Recently Newsweek's Duncan Hewitt spoke to Nicholas Lardy, a leading commentator on the Chinese economy at the Peterson Institution for International Economics in Washington D.C., about the global financial crisis and its implications for China.As export growth slows, China faces renewed pressure to boost domestic consumption, and stimulate its service sector.  Several prominent Chinese economists at a recent conference organized by the Shanghai Academy of Social Sciences emphasized that China had relied too heavily on manufacturing in recent years.   Lardy went further by explaining how the export boom of the past few years, and the resulting over-investment in manufacturing, had had a significant negative impact on the service sector. He said low interest rates and an undervalued currency were two of the main culprits. Excerpts:

Hewitt: How serious is the imbalance between manufacturing and services in China, in your view?

Lardy: There’s increasing evidence that China’s whole growth pattern has been distorted over the past five years: the share of investment going into manufacturing has doubled – and that’s just official data. There are several complementary reasons for this: one is recovery from the last slowdown in late 90s, when the share of narrow manufacturing declined to just 15 per cent which is really low – now it’s up to 30%. Also the undervalued exchange rate has increased the profitability of tradable goods.  More recently there’s also been the under-pricing of energy, which is significant.   We’ve also had an under-pricing of capital: if you can get a bank loan, the cost of capital is zero in the current environment - and that obviously favors capital intensive things over less capital intensive things, so it helps manufacturing.  For service industry the availability of cheap capital is not so important, but if you’re adding ten million tons to your steel capacity it’s very important.