The trap of regional disparities: why the Chinese economy resembles Europe

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Professor Lu Ming of Shanghai Jiaotong University was the first to call the stark differences within China the “Europeanization” (or Eurozonization) of the Chinese economy.

The euro zone consists of 19 European countries with a unified market and a single currency, but with large differences in productivity between them. Of course, this has many advantages, such as promoting the internal common market, reducing transaction costs, etc. However, the proper functioning of the euro zone depends on whether or not its members have similar levels of productivity or public debt. If they are not, it will create a divergence of interests between the “core” countries with high productivity and low indebtedness and the “peripheral” countries with low productivity and high indebtedness.

For example, Greece and Germany use the euro, but Germany’s GDP per capita is more than double that of Greece, with much higher levels of productivity. But the euro exchange rate is the same in Germany and Greece. Thus, if the European Central Bank fixes the exchange rate under conditions favorable to Germany, then the currency will be “too expensive” for Greece. This would limit Greek exports and limit its scale of credit. But if the ECB fixes the exchange rate according to Greece’s economic standards, then the euro will be “too cheap” for Germany. This could lead to inflation and bubbles. It is difficult for the ECB to satisfy both Germany and Greece, and this difficulty causes all sorts of political, economic and social problems.

With low growth and high unemployment, with no way to stimulate the economy, northeast China has become the Greece of the eurozone.

Also in China, the 31 provincial administrative regions of mainland China use the same currency, the RMB, which serves as a unified market. But economic conditions vary greatly from province to province.

This fracture is accelerating. In 2010, for example, Shanghai’s GDP per capita was 3.7 times that of Heilongjiang. In 2019, the gap had widened to 4.3 times.

Like Greece in the euro zone, Heilongjiang cannot unilaterally devalue its currency to stimulate its economy. What is even more difficult for the province, compared to Greece, is that there are many ambiguities around the distribution of responsibilities between local and central Chinese authorities.

Corporate failures in the northeast, often accompanied by high debt, complex debt relationships and ambiguous and shifting government attitudes, have become a hot topic in Chinese economic news.

The biggest problem for eurozone “periphery countries” such as Greece (along with Portugal, Spain, Italy and Ireland) during the European debt crisis of the last decade was that monetary policy was completely out of their control (it falls within the remit of the ECB while fiscal policy was only partly in their hands (euro area countries enjoy some fiscal autonomy but are bound by unified tax regulations).

Northeast business defaults have become a hot topic in Chinese economic news.

Since 2016, China has embarked on a fierce campaign of “deleveraging”, with a rapid credit crunch. In the second half of 2016, Northeast Special Steel, the largest special steel company in the north headquartered in Dalian, whose main shareholder is the Liaoning Public Assets Supervision and Administration Commission, experienced difficulties in financing, defaulting seven times in four months, transforming overnight from contender for “the world’s largest special steel company” to “king of serial defaulters”. Its president committed suicide.

Since 2014, economic growth in the three northeastern provinces has been below the national average almost every year. Liaoning even exposed itself to falsification of the GDP after the change of head of government. With low growth and high unemployment, with no way to stimulate the economy, northeast China has become the Greece of the euro zone. It is in this economic context that young people from Northeast China leave their hometown. After all, it is easier to move from Heilongjiang to Guangdong than to migrate from Greece to Germany.

In light of these developments, China’s population census has drawn significant attention this year, especially from the real estate industry. The days when any domain in China could appreciate are over; 900 million of China’s 1.4 billion people already live in cities and towns, and according to the experience of developed countries, the rate of urbanization will only slow down in the future, which means that real estate investors need to pay more attention to the demographic divide. If the population is decreasing, investors should be cautious.

Local governments in tough economic conditions are finding it increasingly difficult to secure funding — Photo: Nate Landy

Changes in real estate valuations due to divergent population growth could further exacerbate the “Europeanization” of the Chinese economy. The exodus of population and the decline in local financial resources in the Northeast are closely linked to the decline in the government’s capacity to protect the public. Declining population undermines the value of real estate, which in turn would affect local governments that rely heavily on land grants. For some local governments, revenue from land concessions can represent around a quarter of their financial resources, and the loss of this revenue will further undermine local public services and social security systems, triggering a new cycle of exodus of the local population. and entering a vicious circle.

Demographic shifts have indeed hurt the North East’s economic growth in terms of labor contribution rates, but the North East’s overall productivity has been a greater detriment to economic growth in recent years than the negative impact of population exodus.

In addition to population decline, the demographic structure of northeast China presents the disturbing phenomenon of aging and infertility. The three northeastern provinces rank first (25.7%, Liaoning), third (23.2%, Heilongjiang) and fourth (23.1% Jilin) ​​among the 31 provincial administrative regions in terms of the proportion of people over the age of 60, with Shanghai in the lead. second place. The three northeastern provinces are also at the same level as Shanghai on the proportion of population aged 0-14. However, Shanghai is much richer than northeast China, with a GDP per capita 2.7 times that of the region’s richest province, Liaoning.

The three northeastern provinces rank first (25.7%, Liaoning), third (23.2%, Heilongjiang) and fourth (23.1% Jilin) ​​in the proportion of people over the age of 60, with Shanghai in second place.

By comparing the 2010 census data, it can also be seen that northeast China faced the greatest population reduction in the young-adult age group 14-59, which is the group economically dynamic age group: Heilongjiang ranks first in the country with a reduction of 7.6 million people in this age group in ten years, while Liaoning and Jilin rank fourth and fifth with 5, 1 million and 4.9 million. In stark contrast, Guangdong’s population in this age group increased by more than 10 million, while Zhejiang’s increased by 4.1 million.

But the population decline is ultimately a symptom of northeast China’s economic decline, not a cause. Breaking down the sources of economic growth into labor, capital, and total productivity (generally understood as the increase in economic efficiency due to technology or institutions), labor can explain only a tiny fraction of the economic growth of China, no more than 10% after 2000. The remaining 90% of growth comes mainly from capital (about 60%) and technological and institutional improvements (20-30%). Admittedly, demographic changes have indeed hurt northeast China’s economic growth in terms of labor contribution rate, but the drag on northeast China’s total factor productivity economic growth of China in recent years has been far greater than the negative impact of the population exodus.

The population decline is ultimately a symptom of northeast China’s economic decline, not a cause.

The fate of the Northeast is not so much a demographic problem as an institutional problem with strong historical inertia. Liu Shangxi of the Chinese Academy of Finance calls it the “Northeast Phenomenon”: when the national economy is doing well, the decent growth rate can often cover all the malfunctions in the northeast economy. But once there is an economic downturn like the one that started in 2015, when money is tight and local financial autonomy is reduced, northeast China is often the first to be hit. There are frequent jokes on the Continental Network that “investment isn’t the only way to cross mountains and seas”, often due to the lack of separation between government and business in the North East and poor business environment.

China’s economic “sailing against the wind” will be the norm in the future, but there could be a lot more problems to expose in the Northeast. The demographic change is almost impossible to reverse and it is difficult for capital accumulation: since 2018, many new loans have gone to the eastern coastal provinces: Jiangsu, Zhejiang and Shandong have received the most credit resources. Local governments in tough economic conditions are finding it increasingly difficult to secure funding, with negative growth in the scale of funding in Heilongjiang and Liaoning, and only weak growth in Jilin.

The only way out for the economy of the North East in the future is through efficiency and reform. It’s easy to say but hard to do. There is a severe lack of local government financial resources, unclear system powers and responsibilities. People from the northeast leave for Beijing or the southeast coast. It’s called “voting with your feet”, in essence, and it’s a kind of optimization of resource allocation: if the system remains unchanged, then I will leave.

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