China Begins to Feel Economic Shock Waves

China's leaders are worried. The economic chain reaction spreading crisis and confusion across much of Asia is beginning to hit home here, where it's likely to halt building projects and swell the ranks of the poor in the world's most populous nation.

After patterning China's free-market and trade reforms on policies pioneered by East Asia's emerging tigers, the leadership here is watching with concern as economic turmoil engulfs the region.

China's moves toward capitalism and increased trade have fostered a shaky banking system and an overinflated stock-market "bubble" - the same problems that are muting once-roaring tiger economies from Thailand to South Korea.

Yet in China's half-reformed economy, a great wall of isolation still surrounds its financial system, created decades ago when the communist giant was cut off from the West. This isolation so far has protected China from some of the global economic forces that are exposing weaknesses in more-open markets.

"China's banking system certainly has problems comparable to those in South Korea and Thailand," says William Overholt, a manager at Banker's Trust in Hong Kong. "If China doesn't take steps now to reform its economic system, it could end up with an even worse form of turmoil."

Ironically, China may have helped create the current crisis by sharply devaluing its currency, the yuan, nearly four years ago. The move made its exports and labor cheaper than those of most regional rivals.

That set in motion a domino effect as other export-driven economies in East Asia came under increasing pressure to devalue their currencies to stay competitive. That process, accelerated by the current crisis, has now come full cycle, making China appear more expensive to foreign investors and importers.

For the moment, laws that bar freely converting Chinese currency, block foreign banks from equal competition here, and restrict foreign investment in stocks will ward off finance problems that plague more liberal Asian economies, says a Hong Kong-based securities analyst. "Unlike [South] Korea and Thailand, which are creating relatively open and sophisticated economic systems, China is still in transition from a closed, command economy to a market-driven model," she adds.

For decades following China's 1949 communist revolution, Beijing modeled its state-planned economy on the Soviet Union. But China avoided the economic collapse that helped lead to the breakup of the Soviet empire by starting market-oriented reforms and gradual integration with the West in 1979.

Yet China's drive to replace Marxism with free markets has barely touched huge swaths of the economy. State-owned companies still employ roughly 2 out of every 3 urban workers and are managed by party apparatchiks rather than the business-savvy entrepreneurs who run the best private firms.

China's curious hybrid of socialist and capitalist economics has created some schizophrenic statistics:

The economy has been growing at about 10 percent annually for nearly two decades, but state firms are running into the red faster than ever.

While China now has 1 million millionaires, half a billion peasants still earn less than $1 per day.

The fledgling private sector is expanding, but as many as 30 million laborers laid off by the state still can't find jobs - this in a society that lacks comprehensive unemployment benefits.

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