Hugo Dixon

By Hugo Dixon
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

LONDON — Moral hazard is the clue to solving the euro crisis. The idea that entities don’t learn lessons unless they feel pain is valid in the euro zone — but only if the blame is shared properly. The mess isn’t just the responsibility of profligate Greeks, but also of foolish banks and hypocritical Germans and French. Each needs to suffer.

One of the main reasons the region’s financial crisis is so intractable — with endless wrangling over what is the best way forward — is because the different players haven’t fessed up to their own sins. There is therefore a tendency to proclaim their own virtue and pin the blame on others. This makes it hard to come up with a fair settlement.

The main fault line is over whether it is the borrowers (Portugal and Ireland, as well as Greece) who were to blame or the lenders. If, like the German tabloid press, one thinks that it is just the borrowers’ fault, the natural remedy is to crack down on them by imposing stringent austerity programmes in return for bailouts. If one is too lax, they will sin again.

But the lenders were also foolish. That’s something the population in peripheral countries, especially Ireland, increasingly appreciates. Germany and France, though, whose banks are exposed to the euro zone periphery, haven’t faced up to this truth. This causes its own moral hazard: unless banks suffer write-downs as a result of debt restructuring, how can they be expected to learn the appropriate lessons?

Moral hazard also has a third dimension: the hypocrisy of the big, rich countries. Germany and France were responsible for undermining fiscal discipline early in the millennium by breaking the Maastricht Treaty’s rules on borrowing. It is therefore appropriate that they should suffer too, largely through making more cheap loans to Greece and other struggling countries.

A combination of more austerity, haircuts for creditors and further soft loans from rich countries will probably be what eventually solves the euro zone crisis. But the region would get there faster if everybody admitted their own guilt.

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Hugo Dixon

My first visit to China was in 1979. I was a schoolboy. It must have been one of the earliest Western school trips to the mainland. Mao Zedong had died three years before, Deng Xiaoping had launched the country on three decades of supercharged growth and the one-child policy had just been initiated. I hadn’t been back until this March.

Back then, Mao’s image was plastered everywhere and almost everybody wore Mao suits. I even bought one for myself. I also bought a Mao poster and stuck it in my bedroom at school. Nowadays, the posters have virtually vanished, along with the suits.

But that wasn’t the only thing that was different in my recent visit. The main thing that struck me were China’s feisty females. Could this be a by-product of the one-child policy that led to selective abortion, female infanticide and an excess of boys?

Two young women picked me up inside Beijing’s Forbidden City, home of the pre-revolutionary imperial family. Both had steady boyfriends. One actually felt her bargaining position was so strong that she should upgrade her man because he wasn’t rich enough to buy a home. In China, grooms are expected to provide the home, which is quite a burden in the property-bubble infected cities.

I accepted an invitation to tea, even though I don’t like the drink. And when we arrived at the tea house, I went along with the suggestion that we try a little bit of every type. The bill came to a staggering 2,160 yuan ($333). That was eight cups of tea each for three people at a cost per cup of 49 yuan — plus an elaborate assortment of extras. I had been scammed. I negotiated the price down to 400 yuan, still way over the top for the tea but perhaps a reasonable price for the field research.

Zhang Xin

My next encounter was with Zhang Xin, the billionaire chief executive of Soho China, a cutting edge property group. Suave, attractive, sophisticated, she’s not just a member of the Beijing elite; she’s part of the global elite. Zhang had a cameo appearance in the film “Wall Street: Money Never Sleeps.” Oliver Stone, the film’s director, is a friend. Zhang also doesn’t slap up non-descript office buildings. She has commissioned no fewer than three separate complexes by Zaha Hadid, the Iraqi-British superstar architect.

Back in 1979, I doubt there was anybody who straddled these worlds as smoothly as Zhang. But go back another three or four decades and you had Soong Meiling, wife of Chiang Kai-shek, China’s leader before Mao. She didn’t just hold sway in China; she wowed the Americans too. She stayed in the White House with Franklin Roosevelt, was the first woman to address a joint session of Congress and had a close relationship with Wendell Willkie, the Republican whom Roosevelt defeated in 1940.

Karen Chen

SLAUGHTERING THE DUMPLING
A few days later, I sat next to Karen Chen, another fascinating woman, at a dinner in Shanghai. When I travel, I often have round-table dinner parties. In some countries, it’s hard to find a round table. But this isn’t a problem in China. At this particular dinner, in an exquisite boutique hotel, the guests were young millionaires with a conscience. Most had charities they had established, many concerned with the environment.

We were having a lively conversation about culture, politics and economics — or, at least, that’s what I thought — until my neighbor erupted.

“You think you are a hot-shot journalist,” Chen said — or something like that, because this isn’t a verbatim quote. “But you can’t just come here on a Friday night and organize a debate in the way that you want. We want to have fun. We want to relax. You don’t understand China. If you want to understand, you should listen. You shouldn’t try to impose your ways on us.”

My neighbor was “old money” — which, in China, means roughly two decades old, given that it has only been possible to accumulate wealth since Mao’s death. She’d been educated abroad and worked in investment banking before returning to Shanghai to start taking over her parents’ real-estate business. Her big idea was xiao — a word which roughly means respect for one’s elders.

I was reeling. Was I a neo-imperialist, despite my best intentions? All I felt I could do was roll with the punches.

“What’s more, you slaughtered the dumpling.” Chen pressed her advantage. “We were laughing at you. You didn’t notice it. This was a delicious, elegant dumpling. But you don’t know how to eat it. You didn’t ask us. You just poked it with your chopstick and all the juices spurted out.”

It was true. I didn’t know how to eat the dumpling. It was just too vast to pop in my mouth. The correct procedure is to pick it up with your chopsticks, bite the head off, suck out the juice and then gobble up the shrunken mass. But I also reflected that I was nearly twice Chen’s age. I was delighted that, in giving me a dressing down, she had not shown me too much xiao.

My dumpling assailant isn’t the only one demolishing the stereotypical image of the demure Chinese woman. Some 69 percent of China’s women aged 15-64 work, compared with an OECD average of 60 percent and only 34 percent in India. That’s a huge asset, although, of course, it means Beijing has one fewer lever to pull as it looks for new sources of growth. Countries like India can, if they choose, turn to a huge source of untapped labor.

But an army of educated, opinionated women could be a powerful engine of change. If the rest are anywhere near as dynamic as my three experiences suggested, China’s feisty females may be one of the country’s best chances of taking on its considerable vested interests.

This is the final installment of a series. Earlier installments discussed China’s crony capitalism, its brave new economic model, and just how much China can continue to grow.

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Hugo Dixon

China’s economy is riddled with vested interests, while free speech is suppressed. This potentially explosive mixture sounds similar to Hosni Mubarak’s Egypt, though Beijing has been much more successful at promoting economic growth than Cairo in recent decades. No wonder the regime is cracking down on dissent — including arresting Ai Weiwei, the internationally renowned artist. But it won’t be easy to maintain the current political model — or to reform it. And failure to do either could knock the economy off its extraordinary trajectory.

The country is officially run by the Chinese Communist Party. But, apart from the suppression of individual rights, it is hard to see much about it that is communist. Inequality is high and rising. The Gini Coefficient, a standard measure of income inequality in a society, is over 0.4 and, by some measures, is close to 0.5 — high figures normally associated with sub-Saharan African countries.

If this inequality were merely a reflection of the market — the fact that some Chinese are more talented and hard-working than others — it could be motivational. But a lot is also a result of economic goodies being grabbed by insiders, sometimes via corruption and in other cases by excluding outsiders from opportunities. One lesson from the Arab Spring is that populations can grow restless when they think rulers and their cronies are enriching themselves unfairly.

In China, the “class” system operates on several levels. At the top of the socio-economic scale are the “princelings,” children of important party officials, who have become multimillionaires by trading on their contacts. Then there are bureaucrats, who enjoy attractive lifestyles funded by the people’s taxes and sometimes bribes. Transparency International puts China joint 78th out of 178 countries in its 2010 ranking of perceived corruption. State-owned enterprises, meanwhile, benefit from monopolies or oligopolies and pay minimal dividends. The fruits of their economic activity are therefore largely enjoyed by those who run them.

There is also the “hukou” system which prevents rural migrants from participating fully in China’s economic miracle. The country has at least 150 million people who come from the villages but work in the cities. The snag is that they don’t have the right to be resident, so often live in dormitories, and their children don’t get the same access to schooling as local residents, so usually stay in the villages with their grandparents. The cities want these workers but don’t want to be swamped by the need to house them and pay for the education and health care of their families. The result is a potentially unstable two-class society.

Finally, even among the urban population, soaring house prices cause a chasm. The bubble is great for the rich who have bought multiple houses — so long as it doesn’t pop. But it’s tough on those who can’t afford to get onto the property ladder.

CARROTS AND STICKS
The regime is alive to the problem. Up to now, its approach has been a classic mixture of carrot and stick. The carrot has been growth. Even if the benefits of growth haven’t been equally distributed, hundreds of millions of people have still been taken out of poverty. Meanwhile, the stick has been to crack down on anybody who is perceived to be stepping out of line — whether the series of arrests in the past two months or employing an army of censors to police the internet or the killing of protesters in Beijing’s Tiananmen Square in 1989.

The problem is that both the carrot and the stick are becoming harder to wield. Economic growth is going to slow down in the coming decade. It then won’t be as easy to buy off potential dissent. Meanwhile, mobile communications and the Internet are mutating in ways that Beijing will find increasingly difficult to control. True, the authorities have banned Facebook and Twitter, while Google decamped to Hong Kong when it finally had enough of the censorship. But the Chinese people are still finding ways round what has been dubbed the Great Firewall.

What’s more, there’s a connection between political rights and economic advancement. This was not apparent in the past three decades, when the Chinese model was based on low-value manufacturing. Millions of people could be stuck in factories and told to get on with the job. But it will become apparent as Beijing tries to switch to a new model based on services and high-value manufacturing. If this transition is to be successful, people will have to think for themselves more. They will also have to harness the full power of modern communications. It will then be virtually impossible to keep a lid on free speech. On the other hand, if Beijing decides to batten down the hatches, there will be fewer economic goodies to share out — and protests could bubble up in other ways.

There is an alternative: dismantle both the crony capitalism and the Communist Party’s monopoly on power. If this could be accomplished in an evolutionary way — admittedly, a big “if” — China could make a peaceful transition to something more like a Western democracy.

The country has seen big shifts of direction in the past — the Maoist takeover in 1949, the disastrous famine-inducing Great Leap Forward in the late 1950s, the equally crippling Cultural Revolution from 1966 until Mao Zedong’s death in 1976, and the extraordinary successful capitalist revolution initiated by Deng Xiaoping after that.

But, as the economic boom has gathered pace, insiders have an increasingly strong interest in maintaining the status quo. It is doubtful that China’s current generation of leaders has the power to take on vested interests. The present duo — Hu Jintao, the president, and Wen Jiabao, the prime minister — are seen as consensus politicians. The front-runners to succeed them next year — Xi Jinping and Li Keqiang respectively — haven’t shown their hands, but as existing members of the political elite, are likely to be consensus politicians too.

This may have been suitable when the task was to keep the old export and investment model on the road. But it doesn’t look so appropriate given the need to yank the economy in a different direction, while also addressing mounting socio-political problems.

The final part of this series will focus on the role of China’s feisty females. The previous parts looked at how fast China can grow, and its brave new economic model.

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Hugo Dixon

The Chinese government knows it’s time for a change. The old economic model based on cheap exports and eye-popping investment can’t be sustained.

Fortunately, politicians aren’t sitting on their hands. The latest five-year plan, covering 2011-2015, aims to boost internal consumer demand as the main engine of growth. It envisages a bigger share in the economy for services, which are currently only 43 percent of GDP — barely half America’s level. The plan calls for more high-tech industry and for greener, less carbon-intensive growth. There’s also to be a big push into social housing, so the poor can afford somewhere to live.

All this is good on paper — and all these things are already happening to some extent. But to achieve this fully, Beijing is going to have ride roughshod over vested interests and loosen its grip on the economy, society and politics. That’s not going to be easy.

Take the drive into high-technology. Beijing’s approach to date has been to make it hard for foreign companies to sell products such as cars into China unless they set up joint ventures with local partners. The idea is that this helps technology transfer. Until now, foreign companies have been so intoxicated by the opportunity to sell to a market of 1.3 billion people that they have largely gone along with the Faustian pact. But they are becoming more wary: witness this year’s American Chamber of Commerce survey on the business climate in China.

It is, of course, open to China to invent its own technology and certainly large sums are being earmarked for research and development, which is to rise from 1.8 percent of GDP to 2.2 percent of GDP over the course of the five-year plan. But it’s unclear whether the socio-economic system is well structured to encourage invention.

Schools, for example, are often criticized for getting children to mug up facts rather than think for themselves. And even if Chinese companies have technology, they may themselves face barriers to exporting their products. For example, Huawei, the networking giant, has been singly unsuccessful in signing up a big U.S. telecoms operator as a client because of concerns in America that having a Chinese supplier could somehow compromise the security of a vital piece of infrastructure.

Meanwhile, intellectual property rights are poorly protected. That makes it logical for a budding entrepreneur to copy somebody else’s invention rather than invest in research himself — and find that somebody else copies him. This applies not just to manufacturing but to a whole range of services industries especially media and software. Jokers say the acronym “C2C” means “copy to China.”

Equally, further deregulation will be required if the push into services is really going to gather pace. That will mean liberalizing areas dominated by state-owned enterprises, notably media and financial services areas. That could make the authoritarian government feel uncomfortable.

Beijing’s ambition to turn Shanghai into an international financial center is a case in point. This looks an impossible dream unless foreign banks are permitted to have a bigger slice of the market (they currently only have 1.8 percent of total assets), capital controls are removed, the exchange rate is freed up and a proper rule of law instituted (the judges are now subservient to the ruling Communist Party rather than independent). Each of these measures will be hard to push through.

CONSUMPTION CONUNDRUM
China has an abnormally high savings rate — 54 percent of GDP in 2009 compared with 10 percent for the United States. This is partly the result of the carnage in World War Two at the hands of Japan, the long civil war between the Communists and the Nationalists, the horrific famine in the late 1950s and the Cultural Revolution in 1966-1976.

These memories are fading. But the aging population has new concerns about how to pay for its health care and pensions — especially as the state does very little on this front. The one-child policy exacerbates this because the Chinese people cannot look forward to a large brood of kids taking care of them in their old age. With all their eggs in one basket, it makes sense to save a lot.

To get its new economic model working, Beijing will have to cut saving and boost consumption. That, in turn, means increasing the amount of money in people’s pockets and encouraging them to part with it. There are four main ways to do this — but each is problematic.

First, push up wages. This would give people more money to spend. The snag is that wage inflation is already chipping away at China’s competitiveness — and Beijing is scared about what will happen if the economy can’t create the millions of jobs that are needed each year to absorb new migrants from the villages to the cities.

Second, allow the exchange rate to appreciate. That would keep down inflation, likely to be above 5 percent when official figures are released on May 11, and boost consumers’ purchasing power. But again, it would undermine competitiveness.

Third, give the people a better deal on tax and social security, so that they wouldn’t need to save so much themselves. As part of the latest five-year plan, the government does intend to improve pensions and health care. And, in the short run, it is rich enough to afford to. The country has foreign reserves equivalent to 50 percent of GDP, more than offsetting public sector debt which is 17 percent of GDP. But the fiscal position is not as strong as it looks. Local governments have incurred huge off-balance sheet liabilities to finance their investment splurge. And the problem with making generous promises to an ageing population is that the cost mounts year by year.

Finally, give the people a better deal on their savings. At present, deposit rates are set artificially low so that cheap funds can be funneled via state-owned banks to state-owned enterprises. Banks, meanwhile, are guaranteed a fat fixed margin on lending. Even after the latest hike, the maximum banks are allowed to pay is 3.25 percent for one-year deposits — meaning savers get a negative inflation-adjusted interest rate of around 2 percent.

Effectively, this system acts as another tax on the people. Freeing up interest rates would be good for the masses and encourage consumption, but it would hit two powerful vested interests: the state-owned enterprises which would have to pay more for their capital; and the banks which would see their margins squeezed.

It’s doubtful the leadership has the stomach to do all of this wholeheartedly. As a result, consumption and services won’t grow fast enough to take up the running from exports and investment. That leads to an even trickier question for China’s policymakers: how to keep stability in a political system where insiders gobble up economic goodies and free speech is suppressed?

This is part two of a multi-part series. Part one looks at how fast China can grow. Part three looks at China’s crony capitalism.

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Hugo Dixon

How fast can China grow over the next decade? Nowhere near the breakneck speed it has enjoyed over the past three decades. Multiple economic, environmental and political challenges will slow it down.

The capitalist revolution launched by Deng Xiaoping after Mao Zedong’s death still has a long way to go. But it is now in its early middle ages rather than its infancy. The government recognizes that the old model driven by exports and investment is running out of steam; indeed, its recently unveiled 12th five-year plan tries to grapple with that challenge.

But it won’t be easy for the next generation of leaders, who are due to take over next year, to devise a new model that can move nearly as fast as the old one. Growth since 1980 has averaged 10 percent a year, according to official statistics. Such rapid growth over such a long period is virtually unique.

In the early stages of economic development, a country can grow very fast with the right policies. It is in catch-up mode. The quality and quantity of labor expand rapidly as the benefits of education kick in and the labor force grows. The quality and quantity of capital also take off if cutting edge technologies from abroad are adopted and money is poured into equipment, factories and infrastructure. And efficiency improves, especially if markets are freed up to competition.

This is basically what has happened in China since Deng launched his revolution. The country has witnessed a rapid urbanization which flooded factories with cheap labor: the urban share of the total population has grown from 20 percent to 50 percent between 1980 and 2010. People have worked incredibly hard to escape the poverty of their forebears.

Investment has been especially high: reaching a mind-boggling 48 percent of GDP in 2009. And exports have been driven ever upwards by an artificially low exchange rate, combined with closer integration in the world economy since China joined the World Trade Organization in 2001.

ECONOMIC HEADWINDS
These trends can’t continue at the same pace. The country’s exports are now so big that it can’t keep expanding its share of world trade so fast. What’s more, its indebted customers in the West have a limited ability to keep buying.

The West is also turning up the pressure on Beijing to allow the yuan to appreciate, as politicians worry that an undervalued exchange rate is putting their own workers out of jobs. The topic will be on the agenda again when senior Chinese and American officials meet for the latest in their series of strategic and economic dialogues in Washington on May 9-10.

Exports peaked at 35 percent of GDP in 2007, just before the global financial crisis. After that, China’s rapid growth was fueled instead by a stimulus program of heavy infrastructure spending and massive expansion of credit. But, as more and more roads, high-speed railways, factories, office blocks and homes are built, the returns on investment are falling. The net return on total assets in the entire economy is estimated at only 1.2 percent in 2009, according to Lombard Street Research.

The financial consequences of this investment splurge haven’t become fully apparent. The over-investment in property has been disguised by the credit expansion, which fueled what looks like a speculative bubble. Meanwhile, the low returns in infrastructure are often hidden in the off-balance sheet vehicles of China’s local governments.

A burst property and infrastructure bubble would rock the economy, not least because construction has been such an important engine for growth. True, it’s unlikely to lead to a financial crisis because bad debts can be dealt with by the central government bailing out either the local governments or the banks. But Beijing won’t be able to keep repeating the same trick; otherwise its own currently strong fiscal position will be under threat.

MALTHUS WITH A TWIST
If China only had to contend with slowing export and investment growth, it might be able to engineer a gradual slowdown in its economy — averaging perhaps 7 percent over the next decade. That’s actually the government’s new target, although it consistently sets hurdles it expects to be able to jump easily. But demographic and environmental challenges mean that even hitting 7 percent could be tough.

A rapidly aging population is one — the result of rising life expectancy and the country’s one-child policy, launched to prevent overpopulation in 1978. The proportion of people aged 14 or younger was 16.6 percent in 2010, down 6.3 percentage points since 2000, according to the latest census. The number aged 60 or older, meanwhile, rose 2.9 points to 13.3 percent. As a result, the labor force has basically stopped growing. That will slow down growth not just because human capital isn’t expanding but because upward pressure on wages is eating away at competitiveness.

Another constraint is the environment. China is so big that its economic success is applying a brake to further progress. Not only has this helped push up the price of commodities, which are hugely important for China’s manufacturing-orientated economic model; the country will have to reduce the carbon-intensity of its GDP to help stop the planet overheating. As Chinese consumers become more concerned about being healthy as well as wealthy, action will also have to be taken to tackle water shortages, air pollution, traffic congestion and other effects of uncontrolled industrialization and urbanization.

All this is bound to slow China down. And that’s even before taking into account two big challenges China can no longer ignore: the need to switch gears to a new, consumption-led economic model, and the quest for social stability in a country with high inequality and few political rights.

This is part one of a multi-part series. Part two looks at China’s brave new economic model. Part three looks at China’s crony capitalism.

By Hugo Dixon and Neil Unmack
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

LONDON — Portugal’s bank rescue scheme has one big hole. The European Union and International Monetary Fund have come up with a punchy blueprint to restore confidence in the financial system, as part of the country’s 78 billion euro bailout. The plan includes recapitalisations, stress tests and privatisations. But there’s one weakness: funding. Allowing banks to issue state-guaranteed bonds, as envisaged by the plan, is only a partial solution so long as the government’s credit is still weak.

First, look at the good part of the blueprint. Banks will have to boost their core Tier 1 capital ratio to 9 percent by the end of 2011 and 10 percent by end-2012. That’s above the 7 percent agreed under the new global banking rules. If the banks can’t raise this capital on their own, the state will provide up to 12 billion euros.

What’s more, there will be quarterly stress tests. If a bank’s core Tier 1 ratio threatens to fall below 6 percent under a stress scenario, it will have to raise more capital. This is tougher than the EU’s upcoming stress tests, which use a 5 percent threshold. And while the 6 percent figure is in line with Ireland, the idea of quarterly tests seems an innovation.

The bailout plan also envisages Portuguese banks issuing up to 35 billion euros of state-guaranteed bonds to maintain their liquidity. Funding is clearly the sector’s biggest problem. Wholesale markets are largely shut to the banks, with the result that, as of March, they had borrowed 39.1 billion euros from the European Central Bank.

The snag is that state-guaranteed bonds won’t, in themselves, reopen the markets. That won’t happen until and unless investors believe the government itself won’t need to restructure its debts. And issuing such bonds will, in itself, increase the state’s contingent liabilities. In the meantime, the best that the banks may be able to do is issue the bonds to themselves and then pledge them as collateral to the ECB or the Portuguese central bank in return for cash. The latter is similar to what some Irish banks have done.

Such an elaborate money-go-round is not to be sniffed at. It would allow the banks to raise cash if their supplies of high-grade collateral run low. As such, it would buy the sector time until either confidence in the government returns or a longer-term solution is found.