Excessive growth in finance, real estate sectors puts key industries at risk

If there is one thing China can learn from the West's battle to contain the sovereign debt crisis and to stoke its sluggish economies, it is this: never again let the financial industry get out of control and gut other industries.

Asset bubbles, as a result of bullish stock and property markets, helped countries such as Greece relish golden years over most of the past decade. It was during those years that these countries walked away from real industries, "advancing" their economies mainly by speculating on financial and property assets. As a result, industries were gutted.

In Greece, a nation hit hard by the sovereign debt crisis, traditional mainstay industries such as garment manufacturing shrank to almost nothing as residents basked in easy gains through stock and property transactions.

Hollowing out is a dangerous trend, and there are many examples of how a seemingly robust economy can go into a nosedive when its real industries fail to grow on par with the financial sector.

The 2008 financial crisis was a result of that. Before the crisis the United States enjoyed bullish stock and property markets, posting handsome economic data as a whole. But its real industries, of which manufacturing is a big part, performed poorly. An industrial hollowing-out, in which investments in industries such as manufacturing continuously flowed out of the country, took shape.

In those years Wall Street began to shine the way Detroit, the symbol of US manufacturing, used to and became the pillar of the world's largest economy. However, when the credit crunch occurred, the economy suddenly lost steam. Even though the US government brought interest rates to historical lows to boost liquidity, the move did not work, simply because people holding capital found no avenues to invest as the stock and real estate markets were finished.

That is why US President Barack Obama was eager to revive the country's exports and manufacturing businesses to lift the US from the economic woes.

The Chinese economy, too, has shown signs of a hollowing-out, although the trend is far from serious.

Indeed, China's strong growth over the past five years can be attributed, to a large extent, to asset bubbles instead of the progress of its real industries. Stock and property markets, expanding on excessive speculation, have boosted GDP growth, but real industries, notably manufacturing and export businesses, have failed to move with the times.

The huge number of bankruptcies of small- and medium-sized enterprises in Wenzhou, in East China's Zhejiang province, in the second half of last year indicates that manufacturing has been pushed to the sidelines. Business owners cannot stay afloat because they are unable to secure sufficient funding because of tightening policies.

For years Chinese lenders were in the habit of lending to homebuyers and stock investors for quicker and higher returns. Manufacturers did not figure among their top customers.

Investors also tend to put their money into stocks, property, commodities and artwork, investments that allow them to book profits by simply speculating and quickly flipping the assets.

An imbalance in Chinese industry thus takes shape.

In the past few years the focus has been on tertiary industry, the financial and property industries taking the top priority. In a short-sighted policy that pursues immediate economic growth, these two industries enjoyed stellar growth that made the country's economic data look impressive, but that also resulted in skyrocketing asset prices, adding pressure to inflation.

What's worse is that the unchecked growth of equity and real estate markets caused the country to invest less, in relative terms, on agriculture, causing the cost of farming to jump. That explains why food prices, which account for about one-third of the consumer price index, have remained high.

In this period, too, China failed to allocate enough resources to renovate and upgrade its secondary industries. So when the government tightened its grip on financial and real estate industries the economy suddenly lost its power and the brakes came on.

This is exactly what is happening in the West. A too speculative financial market fueled overall costs, forcing real industries to seek low-cost destinations overseas. That trend has become apparent in China. A large chunk of outbound investment has been in manufacturing. If that trend continues, real industries will gradually flow out of China, and the result will be hollowing-out.

This, of course, is highly lamentable, because countries with a strong manufacturing base are able to mitigate economic turmoil. That is why Germany was the first Western economy to have walked out of the shadow of the 2008 financial crisis and remained in good shape despite the sovereign debt woes elsewhere in the region.

If China, a manufacturing powerhouse, fails to curb the financial bubbles and return to the roots of the real economy, it will be hard pressed to avoid the pain suffered by many developed economies.

Fortunately, it seems that the top leadership of China has noticed the trend of hollowing-out.

Speaking at the end of the two-day National Financial Work Conference in Beijing in December, Premier Wen Jiabao said: "In the future, China will stick to the principle of letting the financial industry serve the real economy to prevent virtual bubbles from inflating the economy. The country must resolutely curb the flow of funds from the real economy to a virtual economy where capital is used for speculative gains. We must check the growth of a bubble economy and prevent industries from hollowing out."

Those remarks are excerpts from a statement put out by Xinhua news agency after the conference. And they appeared immediately after Wen summarized the achievements and problems of China's financial work over the past five years.

The pledge to support real industrial activity and curb financial bubbles is not new, but this is the first time that a top Chinese leader has given the matter such prominence in any of his speeches.

In fact, Wen implied that it was the guideline and the goal of how China's financial industry should evolve, as he mentioned this before eight specific tasks for industry over the next five years. The National Financial Work Conference has been held every five years since 1997.

What Wen said at the conference indicates that top Chinese policymakers are aware of the threat of the excessive speculation that has haunted the country's financial market.

That is a move in the right direction.

The author is a financial analyst in Shanghai. The views do not necessarily reflect those of China Daily.

(China Daily 02/10/2012 page9)