The Three Contradictions of China's Miracle

JUNE 15, 2011, 3:50 P.M. ET


China is undeniably an economic miracle. It has been doubling living standards every decade since it started opening up, a feat that took the U.S. about 30 years even in times of its fastest growth. But fissures are showing in China's economic foundations.

Call them the three contradictions.

First, China's leadership is determined to slow the pace of growth and thwart inflation while continuing to raise wages and deliver the goods to the masses. That would be a challenge for any government, and particularly for one so afraid of losing control that it's reluctant to let market forces do much of the work.

Associated Press

A Chinese woman waves a national flag while singing patriotic songs to celebrate the up-coming 90th anniversary of the founding of the Communist Party of China in Beijing, China, Tuesday.

In a country that still has statues of Marx and Engels, wages have been a shrinking share of overall income and the gap between rich and poor is widening, hardly a recipe for more consumer spending. China has plenty of retail stores, but many look like museums. People look, but don't buy.

With demand for labor strong, wages are increasing faster, a key to maintaining social stability Chinese leaders prize and fueling consumer spending needed for China to wean itself off exports.

So far, so good. But rising wages appear to be diluting the competitiveness of Chinese factories. A tell-tale sign: T-shirts in The Gap stores in China say: "Made in Malaysia," and the cheapest toothbrushes are made in Vietnam. The solution is to migrate to more sophisticated manufactures and services. That requires a bigger, better, freer education system than the existing one, which is, as one official says, handicapped by a Soviet-style management model for scientific research and shunned by Chinese elites who send their offspring abroad.

Second, the latest fad in Beijing government circles is "internationalization of the yuan," a currency whose use is nearly entirely domestic now. This is one part national pride, one part a trading power's desire to buy and sell in its own currency, and one part Chinese determination, if there's ever another financial crisis, to be able to borrow as freely and cheaply from abroad as the U.S. did.

So far, so good. But China can't get there from here unless it stops holding interest rates so low that savers aren't even keeping up with inflation. Playing the global game means subjecting an economy to global markets.

Some officials see danger in too-low rates. "You need to do something about negative interest rates in real terms before you lose control," says Guo Shuqing, head of China Construction Bank and possibly China's next central banker, in an interview. "Lots of people feel that putting their money into deposits is no good, so they rush to buy things like gold and silver. A lot of people buy property not because they need a home but for an investment."

Indeed, the rich are speculating by buying third and fourth apartments, while others can't afford one home with prices too high. Asset bubbles in China are driven by Chinese monetary policy, not the U.S. Federal Reserve's.

U.S. interest rates are low because the Fed is trying to spur borrowing. China's central bank wants less borrowing, but politically powerful corporate and government borrowers block higher rates. Global economic analyst Nouriel Roubini describes Chinese policy as "a massive transfer of income from politically weak households to politically powerful corporates: a weak currency makes imports expensive, low interest rates on deposits and low lending rates for corporates and developers amount to a tax on savings."

Making the yuan an international currency means ending the practice of keeping rates below economically optimal levels for political reasons. It means making economic policy transparent. Chinese leaders say they want the first, but aren't so sure about the second and third.

Third, a repressive government has an easier time keeping its people happy when the economy grows 10% a year. So far so good.

But applying the economic brakes, never popular, threatens a government that doesn't trust its people. Twitter is blocked in China. Students complain about being restricted to "the Chinese Internet." And government filters appear to retard Internet speeds.

The people return the favor. Even a foreign visitor senses many people don't trust the government. Over sandwiches at Beijing's Tsinghua University, one graduate student erupts in anger: "What does it say about a country when its leader sends his daughter abroad to be educated?" a reference to China's next president, Xi Jingping, whose daughter has finished her first year at Harvard.

And in a village about 60 miles north of Beijing where the Great Wall winds largely ignored by tourists, one can see a few dozen simple farmers' homes and one new, wider and taller three-story brick house that looks like it came from elsewhere. Everyone knows who built it: the local Communist Party secretary. And not with his paychecks.

Fissures in the foundation do not necessarily presage collapse. But they are signs of tensions that, if unaddressed, can weaken an economic edifice, even one as impressive as China's