China: playing mahjong
Mahjong requires ability as well as patience, and a lot of luck. Fitting the tiles into winning hands can be difficult. It is much the same as with Chinese economic policy. The government wants all the tiles in its hands. But right now, there is no fitting meld of any of them – writes Chief Economist of the Swiss Association of Small and Medium Sized Enterprises Henrique Schneider.
Three sets of problems lie on the table of the mahjong playing central planner: First, there is the trouble in the financial markets. Then, China is losing its competitive edge in exports without internal consumption being able to fill in the gap. And third, China still wants its currency, the renminbi, to become a global reserve currency.
The hand that China is playing right now treats all these problems as if they were one. In order to include the renminbi in its basket, the international monetary fund (IMF) urged China to permit the market to play a larger role in determining the exchange rate. That is exactly what the Middle Kingdom has done. Simultaneously, China’s central bank devalued its currency and opened up the system of its management. Thus, it fulfilled the IMF’s criteria.
But the devaluation should also help to increase Chinese exports by making them cheaper. With a lower exchange rate, China has become less expensive. However, it has been increasing costs and losing its advantage to low wage countries like India and Vietnam.
Lastly, the devaluation also calms financial markets. Not only because of more growth but also thanks to lower prices. As the stock markets weakened, government (or the central bank – a differentiation that does not matter in China) stepped into the markets. But it proved unable to calm the market. This ‘failure’ led investors to seriously doubt the power of state intervention. With the devaluation, faith was restored.
But all of this is just the central planner’s imagination. The winning hand is a fundamentally different one. Yes, all the above mentioned problems are interdependent, But they cannot be tackled with ill-conceived monetary policy or with state intervention. The common factor to all of China’s problems is diminishing productivity.
In other words: the winning hand starts with defining which tiles to play. And the combination that most urgently leads to success is letting productivity unfold. While wages are climbing around 9 per cent each year, productivity cannot keep up. It is only increasing by around 8 percent. Capital productivity is negative. It has been declining around 3 per cent each year since 2008. So, China is structurally getting more expensive but not better at what it does.
What do the productivity tiles look like? They are difficult to find and they are not aesthetically pleasing. Increasing productivity means allowing competition and failure. Companies and individuals must be allowed to fail in order to trigger their ideas and entrepreneurial spirit. And state companies must be allowed to face competition.
Opening the economy to productivity involves accepting business cycles – and not avoiding them. Often, the foundations of future growth are laid out during weak cycles. A good mahjong player knows that a winning strategy also involves risks.