A worker clears a conveyer belt used to transport coal, near a coal mine at Datong, in China's northern Shanxi province.
Photograph by Greg Baker — AFP via Getty Images
By Winter Nie
March 4, 2016

When the bubble burst on Shanghai’s Stock Exchange last summer, China’s government was criticized for a lack of transparency. Not knowing what to expect next, thousands of shareholders bailed out, and for a while, it looked as though the renminbi (RMB) might teeter on the edge of free fall. With the Chinese economy now going through a long overdue deceleration after years of unprecedented growth, Beijing appears determined not to make the same mistake twice. The announcement of dramatic cuts in steel and coal production on Monday took advantage of a state visit by U.S. Treasury Secretary Jack Lew to guarantee widespread news coverage. The need for a radical reform to ensure a soft landing has been recognized for a long time, and China is trying to adjust to a “new normal,” or a more realistic growth rate that is both sustainable and likely to lead to greater economic stability for everyone concerned.

While it is still unclear when these cutbacks will actually begin, it is worth noting that the absence of a fixed timeline gives the government a degree of flexibility so it can gauge international and domestic reactions to the news and still make last-minute adjustments. More concrete details are likely to emerge at the presentation of China’s 13th five-year plan at the National People’s Congress on Saturday. Turning an economy as large as China’s around is a bit like altering course on a gigantic ocean liner. It requires space and time to maneuver, and mostly extreme care.

The changes announced so far aim at reducing steel production capacity by 150 million tons and coal by 500 million tons over a three to five-year period. The cuts will eliminate 1.3 million jobs in the coal sector and another 500,000 in the steel industry. Altogether that represents about 15% of both sectors’ workforce. Beijing has officially set aside $15.3 billion to reallocate and retrain workers affected by layoffs in these two industries, and China’s Central Bank injected $100 billion into the economy on Monday to help ease the pain of the transition. And the cuts may eventually go deeper. Reuters, quoting “informed sources” close to the leadership, reported that 5 million to 6 million workers might eventually be affected, and that the cost could go as high as $23 billion.

The cuts target other sectors experiencing oversupply, too, such as cement and shipbuilding. A prime target is China’s so-called “zombie” enterprises. These are state-owned companies that are no longer producing, but keep employees on the books to avoid an unemployment crisis. State-owned enterprises currently account for around 37 million workers and 40% of China’s industrial output. With growth projected to slow to around 6.5% a year and possibly even less, it is increasingly clear that the economy can no longer afford to carry industries that don’t produce. Much of the resistance to change, nevertheless, comes from local governments that fear dealing with the social unrest that is likely to result from mass layoffs. They argue that without help from the central government, reform is likely to be too destabilizing. The $15.3 billion that has been set aside for cutbacks in the steel and coal industries will serve as an emergency fund once the zombie companies pay off their existing debts or declare bankruptcy. Local governments will also be expected to help in resolving these debts.

 

China has handled mass layoffs in the past. In the five years following the Asian financial crisis in 1998, at least 28 million workers lost their jobs. But China wasn’t as integrated into the world economy back then as it is today, and it was far easier to deal with domestic protest. With some 900 million Chinese connected to the Internet by smartphones or laptops, and social media chat groups gaining popularity, the public is not only more involved in policy issues, but it can also protest with a much greater impact if it feels it is not being treated fairly.

Given these considerations, it’s easy to understand why the government is proceeding with caution. The most likely area for an economic transition and expansion is the service industry, which for the first time last year contributed to more than 50% of China’s GDP. New technologies also offer promising areas for growth. Alibaba, which is driving Internet sales, has created a mini economic boom in a number of previously neglected rural areas.

Transitioning to these new employment options will require retraining and an increased emphasis on education. In that respect, China might take a cue from the United States. At the end of World War II, the U.S. workforce found itself suddenly forced to absorb hundreds of thousands of returning U.S. soldiers. To give itself time to manage their reintegration into the labor force, the government launched the GI Bill and funded thousands of regional colleges and universities, effectively placing veterans on standby. The strategy not only enabled hundreds of thousands of potential workers to improve their skills and capacity, but it also led to the rapid development of many previously neglected rural areas. The result was the creation of a new labor force that was infinitely more adaptable to change. Instead of a drain on the economy, the investment produced an unprecedented economic boom and the rise of a previously untapped market potential.

In China’s case, reform will unquestionably produce a certain amount of pain at first, but in the process it will produce a more stable and sustainable economy that is more in tune with the global marketplace. That alone should make the effort worthwhile.

Winter Nie is a professor at IMD business school in Switzerland.

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