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China’s 12th Five Year Plan. A Necessary Revisiting. Part II. The Reality.

By Dan Harris on Posted in China Business

Yesterday, co-blogger Steve Dickinson wrote a post on the lead up to China’s 12th Five Year Plan. Today’s post is another one by Steve on China’s 12th Five Year Plan, but this one focuses on the plan as actually adopted, which as we will see, is actually surprisingly different from what was discussed. 

IV. The 12th Five Year Plan as Adopted

On March 16, 2011, the People’s Congress made public the Outline of the 12th Five Year Plan  中华人民共和国国民经济和社会发展第十二个五年规划纲要 (The Plan) As adopted, the Plan entirely abandons the Opinion [see yesterday's post] in favor of a infrastructure/industry/export led growth model.

The numerical targets contained in The Plan illustrate this very clearly:

A. Numerical Targets for the Five Year Period Ending in 2015

                                                2005               2010               2015 (Plan)

 

GDP(RMB)                             18.5 trillion    39.8 trillion    55.8 trillion

Service as a % of GDP                  40.5                43                   47

R&D as a % of GDP                       1.3                1.75                2.2

Urban Income(RMB)                      10493             19109              26810

Rural Income (RMB)                       3255               5919               8310

Urbanization (%)                                                 47.5                51.5

Patents per 104 Persons                                        1.7                 3.3

New Jobs                                                      51,000,000         45,000,000

Strategic Industry as % of GDP                                                    8.0 %

Note that NONE of the numerical targets set forth above meet the goals of the Opinion.

B. The basic format of The Plan

1. The Plan follows the basic outline of the Opinion, with the following critical changes:

  • The discussion of “unleashing domestic consumption” is abandoned.
  • The domestic consumption discussion is replaced with a proposal for a massive domestic infrastructure program.
  • Social management and control is given increased prominence.
  • Social measures such as increase in wages, increase in service sector, increase in education and R&D are all reduced to incremental increases from previous levels, mostly in line with projected inflation. No major changes are proposed.

2. The structure of The Plan with highlights is as follows:

Section I: Policy Guidance: Scientific Development

Section II. Reform of Agriculture

Section III: Promote Domestic Industry

Section IV: Promote Service Industry

Section V: Encourage Undeveloped Regions and Promote Urbanization

Section VI: Green Development: Global Warming, Energy and Resource Conservation and Environmental Protection

Section VII: Improve Domestic Innovation, Education and Workforce Training

Section VIII: Improve the Livelihood of the People: Wages, Medical and Pension

Section IX: Social Management and Control

Section X: Cultural Development and Soft Power

Section XI: Improvement of the Economic System

Section XII Continue Opening to the Outside World

Section XIII: Improve the Operations of Government, including Reduction in Corruption

Section XIV: Unify the Country

Section XV: Advance Military Power

Section XVI: Develop Overall Blueprint of Economic and Social Development 

C. The Core of the Plan is a Massive Infrastructure Program.

The only portion of The Plan with any real interest is Section III. This section outlines a massive set of plans to transform China’s infrastructure and manufacturing base. Highlights are as follows:

Article 9: New manufacturing should be located where raw materials and energy resources are already in place:

  • If the material/energy inputs are domestic, manufacturing should be located in the Central/Western regions.
  • Where imports are critical, location should be along the coast.

Fragmentation of domestic manufacture should be reduced through M&A, particularly in the following areas: automobiles, steel, cement, equipment manufacturing, aluminum, rare earths, IT and drugs. The goal is to create national champions that can compete in the international economy (i.e. export oriented).

Article 10: Promote Strategic New Industries

The following strategic industries will be promoted:

  • Energy saving and environmental protection (clean energy technology)
  • Next generation IT
  • Bio-technology (pharma and vaccine manufacturers)
  • High end equipment (airplanes, satellites, high speed rail, power plants, manufacturing technology)
  • New energy (nuclear, wind, solar)
  • New materials (rare earths, nano technology, carbon fiber and related)
  • New energy autos and related (electric and hybrid cars, batteries)

Promotion will be through direct grants, loans, and various tax incentives.

Note again: this is ALL export oriented.

Article 11: Energy 

1. Coal:

  • Complete development of major fields
  • Start work in Xinjiang
  • Build electric generation sites at coal fields

2. Crude Oil

  • Develop domestic oil and natural gas fields on land
  • Push out to deep water
  • Develop coal bed methane

3. Nuclear

  • Concentrate on coastal regions
  • 40 GW new capacity
  • Over 50 new reactors
  • Cost at over $150 billion

4. Renewable Energy

a. Hydro

  • 120 GW new capacity
  • Over 200 new dams

b. Wind

  • 8 new wind farms
  • 70 MW

c. Solar

  • Project in the West
  • 5 MW

5. Imported Oil and Gas

a. Pipelines

  • From Kazakhstan and Burma (Russia not mentioned?)
  • Increase in length by 15,000 Km at cost of over $US 60 billion

Section 12: Create/Complete a Comprehensive Transportation Network

1. Highway

  • Complete the current planned national highway system by adding about 9,000 km  to achieve 83,000 km.
  • This is about 8,000 km longer than the U.S. national highway system.

2. Rail

  • Complete national high speed rail, at cost of 300 billion RMB.
  • Complete passenger rail system to 45,000 km.
  • Complete Western lines linking Tibet and Xinjiang to Eastern regions.
  • Complete coal transport lines from Shanxi and Inner Mongolia
  • Total cost of over $US 100 million

3. Light rail in cities

  • Complete light rail in 21 urban metropolitan areas

4. Ports

  • Complete six new ports for heavy materials
  • Add 440 new 10,000 ton berths

5. Civil Aviation

  • New Beijing airport
  • 11 new regional airports
  • Cost a minimum of US$100 billion

6. The Plan does not mention electric transmission. Required is:

  • Five ultra high voltage lines from Western China and SW China to transport electricity from on site coal fire power and in West and hydro power from the SW.
  • New coal fired power plants sufficient to increase current capacity by at least 70%.

D. Impacts of The Plan

There is no mention of how this massive infrastructure/manufacturing base transformation project will be funded. The Plan ignores the issue both of cost and means of funding.

  • Conservatively, the cost over the next five years is several trillion dollars U.S.
  • The current budget does not provide for funding any of these projects.
  • China does not have a municipal bond market and private funding seems unlikely.
  • The only likely source of funding therefore seems to be lending from the Chinese banks
  • Lending at this scale will likely be massively inflationary. The bad loan pressure on Chinese banks will be increased

The focus of the entire project is to transform China into a modern industrial powerhouse on the model of Japan/Germany/Korea. Assuming the plan can be successfully funded, there are several issues that are not addressed in The Plan. The most important are:

  • What is the source of energy for fueling this plan? Pipelines and power plants are of no benefit without petroleum, natural gas and coal to fuel those plants.
  • Who will purchase the new products produced? China has little use for such advanced industrial production. So who will buy: The U.S.? The E.U.? Japan?
  • The Plan is based on the following foundation:
    • Keep the wages of the Chinese people low.
    • Provide no profitable place for investment of the limited income earned.
    • Provide little social safety net.
    • Thereby force the people to deposit money in the local banks.
    • Take money from the banks and use it for infrastructure development, loans to industry and real estate speculation.

The question then becomes how long will it be possible for China to operate under this paradigm. 

E. The Plan Simply Ignores Certain Issues, Including:

            1. Inflation

From a Keynesian perspective, there are three sources of inflation:

  • Demand Pull
  • Cost Push
  • Expectation

The Plan is likely to create all three sources of inflation.

From a Monetarist perspective, The Plan will flood the economy with M2 currency, creating inflation on a massive scale. Fiddling with interest rates and bank reserves will likely have little impact.

            2. Housing cost in urban areas.

The plan provides for building 32,000,000 units of low income housing. The Plan makes no attempt to address the issue of the cost of housing in urban areas.

  • http://www.pbl.com David

    Steve,
    Excellent “pair of posts.” I think this is close to dead-on (there are some details about social services and medical care/safety nets, but it could be lip service, and there has been some movement towards private investment in projects, but it has been minimal). China’s at a nice place right now, but it’s still a crossroad. Despite the claims in the October Plan, the New Government marks a “formal” (it was already becoming apparent, informally) ideological shift with a focus that is almost to some 30 years ago, or so. Must ask how that will work together with China’s industrial development and globalization over the past 10+ years? Were BJ Olympics and Shanghai Expo mere “historical blips”? We see a call for huge public works (infrastructure) projects to provide the low-wage jobs (welcome back to the Cultural Revolution, folks, only now it’s industrial more than agricultural) while on the private side, China will somehow try (more RMB flowing out–sure does sound like inflation) to push development of new brands and technology (and move up the two sides of the Smiley Curve) with industries that will be more technology intensive than labor intensive (PRC will see what it was like in the West when jobs were lost, 30 years ago, due to those same shifts!). So the rich can and will stay rich, and the average working “Zhous” will remain poor, and due to inflation (anyone notice the price of food in Chinese markets these days? It’s cheaper in the US and most European countries) in fact will be poorer. As it becomes less friendly to foreigners, and returns to insularity (after gathering what it information it can, from the West), how will it ever be able to turn around and sell its products to the outside (and at what costs)? Is China in 2016 to be on its way to becoming a huge Potemkin Village, albeit heavily (but nearly exclusively) populated with (mostly underpaid) Chinese, except for the high rollers in Xintiandi, who will be expected to foresake their beloved Western brands for the new Chinese ones? It would be very sad to witness such a dramatic slide.

  • http://blog.theepochtimes.com/1/china Matthew Robertson

    It’s always gratifying to see the honest labours of independent analysts in looking over the Party’s latest publicity maneuvers. The only point I’d add is that this is all quite _unsurprising_ rather than surprising. Two questions:
    - Are the people that concocted the “Opinion” and the “Plan” the same people? What accounts for the radical difference, to put it simply?
    - Just what is the “Strategic Industry” that aims to be 8% of GDP referring to?

  • Twofish

    In the Keynesian framework, you only have inflation if the amount of money that you are pumping into the system hits the upward sloping part of the aggregate supply curve and by investing a huge amount, you get out of this problem by pushing the aggregate supply curve upward.
    The plan relies ironically enough on Ronald Reagan style supply side economics. Reagan preached small government, but he massively increased the size of the federal government via defense spending during his term.
    Also legally speaking the what things work in China.
    Guidelines -> Opinions -> Regulations -> Measures
    You also have Decisions and Notifications.

  • Twofish

    One thing that is important to realize is that the 12th Plan isn’t a Plan for just the *government*. It’s also a plan for the *entire economy*.
    * Conservatively, the cost over the next five years is several trillion dollars U.S.
    Depends on how you do the accounting.
    * The current budget does not provide for funding any of these projects.
    Large amounts of the spending are off-budget. For example a lot of the spending will be done through state owned enterprises which are off-budget and rely on their earnings in the form of profits.
    * China does not have a municipal bond market and private funding seems unlikely.
    China finances municipal spending through a large number of mechanisms. Also in China, what is “public” and what is “private” is not clear. A lot of the 12th Five Year Plan are directives to SOE’s and funders for SME’s.
    * The only likely source of funding therefore seems to be lending from the Chinese banks
    And invested cash by SOE’s. Chinese corporations are cash rich and so they’ll be involved in capital spending based on using invested reserves. Also, where things can be structured in terms of for-profit, it will be funded from corporate earnings.
    * Lending at this scale will likely be massively inflationary. The bad loan pressure on Chinese banks will be increased
    Mildly inflationary. If Chinese corporations start spending their corporate earnings instead of saving, that will increase the velocity of money. If the spending pushes the aggregate supply curve, you are not going to have much long term inflation.
    Whether the loans will be bad depends on the quality of the loans.
    * The focus of the entire project is to transform China into a modern industrial powerhouse on the model of Japan/Germany/Korea.
    No.
    The point is to leapfrog the industrial stage and go post-industrial. One problem with talking about China is that China is China. China is not Germany. China is not South Korea. China is not the United States. At some point you have to stop relying on models since what China is doing has never been done before.
    At some point you have to stop arguing based on theory and “seek truth from facts.” My view is that China is following some very sound Ronald Reagan-style economic policies in contrast to the United States which is massively underinvesting in infrastructure.

  • dan berg

    More first rate work by S. Dickinson. Nouriel Roubini makes the same point from a very different perspective at Project Syndicate; as does Michael Pettis. Matthew Robertson asks the obvious: why? to which the answer is equally obvious: political economy. America has a deficit/debt problem. The solutiion is trivial: cut spending and/or raise taxes. Why doesnt the govt do that? Same problem in China; but the result is much easier to predict in China than in USA; unless you really believe in the munificent benevance of those who will make the decisions.

  • Twofish

    berg: More first rate work by S. Dickinson. Nouriel Roubini makes the same point from a very different perspective at Project Syndicate; as does Michael Pettis.
    And there are people like myself that think that these people are all wrong.
    berg: America has a deficit/debt problem. The solutiion is trivial: cut spending and/or raise taxes.
    The reason that I bring up Ronald Reagan is that he figured out that the solution to the deficit was to *increase* spending. If you increase spending, and spend it on the right things, then you end up with a short term increase in the deficit, but you end up increasing tax receipts in the long term. During the 1980′s, Reagan massively cut taxes, but he also massively increased the size of the US Federal government through defense spending. A lot of that defense spending went into new technology, which increased tax revenues in the 1990′s as things like the internet came on line. During the late 1980′s and 1990′s, there were some modest increases in tax rates, but they were still lower in 1995 than they were in 1975.
    Personally, I think that the US has a serious public infrastructure spending problem, and needs to massively increase public spending. If the US tries to fix the problem through cuts, then it’s just going to get worse, because cuts in public spending will cause tax revenues to go even lower.
    You also saw this in World War II. The US blew its budget in World War II, but this created the groundwork for the economic growth of the 1950′s and 1960;s.
    You don’t believe me…. I don’t expect you to believe me…. So lets do an experiment. Try to have to the US get out of the mess by cutting spending. Have China deal with it’s economic situation by increasing public spending, and we can come back in five years to see what things are like. The US economy is big and robust enough so that going in the “wrong direction” for a few years won’t be the end of the world.
    berg: Why doesnt the govt do that? Same problem in China; but the result is much easier to predict in China than in USA; unless you really believe in the munificent benevance of those who will make the decisions.
    One problem is that people disagree about some pretty basic things. Michael Pettis is a bright, smart individual, but I happen to think that he is totally wrong about how economies work, and therefore the advice that he is giving is just wrong. The hard part in running a political system is to deal with the fact that people disagree about basic things, and being able to deal with basic disagreements without anyone ending up in jail is something that the US does better than China.
    However, on economic issues, there is a lot of room for open discussion. Much of the reason that China allows a lot of open discussion on economics (i.e. neither myself or Pettis are going to end up in jail for anything we say on monetary policy) is that China tried the “since we know what to do, let’s do it, and shoot anyone who disagrees” approach in the 1960′s, and that didn’t turn out well.
    One problem that Michael Pettis has is that as far as I can tell, no one in China is listening to him. The reason that no one is listening is if you go back to 2007, and look at the advice that he was giving, you’ll find that the Chinese government did 180 degrees the opposite thing, and it seems to have worked out pretty well. In fact, if you go over the past ten years, the Chinese government has been more or less ignoring the advice of Western economists and doing the opposite, and since that has worked out, there’s not that much interest in Beijing in listening to theories that seem contrary to what people are seeing, especially since as far as I can tell, none of the people who have been giving advice has admitted that their advice was bad.
    Some of the advice that Pettis is giving seems pretty useless. He seems to believe that the Chinese economic is inevitably headed for a crash. I agree. I happen to think that boom and bust cycles are an natural consequence of market economies, so the Chinese economy will crash. That’s not the question. It’s like telling me that I’m going to die. I know that I’m going to die, and the fact that I’m going to die is one of the one things that I’m absolutely certain of. The question is not whether I’m going to die or whether the Chinese economy will crash. The question is when and how. If you can get the Chinese economy to grow for twenty years and get to US/Japan levels of income before blowing up in a real estate bubble, that’s pretty good.
    If you are trying to argue that the Chinese economy will blow up next year, that’s different. But first we need to realize that eventually you will be right. If you keep telling me that I’m going to die this year, and I live to be a hundred when I finally kick the bucket, you can be satisfied that you were right in the end. But since it’s 2011, before I change my life so as if I’m going to die in 2012, you have to explain why your prediction of my death in 2012 is different than your prediction in 2001, 2002, 2003, etc.
    The other odd thing is suppose that we were in agreement that the Chinese economy is going to blow up in 2012 and suppose we can’t stop it. Well, what is life going to be like in 2013? One thing that I find odd about people that predict a blow up is that they really haven’t given much thought to what life is going to be like *after* the blow up.

  • Patricia Craven

    I’ve been studying China in my political science master’s program in Colorado. The above analysis made my jaw drop. Is this yet another disaster-in-the-making for China (along the lines of the Great Leap Forward) ?

  • greg

    Patricia Craven: I’ve been studying China in my political science master’s program in Colorado. The above analysis made my jaw drop. Is this yet another disaster-in-the-making for China (along the lines of the Great Leap Forward) ?
    Good question. Which raises the question: Do you trust in a foreign lawyer’s interpretation of China’s 12th Five-Year Plan or in the government and its policy makers who have managed the most successful large economy in the last 30+ years despite all the detractors?
    Frankly, I can’t believe Steve is making the kind of accusations he made in the post. Take a few examples:
    “C. The Core of the Plan is a Massive Infrastructure Program.
    …
    Note again: this is ALL export oriented.”
    “The Plan is based on the following foundation:
    * Keep the wages of the Chinese people low.
    * Provide no profitable place for investment of the limited income earned.
    * Provide little social safety net.
    * Thereby force the people to deposit money in the local banks.
    * Take money from the banks and use it for infrastructure development, loans to industry and real estate speculation.”
    The above is much worse than misleading -sorry about my bluntness. Be real careful to learn China’s policies and development from such sources.

  • http://www.chinalawblog.com Dan

    Greg,
    You are not even making sense or you failed to actually read what Steve wrote.
    All Steve did was point out the reality of the plan. He absolutely never said it wouldn’t work, nor would he say that. This is basically the same plan China has been using for the last 25+ years and it has worked to grow the economy, but it hasn’t provided good wages or a safety net or a consumer society. I don’t think these statements can even be disputed and if you are going to do so, I would suggest you read the plan (in Chinese) and the newspaper articles on it (again, in Chinese), as Steve did. I would also suggest you take a few macroeconomics classes in addition to your poly sci class. I will also note that Steve has been retained by no fewer than three embassies and a leading think tank to speak to their people on the 12th five year plan, so obviously there are people out there who think he knows whereof he speaks on this, not to mention that he has been invited to speak at around a half dozen chambers of commerce on this topic.
    College is a great thing and I hope you use it to expand your thinking and learn to think critically (which is a very different thing than being critical) and I am serious about the economics classes.

  • Twofish

    Craven: I’ve been studying China in my political science master’s program in Colorado. The above analysis made my jaw drop. Is this yet another disaster-in-the-making for China (along the lines of the Great Leap Forward) ?
    Depends on how you think societies and economics work. One problem with economic predictions of Chinese doom is that people have made so many of those predictions in the past, that at some point, it’s hard to take “yet another prediction of doom” seriously.
    One reason I don’t think that a GLF like disaster is likely is that if the Chinese government starts doing things and they don’t work, they’ll stop and do something else before anything really, really bad happens. Something to realize is that most of the major economic shifts in China were things that were unplanned.
    Dan: This is basically the same plan China has been using for the last 25+ years and it has worked to grow the economy, but it hasn’t provided good wages or a safety net or a consumer society.
    Except that it has.
    Dan: I will also note that Steve has been retained by no fewer than three embassies and a leading think tank to speak to their people on the 12th five year plan, so obviously there are people out there who think he knows whereof he speaks on this, not to mention that he has been invited to speak at around a half dozen chambers of commerce on this topic.
    Except that this can cause problems…..
    One problem that experts have is that I’ve found that experts have an extremely difficult time saying “I don’t know” or “I was wrong.” Once you make a significant amount of money with consulting, it becomes very difficult to say “I really have no idea what is going on here” or “Forget what I said last year, it turned out to be totally wrong, and I’m not that sure what I’m saying now is correct either.”
    The other problem is that experts often have gaps in knowledge. If you really want to find out how inflation is affecting a farmer in Sichuan, you find a farmer in Sichuan to tell you, and the fact that the person has an elementary school education is pretty irrelevant.

  • Twofish

    Dan: I don’t think these statements can even be disputed……
    I ***very strongly*** dispute both statements.
    (i.e. This is basically the same plan China has been using for the last 25+ years and it has worked to grow the economy, but it hasn’t provided good wages or a safety net or a consumer society)
    One thing about experts. If you find all your experts are agreeing, then you need to look very hard for an expert that disagrees.
    Part of the issue is the term “basically the same”. Personally, I think that it’s incorrect so that this plan is “basically the same” as how China has been growing the economy for the last 25 years, because China has used some fundamentally different mechanism to grow it’s economy over the last 25 years. For example between 1978 and 1985, much of the economic growth was done by decollectivizing agriculture. Between 1987 and 1993, the growth involved “marketizing” the economy. etc. etc. etc. A lot of the growth between 2000 and today has been in the form of net exports, but that can’t be used even if the Chinese government wanted things that way.
    As far as “good wages”, a “safety net”, or a consumer society. I *VERY* strongly disagree with that. Chinese wages have been increasing pretty dramatically across the entire population. The “safety net” in China isn’t as strong as it could be but it is strong enough for large segments of the population, and it was good enough to allow China to absorb the massive costs of reorganization the state owned enterprises. China is a lot more consumer focused than it was in 1978.
    You can only argue these things if you use economic measures that don’t matter to most people. For example, wages have gone consistently upward in China. The share of wages of as a fraction of GDP has gone, but “so what?” One thing that’s great about an economy that is growing at 10% is that you can increase incomes by 5% and then do something else with the other 5% and people aren’t going to get angry at you.
    Also, higher education is difficult, because you can’t just take classes. One thing that you have to realize about economics classes is that a good fraction of what they teach you might be wrong. If you take certain theories of economics (Washington Consensus, and neo-liberal economics), then China would have blown up a decade ago, and the crash of 2007 shouldn’t have happened.
    Taking macroeconomics is important so that you can follow the debate and understand what people are saying, but you do have to realize that there is a debate. The point of taking the class is so that you can say “I know what Milton Friedman, thinks but he is just wrong.”
    Steve Dickinson seems to think that the plan will cause massive inflation, but there are obviously people in the Chinese government that agree with me that it won’t, and it’s important to understand why we disagree with him.

  • Twofish

    Since we are talking about economics, one of the things that I think is the root of the degreement that I have with Michael Pettis and maybe Dickenson is that I don’t think that the Solow exodegenous growth model is an accurate description of an economy.
    Here is the model…..
    http://en.wikipedia.org/wiki/Exogenous_growth_model
    The model is that if you assume certain assumptions, then it turns out that you don’t get more economic growth if you save more. You can then argue that the massive amount of savings that China is putting in infrastructure is “wasted” and that China really should consume more.
    The problem is that this conclusion comes from the *assumptions* of the model, and I would very strongly question the assumptions. In particularly
    1) savings allows you to have a reserve that prevents a general meltdown in case of an economic crisis
    2) the Solow model *assumes* that productivity is an independent variable that you push in from the outside, but I would very strongly argue that it’s not. Higher savings rates allows for investment in both human and physical infrastructure that increases productivity. once you connect the two, then the whole model falls apart.
    One of the more alarming papers that I’ve read is this
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1053541
    Vladimir Popov argues that the Soviet Union collapsed in the 1990s because after the 1950′s, there was not enough capital spending.

  • dan berg

    Twofish: I happen to agree that the US should INCREASE spending now, because the output gap remains large, interest rates low. Medium or long term spending will have to be CUT – a lot – but I further do not think that politically an increase in spending is possible ; the American public is too worried about rising deficits and debt; a price you pay for living in a democracy. But do you really believe that Greece, Ireland, Portugal can get out of their troubles by INCREASING spending, thereby later increasing tax revenues.

  • dan berg

    Twofish: “. . .if we go back to 2007…things worked out pretty well.” The economist’s job is to point out problems, especially in China. The growing inequality, environmental degradation, low wage rates, NPLs, bank debt, corruption, low consumption etc. , of which you are quite aware , are a function of what ever model the govt is using. If you really believe that further 10% gdp growth suffices and should continue , in spite of these growing problems- that’s not an economic nor technical decision, but a value judgment. You also seem to assume that honest, hardworking bureaucrats are busily attempting to solve all of these various problems; again, an assumption that has little to do with economics.