KEY POINTS:
China looks poised to bust records and score the most gold medals at the 29th Olympiad. But all the signs are it will be left nursing a sharp "economic hangover" as the Chinese economy adjusts to the weeks of lost production enforced by authorities trying to bring pollution down to "acceptable" levels for the Olympic athletes.
With the global economy already under severe pressure from the United States' downturn, the credit crunch, and high prices for oil, food and steel, the last thing Western consumers need is for the the world's economic motor to slow down.
But that's exactly what is happening.
The outcome should have been self-evident given that Beijing has imposed extensive restrictions which have brought construction sites to a halt in China's capital, stopped factories from running in the major production belts surrounding Beijing and called a halt to coal mining and steel smelting in neighbouring provinces.
That's on top of the most visible intervention - getting nearly two-thirds of Beijing's traffic off the road.
But the markets did not appear to factor in a short-term Olympics downside until Goldman Sachs released a report on Monday which effectively said that China's outward display of confidence to the world was undercut by economic problems.
The report sparked a sell-off at the Shanghai stock exchange and a few less-than-subtle suggestions that the US investment bankers were simply piqued that China had outranked the US in the gold medal stakes.
In fact the problems affecting the Chinese economy are much more profound than the Goldman Sachs analysis suggests.
On October 1, New Zealand exporters will begin to sample the first fruits of the bilateral China free trade deal as the first round of tariff cuts go into effect.
New Zealand's access to the Chinese market will gradually increase, with many of the predicted benefits expected to come from behind-the-border reforms which cut back regulatory red tape and measures to improve New Zealand companies' ability to tender for contracts to provide services ranging from aviation to environmental technologies.
But the big issue - which has yet to be confronted - is whether persistently high international energy costs will force a change to the Asian economic model which has changed the way Western nations do business: incentivising companies to plug China and its neighbours at the centre of global supply chains.
This year's oil shock has got New Zealanders out of their cars and into public transport. It's pushed up the cost of transport internally, helping fuel price rises for domestically produced goods at the supermarkets and big barns built on the outskirts of towns.
China is also feeling the pinch from the persistently high costs of imported fuels including oil and coal which has trebled in price.
But unlike New Zealand, the Chinese central government subsidises domestic oil and coal. The subsidies are a double whammy. They keep producer costs artificially low, but contribute to environmental degradation by removing the incentives for factory owners and industrialists to use energy more efficiently.
China can go on subsidising its manufacturers and transport operators for as long as it can afford to do so. But it cannot control the international freight market where the costs of transporting containers has escalated since the oil price shock.
The key question for New Zealand manufacturers is at what price point does it become uneconomic to manufacture high-end clothing in China, if it involves first sending material to China before onsending finished products to major markets in the US?
There are a raft of other issues impacting on Chinese production. Chinese news reports say:
* Half the shoe factories in Guangdong have shut as high international freight charges coupled with higher Government-imposed wage rates impact on business efficiency.
* Twenty per cent of about 300,000 small firms in Wenzhou, one of the Zhejiang province's manufacturing hubs, have stopped operation, and, in nearby Yiwu, about 5000 out of its 18,000 factories are facing bankruptcy.
* Chinese firms are now facing difficulties obtaining cheap credit to expand their plants or introduce higher-level technologies to reduce the reliance on cheap labour and energy.
* The Government's exchange rate policy is not as favourable as it was. * There is considerable bottled-up inflation due to subsidised fuels. Inflation is running at just under 8 per cent but long-term pressures are not expected to ease due to reliance on imported fuels, minerals and agricultural commodities.
* Energy demand has levelled off in the short term due to a cutback in external orders.
* The booming sharemarket is off the boil due to the lack of transparency in Chinese companies and the previously skyhigh valuations that have not been backed by results.
* Galloping pollution is taking at least 15 per cent off China's GDP - through resource pressures.
Just before the Games began President Hu Jintao - and his politburo - dispatched officials to all corners of China to report on the state of the economy and the emerging problems which will probably have a longer-term effect than the Sichuan earthquake and the earlier snowstorm.
Hu has pledged to tackle the economic problems once the Games are out of the way. With New Zealand's level of integration into the Asian model it is important for our economic health that he gets it right.
