The Organization for Economic Co-operation and Development released a survey last week projecting that China would be the world’s largest exporter and the fourth largest economy by 2010. Richard Herd, senior economist of the OECD supported the statement, saying that China’s phenomenal growth has been driven by the fact that they “have not flinched from reform”.

Recognizing the results as extremely impressive, this author can still think of a few overlooked flinches at reform that are worth reminding ourselves about.

First, the tattered state of the country’s intellectual property protection system has been exposed so many times that the mention of pirating schemes has become all but trite. To Americans, Beijing is now associated with images of fake Marlboros and bicycle baskets full of 75 cent Star Wars Episode III DVDs dumped onto markets days after the movie hit theaters. Not only is there almost no certainty in protection of intellectual property rights, the lack of legal infrastructure plagues bankruptcy procedures, contract enforcement and corporate governance – key areas required by the large sector of moderately risk-averse businesses to make investments. Reforms have been promised ad nauseam, but little progress has been made.

Second, the country continues to get the willies every time the world begs them to let go of their rusty pegged exchange rate. Yeah, yeah, so the yuan’s peg to the dollar was traded for a “managed float” relative to a basket of currencies this summer. But in reality, this managed float is just a bit too managed to be flexible. So far the currency has only been allowed to appreciate 2.1% to the dollar despite the fact that economists claim that it is undervalued by 12% to the dollar. Again, reform has been weak.

And, as a third glaring example, significant banking reform has so far eluded the country. Transparency and risk management remain big problems. Since December 2003 China has been working to recapitalize its state-owned banks and decrease failed loans. But “recapitalization” translates to “multi-billion dollar bail-out”, and moral hazard problems still abound.

All of these items were indeed cited as concerns (caveats) regarding the OECD’s projections.

It is natural to stare wide-eyed at China’s 9.5% annual growth (which, by the way has persisted on average for 20 years) and think that the country is unstoppable. But one must remember that much of this growth has been driven by massive privatizations, with the state sector selling off enormous assets and allowing private (and foreign) investors to come in and take the reins of companies that were ridden with inefficiencies for decades prior.

Without proper changes in the areas mentioned above, and once assets for privatization have been tapped out, China's flinches will make it harder to reach the top come next year's survey.

Posted by Michelle Smith on September 25, 2005 08:17 AM