A Great Shift Unseen Over the Last Forty Years

Xiang Songzuo, December 28, 2018

On Dec. 16, Prof. Xiang Songzuo (向松祚) of Renmin University School of Finance and former chief economist of China Agriculture Bank, gave a 25-minute speech during a CEO class at Renmin Business School that was apparently applauded by the audience but immediately censored over the Chinese internet. Singling out 2018 as the year when China comes to a large shift unprecedented over the past 40 years, the speech can be seen as a landscape survey of Chinese economy, and obliquely, also of politics. Just as Tsinghua law professor Xu Zhangrun’s (许章润) broadside “Imminent Fears, Immediate Hopes”, which was superbly translated and widely talked about among China watchers, Prof. Xiang’s speech is another rare burst of Chinese intellectuals’ discontent with the direction the country is taking under Xi Jinping. With this unauthorized translation of the speech, China Change wishes our readers a happy New Year! — The Editors

I want to share two characters with my fellow alumni here. I hope that everyone present, every entrepreneur here, can reflect together with me. These two characters are fan si (反思, reflect). What do we reflect on?

China’s economy has been going downward this year, as everyone knows. The year 2018 is an extraordinary year for us, with so many things taking place. But the main thing is the economic slowdown.

How bad are things? The number that China’s National Bureau of Statistics (NBS) gives is 6.5 percent, but just yesterday, a research group of an important institution released an internal report. Can you take a guess on the GDP growth rate that they came up with using the NBS data?

They used two measurements. Going by the first estimate, China’s GDP growth this year was about 1.67 percent. And according to the other calculation, the growth rate was negative.

Of course, my main point here is not about the accuracy of these calculations, or which one is more credible. But this year, there have been three issues regarding China that we either failed to consider, or about which we have made serious misjudgments.

First, the trade war between China and the U.S.. Did we make some inaccurate assessment? Did we underestimate the severity of the situation? Let’s recall some slogans from the mainstream media at the beginning of the year: “In the trade war between U.S. and China, the Americans are lifting rocks only to smash them on their own feet, China is sure to win.” “China will win the trade war without a doubt, be the battles big or small.”

What’s behind this kind of thinking? To this day, we keep suffering from a cognitive dissonance between our understanding of the Sino-U.S. trade war and the international reality. This calls for deep reflection.

Second, what was the cause for the economic downturn? Why did private enterprises suffer setbacks in 2018? Looking at the data, investment by private businesses has dropped substantially, so what made private business owners lose confidence? On November 1, the national leaders convened a high-profile economic conference, which some interpreted as a signal that the government wants to win back the confidence of private businesses as the economy worsens.

Since the beginning of the year, though, all kinds of ideological statements have been thrown around: statements like “private property will be eliminated,” “private ownership will eventually be abolished if not now,” “it’s time for the private enterprises to fade away,” or “all private companies should be turned over to their workers.” Then there was this high-profile study of Marx and the Communist Manifesto. Remember that line in the Communist Manifesto? Abolition of private property. What kind of signal do you think this sends to private entrepreneurs?

This is why we need to reflect on China’s economic downturn, the pressure on Chinese economy, and the trade war between the U.S. and China that is escalating with every passing day. We need to reflect on what we did wrong, on how to revive the economy as we walk into the future, and what steps we should take to ensure that China’s economy maintains its steady rate of growth.

Xiang Songzuo, 民营企业家.png

You might not agree with what I say, and please feel free to give your opinions. But I hope that you can think in a sober manner after we finish today’s seminar. Why do I say this? Because the problems that we face are our own doing, and there are a lot of them. But many of them have been addressed in superficial terms only.

At the symposium on the private sector, General Secretary Xi Jinping talked about six issues. Among them I am most concerned about the sixth: the protection of personal safety and property. Think about it. In a country with robust rule of law, where everyone is equal before the law, shouldn’t these basic rights be properly guaranteed for everyone, entrepreneurs and  commoners alike?

It has been four decades since the reform and opening up, yet the General Secretary still feels a need to specifically promote entrepreneurs’ rights to personal safety and the security of their property. This reflects the gravity of the issues facing the governance of Chinese society and state. In my view, China’s economy will face six internal challenges that deserve our serious consideration. Due to time constraints, I won’t be able to get through all of them.

In addition to this, there are three major external challenges. The first is the trade war, which is in fact no longer a trade war but rather a clash between two opposed value systems. It can be said with certainty that the Sino-U.S. relationship has come to a crossroads right now and faces significant historic challenges. What are we to do? To be honest, I don’t think we have really found much of a solution.

You are aware that Huawei’s CFO Meng Wanzhou was recently detained in Vancouver. In the past two days, mainstream media such as BBC and CNN have been reporting on how the U.S. is going at Huawei on all fronts. What this tells us is that this issue is not simply about trade or economics.

We used to speak of “China’s period of strategic opportunity for economic growth.” Does this period of strategic opportunity still exist? Personally, looking at the international situation, I think this period of strategic opportunity is fading quick.

Xiang Songzuo, online.jpg

Let’s think about what “international period of strategic opportunity” means. It means that in the past, international regulations have been favorable to us; we had open access to technology, capital, talent, and markets. Because of the imminent changes we face on the domestic and international fronts, I have titled today’s speech “the great shift unseen over the last forty years.” (四十年未有之大变局)

Have we really given the problems due consideration? Of course the short-term problem we are looking at is economic decline; the preponderance of data demonstrating this point needs no introduction here. Data concerning performance in November hasn’t been released, but you can extrapolate based on the October figures: there’s been a decline across virtually all sectors, from consumption in retail, autos, or real estate. Just look at China’s exports. Who can say that the trade war didn’t impact China and that China is sure to win the war no matter how big it is? Why don’t the people who were saying this kind of thing in April and May stand by their words now?

Why did we made such mistakes in assessing the international circumstances?

Look at these numbers. That China faces a long-term economic downturn is not a problem by itself. But you may have noticed that the consumption and the service sectors now make up 78.5 percent of GDP. Going by the government’s logic, this should be a good thing, since it means the economic transition to a consumption economy has been successful: we used to rely on investment and export, now we rely on consumption and the service sector. This sounds reasonable, but think about it: in a country like China, as investment slows dramatically, how can we maintain economic stability by solely relying on consumption?

The fact that consumption and services comprise 78.5 percent of GDP may be good news to some extent, but is far eclipsed by the negative implications. Take a look at investment. More importantly, can consumption alone support faster economic growth?

In the four decades following the economic reform, we have undergone five phases of consumption. The first was to solve the food problem, the second was the “New Big Three” [新三大件, short for refrigerator, color TV, and washing machine], the third was the consumption of information, the fourth was automobiles, and fifth was real estate.

But these five waves have essentially all come to an end. Car sales have dropped sharply and real estate spending is also substantially decreasing, so we are facing serious problems. This is the crux of the six stabilities called for by the Politburo [stable employment, stable finance, stable foreign trade, stable foreign investment, stable investment and stable expectations], or as some internet users have joked, the six “tender kisses” [吻, kiss, is a homophone for 稳, stability].

Now, let me give you three more “kisses”: stable reserves, stable exchange rates, and stable housing prices.

It should be fairly obvious that these stabilities are difficult to achieve. For now it looks that “stable foreign investment” and “stable foreign exchange rates” shouldn’t be a problem. Foreign investment is basically stable. But how can you stabilize investment, exports, real estate market, and employment? The reason that I want to share the word “reflect” with everyone today is that we need to reflect on why this happened, and on how to find an appropriate solution.

As economy slows, financial risk escalates and shadow banking shrinks rapidly. Some say that the president of China’s central bank has come out to apologize, saying that their prior policy was not well thought out, lacked coordination, and wasn’t properly implemented, that these, coupled with the effects of overbearing regulations, caused credit to recede. This is certainly an important reason, but it’s not the fundamental issue.

We can see that the direct financing market, whether the bonds or stock market, has been cut in half in 2018 and that many companies have defaulted. Total debt due to default has exceeded 100 billion RMB ($14.5 billion) for the first three quarters.

According to data provided by the government, the corporate debt default could exceed 120 billion RMB, and many businesses have gone bankrupt. As Cao Dewang (曹德旺) put it, companies are collapsing in droves; not even state-owned enterprises are spared this phenomenon. Bohai Steel, once listed in the Fortune Global 500, was 192 billion RMB in debt when it bankrupted; the real number could be as high as 280 billion RMB.

Local debt is a big problem in China’s financial market. As for the actual number, the National Audit Office claims it to be about 17.8 trillion RMB, while He Keng (贺铿), vice director of National People’s Congress Financial and Economic Affairs Committee, thinks it’s over 40 trillion RMB. Worse yet, not one local government intends to pay back its debts.

So this is the larger context. Then there’s also the stock market crash. My friend Mr. Jin Yanshi  (金岩石) will share with you shortly his thoughts about an impending stock market rebound, but in my opinion, it’s far from forthcoming. You can look at the history: only the Wall Street Crash of 1929 can compare to the steep decline that the Chinese stock has experienced this year. Many stocks are down 80 or even 90 percent.

So here’s a problem that we need to think about today: we know China’s stock market is feeling the pain, but what exactly is hurting?

Some people blame the securities regulators, Chairman Liu (刘主席), or this and that, but I think they are going after the wrong people. The problem lies in regulatory policy, which I fear may be lacking. The absence of comprehensive stock regulation might be an important issue, but it’s not the crucial one.

Look at our profit structure. To put it plainly, China’s listed companies don’t really make money. Then who has taken the few profits made by China’s more than 3,000 listed companies? Two-thirds have been taken by the banking sector and real estate. The profits earned by 1,444 listed companies on the SME board and growth enterprise board are not even equal to one and half times the profit of the Industrial and Commercial Bank of China. How can this kind of stock market become a bull market?

When we buy stocks, we are buying the profits of the company, not hype and rumors. I recently read a report comparing the profits of China’s listed companies with those in the U.S. There are many U.S. public companies with tens of billions dollars in profits. How many Chinese tech and manufacturing companies are there that have accomplished this? There is only one, but it’s not listed, and you all know which one that is. [Xiang is referring to Huawei, the Chinese tech company.] What does this tell us? As Yale professor Robert Shiller said: stock market performance may not work as a barometer of the economy in the short run, but it does for sure in the long run.

So I think that the terrible stock performance only demonstrates one thing, which is that the real economy in China is in quite a mess. Where is the stock market rebound? I think it’s obvious that investor confidence has yet to recover.

A number of policies came out on October 19 and 20, and Vice Premier Liu He (刘鹤) personally gave a speech to pledge results, but what of it now? The SSE Index fell to 2600 points by last Friday, and just stayed there, barely alive. When is the market rebound coming? Real estate is not showing much cause for optimism right now, but I won’t go into details for lack of time. You can take a picture of the data for your reference.

That’s why China wants to fight the three tough battles. China’s economic decline indicates that there is a major issue with the focus on expansion and growth:  It has deviated from the fundamental and moved to speculation. These are the words of former chief of China’s central bank, Zhou Xiaochuan (周小川).

What are our current financial risks? They are hidden, complex, acute, contagious, and malevolent. Structural imbalance are massive, and violations of law and regulations are rampant. There are black swans to prevent, and gray rhinos to stop. A reporter once asked Zhou, “Where are the black swans? Which ones?” Zhou smiled and did not answer.

The black swans are right next to you. The P2P lending, blockchain, Coin Circle, aren’t all these black swans? But you can’t see them. As for the gray rhinos, they can charge at any time. The biggest of them is real estate.

We have rampant speculations everywhere, in too many aspects. In short, it’s arbitrage.

During the national finance work conference last year, the General Secretary and the Premier strongly criticized the Chinese financial sector with a pile of literary-sounding polemics, saying that they were entertaining themselves without the slightest consideration for reality, and that the financial sector was in chaos and was a horrible sight to behold.

Apart from this financial arbitrage, what do most businesses do with their money? Forty percent of it goes to the stock market, speculation, and buying stocks of financial companies, but not investment into primary business. Then can this be considered a good situation for listed businesses? You can say goodbye to the equity pledges, game over. As an economist, I am opposed to the government bailing out the market. If stock pledges collapse, let it be: what’s the point in bailing them out? What are you doing using stock pledges for other purposes anyway? What did you do with the loans you get from stock pledges?

I’m acquainted with many bosses of listed companies. Frankly speaking, a large part of their equity pledge funds did not go into their primary business, but used on speculation. They have many tricks. They buy financial products; they buy housing. The government said listed companies have spent 1-2 trillions on speculative real estate. Basically China’s economy is all built on speculation, and everything is over leveraged.

Starting in 2009, China embarked on this path of no return. The leverage ratio has soared sharply. Our current leverage ratio is three times that of the United States and twice that of Japan. The debt ratio of non-financial companies is the highest in the world, not to mention real estate.

Having shared all this data with you, shouldn’t we be arriving at a conclusion now?

“The swallows come back every three years.” [This is a reference to the three years of RMB growth between 2005 and 2008.] Now they are back again. The economic decline has created a lot of pressure, so now the government brings back its old set of tricks: relaxed currency regulations, aggressive monetary policies, relaxed financial policies, and aggressive capital financing policy.

But now I want to ask a question. Everyone in the audience is an alumnae of Renda business school and capable of thinking independently, so give it some thought: Will these policies work? Can they solve China’s fundamental problems? It’s not that our currency regulation this year was not relaxed enough—we released 400 billion yuan in liquidity, 2.3 trillion yuan in hedging or medium-term lending facilities. 2.3 trillion times the money multiplier is about a dozen or so trillion.

Three monetary policy “arrows” have been fired, also known as “Bank Chief Yi’s three arrows.” The first is loans, the second is issuing debts, the third is to solve the problem of stock pledges. Even more mind-blowing was the “125 Target.” [Guo Shuqing (郭树清), CCP committee secretary of the People’s Bank of China and chairman of the China Banking and Insurance Regulatory Commission, said in November that banks’ lending to private companies need to meet the “125 Target,” which means that in new corporate loans, the big banks should issue no less than one-third of the loans to private firms, medium and small banks should issue no less than two-third of the loans to private firms, and in three years the goal is for banks to lend no less than 50 percent of its loans to private enterprises among their loans to new companies.]

We recently went to the Pearl River Delta and some other regions to conduct field research, and locals told us that the local officials invited the bank chiefs over to meetings and told them which banks to turn to for loans. What is this nonsense?

So we need to reflect on our current problems: can these policies of ours solve the deeper issues?

As for the debt-for-equity swap, the capital market has issued many policies but I don’t see any of them will really be useful. It’s been another two months since October 19, have they been effective? So we have to ask ourselves: What has really gone wrong with our economy?

My own reflection has reached its conclusion: The problem with the Chinese economy is no longer speed or quantity, but quality.

The official report of the 19th Party Congress is an excellent report. So is the report of the Third Plenum of the 18th Party Congress. All of these major decisions were beautifully written and made all the right points. Sadly, they have not been followed through. The structural problems we face as a country, the “Six Big Imbalances,” are not sufficiently addressed. Think about it, entrepreneurs and alumni of Renda business school in the audience, can any radical credit policy or monetary easing solve these problems?

Moreover, these credit and monetary policies can only make short-term adjustments that are incapable of fundamentally solving the “imbalances” I mentioned earlier. We are still trapped within the box of the old policy and the old way of thinking. The key to whether transformation will be successful is the vitality of private enterprises—that is, whether policy can stimulate corporate innovation.

We have been making a game of credit and monetary tools for so many years. Isn’t this the reason we are saddled with so many troubles today? Speculation has driven housing prices sky-high.

The problems that private business actually faces are not difficulties in financing. What is it then? They are afraid of unstable policy and the government not keeping its word.

The leader of the State Council said it clearly in a meeting of the Standing Committee: in China, the government is what can be least trusted. Therefore, in order to solve the debt problem, first, the government has to pay back debts it owes businesses, the state-owned enterprises have to pay back debts they owe private enterprises, and large private enterprises have to pay back debts they owe smaller ones. The three costs keep going up [production cost, transnational cost, and systematic cost], therefore tax cut and fee reduction is the primary appeal.

My basic assessment of the overall issue is that these short-term monetary credit schemes are wholly incapable of solving the problem. For the Chinese economy to continue growing in a truly stable fashion, and extricate itself from its present quagmire, it must implement the following three essential reforms: tax system, reform in the political structure, and reform in state governance.

How to reduce taxes and fees? The structure of the government must be streamlined by cutting large numbers of staff. Personnel must be let go and expenditures have to drop, which means that structural reforms have to be carried out.

Professor Zhou Qiren (周其仁) of Peking University is someone I respect and admire deeply. All these years, he has been saying: what is China’s biggest problem? The costs of societal administration are too high.

Then there are the matters of governmental  reform and reforms in the structure of state governance. Of course, there’s also reform of academia and research.

I hear that the day after tomorrow, there’s going to be a grand conference to mark the 40th anniversary of the “reform and opening up.” I sincerely hope that we’ll hear something about further deepening of reforms at that conference. Let’s wait and see if any real progress can be made on these reforms.

If this doesn’t happen, let me conclude on these words: the Chinese economy is going to be in for long-term and very difficult times.

More information about Prof. Xiang Songzuo can be found here


Economics Professor Expelled for ‘Politically Harmful’ Expressions, Including Estimate of Staggering Cost to Maintain the Communist Party Apparatus, China Change, August 21, 2018.

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61 responses to “A Great Shift Unseen Over the Last Forty Years”

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