China shares same problems as other developing nations

Throughout history, unequal development has been the norm: there has never been a time when different nations did not have radically different levels of development. But the economic forces causing a convergence of development levels have never been so powerful as they are today. The countries moving ahead most quickly, including India, China, Egypt, Brazil and Russia, might be called "late developing nations". It goes without saying that the late developers face many huge challenges. But they also have advantages. Many have leapfrogged transitional stages of development by adopting more advanced technologies.

For example, China has jumped directly to ATM cards, bypassing the cheque book stage. Since its ineffective legal and banking systems can hardly support the wide use of chequebooks, ATM technology has nicely covered up the holes. Another example is mobile phones being adopted before conventional landlines: China now has more handsets than wired phones, - 340 million versus 317 million - a direct result of developing late.

China's rapid development has generated vast interest around the globe. Any developing nation that can consume 100 million hamburgers, sodas and chocolate bars a day is sure to attract interest from the McDonald's, Coke and Nestle men. As the Chinese saying goes, "It is easier to share good fortune than misery". Today, foreign investors are racing into China and benefiting hugely from the expanding pie. But they are contributing more than capital, products and services. These foreign "wolves" are making the domestic "sheep" run faster. Lenovo, the Chinese PC maker which recently acquired IBM's legendary PC unit, is only one of the new domestic competitors produced by the "wolves".

India provides more examples of this phenomenon. Indian railroads may be third-world quality, but its "IT army" is world-class and has become a powerful link between India and the global economy. And watch out for the Indian biotechnology industry, which is also on the move.

China and India are not the only late developers. Islamic states, Latin American countries, and the ex-Soviet states are other examples of countries facing a common situation - underdevelopment - but with plentiful natural resources. Rising commodity prices recently have been a boon for these nations. Resource revenues, particularly for oil, have boosted their economies more than any conceivable aid program ever could. The resource windfall has opened the door to sustainable development for them - if they are wise enough to enter it.

Today, the late developing states, especially China and India, have become new theatres for globalisation. By being open, they can better employ their best resources and energy for development. The vast entrepreneurial armies in the two Asian megastates are the best creations of the new openness, and have helped both nations to participate effectively in global development. These new entrepreneurs are vast in number, limitless in their capacity for hard work, and boundless in their aspirations. Indeed, it is not too strong to say that they represent the best hope for a better society.

The recent history of both countries shows convincingly that what most impoverished nations really need is more entrepreneurs and less bureaucratic meddling. If the number of government bureaucrats can be halved and the number of entrepreneurs doubled, the potential gains to humanity are staggering.

The flip side of the coin, of course, is a set of common problems faced by the late-developing economies. These formidable obstacles include:

• weak financial markets and regulatory structures;
• growing income inequality, which threatens social stability; and
• corruption.

Indeed, there is no shortcut as far as building modern institutional and legal systems is concerned. Otherwise, there is a massive price to pay.

The ups and downs of China's stock market are a good example. The Chinese market has only existed about 13 years, but it has already gained some 71 million investors. Foreign investors are interested, too, although they have only been allowed market access since spring, 2003.

Numerous overseas financial players - including HSBC, Citibank, UBS and Nomura - are now investing in Chinese stocks. Even Bill Gates's family trust fund has bought into China. Overall, nearly US$4 billion of foreign money has been injected into the Chinese equity market, which now has 1,400 listings with a market value of more than US$500 billion.

But the market has also shown frightening volatility, caused many naive investors to lose their shirts, and now stands at a six-year low, having deflated even more dramatically than the notoriously over-invested NASDAQ in the US. It is seriously affected by widespread abuses, built-in flaws, and populated by many Chinese Enrons and WorldComs. As a result, investor interest in the Chinese stock markets has cooled so much that reforming the stock market has become a major priority for the government.

Why did China fall into this trap? One would think that, being a late developer, China would have learned the hard lessons from older markets elsewhere. Every nation with financial markets has seen great crashes. But the Chinese, instead of learning from past mistakes, are reliving them. It seems that folly knows no nationality, and "the madness of crowds" is universal.

But the Chinese are not alone. In India, certain statements of the New Congress Government caused a panicky selloff, reducing the stock market's value by more than 20 per cent in just two days. Although dramatic new reform policies have now pushed the index to an all time high, what turmoil Indian politicians have created for investors! Russia and Latin America have faced similar problems - wild currency fluctuations have caused all sorts of damage.

The potential instability in the late developers casts new light on the current clamour to revalue the Chinese currency. Strengthening the yuan might provide temporary relief for developed countries facing a trade deficit with China, but China's trouble-prone legal and financial system, with its chronic corruption, means that a revaluation now might seriously destabilise the country. Eventually, there is no doubt that China must free its currency, and have a free flow of capital, but to take that step now without rooting out corruption first would create more problems than it would solve.

Although the late developers' recent progress has attracted a lot of attention from the outside world, in actuality they have made only a small step towards prosperity. China may have 16 million cars on the road, legions of millionaires, and even a few billionaires, but its GDP per person is still only around US$1,200 and the average manufacturing job pays only around US$115 per month. In fact, its economic development remains very much at the early stages. Lifting the standard of living for 1.3 billion people is no small task.

In particular, China is going through a painful transition from a state-run economy to a market-oriented one, and stands uncertainly between a failing old system and a new one which is very slowly being introduced. Moving to the next stage for a country like China is not straightforward: Rather, it is like an aquatic animal slowly evolving to live on land. It would not surprise the Chinese if it took a couple of generations, or even more, to build a functional market economy and legal framework - fair to all, and free from bureaucratic meddling.

So far, China has been undergoing a painful transitional experience, and many of the remaining problems cannot be resolved without fundamental reform. There are just too many barriers to overcome. At the same time, countless people depend on the old system; in 2004 alone, 43,757 government officials were found guilty of corruption. Knowing the depths of these problems is a necessity to understand the tremendous struggle China is going through. Although exaggerating the problems may be harmful, minimising them could be equally damaging.

The developed world, which is hardly problem-free itself, has a great influence on the prospects of the late developers. Indeed, increasingly, the developed world risks losing its historic role as the engine of global growth.

Now, the well-known problems with the anaemic Japanese economy pose a direct threat to global health. What are the possible root-causes of the Japanese mess? They stem directly from the tightly closed Japanese system. This closed system is most effective in fending off foreign interests. Your beef may be five times cheaper than Japanese beef, but the Japanese have invented numerous barriers against your entry. Yet, Japan is most vulnerable to the foes within. Protectionism is a very ancient practice based on a tribe mentality and is now backfiring. Backing out of this mess is easier said than done. So, more than likely, the Japanese economic problems will increase unless it can break the hold of protectionism to make Japan a truly open economy and society.

Furthermore, there is great uncertainty currently over the weakening dollar. What is really troublesome is not the dollar's declining value per se, but what lies behind it.

The United States has become the biggest debt-issuer ever. Spending beyond one's means would spell trouble for anyone, and the US will ultimately be no exception. There is a great need for the US to put its fiscal house in order. Failure to do so risks reduced long-term borrowing power, an economic downturn or both. To express these concerns is not scare-mongering. The US savings rate is flat, but spending keeps rising. At the same time, the US government keeps borrowing from the outside world, with total borrowing now exceeding US$1 trillion. Even some US writers forecast a potential economic doomsday if current trends continue too long.

One way out is for faster development in the emerging economies, which will give rise to more consumption there. In this regard, the high-speed growth in India and China is very positive. China imported US$560 billion worth of goods in 2004, and this statistic could reach US$1 trillion by 2009. India, Russia, Brazil and many other emerging nations have been sharply increasing their consumption of late. One thing is clear, developed nations and the late developers are more than ever in the same boat.