Some structural flaws could hinder the health of China's economy if not handled properly, even though gross domestic product grew by 8.2 per cent year on year in the first half of this year, warned an article in Outlook Weekly.

The article by Xu Lianzhong - "Three latent problems in economic development" - was published in the August 18 issue of Outlook Weekly.

A particularly sticky problem is that consumption and investment - two major driving forces of economic growth - have grown "exceedingly out of tune" with each other, Xu Lianzhong said. Investment growth in recent years has far exceeded the growth in demand as a result of the government's proactive fiscal policy, which features massive State investment.

In 2000, China's fixed-asset investment increased by 10.3 per cent compared to the year before, by 13 per cent in 2001 and by 16.1 per cent last year. These figures compared to consumer retail growth rates of 9.7 per cent, 10.1 per cent and 8.8 per cent in the same years.

Fixed-asset investment in the first half of this year surged by 31.1 per cent year on year, while the consumer retail volume increased by only 8 per cent - partly because of the outbreak of severe acute respiratory syndrome (SARS).

GDP growth in the first half of this year was almost solely propelled by fixed-asset investment, Xu said. The amount of that investment increased by about 488.4 billion yuan (US$59 billion) compared to the same time last year. That increase was even higher than the increased GDP value of 451.7 billion yuan (US$54.6 billion).

Investment-driven economic growth is generally believed to be unsustainable because it is difficult to absorb new productivity generated by investment without equal growth in consumption.

Xu recalled the boom of the late 1980s and mid-1990s, when consumption grew in line with investment. He said the sluggish consumption at present is a direct obstacle to a new boom cycle.

An imbalance between the manufacturing sector and the service sector is another problem standing in the way of further economic growth, said Xu.

The output of the service sector rose by only 4.2 per cent year on year in the first half of this year.

In contrast, the manufacturing sector soared by 11.4 per cent in the same time, making up 78 per cent of GDP growth.

The service sector's languid performance has seriously curbed employment and increases of private income. This will, in turn, force people to tighten their purse strings.

Under such circumstances, the prosperity of the manufacturing sector is likely to result in excessive production, said Xu.

As the prices of production materials are still rising despite weak demand, many enterprises could suffer declining profit margins or even go into the red, Xu warned.

Key resources such as machinery and raw materials - defined as the means of production - saw a price rise of 6.5 per cent in the first half of this year.

However, the consumer price index increased by only 0.6 per cent, and the retail price index slid 0.4 per cent.

The situation is likely to end in a decline in prices of upstream industrial products rather than a rise in the prices of consumer goods, considering that there is already an excess supply of consumer goods and a slow growth in private incomes, Xu pointed out.

The price rises of upstream materials has meant a considerable increase in costs for many enterprises, forcing some firms to cut output or even close.

A typical case is the sharp rise in steel prices earlier this year, which put many Chinese shipyards into difficulties.

Pressed by shrinking demand, some upstream industrial products showed signs of price decreases in June, Xu noted.

The key to solving these structural problems is to create more jobs and increase private incomes to stimulate spending, he said.

The increase in private incomes has lagged far behind GDP growth in recent years. In particular, the income of farmers and poor urban residents has been almost at a standstill since the late 1990s.

Between 1995 and 2000, the income of urban residents increased by an annual average of 6.2 per cent and that of rural people increased by 4.6 per cent on average. These rates were much slower than the average annual GDP growth of 8.1 per cent in the same period.

The government needs to adjust its taxation policy to strengthen private incomes and relieve the widening wealth gap between different social strata, said Xu.

A social security network should also be developed to encourage people to spend money, he added.

While economic reforms are forging ahead, a social security system covering pensions, housing, healthcare and unemployment insurance has yet to be completed.

Therefore, people tend to cut back on their spending but save more money in the bank for a rainy day.

Despite a slowdown in income growth, the balance of private deposits in banks surged by 19.5 per cent year on year in the first half of this year to more than 10 trillion yuan (US$1.2 trillion).

The government can opt to increase financial subsidies, issue special welfare bonds or sell some State assets to solidify the social security funds and ease people's misgivings about spending, Xu suggested.

It should also offer some preferential policies such as tax exemptions to help develop the job-generating service sector, he added.

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