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Economic Report

Economic reports, briefs issued by Samsung Economic Research Institute

"Likonomics": New Paradigm for Chinese Economy

"Likonomics": New Paradigm for Chinese Economy

OM Jung-Myung

Sept. 9, 2013

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Anxiety is rising in China about its economic prospects. Growth has slowed to the 7% range; investment efficiency has declined, challenging the nation's economic model led by investment and exports; and some economists are warning about implosions of asset bubbles and economic hard landing.

After the global financial crisis erupted in 2008, the Chinese government unleashed massive stimulus to blunt the economic fallout. The economy maintained its fast pace growth, but the government spending along with a flood of state bank lending has resulted in a glut of public infrastructure, housing and factories. Therefore, efficiency on capital investment has declined since 2010; about 10% of its GDP is traced to over investing. The marginal efficiency of capital, a measure of investment efficiency, also has seen a sharp drop, to hit 0.17 in 2012.

Robust wage increases and appreciation of the yuan also has weakened export competitiveness. The goal of the current five-year economic plan is to double average wages by the end of 2015 to encourage domestic consumption and more fairly distribute wealth. Indeed, nominal annual wage growth across China has been 14.9% since 2007. This has led to an increase in manufacturing costs. As for the yuan, it has steadily appreciated due to pressure from advanced countries. In July this year, the yuan/US dollar exchange rate reached 6.18, a 25% rise in value from 8.27 in 2005.

Consequently, export growth, after peaking at 31% in 2010, slowed to 20% in 2011 and 8% in 2012. In the first half of 2013, growth was 10%. As advanced economies continue to limp, China will continue to be compelled to allow the yuan to appreciate further.

Another concern is mounting corporate debt. The lending by state-owned banks to the corporate sector to stimulate investments has lubricated construction of housing and related infrastructure to urbanize most of China's 1.4 billion residents. But it also has produced a long list of state enterprises who over borrowed. As a result, their debt-to-GDP ratio rose to 120% in 2012 from 93% in 2008.

Adding to worries about the health of the financial system is "shadow financing." When the government reined in excess lending by state banks, private companies in particular turned to non-conventional lenders. Shadow financing has significantly higher chance of turning sour compared to bank loans due to its high- risk, high-return characteristics. Shadow financing in China refers to loans from non-bank sector, trust loans, bank-guaranteed commercial papers and private financing. It reached 36 trillion yuan, or 70% of GDP, in 2012, up from 8.4 trillion yuan, or 27% of GDP, in 2008.

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