Examination of Witnesses (Questions 20-39)
8 FEBRUARY 2005
MR RAY
BARRELL, DR
GERARD LYONS,
MR PETER
NIGHTINGALE AND
DR LINDA
YUEH
Q20 Mr Beard: Changing the subject, the
current pattern of the world economy can be broadly categorised
as the emerging economies focusing on manufacturing while the
developed economies focus on services, but a number of studies
have shown that up to five million service sector jobs could move
offshore over the next decade from the USA and Europe as new technologies
allow the service sector to be more tradable. As the world's largest
net exporter of services, how is the UK likely to fare and compete
if this shift happens and should we be concerned that China is
going to emerge as a service provider in the world?
Dr Lyons: In terms of this issue,
I think it is important not just to talk about China, but also
to recognise the huge importance of India, but also in the same
way it is vitally important to recognise that India is likely
to become as competitive as China in manufacturing as well given
that 45% of its population is under 19, for instance. Many emerging
countries have gone for manufacturing, so to speak, because that
is where their natural immediate advantage is, and it is seen
as job creating, but we are seeing, as you mentioned, as telecommunications
skills, etcetera, become easily transferable, India has
probably led the way initially by moving into low value-added
services, but when one visits India it is quite clear, given their
skills base, that they intend to move into higher value-added
services across the board, and if India is likely to do that it
is likely that China too in time will do that. I think we should
view China and India both as huge economies in terms of manufacturing
and in service skills. Is that a threat or an opportunity for
the UK? In terms of the financial sector, it is a huge opportunity
for the UK, and we are seeing this already in China itself. My
bank, Standard Chartered, has a significant operation in China.
We, like other international banks, are seeking to buy into China.
We have just bought 20% of Bohai Bank and we are seeking to acquire
again in China. It is both an opportunity as well as an interesting
competitive issue for international financial companies. The way
I see it, international banks bring many skills to China. I call
it the (a), (b), (c): (a) they accelerate pace of change, (b)
they bring in best practice and, (c) they add to competition in
these banking and financial sectors. Given the huge competitive
advantage one sees in the UK in terms of the financial sector,
one should view this as an opportunity. In terms of broader range
services, I think there will be challenges as well. I think it
is difficult to map out. I think we have to accept that the service
sector across China as well as India will become a lot more competitive
and therefore it is important for us to make sure that we continue
to build on our first mover advantage. In terms of the financial
sector, I see it as a huge opportunity. One only needs to look
at the success of Hong Kong and its position in China to see that
is the case.
Q21 Mr Beard: The implication of that
is that far from the economies differentiating themselves, they
are almost converging, the structure of western economies and
India?
Dr Lyons: Skills are easily transferable
and investment is the key. If trade is open, then there is no
reason why other economies such as China and India cannot move
up the value curve in services.
Q22 Mr Beard: China is already the largest
consumer of many of the key commodities in the world, particularly
oil and energy. On current trends it is suggested that by 2020
China could account for nearly a quarter of the world's energy
consumption. Are the recent trends in Chinese energy and commodity
consumption sustainable given the price rises they have prompted
already?
Dr Lyons: This is a big challenge
really. China has a huge issue. The demand at the moment is in
terms of hard commodities including energy. The big future issue
for China is going to be soft commodities as it tries to feed
its growing population. In terms of the current trends, it is
always very difficult to extrapolate, but if an economy like China
has a trend growth rate of around 8 to 8½% then its future
energy demands will be huge. Brown-outs have been quite common
in China in the last couple of years, but what is interesting,
as opposed to when they happened here in the UK in the early 1970s,
is that China has been able to cope; the labour force is very
flexible. The immediate response has been to try and improve energy
capacity within China, but if one looks at the current trends,
then the big issue is in terms of price of energy and commodity
prices. The long-term trend for commodity prices is that they
tend to fall in real terms. Many economists expect that to continue,
but when you look at the sheer size of China and India, it is
quite possible that that trend might be reversed, and quite clearly
there is going to be huge demand from China and from India. The
supply side, particularly in terms of energy output, is likely
to be changing, and some people claim that we are about to hit
a peak in terms of oil output, but I think the trend for energy
prices is unlikely to follow the long-term trend of commodity
prices, which is down. I think we could easily see volatility
increasing, but it is difficult to predict. It is a big challenge
for China how it meets its current demand for hard commodities
and for energy, and in the next 15 years how it meets its demand
for soft commodities, particularly food.
Dr Yueh: A lot will depend on
how China's energy policy gets underway. It does have an energy
policy in place. More than half of China's energy consumption
is in coal, and it is trying to move away from that and into hydro-power
and alternative sources, including nuclear power. I believe they
are working on a pebble type reactor. So there is a strong move,
because China realises, like most Asian economies, it is not energy
efficient. As a percentage of GDP the energy efficiency of its
consumption is much higher than it is for OECD countries. In fact
in terms of efficiency it is only one seventh of Japan. Provided
that China can work on its energy policy, increase the efficiency
of that consumption, and China was also an oil producer even though
it has imported oil since the mid 1990s, and in terms of diversifying
its own energy use, I think this is something which is going to
be hugely important, but I think in terms of the world economy
China is but one player in this. Say China grows at the rate it
is currently growing at, India continues to grows at the rate
it is currently at add the growth of Brazil and South Africa,
then I think that is a real issue in terms of global energy demand,
because even if they are completely efficient, they will still
over consume—it is the nature of a product such as energy—and
therefore not internalising the externalities such growth causes.
So I think in terms of working at it from a policy front it will
be very important to do so.
Q23 Mr Beard: If you have a limited amount
of oil and we cannot see it expanding hugely beyond present supply
and you have all the expansions that you are referring to (8 or
9%) in China? Are there not going to be tensions arising before
the price mechanism Dr Lyons spoke of trips in? Is it likely that
we are going to see a tension or an ambition to expand northwards
into Siberia and secure these energy resources by force of possession?
Dr Lyons: There is a whole host
of issues there. It is important to stress that new investment
in China is incredibly energy efficient. The new plants in the
Pearl River Delta, Yangtze River Delta are incredibly clean and
environmentally friendly. There is a whole host of plants. There
are legacy issues in the north-east of the country, so even though
the figures suggest it is energy inefficient, I think it is important
to stress that that is rapidly changing. One of the key issues
the new premier in the last couple of years has stressed is the
environment. They are keen to improve on that. Are there challenges?
It is important to stress that China is seeking to expand its
political ties in terms of countries that are energy exporters—West
Africa, Central Asia—so it is developing trade links with
energy producers.
Q24 Mr Beard: Siberia is on its doorstep?
Dr Lyons: Yes, but Russia. China
could easily develop trade ties to exploit that. Russia has its
pipeline going to the coast and that will service China and Japan.
Mr Fallon: Let us move on to another
section. David Heathcoat-Amory.
Q25 Mr Heathcoat-Amory: We have talked
about the Chinese economy as though it is a single entity, although
we have heard about the federal structure, Westerners visit the
coastal areas and think they have visited China. Can you tell
us a little bit about the past hinterland, that inland area with
millions of people living in it? Is it simply a reservoir of cheap
labour or are there interesting economic developments going on
there? Can you characterise them?
Dr Yueh: It is hugely interesting,
the rest of China. What is interesting about China is the division
is between the coast and interior, but also rural and urban. For
the visitors to China, if you manage to get out of the cities,
you will see a lot of the interesting rural areas. We must remember
that China's growth started in the countryside. When reforms began
at the end of 1978 it was in a reform of the rural economy. It
was the creation of township and village enterprises which was
the real engine of growth in China before urban reforms took off
in the mid 1980s. If you go to the rural areas today, there will
still be TVEs which have been transformed from the old collectives,
and even though livelihoods have not been grown as well in rural
areas as they are in urban areas, in terms of real standards of
living, they have improved from before the reform days. For those
reasons the rural economy the engine of growth, and if China is
to grow in the future it is going to have to return to how to
stimulate the rural economy, and recent policy measures aimed
at cutting grain taxes, improving infrastructure investment, facilitating
FDI into the interior, are all facets of this recognition that
the rural economy must keep up if China is to attain sustainable
forward growth. Also, if I might add, many people have brought
up poverty reduction in China as a huge success an this is because
of a number of factors. I think very good research done by the
World Bank has shown that half this kind of poverty reduction
happened in the early 1980s with the creation of TVEs in the rural
countryside; so it has been an engine of growth, and I expect
that there is a lot of potential still. However, I should say
there are a lot of difficulties for the rural economy because
China has less than 10% arable land, so there is a lot of pressures
on the land and getting these areas industrialised, allowing you
to compete effectively in this new industrialised more competitive
sphere is going to be difficult.
Q26 Mr Heathcoat-Amory: Is this rural
economy based on security property rights, the contract economy
that we witness when we move from state to contract in our industrial
revolution, is this familiar to a Chinese dweller in the interior,
planning laws and administrative efficiency, tax payments which
pay for local public services? Is this a reality now for the ordinary
Chinese?
Dr Yueh: I think local government
structures are in some places in some ways much more like what
we see here than even in urban areas, because there has always
been a fairly self organised communities. The rural economy is
self-governing, the townships and the villages have a centre,
a committee, some of whom there have been recent experiments with
democratically electing the officials, and although there is not
security of property rights there is very clear demarcation of
residual control rights, and this has been in place since the
abolishment of the communes and the collectives, but even during
that period we find that there was a claim to certain types of
property and that was the basis of the Household Responsibility
System which allowed people to retain a share of what it is that
they put into the land, implicitly giving them some of the property
rights. In terms of tax and public finances, it is difficult to
generalise. My understanding is that there are some areas in China
for which it has done much better because for a number of institutional
reasons, the way that the people have been running it in the past,
but it is not a clear system, a lot of the problems in the banking
sector and problems with statistics in terms of recording public
finances has a lot to do with how decentralised a lot of these
services are locally, and then a lack of monitoring as to how
it is actually done.
Q27 Mr Heathcoat-Amory: Dr Lyons, you
are an economist. How would you characterise the secondary Chinese
economy? Is it a free market economy, is it based on property
rights or is it a separate model?
Dr Lyons: The economy is evolving,
and one can see this in terms of the way in which the price mechanism
is taking hold. I would say that it was very much centrally planned
previously, and one can see that—not only reinforcing the
point about property rights, but very much from the macro-economic
perspective, you can see that market mechanism is taking hold
across the country in terms of prices not being set centrally
but being determined by demand and supply, and that is also forcing
macro-economic policy to therefore evolve as well. From the middle
of 2003 to October of last year, to control the economy it was
very much administrative measures aimed at certain sectors. That
proved partially successful, but what we are seeing is that in
response to the way in which the economy itself is changing the
central government and the policy makers are having to move towards
more market based mechanisms to control the economy, such as raising
interest rates last autumn and likely to move to more flexibility
in interest rates this year. So from a macroeconomic perspective
you can see that the economy is evolving in terms of the price
mechanism in the way in which policy is responding. The other
way in which you can see the economy evolving is very much by
looking at the income statistics, income per head. The trend is
clearly up across the whole of the economy, but within that there
are clearly differences that have been mentioned between the coastal
and rural areas and between the urban areas and rural areas. In
terms of the other aspects of China, if one goes to Western China
it is quite interesting. Sichuan is the big province there and
Chengdu the regional capital city. That has developed quite significantly
in the space of the last five years, and it is easy to see that
what has happened in the Pearl River Delta and Shanghai region
is now being transferred to the other areas, but what is clearly
holding back the Western part of China is primitive investment.
I known in North-east China—Peter was there last week—but
you will see that region as well is developing. What we are seeing
is things are happening in different timescales. The initial phase
of adjustment and change has been very much in the coastal areas
and it is now spreading inland. The big challenge is, of course,
as more people move from the rural areas to the city areas in
terms of urbanisation that creates problems in itself. The immediate
issue we have seen in terms of China is that there are 95 to 120
million displaced workers who have moved from inland and from
the former state-owned enterprises to the cities. That has created
an immediate pool of cheap labour, but we are likely to see more
displaced workers in the future as urbanisation and infrastructure
investment takes place. You are likely to see a complete change
in terms of the rural part of the economy in the future.
Q28 Mr Heathcoat-Amory: Can I ask Mr
Nightingale a question that leads on to this, which is the WTO
rules. Broadly, China seems to be complying with the rules, but
there are issues of intellectual property. I have been asking
whether Chinese people could have heard of their rights. Perhaps
Mr Nightingale can reveal whether foreign investors or British
people trading with China can defend their rights, particularly
in the intellectual property sphere in China now?
Mr Nightingale: I think you are
right. On the whole international business has been quite pleased
with the way that China has met the obligations that it signed
up to when it joined the WTO. Sectors have opened up, rules have
changed and foreign companies have been allowed to participate
in much more of China's business than was the case before hand.
I think what has been seen, however, is that there have been a
number of non-tariff barriers raised in certain sectors, and the
banking sector is one of them, which the negotiations for WTO
did not anticipate; so that while the sector opens up, according
to the agreement under WTO, other barriers are raised which make
it correspondingly more difficult for foreigners to operate in
that sector, and those barriers have to be negotiated and dismantled
one by one. I think there has been some success in doing that
in certain sectors, but it has proved to be an unexpected barrier
to developing in some sectors. On the question of intellectual
property, I think that the rules and regulations are there; the
real problem is how those are implemented across the enormous
country that China is at all sorts of different levels. They are
not implemented very well, but I think there is evidence, firstly,
that the leadership in China is very keen that implementation
process should be improved. The other thing that is significant
is that there are now Chinese companies that have intellectual
property to protect and therefore there is pressure from Chinese
companies on the Government to make sure that the implementation
process is improved, and I think that helps foreign companies
as well because, as the pressure gets greater across China to
improve intellectual property protection, that will assist foreign
companies and Chinese companies alike, and there is evidence that
that is happening, although it is not, of course, by any manner
of means perfect.
Q29 Mr Heathcoat-Amory: Is there a danger
that China is so powerful economically that we lose our leverage
over Chinese policy? In other words, every other country wants
to be in China and will make almost endless concessions to try
and get ahead in the energy contracts or trading of one sort of
another, and therefore matters like property rights, rights of
contract, transparency of corporate law, intellectual property,
simply get downgraded and we lose any means to counter these trends
because we have lost our leverage. Mr Barrell, I wonder if you
have any view on that? You have not answered these questions so
far?
Mr Barrell: On the trade issues,
the leverage we have comes through the agreement we have through
the WTO, and we can interfere in the process of Chinese exports
to the extent that they break WTO rules. If, however, the question
is are other people willing to spend a lot of money trying to
get into the Chinese market and therefore allow the Chinese to
avoid these rules, there is little we can do about that. I think
a desire to be in the market just because it is there may be unwise.
It is an expanding market, but the Chinese share of world imports
and the Chinese share of world exports is still smaller than the
UK's; it is still a smaller market in that sense, and therefore
one has to be cautious about thinking that these developments
are so important. We do have rules to stop them doing things that
are very wrong, and I think they are beginning to behave a better
way in the areas where in the past they have broken the rules.
Dr Lyons: There are two levels
to this. First, the Chinese authorities want their economy to
be successful. Therefore to be successful clearly they need to
adopt the best international practice. Clearly they might do that
at the pace that best suits themselves.
Q30 Mr Heathcoat-Amory: Let me stop you.
That is a non sequitur. They could all want it on their
terms to keep to the rules when it suits them but not when it
does not?
Dr Lyons: Okay, there are two
aspects to that. In terms of the WTO where there have been measurable
and objective obligations the Chinese are seen to have applied
to the WTO rules. The disagreements and criticisms of the WTO
are where you cannot objectively measure things, where there is
a lack of transparency, etcetera. Clearly where there are
ground rules such as where they have to apply in terms of tariff
barriers with specific numbers, then you can measure progress
and it is quite clear that the Chinese have implemented these
changes. Where is less clear and where there have been objections
is where there are no figures or measures in place. That might
suggest that they always want it in on their terms, but if you
want it in terms of best international practice, best corporate
governance, if you want foreign companies to continue to invest,
you have to apply by the international rules as well. If you are
telling me that China will set its own rules, the down side to
that is that they might suffer in terms of FDI for those coming
into their economy, and ultimately their economy will suffer as
a result of that, but the other point is that in terms of global
trade deals at the moment, the US is doing lots of bilateral trade
deals. If countries see a huge market to sell into, countries
are quite likely to make short-term deals to serve their own country's
needs, and you will see that in bilateral trade deals. Could that
possibly happen in the future of China? Yes, but what is interesting
is that in the last couple of years China started to play a much
bigger role in the ASEAN+3, for instance, in Asia, and you can
actually argue that whilst China is the big economy or the big
emerging economy so they might exert greater influence, there
seems to be collective agreement in terms of what needs to be
done. I think your question is a very valid one, but the way things
have gone to date suggests that it is an evolving process, but
it does not seem to be the case that they want everything on their
own terms.
Dr Yueh: If I may come in, on
two points. The first is that China's own terms are actually consistent
with maintaining the power of the Chinese Communist Party, which
is predicated on economic success. I see where your question is
coming from, because in the recent 15 years FDI has flowed freely
into China and it holds the world's third-largest stock, it is
easily the leading destination behind, just, the United States
or before it, regardless of the fact that there happen to be a
lack of clearly defined property rights and an insecure legal
regime. So the presupposition is that it may be that there will
be more influential as they become more economically powerful.
I would argue it is somewhat the other way around: one because
there are limits to what one is able to do when you become more
open to the global economy and, also, to do well in the open global
economy then international standards do have to be met and every
indication is that Chinese policymakers seek out advice on how
to improve corporate governance, how to improve constituting corporate
directorships, how to make better laws and how to implement them
because they are keen to hold on to power. I think the second
part of that is that to become increasingly open means you are
subject to the strictures of international economic law, which
extends beyond trade: it covers financial liberalisation, it covers
intellectual property rights (TRIPs), it covers trade in services,
and the WTO mechanism is such that there is a body before which
disputes can be brought. To give you an example, 20% of all actions
brought before the DSU in the WTO relate to the TRIPs Agreement
already. By all indications, most countries do not want to run
afoul of and will abide by a DSU-type ruling. So there are going
to be strictures that the Chinese will be keen to avoid and, I
think, more importantly, they are keen to comply with because
they are very interested in success.
Q31 Mr Walter: I wanted to carry on with
this theme of foreign direct investment and, really, look at the
quantum of it. You have just mentioned, Dr Yueh, that China has
moved up the league and very much leapfrogged over the UK in terms
of being a destination for foreign direct investment, and India
has seen significant growth as well. Is there any evidence of
investment in China being at the expense of investment in the
UK; that projects have taken place there rather than here?
Dr Yueh: I think because of the
differences in the structure of the economy what tends to happen
is that FDI, possibly (again, it is hard to know from aggregate
data about individual firm decisions ), is growing rapidly in
China but it is FDI that would have gone, possibly (I do not know
this for a fact) to other developing countries at a similar stage
in its manufacturing capacity. What we do know is that FDI has
been growing quickly in China, over 60 billion last year, and
the amount that goes into China has exceeded the entire amount
which has gone into the Asia region since 1992. However, the amount
of FDI going into the Asia region has actually grown over this
period, just more slowly than China. So I think what we are seeing
is a growth as the pie gets larger and there are more funds to
invest, so China's competitors, in terms of FDI, are likely to
be Latin American developing countries and unlikely to be developed
countries, because the nature of the FDI is different. If anything,
there is quite a big potential for FDI from China to go into FDI,
for instance, in the UK and the US. The final thing I will say
about FDI is that the figures that we see for China are not necessarily
reliable because they include a lot of what is known as "round-tripping".
Chinese capital that leaves China and then comes back into China
is granted better tax concession than if they were invested domestically.
So the leading investors in China come from Hong Kong and the
Virgin Islands. Those are conduits rather than initiators of capital.
Mr Nightingale: I was going to
say that if you look at the main foreign investors in China, Hong
Kong is certainly one but they are Taiwan, South Korea and Japan,
and I think those are investing in China because it is regionally
a powerful economy.
Dr Lyons: I think there are two
points which are very relevant for the UK, reinforcing what has
been said. First is that it is not direct competition between
the FDI that has gone to China and would have come to the UK,
but the UK can make itself an attractive location for future investment
from China in terms of RD and D (Research, Design and Development)
particularly in education and those sorts of areas, just as there
was big Japanese investment during the 1990s. So we can make ourselves
a very attractive recipient of future investment from economies
such as China as they open up. The second point, which is very
relevant to the near-term macro-economic picture in the UK, is
that the FDI into China has gone hand-in-hand with supply chains
across Asia becoming more interlinked, so economies across Asia
are more interlinked. Trade from other Asian economies to China
has risen at three times the pace of world trade in recent years.
So you now have lots of supply chains interlinked across Asia,
and the big issue across Asia is what is called "supply chain
optimisation", which means that basically if you bought a
good in a shop for £4, roughly speaking, £1 of that
is production costs. Those production costs have now been squeezed,
so companies are trying to get that other £3 of value out
of the supply curve, and you are likely to see increased competition
now. That is the second big issue that is going to be linked into
this FDI into China; we are going to see increased competition
in supply curves which means another big disinflationary threat
for economies such as the UK. However, you are basically seeing,
in summary, FDI into China, and FDI into China may be at the expense
of other economies initially but in time—and we have already
seen this occur—China has become interlinked with those
other economies, so they are all starting to benefit and supply
chains are starting to become very interlinked across the whole
of Asia.
Q32 Mr Walter: If supply chains are becoming
interlinked across the whole of Asia, is the FDI at the expense
of other Asian economies?
Dr Lyons: You could argue that,
in the first instance, but really if you look at what is happening
collectively in those economies, you could say that it is wrong
to think of it as "at the expense of" because, collectively,
they all now seem to be benefiting. Basically, we calculated at
Standard Chartered about a year ago that half of the exports from
the rest of Asia into China were re-exported, effectively, to
the US and other G7 countries, but half of the exports from the
rest of Asia into China were to meet domestic demand. If you went
across Asia three or four years ago and spoke to companies, they
talked about China very much in terms of competitive threat. They
still see China being competitive but they are now seeing China
increasingly as a big growth market to sell into. So to say "at
the expense of" tells only part of the story.
Mr Barrell: To add to that, we
should not think of there being only a fixed pool of FDI that
moves around the world and if it is in one location it is not
in another; FDI takes place for a number of reasons. The competition
for FDI comes, really, only over the FDI that goes to a country
to set up a plant for export to send the goods back to the market
the FDI came from or from another market. FDI can also take place
to make the production process as a whole more efficient, the
area becomes more integrated, and increasingly in China FDI is
taking place to set up plants owned by foreigners to produce their
goods for the Chinese market. They are able to make a profit by
producing in China things the Chinese want, and that is good both
for the country sending the FDI to China and for the Chinese because
the profits of the firm that is investing there are higher and
the efficiency of production is higher. Only in limited areas
is there competition over FDI anyway; that competition for FDI
is probably regional not global, it is also industry-specific
and one could only see a few industries where there would be export-based
competition for the UK. That is in things like the production
of chemicals—relatively simply things—that can be
produced very efficiently in China. I think the amount of competition
between the UK and China for FDI is going to be limited both by
the type of things that are produced in China and the distance
between them.
Q33 Mr Walter: Are there any losers?
You are talking about the interlinked Asian economy and the squeezing
of costs, and so on, and China being, obviously, a lower-cost
economy. There is some evidence, is there not, that with, let
us say, Japanese products that appear here branded as Japanese
goods, the real high-tech bits are made in Japan but the rest
is made in China? Is that not a diversion of direct investment
that would otherwise have gone to Japan or, possibly, to Taiwan
or Korea?
Dr Yueh: Up to 50%, it is found
in studies of Chinese exports, are actually produced using intermediate
goods from other countries. That is actually much higher in certain
sectors like the high-tech sector. So, if you look at the supply
chain and patterns of trade, you are seeing essentially a growing
connection between a part created by South Korea and then it will
be produced in China and shipped out to Japan. All the indicators
for intra-industry trade are rising for China and the Asian region
as well, including the South-Asia region. So what this suggests
is that if moving across borders improves the production process
and reduces costs then this would make goods cheaper, it would
increase profits and it is beneficial for investors to go in in
that way. This is why, I think, you are finding that FDI is going
in and there may be an issue of locating in China, but they are
taking advantage of neighbouring countries because of risk diversification,
amongst other reasons, for why FDI would go into several ather
than one country. I think the other thing about FDI to know, which
has been mentioned, is that if you look at the statistics of the
form of FDI, in 2000, a year before WTO accession, 75% of FDI
used to have to go in as joint ventures, either equity or co-operative
and only a quarter could go in as wholly-owned enterprises. In
2003 the proportions have entirely shifted; three-quarters of
FDI goes in as wholly-owned enterprises and these enterprises
have much more control over the nature of their investment and,
also, they are in because they intend to penetrate China's domestic
market. So if they are going in to penetrate the domestic market
then the competitive element is much less because the East Asian
countries that we are talking about which are its nearest competitors
do not have, although it is growing, significant domestic consumption,
which is why they have always been very reliant on exports and
US growth to drive a lot of their growth rates. So I think we
must look very carefully at the type of FDI and possibly what
type, if it is entirely export-oriented as it has been in the
past, and how much of it is actually going into the domestic economy.
Q34 Mr Walter: Can I come back to my
original question? Are there any losers? Are there economies that
are worse off as a result of FDI to China?
Dr Yueh: There is one, in terms
of trade, and it is Hong Kong, but it is not necessarily—
Dr Lyons: I dispute that completely.
Dr Yueh: Hong Kong is the only
of its neighbours that has lost global market share in manufacturing
goods. Global market share in manufacturing products comprises
about 83% of world markets and Hong Kong has lost 30% of its share
between 1990 and 2000. The reason for its loss is not necessarily
due to trade or China's competitiveness; it is largely a change
of the domestic structure in Hong Kong's economy, but it does
not mean that Hong Kong does not have growth prospects in other
areas. If you want to draw a very simple analysis, simply on global
trade share or market share or share of FDI, then I think, at
least on the trade side, we have seen Hong Kong decline, but,
again, my caveat is that the most growth potential for
an economy is not dependent on trade, it is dependent on its own
domestic capability, and that is what is affecting Hong Kong's
competitiveness.
Dr Lyons: I would like to clear
up the point about Hong Kong, because I have a different view.
It is interesting in the UK that we tend to overlook Hong Kong,
thinking that it is a historical legacy and we should focus on
Beijing and Shanghai. Hong Kong has done phenomenally well; Hong
Kong is actually really well-positioned in the Pearl River Delta.
The Pearl River Delta, geographically, is a tiny part of China
but it has accounted for one-third of the exports of China over
the last 25 years. In fact, it has been the fastest growing region
in the whole global economy and part of the reason for that growth
is not just because of the changes on the mainland side of the
border but because of the inter-linkages with Hong Kong, which
has phenomenal skills. It comes back to some of the questions
earlier: Hong Kong has the law, it has the language and it has
the Western corporate governance. So all of those are things that
have put Hong Kong in a very good position now to help the Pearl
River Delta, and are probably an indication of what else needs
to be done in other parts of China as well. In terms of who are
losers, we are presenting a picture here where it is hunky-dory
and it sounds phenomenal but one of my biggest worries is that
the whole global economy is becoming very much synchronised at
the moment. In previous cycles, if the US went up and came down,
if the US slowed we would have Europe and Japan kicking in. Europe
and Japan have ageing populations, and are slow growth economies;
China is now increasingly interlinked with the US economy, so
the synchronisation between China and the US is such that if the
US slowed, as is quite likely (having had a pre-election boom
it will have, at some stage, a post-election slowdown), you will
then have China slowing, and because of China's inter-linkages
with the rest of Asia and Africa you will see slowdown elsewhere,
so it becomes harder, maybe, to manage the global economy. That
in itself is a worry. In terms of the UK, where are our future
jobs going to come from? That is a big challenge. We need to move
up the value curve. All economies are moving up the value curve—China,
India, all other economies in Asia—so it becomes a lot more
difficult to compete. The benefit in historical terms has been
that when world trade has increased all economies have benefited,
some at faster rates than others. So the hope is that that continues
in the future. So it is difficult to say who will be the losers,
but if the world economy takes a big shock then everyone will
suffer, if world trade is hit then everyone will suffer, but if
we start to see the opening up and integration of China as a very
open, tradable economy, then everyone should benefit, but quite
clearly in Western Europe the future pace of growth (let us not
kid ourselves) will be much slower than the pace of growth in
the young economies in Asia.
Mr Barrell: In terms of who might
be losing, there is a very interesting pairing in East Asia. Over
the last 20 years Japanese exporters have lost market share very
noticeably. Japanese firms have not lost world market share noticeably
because Japanese firms have been relocating. This has actually,
probably, been one of the few cases where outward foreign direct
investment has damaged the growth prospects for the economy because
the capacity of the Japanese economy has not grown as fast as
it might otherwise have done. That relocation out of Japan into
countries like China has taken place for two reasons: one of them
geopolitical and the other one simple economics. The geopolitical
one is Japanese firms based in Japan seem to have had problems
entering markets with their exports—that is in the US and
in Europe. The US and Europe both appear to have put up non-tariff
barriers to Japanese exports in the 1980s that they did not put
up to exports from countries such as China. Therefore, a Japanese
firm might find it more profitable to locate in China to take
a share of the European market than to locate in Japan. So, firstly,
firms have relocated for geopolitical reasons, not only to China
but China has been a major gainer. Secondly, the yen has been
rather stronger, which has been the cause of deflation in Japan
over the last decade, than one might have liked, and that has
been another reason for relocation. China has been a cheap location
for Japan because the yen has been strong, not just because labour
is cheap. So if anybody is in the counterparty which has lost
out for the growth of the rest of Asia, it might be Japan. That
may not be a source of complaint in Japan but it is a relatively
efficient way of increasing your economic power in the area to
have foreign direct investment throughout it, and you at least
make the profits from plants. There is an answer to your question,
that potentially one country which may have lost in the last decade
or two is China (sic), and other countries have gained.
In the statistics it is not always obvious that it is Japanese
firms who are doing the foreign direct investment, and that is
partly why there is so much flow through Hong Kong. For historical
reasons, Japanese investment has not always been welcome, so money
arrives in Hong Kong and it then leaves Hong Kong. It has changed
its nationality on leaving, but the firm has not changed its nationality.
Dr Lyons: Just one point: the
ending of the MultiFibre agreement, clearly, will pose big competitive
threats for some economies which were previously protected by
quotas as China comes into that field.
Q35 Mr Walter: Could I move on very quickly
to the quality of the foreign direct investment? Dr Yueh, you
have mentioned that two top sources of funds coming into China
are from Hong Kong and from the Virgin Islands. The Virgin Islands
is a delightful place, and the population, I think, is just under
20,000 and Road Town is hardly the centre of the world economy.
It is round-tripping. Can you sustain a situation in which you
are building your economy on direct investment that is a tax scam—there
is a tax evasion exercise?
Dr Lyons: I will not comment on
the tax scam but it is quite interesting that just in numerical
terms there is no ideal level of investment in any economy but
the level of investment in China now is similar to levels of investment
seen ahead of the Asian crisis in other countries. You can have
too much of a good thing, there is no doubt about that. From a
pure macro-economic perspective, and I think your question was
coming from a slightly different angle, you can have too much
investment, and that is a potential danger for the economy in
the near-term—having over-heating in some sectors and over-investment
in other sectors. The authorities have tried to manage that in
the last year-and-a-half in China, but I think that is a potential
near-term worry.
Q36 Mr Walter: I was more concerned about
the questions of governance and transparency, and so on.
Dr Yueh: I think we should probably
put FDI into some type of perspective. It is difficult to estimate
the stock in China but it is thought to be about $500 billion,
and last year and in years before we have seen a lot of flows
of FDI exceeding $50 billion per annum. Nearly 50% of China's
GDP is actually actually made up investment, so that makes FDI
a very small fraction of what total investment is in China. Even
if, for instance—I do not know very much about the Virgin
Islands—
Q37 Mr Walter: They are a lovely place.
Dr Yueh: Say those avenues collapsed,
or what-have-you; I do not think, in terms of China's growth prospects,
FDI has that particular central role. Why FDI is important and
attractive is because it is the traditional vehicle to allow countries
to imitate more advanced technologies in order that they grow
and catch up in the growth process. So FDI has that advantage
in that the Chinese need not reinvent the wheel and Western companies
can gain from utilising its abundant and cheap labour to produce.
That being said, FDI even of itself is only one component of capital
flows, so what is worrisome and destabilising is actually short-term
capital flows and not FDI; FDI is long-term investment in plants
and projects. Short-term capital flows—hot money—dominates
FDI flows and that dominates world markets. It is the hot money
flow going into a liberalised credit sector which is going to
be a huge concern for China, but that is not going to bring with
it any of the good things that we have talked about. Liquidity
in markets is a very good thing but if you are asking about corporate
governance—and I am also talking about technology, knowledge
transfer—that comes from FDI, good practices, bringing together
a board of directors that is, say, half foreign and half Chinese
and bringing along better standards of corporate governance. That
is actually, in terms of introducing a commercial credit culture
and a commercial market culture, what the Chinese authorities
are very keen on. So I think it is important that we recognise
that FDI is meant to serve this type of role. There is not that
much evidence that it has, and this is a little theoretical, but
even of itself FDI is still much more attractive than other forms
of capital, but it is not the basis upon which China has actually
grown. In fact, until 1990 China grew spectacularly well with
a relatively closed economy.
Q38 Mr Walter: One final point, which
is really about a level playing field. In terms of the foreign
direct investment, the domestic investment and the round-tripping
investment, I am looking here at an article from The Daily
Telegraph, talking about foreign companies—Wal-Mart
and Tesco—being very successful and the Chinese government
saying: "We can't allow this to happen; we have to build
up the competition." Is there any evidence of protectionism
in the sense of trying to defend what could be Chinese investment
against foreign investment? Also, I wonder if anybody has any
thoughts on what has been said to me by a number of people who
have been involved in this, that there is still a level of corruption
in terms of: "You grease my palm and I will make sure you
get that particular project."
Dr Yueh: I think there is an issue
of corruption, but I think it is, again, something which the Chinese
are keen to address because it can be detrimental to growth. So
they are looking to reform, and there have been several high-profile
instances of this. Funnily enough, the complaint in terms of legal
protection has usually come from Chinese firms because joint ventures
have traditionally been given better property rights protection
than Chinese entrepreneurs and enterprises, but that is not to
say that there are not a lot of barriers to operating in China,
and China is well-known for having geographical restrictions as
well. When I was a lawyer in China, it was quite difficult to
negotiate moving ahead with a particular project for any number
of reasons: it could be competition or because they wish to build
up their own retail/wholesale sector, but a lot of the big players—like
Carrefour, for one—are foreign firms since that sector of
the economy opened up in the early 1990s. However there could
be other reasons; there could be a reluctance to allow a certain
firm to come in not necessarily for competition reasons but because
of political reasons. I am being a little big vague because I
do not want to name companies that have really struggled with
this, but it is a long process, and I do not think anybody would
doubt that. The motivation for it is not as simple as protectionism,
although that is an element, because China's big companies are
competitive and they are national champions in that their industrial
policy has been designed to help promote them, so this could range
from traditional companies, like PetroChina, all the way to new
sector companies like Lenovo, which used to be Legend.
Mr Nightingale: I think what has
been said is entirely right and it is a difficult country to do
business in, which is one of the reasons why the China-Britain
Business Council exists to help; if it was like doing business
in Holland we would not exist. On the other hand, I think, there
is plenty of evidence that companies, large companies and small
and medium-sized enterprises, can make headway in China, can set
up in China and do very successful business. So that it is not
a barrier which prevents everybody from getting in, it is a barrier
which prevents some companies from doing things smoothly. On the
other hand, we have got plenty of examples of companies getting
on with their business, registering and licensing in a relatively
smooth and easy way, and I think one should not forget that.
Mr McFall resumed the Chair
Q39 Mr Fallon: Could we now turn to the
exchange rate, and the key issue of whether the renminbi is undervalued
or not? Clearly, Dr Lyons, you say, in your memorandum: "We
believe that the economic case for a revaluation . . . is strong."
Ray Barrell, if I understand your memorandum correctly, you say
that this perception is really attributable to something else,
the expansion of the economy. Could you start on that, Ray?
Mr Barrell: Evaluating whether
exchange rates are undervalued or not is very difficult indeed.
I have spent a lot of my career doing it and I have decided it
is too difficult to be too concrete on. China may look undervalued
but it is not clear that it is. Firstly, China is a very flexible
economy. China looked overvalued in 1996/97 and prices fell. Therefore,
the real exchange rate adjusted, and if China is now undervalued
because it has moved with the dollar, what one would expect to
see is that prices will rise. Domestic prices in China have started
to rise quite rapidly. Indeed, the Chinese are worried about that.
I think within a year or two the competitiveness gain the Chinese
have had from the fall of the dollar (they have been linked to
the dollar) would disappear through domestic inflation. That is
a reasonably strong thing to say. I would also judge that if the
Chinese decided to float and liberalised capital flows there is
no necessary reason to expect the exchange rate to float up because
the capital flows might be largely outwards, pushing the exchange
rate down. So it is not clear that either the economy cannot adjust
quickly or that the exchange rate must float upwards. The reason
why the Chinese have been gaining market share, especially in
the last three or four years, is they have become increasingly
efficient; they have been able to cut the prices of their manufactured
goods relative to their domestic prices. That is just increasing
the scale of production. I think it is not just a matter of having
a low exchange rate; their import penetration is increasing in
other markets because of the sheer scale of production and that
pushes their prices down, and it pushes other people's prices
down. So the fact we have seen falling export prices for China
but a relatively stable real exchange rate in terms of domestic
prices is very interesting. That is what leads me to think that
it is the scale of production that matters, at least as much as
anything else, for pushing export prices down. However, the dollar
has been very weak recently and the renminbi has gone down with
it, and when I say any undervaluation would be removed by inflation
that may be a worry for the Chinese authorities. The fact that
I do not think there is a particular worry on undervaluation does
not mean to say they will not shift the exchange rate, because
they may be so worried about the destabilising effects of inflation
that they would need to get rid of any undervaluation a fall in
the dollar has produced. So one possibility over the next two
years might be that at some point the Chinese authorities decide
to shift the exchange rate peg; not float with no capital controls
but to shift the exchange rate peg in order that non-inflationary
growth can continue. Low exchange rates cause high growth, low
exchange rates cause high inflation. So a revaluation might be
designed to control domestic inflation.
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