China Says This Year 'Most Difficult' Of Century

The Chinese have a saying: "When you go up the mountain too often, you will eventually encounter the tiger."

Usually, that bit of folk wisdom refers to social life. It is a way of warning that immoderate behavior brings risks. But these days, the adage seems to perfectly describe what has happened to the Chinese economy.

Ever since Communist China opened to the West, it has enjoyed spectacular economic growth rates of up to 10 percent a year by investing in its export sector.

China's workers -- making an average of $0.60 an hour in heavily polluted factory towns -- have manufactured so many low-cost export products that today the country holds one of the largest foreign-currency reserves in the world.

By many estimates, the reserve totals some $2 trillion, mostly in U.S. dollars.

But now, the United States is in recession and so are China's other export markets. Chinese global exports fell 17.5 percent in January compared to the same month last year, the sharpest drop in a decade.

End Of The Export Model

And as the export market collapses, China is suddenly face-to-face with its "tiger." It has relied too much on a single strategy and it has no ready alternatives.

Michael Pettis, a professor of finance at Peking University's Guanghua School of Management in Beijing says China is now in the middle of a great debate over what to do next. He says one group in the government supports maintaining the status quo.

"The argument there is let's continue investing [in the export sector], let's prevent bankrupt factories from closing, let's give them the funding to continue staying open so that they keep employing workers, so that unemployment, which is rising, rises more slowly," Pettis says.

The opposing group says that China has been export-driven for too long. They say now is the time to begin putting the Chinese economy on a more normal basis where growth comes from domestic demand for goods.

"They argue that since reforms in China only seem to take place during or following crises, they argue that this crisis is a very important tool to force through a number of important reforms that will shift the model, that will bring the transition to more of a domestic economy," Pettis says.

Pushing Domestic Demand

So far, neither camp is clearly dominant. As a result, Beijing is forging a new strategy that tries to satisfy both at once.

Prime Minister Wen Jiabao signaled as much as he told parliament on March 5 that the government will have a record annual budget deficit of $140 billion. The deficit will result from the government plans to both cut business taxes to help the export sector and increase spending to put more money into the domestic economy.

In recent months, the government has tried to preserve the status quo by ordering state-owned companies not to fire workers without consulting unions. It also appears to have put discussions of increasing the minimum wage on hold.

Despite this, 15 million Chinese workers are reported to have lost their jobs due to the shrinking market for exports.

At the same time, Wen said he is going ahead with the promised $585 billion stimulus package announced in November. The money will be spent infrastructure projects to create new jobs and -- with the new wages -- stimulate consumer demand.

Gareth Leather, a China expert at the London-based Economist Intelligence Unit, says Beijing also is trying to spur domestic consumption by making mortgage loans and household products more affordable.

"If they can get people to start buying more property again [that is what they will do, because] when that happens, people typically go and refurbish the homes and that supports furnishing shops," Leather says.

"In addition to that, they have given out vouchers in some provinces to consumers to go out and buy and, certainly, this subsidizes their private consumption habits and finally, in the countryside, rural dwellers have been given incentives to buy things like televisions and washing machines and stuff by being given big discounts by the government."

Basic Changes Needed

But there is one major obstacle to plans to grow the domestic market. And that is Chinese consumers' desire to save, rather than spend, their money.

China, despite being officially a communist people's republic, does not provide state pension plans, state health care, or social security. Families have to save enough money to provide for those needs themselves.

So, it is an open question how much and how fast China's domestic consumers will be able to support the country's supersized consumer-goods sector.

Still, many economists believe that China ultimately has no choice but to develop its domestic market if it wants to have a stable and sustainable economic future.

Pettis says that is quite independent of whether the current global crisis spurs it to do so now, or not. He says that China "will adjust, there is no question. And the hopes are that the adjustment, although it will be very difficult, will eventually bring us to a point in 10 or 15 years where China depends primarily upon its domestic market for growth."

But it will be a wrenching process.

Among the toughest parts include more people losing jobs as some surplus factory capacity is shed. That is scary for China's leaders, who fear unleashing any social unrest that could weaken their hold on power.

Other tough steps include taking money that once subsidized high-employment state factories and investing it instead in slower-growing service sectors, or improving health and social services.

Still, China is fortunate in many ways. Its years of export-led development have left the government with a full treasury despite this year's record deficit. Now the question is whether it can find the political will to use that money to build for the future rather than try to rescue the past.