiaires: Les banques centrales dépassées par la globalisation, Paris, Perrin, 2007. 5 Superintendant Eric Dinallo, New York State I nsurance Department, Testimony to the US House of Representatives Hearing to Review the Role of Credit Derivatives in the US Economy, Washington, 20 November 2008. 6 See Martin Neil Baily, Robert E Litan and Matthew Johnson, The Origins of the Financial Crisis, Paper 3, November 2008, The Brookings Institution, Washington, 47. In May 2006, Alan Greenspan called the CDS “the most important instrument in finance”, adding “What CDS did is lay off all the risks of highly leverage institutions … on stable American and international institutions.” Contrary to Greenspan’s comments, the “biggest source of recent growth of the CDS market was not among stable institutions, but rather among highly leveraged institutions like hedge funds and investment banks” (33). 7 Idem, Testimony of Henry TC Hu, University of Texas School of Law, 13 October 2008. 8 Bank of International Settlements, Annual Report 2002, Bâle. 9 IMF, Global Financial Stability Report, April 2007. 10 IMF, Global Financial Stability Report, April 2007, 54-57, for the weight of hedge funds in the US. For

their weight in stock-markets transactions, see Michel Agglietta in Patrick Artus et al, La crise des subprimes, Report of the CAE, La Documentation Française, 2008, and Hubert Reynier, Director of International Affairs Regulation, at the French “Autorité des Marchés Financiers” in Le Monde Economie, II, 3 October 2006. For the statistics on M&A, World Investment Report, 2008, UNCTAD,

6. In 2006, hedge funds drove nearly 60% of CDS trading volume (see Martin Neil Baily and others, paper cited, 33).

11 Hannes Androsch, idem note 2.

12 US General Accountability Office; $350 billion represents not only 10% of the fiscal receipts but 80% of the US fiscal deficit in 2008, estimated at $438 billion; Christian Chavagneux, “Le boom de la finance offshore”, Alternatives économiques, n° 75, p 44-45.

13 Dani Rodrick, “Let Developing Nations Rule”, Project Syndicate, December 2008, www.

14 Guilhem Fabre, Criminal Prosperity: Drug trafficking, Money Laundering and Financial Crises after the Cold War, RoutledgeCurzon, 2003.

15 Jeffrey Sachs, “Boom, Bust and Recovery in the World Economy”, www.

16 Jacques Sapir (EHESS, Paris), Les sources internationales de la crise actuelle, 2008. Since the 1980s, home equity loans were advertised by banks as a way for homeowners to “extract wealth” from their home in order to finance credit consumption. Greenspan and Kennedy (Discussion Paper n°2007-20, Board of Governors of the Federal Reserve System) estimate that homeowners extracted $747 billion in net equity from their homes at the peak of the housing boom in 2005, up from $229.6 billion in 2000 and $74.2 billion in 1991 (cited in Martin Neil Baily and others, The

Origins of the Financial Crisis, p 17). 17 Lawrence Summers, Financial Times, 26 October 2008. In 2006 alone, the value added of the US parent companies in the finance (except depository institutions) and insurance sectors increased by 43.8%. (Raymond J Mataloni Jr, “US Multinational Companies, Operations in 2006”, Survey of Current Business, November 2008, 31.) 18 Nouriel Roubini, “From Financial Meltdown to

Global Depression?”,

19 Adam Chen, South China Morning Post, 5 January 2009.

20 South China Morning Post website, Hong Kong, 20 November 2008.

21 Shanghaï, Reuters, 5/11/2008; Le Figaro, 21 November 2008.

22 Wu Xiaoling, former vice-governor of the central bank, in Xinhua, 25 October 2008. On the likelihood of a US dollar depreciation to decrease the US foreign debt, see Yu Yongding, Director of the Institute of World Economics and Politics, Chinese Academy of Social Sciences, in Caijing (Finance Magazine), 17 December 2008.

23 Nicholas R Lardy, “Financial Repression in China”, Peterson Institute of International Economics, September 2008, according to a study by Li Jianzhun, Capital University of Finance and Economics, “ Irregular Credit Completely Offsets the Retrenchment Gap”, China Economic Management Report, 6 July 2008. As for the strong bias in favour of the coastal regions, since the opening up of China in 1984, let us remember that in 2005, with 43% of the population, they were responsible for 62% of GDP, 86% of FDI and 93% of exports.

24 WTO, World Trade Report 2008. If we include reexports through Hong Kong, the real breakdown of China’s exports are in 2007, 27% for Europe, 22% for the US, 9% for Japan, 21.6% for Hong Kong, Korea and Taïwan and 3.9% for CIS-Ukraine, cf Missions économiques, MINEFI, 17 March 2008.

25 Kyodo News Service, Tokyo, 13 December 2008; Chungang Ilbo, Seoul, 13 December 2008.

26 Central News Agency Website, Taibei, 3,5, 6 November 2008.

27 World Bank, Beijing Office, Quarterly Update, D ecember 2008.

28 Xinhua, Beijing, 1 November 2008.

29 Xinhua, 13 December 2008. That figure does not include smaller firms, for which there are no available statistics.

30 Xinhua, 3 January 2009; Xinhua, 20, 21 November 2008; Nanfang ribao, Guangzhou, 18 November 2008.

June 27, 2009 vol xliv nos 26 & 27

31 Bulletin économique Chine, Missions économiques, Pékin, Novembre 2008, 2; Xinhua, 18 December 2008.

32 Guilhem Fabre, Integration Versus Fragmentation?: A General Framework for Post Deng Xiaoping Economic Policy, London, Imperial College, September 1994; Une politique économique alternative pour l’après Deng Xiaoping, Cahiers du Centre Chine, EHESS, 1996; Nicolas Lardy, China: Toward a Consumption-Driven Growth Path, I nstitute of International Economics, Washington, October 2006.

33 Thomas I Palley, former chief economist with the US-China Economic and Security Review Commission, “Humpty Dumpty and Global Financial Imbalances”, Project Syndicate, 2007. As China’s huge trade surplus with the US is more the reflection of structural issues than the under appreciation of the China’s currency, it cannot be addressed by a change in relative prices. Justin Lin, from the World Bank, underlined, “If the yuan were allowed to appreciate as much as 40% ... it could increase the price of imports to the US and reduce Chinese exports. That would put even more of a dent in the struggling world economy.” (Conference organised by Brooking Institution and Caijing (Finance) Magazine, Wall Street Journal, 13 January 2009.)

34 Xinhua, 30 December 2007.

35 Xinhua, 6 November 2008.

36 Xinhua, 20 December 2006.

37 Chen Zhiwu, Yale School of Management, South China Morning Post, Hong Kong, 29 November 2008.

38 Xinhua, 22 November 2006.

39 Xinhua, 17 November 2006; 29 December 2006. More than 7 million hectares, nearly 9% of the country’s total farmland, have been taken over for industrial and other purposes, according to

o fficial data (South China Morning Post, 6 January 2009). 40 Wall Street Journal, 2 December 2008. 41 Xinhua, 7 January 2007. 42 Cited by Fiona Tam, South China Morning Post, 6 January 2009. 43 International Herald Tribune, 12 October 2008.

44 Contribution from the property industry accounts for a quarter of Beijing’s tax revenue, according to Xinhua, 13 January 2009.

45 South China Morning Post, Hongkong, 28 November 2008.

46 South China Morning Post, 10 December 2008.

47 Wall Street Journal, 24 November 2008.

48 Financial Times, 15 December 2008; Xinhua, 29 November 2008; Zhong Zhuwen, Renmin ribao website, 28 November 2008.

49 China Quarterly Update, World Bank Office, B eijing, December 2008.

50 Zhongguo xinwen she, 7 January 2005.

51 Xinhua, 5 August 2004.

52 Xinhua, 8 December 2005.

53 Xinhua, 2 November 2008.

54 Xinhua, 7 January 2007. National Bureau of Statistics of China, 2005.

55 Chen Zhiwu, Yale School of Management, South China Morning Post, Hong Kong, 29 November 2008, and Project Syndicate. Brazil’s government spends 4.7% of GDP on healthcare alone, and 5.4% on education, against around 3% for China.

56 Bulletin économique Chine, Mission économique de Pékin, n°7, novembre 2008, P 5 Local governments manage 91% of retirement funds, 87% of social security, 99% of social assistance, 97% of health care, and 94% of education funds.

57 Le Figaro, 28 November 2008. 58 Chen Zhiwu, Project Syndicate, November 2008.

59 South China Morning Post, Hong Kong, 3 December 2008.

60 Xinhua, 23 November 2008.

61 Xinhua, 1 January 2008.

62 Niall Ferguson, “The Age of Obligation”, Financial Times, 18 December 2008.

63 Michael Pettis, who teaches finance at Peking university, has estimated that a decline in US consumption equal to 5% of US GDP would require an increase in Chinese consumption equal to 17% of Chinese GDP, or a nearly 40% growth in consumption (Financial Times, 14 December 2008).

64 This point is well illustrated by Jacques Sapir, for the case of France and the Eurozone (see “Les souces internationales de la crise actuelle”).

65 The Economist, “How China Runs the World Economy”, 30 July-5 August 2005, 65-67. However, it is not relevant to blame China as responsible for the asset inflation in the US. As Martin Neil Baily and others rightly underline: “Without access to foreign funds, the US economy would have invested less in all kinds of capital. The problem was the diversion of too much investment into housing, that was not productive at the margin, a problem we should blame on ourselves more than on those who lent the money”, The Origins of the Financial Crisis, Paper cited, 38.

66 Le Monde, 6 January 2009, 8.

67 China’s Construction Fetish, Project Syndicate, 2008.

68 Niall Ferguson, Financial Times, 18 December 2008.

69 Let us remember that these capacities of production concern practically all sectors, from ICTs to naval construction and aeronautics, as Boeing and Airbus have outsourced in China parts of their new programmes to reduce their production costs.


April 18, 2009

Medicine, State and Society –V Sujatha, Leena Abraham
‘Commercialising Traditional Medicine’: Ayurvedic Manufacturing in Kerala –M S Harilal
Can Maternity Services Open Up to the Indigenous Traditions of Midwifery? –Mira Sadgopal
Recovering from Psychosocial Traumas: The Place of Dargahs in Maharashtra –Bhargavi V Davar, Madhura Lohokare
Medicine as Culture: Indigenous Medicine in Cosmopolitan Mumbai –Leena Abraham
The Patient as a Knower: Principle and Practice in Siddha Medicine –V Sujatha

For copies write to: Circulation Manager, Economic and Political Weekly, 320-321, A to Z Industrial Estate, Ganpatrao Kadam Marg, Lower Parel, Mumbai 400 013.


Economic & Political Weekly

June 27, 2009 vol xliv nos 26 & 27

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