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.Such is the imbalance betweenChina s prosperous areas and the rural parts, and the government s fear thatit could threaten stability, that the Party unveiled measures in 2004 aimed atredressing farmers complaints and providing tax relief, while offering subsi-dies and encouragement for industries to locate in the poorer regions.AlienationFarmers are not the only ones who are disenchanted.Much resentment isfuelled by the seizure of houses and land, with little compensation, by localofficials in cahoots with property developers.The urban poor and dispos-sessed, like the farmers who migrate from the countryside to join them inincreasing numbers, seem alienated from their country s economic trans-formation.In 2005, there were 87 000 demonstrations and other protestsaround the country, a tenfold increase since 1993 (Callick, 2006d).Paradoxically for an authoritarian state, central authorities find itdifficult to rein in headstrong local and provincial governments.Ironically,this impotence is a legacy of Mao Zedong s omnipotence. His violentswings in policy left the legacy of a weakened central bureaucracy and acountry organized along territorial lines with well-entrenched provincialgovernments (Chiu and Lewis, 2006, p.29).Environmental degradationThis problem poses a severe threat to China s continued economic growth.One third of China suffers from severe soil erosion, 80 per cent of the China and the United States 215country s lakes and about one half of its rivers have been polluted, five of theten most polluted cities worldwide are in China, acid rain falls on one-thirdof the country and 80 per cent of the rubbish in cities is treated in an envi-ronmentally unsustainable way (Pei, 2002; McCarthy, 2005).It has been esti-mated that environmental damage cost China the equivalent of 3 per cent ofnational output in 2004 (The Australian, 9-10 September 2006, p.36).Unfinished enterprise reformsAfter nearly 30 years of reforms and vast institutional changes, the financialsystem remains largely as it began, dominated by banks, dominated by statebanks, dominated by lending to SOEs and saddled with non-performingloans.A programme of recapitalization, strategic foreign investments andcorporatization is well under way, but this remains work in progress.Muchthe same is true of the SOEs themselves.They have been merged, combinedinto enterprise groups, corporatized, and partially privatized.But many ofthem continue to lose money.SOEs sizeable demand on the banks (theyabsorb about three-quarters of bank credit) undermines an already weak-ened state banking system, and crowds out access to credit by private sectorfirms.By spilling over to the financial and fiscal sectors in terms of bankloans and fiscal outlays, China s SOE problem jeopardizes other importantelements of the government s economic reform programme.Macroeconomic structuresOn the macro front there is also unfinished business.The PBOC, the centralbank, has been drastically re-organized geographically and administra-tively to enable it to concentrate on monetary policy.By Chinese standardsit has a high degree of independence, but it is still answerable to the StateCouncil.PBOC officials call this relative or partial independence.China sexchange rate system, administered by the PBOC, has been detached fromits de facto peg to the US dollar, but remains tightly managed.Capital con-trols remain tight, limiting speculation and enabling the large trade sur-pluses, combined with capital inflows, to boost international reserves whileat least limiting monetary growth.Savings and investment is unbalanced.Investment at 40 45 per cent of GDP is very high by any standards, butsaving at one half of GDP is even higher, with the difference representingthe macroeconomic counterpart to the large trade surpluses (see Figure8.1).Much of the investment is undertaken by the SOEs using cheap bankcredit, indicating the close interconnection between enterprise reforms andthe macroeconomy.How long can this macroeconomic position be sustained? How long can themanaged exchange rate and tight capital account controls be sustained? 216 Untangling the US deficit55.010.0(as a % of GDP)50.0Saving* (RHS)7.545.040.05.0Investment (RHS)35.030.02.525.020.00.0Current account balance (LHS)15.010.0 2.55.0 5.00.01985 1990 1995 2000 2005Sources: People s Bank of China; authors calculations *National saving rate calculated byresidual; Reuters Ecowin Pro.Figure 8.1 Chinese gross savings, investment and current account balance,1985 2006 (as a % of GDP)Will China sign on to the American-inspired agenda of faster financial lib-eralization and market-led reforms to the financial system? There are thosesuch as Prasad and Rajan (2006) who argue that the cautious, incrementaland experimental reforms that have marked the past decades are no longerenough, and that a bolder approach is needed.13 Are they right? These aresome issues taken up in the next section.CHINA S EXCHANGE RATEIn Chapter 2 we discussed the yuan US dollar link at some length.Introduced in the context of the Asian financial crisis, the de facto peg tothe US dollar served China s neighbours well by enabling the countriesof East Asia (Taiwan POC, Republic of Korea, Singapore, Thailand,Philippines and Indonesia) to increase their competitiveness vis-à-visChinese exporters and Hong Kong SAR.Since then the fixed or relativelyfixed link has served the United States and the rest of the world well byallowing the China price to be reflected in low inflation on a global basis,rather than having the high rate of labour productivity put sustainedupward pressure on the yuan.Few worried when the yuan was over-valued.Now that there is generalagreement that the renminbi is undervalued, there is concern.The preciseextent of the misalignment remains difficult to quantify
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