In posting 100, an extremely positive description of China as a super-growth economy was given. However, there is always the other side of the coin, and the one in this case -- the renminbi, literally the "people's coin" -- is that the Chinese authorities are constantly worried by the possibility of social breakdown unless the present growth rates are maintained. Considering the whole history of China of probably nearly three thousand years' duration, then at least a thousand years of it were spent in rampant warlordism and civil breakdown.

The situation in China today is somewhat reminiscent of England in the 19th century -- or at least, of the first half of it. At the same time as the seedcorn for prosperity was being sown there was also incipient unrest when working class radicals were holding meetings all over the North and the Midlands demanding reform and cheaper food. Those who attended one in Manchester at St. Peter's Fields in 1819 were hacked down by the yoemanry with bare sabres. Eleven people were killed in what has been known since as the Peterloo Massacre and over 400, including 100 women, were injured. In the following year, the 10th Hussars were called out to dampen down what the authorities imagined to be an armed uprising in Glasgow. Indeed, this is one of the reasons why Acts of Parliament enabling railway companies to compulsorily purchase land were so swiftly passed in the 1830s and onwards. As a byproduct of the commercial reasons to build them, the railways also enabled the government to move regiments from one end of the country to another very rapidly if the need arose in order to squash civil disturbances.

Considering that, at any one time, scores of millions of Chinese from the countryside are entering the large cities looking for work and accommodation, then the possibility of sizeable demonstrations, if not serious uprisings, cannot be ruled out. The memory of the student demonstrations in Tienanmen Square in 1989 that were squashed by Deng Xiaoping is still quite fresh in the mind of the Chinese Politburo. One of the reasons why Deng Xiaoping put the demonstration down so forcibly was that his own son had been crippled by similar student demonstrations during the Cultural Revolution in Mao Zedong's regime. Otherwise, Deng Xiaoping was one of the greatest reformers in world history. Besides, Tienanmen Square was not really about demands for democracy -- as is so often claimed in western newspapers. It was an opportunistic use of the general feeling of anger felt by urban (though not rural) populations at the time against the austerity measures that the authorities had imposed. And this is the current fear, too. If the Politburo try to rein back the present hectic growth rate too sharply and thus frustrate the millions of unemployed in the streets of the large cities then further sizeable demonstrations cannot be ruled out. This is why China still has a large army even though there is no prospect in sight of any sort of traditional war with neighbours.

But apart from the ever-present possibility of general social unrest, the rejuvenation of the Chinese economy is different in many other respects from the industrial revolution in England in the 19th century. It is much faster, for one thing. For another, unlike the Chinese, the English created their banks as they went along. The financing of business was mainly carried out by a multitude of small country banks which sprang up as they were needed and grew as they were needed. Many of them collapsed because they made bad risk judgements, but many also survived because they became skilled at assessing the risks of the various enterprises in their area. In time these amalgamated into the large retail banks that we know today. However, the mainland Chinese have never had those sorts of banks -- at least within living memory. What they have are a few mammoths that were bequeathed to them by the Communist regime (that is, when China was communist in fact as well as name). These banks are still loaded down with debt because the large state industries they financed were not profitable. They're not so much banks as warehouses of money -- but also of non-performing loans (NPLs). So this is another big difference. If China could magically sort out its banks overnight and get rid of its NPLs then the economy would be able to grow even faster without overheating and absorb many more of the unemployed. But there is, at present, a big danger of property assets becoming overpriced, ballooning out of control and then suddenly collapsing as they did in Japan a decade ago -- and from which it still hasn't recovered. In Japan this has held back the growth of a general prosperity that was already at a high level, so it has not had revolutionary consequences, but if the same were to happen in China then the frustrations of scores of millions of ex-peasants would be dynamite.

So that's the other side of the renminbi. The following is the second of a five-part series on China from the Financial Times:

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CHRONIC OVERINVESTMENT, EXCESS SUPPLY AND ENDEMIC CORRUPTION: CAN CHINA KEEP ITS BOOMING ECONOMY ON TRACK?

Political reform and market disciplines are imperative to curtail imblanaces. But with 30 million unemployed, Communist leaders are afraid of igniting social chaos

James Kynge

The name Wuhu means "reed lake". And until the mid-1990s it seemed an apt description for an urban backwater on the Yangtze river distinguished by little except a crumbling, mildewed cathedral built long ago by the British.

But over the past five years, largely unnoticed, Wuhu -- the second city in Anhui, a poor central province -- has been seized by the type of transformation that is driving China's economic expansion.

The process is not pretty. Youthful labour is consumed amid a clash of steel; jobless girls are forced into prostitution; the intellectual property of foreigners is stolen; and the gulf between rich and poor grows wider. But the combination of energy, suffering and guile has brought results. Wuhu is now served by four expressways, a bridge over the Yangtze and a busy port, all built or expanded since 1998. Some 250m people -- equal almost to the population of the US -- can be reached within 10 hours, according to Chen Xiaosu, Wuhu's deputy mayor.

Its new-found accessibility has sired an investment boom. Makers of car parts from the US and Europe have set up shop. Midea, the world's biggest maker of air- conditioners, recently moved a factory to Wuhu from near Hong Kong because of lower labour costs. Yoshii Jiro, the local boss of Hitachi, another recent arrival, says Wuhu provides the lowest costs anywhere for the Japanese multinational.

Down the road from Hitachi is Wuhu's favourite son: Chery, the first entirely Chinese company to make a successful modern car. No matter that both Volkswagen and General Motors have alleged gross theft of their intellectual property. Chery employees are fired by a sense of pride. "It took just 33 months to build our first car from scratch," says Zhang Ping, assistant to the general manager. "When it came off the production line nobody could hold back their emotions. Even the boss was in tears."

Such are the endeavours -- multiplied in thousands of nameless cities throughout the world's most populous nation -- that underpin China's boom. The value being created in places such as Wuhu is real and the lives of hundreds of millions of Chinese have changed beyond recognition.

What is not so clear, however, is how long it can continue. Almost as quickly as some parts of China's economy create value, other parts destroy it.

Official figures show an average annual growth rate of 8.6 per cent since 1980, a pace that -- if accurate -- describes the most striking economic transformation in human history. Yet behind the publicised headline figures, the concealed costs of breakneck development are mounting.

The big question now, not only for foreign investors but also for an increasingly worried Communist government, is whether China's model is sustainable. The government of Wen Jiabao, premier, has begun to canvass ideas from think-tanks, including the World Bank's office in Beijing, on how to espouse a more balanced approach to development instead of the monolineal pursuit of rapid growth.

Multinationals seeking to lower production costs look to China for solutions. The country eclipsed the US last year as the world's top destination for foreign direct investment, pulling in $52.7bn (€62bn) (£32bn). This year China has become Japan's and South Korea's largest trading partner. Its success in generating economic growth has turned Beijing from a critic of globalisation a decade ago into an active member of the World Trade Organisation.

To be sure, foreign companies still face several challenges in the domestic market but, relative to the size of their economies, the Chinese far outstrip the Japanese as consumers of foreign goods.

Any collapse of China's boom would, therefore, be deeply damaging. One early casualty would be Beijing's ability to continue financing the US budget deficit. Without Chinese purchases of its government bonds, the US might face»a rise in domestic interest rates that could threaten its nascent economic recovery.

With so much in the balance, the health of China's economy is a matter of paramount importance. "Sustainability is the key issue now," says Hu Angang, a renowned economics professor at Tsinghua University. "Since 1978 the reform's have aimed at economic advancement but they haven't resolved the fundamental unfairness and resource dislocations in the economy."

The distortions and waste derive from three main shortcomings, all systemic in nature. The first is that China lacks market mechanisms to price capital. The second is that the government, fearful of unrest among the swelling millions of unemployed, is reluctant to allow businesses to fail. The third is the dearth of independent institutions and courts to regulate economic activity.

All three contribute to the symptoms that cloud China's future: overinvestment, oversupply and a rapaciously corrupt officialdom. The dilemma for the Communist party is that the solutions to all three problems require, in varying degrees, the surrender of administrative control to freewheeling market forces and the independent rule of law. "The historic task we now face is building a new national system," Prof Hu says. "The big shift we face is the shift to a new [political] system."

The problem of overinvestment is, for the moment, the most pressing. Seduced by six interest-rate cuts since the Asian financial crisis in 1997 and six consecutive years of fiscal pump-priming, China has gorged itself on easy money. A new Beijing villa complex called "Champagne Town" is just one sign that the bubbles are rising. "I ask people if they know that China has a new national bird," says Prof Hu, pointing to a skyline abuzz with construction. "It is the crane. That is all you see in the sky."

The ratio of investment to GDP is 42 per cent, a figure reminiscent of trends in Malaysia and Thailand before the Asian crisis struck. Money supply at the end of 2002 was 177 per cent of GDP, and banks had on their books some Rmb 4,300bn ($520bn) more in deposits than they could lend. The result is that almost any project proposal wins approval for a loan.

Chronic oversupply has created a cauldron of industrial competition which ensures that if Chinese manufacturers can survive at home, they can often undercut rivals abroad. But price wars and falling profit margins on their core products push many companies into a dizzying effort to diversify. Midea, the air-conditioner maker with a base in Wuhu, has recently launched no fewer than six products: bread-makers, coffee pots, refrigerators, dish-washers, microwave ovens and smoke extractors. Lifan, a big motorbike maker, has expanded into buses, mineral water, paint thinner, imported wine, newspapers, a football team and duck-down garments. It also wants to open a bank.

The wastefulness of such investments is eloquently expressed by a single statistic: of all Chinese manufactured products, 90 per cent are in oversupply and there is a shortage of nothing, according to the National Statistics Bureau.

Eventually it is the banks that pick up the tab for misguided expansions into saturated markets -- and the cost of China's distorted development model becomes clear. Officially, the non-performing loans in the banking system account for just over 20 per cent of total loans. But independent observers, such as Standard and Poor's, the rating agency, put the figure at 45 per cent of GDP. By either measure, China has the weakest banking system of any large economy.

The banks are almost powerless to sort themselves out. With interest rates fixed by the government, loan officers are unable to price for risk. Banks are also rarely allowed to push for the liquidation of a bad debtor. "The proportion of companies that go bankrupt in China [relative to GDP] is less than a tenth of that of the US," says Cao Siyuan, director of the Beijing Siyuan Research Centre. Beijing is so concerned by social unrest that it has put off enacting a new bankruptcy law for more than six years out of a fear that a surge in redundant workers might trigger a rebellion.

Ultimately, it is this issue that presents China with its biggest barrier to sustainable growth. Out of a population of 1.3bn, at least 30m are thought to be unemployed in the cities. A further 150m or so former rural residents are thought to be roaming at any one time from job to job in urban areas. At least another 200m people remain on the land but have virtually no work to do.

These mind-boggling figures show a central paradox in perceptions of China: while the national growth rate of 8-9 per cent appears as a bonanza to the outside world, Beijing's leaders feel trapped in an unending employment crisis. The availability of cheap capital over the past few years has exacerbated the problem. Companies have often found it cheaper to spend money on mechanisation than to employ and train workers. This has resulted in a fall in the number of jobs created per percentage point in GDP growth in recent years, says Li Shuguang, professor at Beijing's Zhengfa University. The number of urban unemployed is rising despite the rate of headline growth, officials and academics say.

This fact, added to an ancient psychosis over social turmoil, illustrates the policy bind in which China's leaders find themselves: they cannot administer the austerity that the economy needs for fear of igniting social chaos. The unemployment crisis also helps to explain why Beijing has not yet scrapped a six-year-old fiscal stimulus programme despite record budget deficits and why it is reluctant to allow an appreciation of the renminbi despite mounting US pressure, academics say.

All this leaves the Communist party with little room to manoeuvre. In order to deliver the growth on which its legitimacy rests, it must pick apart the framework that underpins its own power to release the vigour of an independently regulated market economy.

Yet such a transition is under way. Beijing has been loosening Communist restrictions on where people can live and work; it is set to approve more private banks to compete with its own state-owned behemoths; it is planning to amend the constitution to elevate the status of private business. And slowly, it is trying to create a legal system that is independent enough to keep the rampant corruption of its own officials in check.

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Financial Times 23 September 2003