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China powers regional prosperity
[April 03, 2007]

China powers regional prosperity


(The Jakarta Post Via Thomson Dialog NewsEdge) from THE JAKARTA POST -- TUESDAY, APRIL 3, 2007 -- PAGE 7 The East Asian financial crisis in 1997 did something which turned out to be quite profound

In a stroke, it directed the great flows of foreign direct investment away from South East Asia to North Asia; to China in particular

In many respects, China became the principal beneficiary of the crisis. Not that China did anything to promote the crisis, nor did it seek to be the principal beneficiary, but that is how it turned out

When China, showing judgment and concern, maintained the exchange of the RMB while the currencies of all the countries around it were depreciating markedly, it won grand plaudits from the United States and the international trading community generally. This was one of the actions by China which practically promoted its membership of the World Trade Organization



Also, in responding to the crisis, the government of China embarked upon a massive government sponsored infrastructure program to lift domestic demand to compensate for the negative employment effects on its export markets

This combination of factors, the enhanced flow of FDI into China, the infrastructure program and China's own acceleration in the dismantling of its state-owned enterprise structure gave China a momentum which has propelled it, in a decade, to be the state we know today


And China, by adding so much to world GDP, has also had the effect of helping to pull Japan from its structural recession. Now we have the second and the third largest economies in the world, both in Asia, growing significantly

China's GDP, which, by all reasonable measure, must stand at around US$4-5 trillion, will this year grow by 10.4 percent, contributing $400- 500 billion of new wealth. By contrast, the U.S. itself, off a base of $12 trillion and growing at 3.2 percent GDP growth, will be adding around $384 billion. Let's call it $400 billion. In other words, China is adding to the world economy, wealth comparable to the increment flowing from the U.S

This is a profound development. Indeed, never before in world economic history have we seen anything like it

China is already a motor of the world economy and it is a motor which spins in our backyard

Already, we are witnessing China's quest for resources and semi- finished products. Australia, for instance, is a major supplier of iron ore and other non-ferrous metals. Countries like Indonesia, Malaysia and Vietnam will become caught up in China's supply chain. We are already seeing the signs of Chinese direct investment in the supplying countries to its south. These investments will begin to add to national product in the ASEAN group of countries, as it will do in Australia

China is also attending to the foreign policy structures which best suit its position as the motor economy of East Asia. It is principally responsible for establishing ASEAN plus 3, which in reality is, China, Japan and Korea plus ASEAN

It will deal through these structures with, I believe, a great degree of maturity and regard for the nations which are party to its growth and development and central to the peace and order of the region

Yet behind these approaches lies one of the most active transformations in economic experience. With urbanization as the principal driver of change in China, China has to switch the growth in its economy from net exports to domestic demand. At the moment, investment as a proportion of GDP is a multiple of that experienced in any OECD country. The fact is, the availability of liquidity has caused China to be over-invested. We are now seeing myriad sub-optimal investments across China, when those resources would be far better employed in housing and consumption

A long term, balanced economy must find equilibrium between housing and consumption and export led development

China has to secure that balance and in my opinion, it will. But before it can, its weak financial services industry and capital markets will have to strengthened and brought up to speed. There are a lot of structural issues in this. In effect, what foreign direct investment has done is to have brought innovation and capital to China, by-passing China's immature financial system. In effect, sidelining it. This kind of foreign investment may work for exports and import replacement, but it will not work for consumption

Perhaps the first of the first order structural issues needing to be dealt with is the exchange rate mechanism itself

The managed exchanged rate system of the renminbi obliges the Central Bank of China to buy all foreign exchange. This is then added to the domestic money supply in local currency. The consequent growth in the monetary aggregates then floods liquidity into the banking system which it, in turn, funnels into investment. This system also places an enormous strain on the national budget in mopping up the excess liquidity with a vast Bond program

More than that, managed systems never get the exchange rate right. China's exchange rate encourages exports to the cost of domestic consumption and domestic demand. The exchange rate, the most important price in the economy, ends up sending the wrong price signals through the economy. The Chinese government and its central bank governor understand this well

We should remember that the Chinese economy has gone from being an agrarian economy 25 years ago, to a rapidly developing economy today. The country has, as a result, become very much wealthier. Therefore, the real exchange rate of the renminbi has to rise. And attempts to hold down the nominal exchange rate will only end in tears as such action fuels domestic inflation

The government of China will have to let the exchange rate go. And I believe it will go much earlier than most people think. Indeed, the quicker it goes, the earlier China will move to a more sustainable basis of economic growth

The United States dollar also needs an effective real depreciation against the rest of the world. With the renminbi and the yen effectively shadowing the dollar down, the dollar gets no clear room to turn around the U.S. trade account

When China lets its exchange rate go, it will take an even larger seat in that small community of top performing economies. Such a development will help it better foster its urbanization and with that, a plethora of opportunities will open up for the countries around it, especially South East Asia and Australia

Such things as the removal of exchange controls and Chinese personal investments in this part of the world will make a great difference to regional prosperity. Outbound Chinese tourism is only just beginning to grow, but when their currency can buy more, it will grow a treat. Countries like the Philippines, Indonesia and Vietnam will be the first beneficiaries of this development

Indonesia has always had an active Chinese community. A large part of its business community has been ethnically Chinese. This will be a real strength in the coming years. As the Chinese diaspora move in and out of China and are joined by Chinese nationals all around the region, we will witness the kind of cooperative prosperity this region has never before seen. This article is abridged from a key note address by former Australian Prime Minister and Treasurer Paul Keating delivered before the Asian Banker Summit in Jakarta on March 26. He periodically visits China as an international consultant. Paul Keating, Jakarta Copyright 2007 The Jakarta Post

Copyright 2007 The Jakarta Post. Source: Financial Times Information Limited - Asia Intelligence Wire.

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