August 19, 1999
Fearing Deflation, China Orders a Ban on New Factories
Amid Unrest, Chinese Face an Ugly Reality: Deflation (July 24)
China from Microsoft Encarta Concise Encyclopedia
Join a Discussion on China's Future
By SETH FAISON
EIJING -- In a drastic move aimed at reversing a steady fall in
prices, Chinese officials announced Wednesday that they would ban
construction of any new factories that make a broad range of
ordinary consumer items, from refrigerators and air conditioners to
candy, apple juice and liquor.
The ban also covers the construction of luxury hotels, apartment
and office buildings, and department stores, which have also
suffered sharp falls in prices for many months as the market has
become glutted. In some Chinese cities, these buildings sit empty
or barely used.
By withholding approval for any new production lines, while
allowing existing output to continue, officials apparently hope
they can shackle China's deflation, a self-perpetuating spiral of
falling prices and falling demand that has become a serious new
economic threat in Asia's biggest country, where growth has started
China's economic troubles are compounding just as modest
revivals are happening elsewhere in Asia, where a severe financial
crisis flared two years ago and sent shudders through markets
around the world.
Prices of consumer goods in China have fallen for 22 months in a
row. While that is good news for Chinese consumers, fewer and fewer
of them are buying. Instead deflation is causing many factory
stockpiles to overflow, and forcing producers to suspend their
output, even though most are required to keep paying the same
number of workers.
Deflation also is prompting price wars among many producers, a
new phenomenon for Chinese officials that they find unsettling.
"Producers have resorted to malicious competition by slashing
prices drastically for survival," was how the official New China
News Agency put it Wednesday as it announced the ban, which begins
Sept. 1. How long the ban would last was not announced, and it was
unclear if the ban was aimed at industries that produce goods for
It also was unclear how effectively the ban will be enforced.
Although it applies to producers of consumers goods all over the
country, such central directives are often quietly ignored.
Still, economists expressed concern that the ban includes hidden
dangers that could actually worsen the deflation problem.
Nicholas Lardy, a senior fellow at the Brookings Institution in
Washington who specializes in China, said the ban could aggravate
the situation by forcing cutbacks in construction jobs.
"It could mean less employment and more deflation," he said.
"With fewer people working, demand will go down."
In many industries, state regulators have imposed minimum prices
to try to prevent producers from undercutting each other with price
slashing. Meantime, financial authorities have authorized several
interest rate reductions to spur consumption by lowering the cost
of borrowing. But the success of that effort has been limited.
Weak demand for consumer goods has grown out of a serious
deterioration in consumer confidence. Many ordinary consumers fear
that the economy will continue to weaken, and that it may lead to
job losses and a reduction of welfare benefits, including pensions.
So instead of spending their money they are saving it.
Some Chinese economists have gently begun recommending that
Beijing consider a devaluation of China's currency, the yuan. That
would theoretically help stem deflation by raising the cost of
imports and would stimulate the economy by raising foreign demand
for China's exports, which have been falling. But a devaluation
could have destabilizing effects in China and elsewhere in Asia by
unnerving foreign investors and raising the cost to China of
repaying foreign loans. It appears that the authorities remain
unwilling to devalue the yuan for the time being, at least until
they see if falling exports and prices can be controlled.
"The yuan is unlikely to be devalued this year and early next
year," Joe Lo, senior economist at Citibank in Hong Kong, told
Reuters. "A devaluation can be an option if exports continue
performing poorly and the economy is not improving after exhausting
China's trade surplus in the first half of 1999 reached $8
billion, down from $22.5 billion a year earlier. Exports in the
first half fell 4.6 percent while imports surged 16.6 percent. At
the same time, foreign direct investment declined 9.2 percent to
Government economists have said that if Beijing does decide to
devalue its currency, it is likely to orchestrate a gradual process
in several steps, unlike the last time it devalued in 1994, by 33
percent, in one step.
For China's leaders, long afraid of inflation and the potential
social disruption it could cause, deflation is a new phenomenon
that few took seriously until recently. But it has continued for
much longer than anyone expected, and now threatens to seriously
undercut government projections that economic growth will reach 7
percent this year, compared with 7.8 per cent in 1998.
"China doesn't need a cheaper currency," wrote Gilbert Choy,
head of China research at Dresdner Kleinwort Benson Securities
(Asia), in a recent report. "Chinese exports continue to gain
market share in their major overseas markets. More important, the
growth of exports is roughly in sync with the recovery of China's
Choy argues that because a substantial percentage of China's
exports involve processing of imported materials, even a
substantial devaluation is unlikely to strengthen exports by much.
"The real solution is to have the central bank, the People's
Bank of China, print money," Choy wrote. "The best way to give
the economy a boost is to inject a massive dosage of wealth effect,
changing the psychology of consumers to expect a rise in permanent
Other economists recommend that Beijing continue to expand its
issuing of treasury bonds to finance the setting up of a social
safety net, including a nationwide social security system and a
national medical insurance plan.