Chinese welfare reform key to stability, says Roach

Asian capitalism since the end of World War II has had many variants, but in general one of its biggest differences from that of the West has been its lack of welfare systems.

It's been relatively easy for most Asian governments to ignore welfare needs, because they have been busy growing their economies. There's been enough private wealth generated to take care of people, on the whole -- and not spending on a destitute minority has kept government balances healthy. In most countries, there has always been a village to fall back on if the city job doesn't work out, and a family for support if you get sick or old.

All of this needs to change -- and very quickly -- if Asian countries are to sustain their impressive rates of economic growth. So warns Stephen Roach, Asia chairman of Morgan Stanley.

He was addressing a luncheon earlier this week organised by the Asia Society in Hong Kong to promote his book, The Next Asia: Opportunities and challenges for a new globalisation. In it, he argues that welfare reform is the missing ingredient that will help Asian export-driven economies, primarily China's, make the switch to a model more focused on domestic demand.

Roach quips about his reputation as a perennial bear, but notes that this is in relation to the US: "I tried being a bull once for a couple of years, but it just didn't feel right."

On Asia, especially China, he is a bull. He is confident that the country's leadership is well aware of what it needs to do, that it has the ability to do so, and that success will not only keep Chinese growth on track, but globalisation intact.

For the past three decades, China's export-orientated model of growth has been an enormous success story, based on demand in foreign markets catered to by huge investment in domestic infrastructure and manufacturing capability. But in 2007, Chinese prime minister Wen Jiabao made public his conclusion that this model had become unstable and unsustainable, because it was too reliant on supply-side factors and not enough on domestic demand.

Roach cites Wen's characterisation of this year's market recovery as "shaky" to demonstrate that the premier understands the problem. Yet Chinese stimulus has been largely focused on fixed investments. If America has its 'cash for clunkers' programme, China has 'cash for bridges', Roach says.

Instead, he says, China must make a massive and sustained investment in social safety nets, and build social security, state pensions and insurance for medical and unemployment needs. So far, Beijing has only committed itself to "baby steps". The $82 billion national Social Security Fund can pay only $90 per urban worker for a lifetime of social-security benefits. The recently announced healthcare scheme can cover each person for only $30 per annum for three years.

"The high level of fear-driven forced savings must be put to work," Roach says. "If China does this, the rest of Asia will follow."

One reason he is optimistic that this will happen is that there really is no alternative. Current policy has been on the wrong track because too many people and vested interests in China are hoping the US consumer will stage a recovery. Roach characterises the typical analysis coming out of China on US recovery as pinning hopes on policies from President Barack Obama and Federal Reserve chairman Ben Bernanke. But this is fantasy, Roach argues. Hence, Asian governments will soon realise they must change tack and draw on their own consumers for sustainable growth.

In fact, the 2006 five-year economic plan promoted by Beijing was meant to do just that. But the government didn't follow through, because the Chinese were just as dazzled as the Americans by the explosive growth in global trade. Chinese GDP growth of 11-12% brought riches beyond anyone's expectations. The pro-consumer agenda went ignored.

Today, however, export growth is negative, and millions of factory workers in Guangdong have lost their jobs. "This is China's wake-up call," Roach says.

He acknowledges that the current generation of urban workers has been shocked by the destruction of the iron rice bowl and mass retrenchments. It will not be easy to convince these people to stop saving. But a loud and bold pronouncement by Communist Party leaders would at least set the stage for an eventual shift in consumer behaviour, Roach says.

A positive side-effect of moving towards a consumer-led model of economic growth would allow China to reduce its reliance on polluting factories. "A service-based economy is lighter and greener," Roach notes.

He also acknowledges that the Western example of welfare states is not one to be followed blindly. He is not calling for a US-style consumption binge levered off of bubbly assets. China is so far from transitioning to a domestic economy because people feel like they need to save for a rainy day that any such consumer boom is unlikely anyway.

As for the mismanagement of welfare systems in the West, Roach makes a distinction. Using the US as an example, he says America's social security programme can be put on a sounder footing with some relatively easy technical fixes, such as raising the retirement age.

The bigger issue is healthcare. China may also face a healthcare crisis 10-15 years from now, as its population starts to grey rapidly. All the more reason to put in place a proper safety net, lest China's demographic problems threaten to overwhelm it down the road.