Beijing in Economic Bind

Inflation remains high despite slower growth.
An analysis by Michael Lelyveld
A butchery section at a supermarket in northeast China's Shandong province. China's consumer prices rose 6.1 percent in September from a year earlier.

China is walking a fine line between driving down inflation and maintaining high growth to create jobs, economists say.

While visiting China's southern Guangxi Zhuang Autonomous Region on Oct. 22, Premier Wen Jiabao voiced concerns over both prices and job opportunities.

"Currently, economic growth is slowing and external demand is falling, and we should make employment even more of a priority in economic and social development, doing our utmost to expand employment," Wen said, according to People's Daily.

Wen is worried by consumer complaints about inflation, which stayed stubbornly high at 6.1 percent in September, far above the government's 4-percent goal for the year.

The government has been battling both rising food prices and the high housing costs that drove the construction-led investment boom of recent years.

But reining in the real estate sector may cost construction jobs, while lower food prices will hurt farmers'
incomes and purchasing power.

The government has tightened credit to cool the economy and bring down inflation, but it fears the effects could go too far.

"This is the Chinese version of stagflation, which hit the U.S. economy way back in the 1980s," said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington.

The difference is that China's economy is still rising at relatively high rates with GDP growth of 9.1 percent in the third quarter, down from 10.4 percent in 2010.


The higher-than-normal prices have combined with lower- than-usual growth, raising doubts for an economy that has relied on double-digit expansion.

The concern is for employing 153 million migrant workers who come to cities for construction and factory jobs, Reuters reported. Another 6 million college and university graduates add to the labor market each year.

"They have employment problems while they have inflation higher than is comfortable for them, so it's an uncomfortable situation," Hufbauer said.

Last week, the National Development and Reform Commission
(NDRC) said it expects inflation to fall soon. Peng Sen, an NDRC vice director, said the consumer price index (CPI) will dip below 5 percent "in the next two months," the official Xinhua news agency said.

Peng said the government has lowered logistics costs and "clamped down on price disorder," but experts also point to other factors affecting food prices, which make up a large part of China's CPI.

Pieter Bottelier, a nonresident scholar in economics at the Carnegie Endowment for International Peace, said China's drought has eased in much of the country, boosting food supplies. For much of this year, pork prices have been driven higher by pig diseases, he said.

Bottelier said the government faces a series of economic challenges but he voiced confidence that it can manage a transition to more sustainable growth.

"They have an extremely complex situation to deal with," he said.

"They have to bring the growth rate down because it was overheating, they have to deal with the excess liquidity in the economy and they have to make sure that not too many people are being laid off," said Bottelier.


While China is still enjoying enviably high GDP growth, some policy makers have become alarmed that it is falling too fast.

That has led to pressure for easing monetary policy to maintain GDP growth at a high level next year. But so far, the leadership has resisted because of price growth.

"I think the political leadership is more concerned right now about the inflation," Bottelier said. "Wen Jiabao has repeatedly said, including during his trip to Guangxi, that inflation remains his top priority."

The liquidity squeeze has led to a surge in illicit underground lending at high rates. Some factory owners have fled to escape debts, leaving their workers unemployed.

In Wenzhou, the business center of eastern Zhejiang province, one-fifth of the city's 360,000 small and medium- sized businesses have stopped operating after running out of cash, Xinhua said.

Premier Wen has responded by ordering a crackdown on underground lending while encouraging more bank loans for small firms

The government has actually called for a far lower 7- percent annual GDP growth rate under its 12th Five-Year Plan through 2015, but given the debate over the economy and jobs, no one knows whether it will dare go that far.

Bottelier said the situation is "full of dilemmas and unprecedented choices." But in the longer term, he sees fewer reasons to worry about employment.

Demographic changes have started to shrink the surplus workforce, while industries are still seeking workers despite high wage growth this year.

"The dominant factor of the labor market is labor shortage, not labor surplus," Bottelier said.

The inflation fight is likely to strengthen the case for critics of China's currency policy. They argue that a revaluation of the yuan would slow inflows of "hot money"
that fuel inflation while giving consumers more buying power.

But Hufbauer said China's current economic bind may make such a decision more difficult, since exports are already under pressure due to lagging foreign markets.

"They might be better off economically but they will pay a high price in terms of acute discontent among all those exporting firms, which are already seeing their growth slow down," Hufbauer said.


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