LEADING CHINESE ECONOMIST ON CHINA'S CHALLENGES

UNCLAS SECTION 01 OF 03 BEIJING 022876

SIPDIS

SENSITIVE
SIPDIS

USDOC FOR 4420
STATE PASS USTR FOR STRATFORD, WINTER, ALTBACH
STATE PASS CEA FOR BLOCK
TREASURY FOR OASIA/CUSHMAN
USDA/ERS FOR LOHMAR, TUAN, SYLVANA LI
USDOL FOR ILAB
NSC FOR SHRIER, HUNTER

E.O. 12958: N/A
TAGS: ECON EFIN EAGR ELAB PGOV SOCI CH
SUBJECT: LEADING CHINESE ECONOMIST ON CHINA'S CHALLENGES


SUMMARY
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1. (SBU) One of China's leading economists briefed China
Mission Economic Officers on the country's economic
challenges. Although he expressed concerns about income
inequality, deflation, and the challenges of following
through on economic reforms, his overall message was that
the quality of leadership on economic matters warrants
broad optimism. Participating Econoffs responded in
particular with questions about China's ability to pursue
income distribution and economic restructuring goals under
the Eleventh Five-Year Plan (FYP). The researcher insisted
that the FYP is a step in the right direction towards
rebalancing growth and solving socioeconomic problems,
including China's income disparity, aging population,
resource inefficiency, and social instability. END SUMMARY.

BIO NOTE
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2. (SBU) Justin Yifu Lin founded the China Center for
Economic Research at Beijing University in 1994. Lin,
considered one of China's leading economists, also advises
the Central Government on economic policy. Lin earned his
PhD in Economics from the University of Chicago in 1986.

CHALLENGES FOR CHINA'S ECONOMY
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3. (SBU) At a mid-October briefing attended by Economic
Officers from Beijing, Shanghai, Chengdu, Guangzhou, and
AIT Taipei, Lin noted that the Eleventh FYP (2006-2010) is
based on China's strong economic performance since reform
and opening in 1978, particularly the strong growth of the
past three years (10.0 percent in 2003, 10.1 percent in
2004, and 10.2 percent in 2005). He emphasized, however,
that during the Eleventh FYP, China would need to overcome
six significant challenges: 1) deflation, 2) low per
capita income, 3) resource shortages, 4) income disparity,
5) an inadequate social safety net, and 6) the government's
unfinished reform agenda.

THE THREAT OF DEFLATION
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4. (SBU) Lin said that most Chinese economists are less
concerned with inflation than they are with deflation.
From 2003 to 2005, overheating in several energy-intensive
sectors prevented deflation by artificially raising the
prices of construction materials. In the wake of 2005-2006
investment growth rates above 25 percent, the Chinese
Government is now taking action to slow things down and
this brings with it a strong possibility of deflation.
China's current low inflation rate of approximately 1
percent would be considered deflation in almost any other
country, he said.

GROWING INCOME GAPS
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5. (SBU) A longer-term concern is low per capita income,
Lin stated. Most non-Chinese analysts fail to recognize
that the country's per capita income remains very low at
USD 1,730 per year, which amounts to only 4 percent of the
U.S. average, he said. Further complicating matters,
income disparity is growing, potentially fueling social
instability. China's Gini coefficient is now 0.45, with
urban income three times higher than rural incomes. (Note:
The Gini coefficient measures income inequality in a
society, with a measure of 0 equaling full equality and 1
equaling full inequality. The U.S. Census Bureau estimates
the Gini coefficient in the U.S. in 2004 for money income
to be 0.45. End Note.)

FACING SOCIAL CONCERNS
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6. (SBU) Lin said China has consumed a disproportionate
amount of resources during its rapid economic growth.
According to Lin's statistics, in 2004, China's GDP was
only 4 percent of the global total, but the country
consumed 12 percent of the world's energy and 15 percent of
its fresh water. China must also face rapid aging: more
than 12 percent of the population is over 60, and the
social security fund is estimated to have a shortfall of
RMB 300 billion to RMB 1 trillion (USD 37.5 billion to USD
125 billion).

THE GOVERNMENT'S UNFINISHED REFORM AGENDA
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7. (SBU) Lin endorsed the Eleventh FYP as a means to
address problems resulting from unfinished reforms,
including non-performing loans, county-level government
debt, and state-owned enterprises with poor performance.
President Hu Jintao's emphasis on scientific development
steers the government towards continuing to rely on
economic development and reform to solve emerging problems
but also recognizes that China needs to achieve balanced
growth, especially when facing problems such as income
inequality or resource inefficiency.

LIN'S OPTIMISTIC OUTLOOK
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8. (SBU) Lin strongly intimated that the government will be
able to resolve China's most pressing socioeconomic
problems. According to Lin:

-- Deflation will not prevent the economy from maintaining
robust growth of at least 8 percent per annum, as deflation
would be caused by overinvestment in certain sectors rather
than by a bursting bubble in those sectors.

--The Eleventh FYP's New Socialist Countryside initiative
may unleash a significant pending demand and absorb
existing excess capacities.

--State-owned enterprise (SOE) reforms will reduce the need
for policy loans in the banking sector, and the entry of
foreign banks will speed up banking reforms.

--The Chinese Government remains in firm control and social
unrest is unlikely to grow beyond localized conflicts. FYP
strategies on income distribution, addressing regional
disparities, and promoting social development will
alleviate social tensions in rural areas.

COMMENT: TOO OPTIMISTIC?
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9. (SBU) China Mission Economic Officers attending the
presentation believe Lin's assessment of China's policy
prescriptions is overly optimistic. Lin's briefing perhaps
reflected a common problem in Beijing where academics often
are co-opted into the policy process and then feel
compelled to defend those policies. We found it
interesting, for example, that Lin took credit during the
briefing for contributing to formulating the New Socialist
Countryside policy and then proceeded to exude a degree of
optimism about the policy that we believe is unfounded.


10. (SBU) During the briefing, Econoffs questioned Lin on a
variety of topics, including: the impact of deflation on
economic growth, funding fixed asset investment through
retained earnings, the socioeconomic situation in the
countryside, trade and services liberalization, reform of
equities markets and securities firms, implementation of
the FYP, and mergers and acquisitions regulations. Lin's
answers on several topics sounded like Party-line talking
points, particularly with regard to rural policy, financial
reforms, and liberalization of trade and services -- all
areas where we do not feel China's progress justifies Lin's
rosy outlook.


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