The Conference Board, an international economic-research organization financed by donations from large corporations, is out with a new report claiming that the Chinese economic miracle is over, and that things are about to get sticky for what is now, by some measures, the world’s second-largest economy. During the next few years, China probably faces a period of turbulence and uncertainty, as well as the possibility of a serious financial crisis, the report says. And, over the long term, it will have to be content with annual G.D.P. growth of about four per cent—less than half the rate seen in recent decades.
It’s not surprising that the Wall Street Journal and other media outlets have picked up on the report. Its conclusions, if they hold up, have important implications for everything from the future of the Chinese Communist Party to the price of oil to the security situation in the Far East. But how plausible are they?
Some things we know for sure. The Chinese economy, after growing at an average annual rate of about ten per cent between 1993 and 2011, is already slowing down. This year, G.D.P. growth is expected to be about seven per cent. By Western standards, that’s a very rapid rate of expansion: recent estimates peg the long-term growth potential of the U.S. economy at about 2.5 per cent a year, or even less. The Chinese government, which helped engineer the recent slowdown by restricting the supply of credit (for reasons I’ll get to in a moment), would be delighted to see seven per cent growth continue indefinitely. If such a rate could be sustained for the next ten years, the Chinese economy would once again double in size, and it would overtake the U.S. economy as the world’s biggest. (In terms of domestic purchasing power, this may already have happened. Earlier this month, the Financial Times, citing data from the International Monetary Fund, reported that China’s G.D.P., when it is adjusted for the fact that the prices of many things are considerably lower there, is already slightly bigger than American G.D.P.)
But can Chinese policymakers pull it off? They face two separate challenges. Right now, the task is to slow things down without precipitating a property crash and a banking crisis. After a period in which the amount of credit being extended has grown much faster than G.D.P., and in which property bubbles have emerged in some cities, this won’t necessarily be easy. The second challenge is to make the transition from one growth model to another—from expansion fed by the country’s resources, and by heavy investment in industry and the recruitment of hundreds of millions of workers from rural areas, to growth that relies more on innovation, increased productivity, and consumer spending. The authors of the Conference Board report, David Hoffman and Andrew Polk, argue that the China optimists have underestimated both of these tasks. “In the short term (i.e., the next two or three years), we have difficulty seeing anything but a rocky and turbulent adjustment,” the report says. And it goes on: “The full transition of China’s economic growth model is likely to be a long slog as it presents many challenges: political, economic, social, and even cultural.”
I find it hard to argue with the first conclusion. The report shows just how reliant China has become on credit growth, particularly on bank loans to property developers and other businesses. “Private sector debt, now at almost 200 percent of GDP and up from 117 percent at the end of 2009, is still accruing at 15 percentage points per year,” the authors note. This pace of credit creation is unprecedented for China, and the result has been over-all debt levels that are now “well in excess of the thresholds that have historically triggered financial crises in other countries.”
If China were a fully capitalist economy, the outcome would be eminently predictable: a 2008-style “Minsky moment” in which something bad happens, creditors panic, new lending dries up, and a crash ensues. China would join the United States, the United Kingdom, South Korea, Argentina, Mexico, and a long list of other countries that have experienced credit binges that ended badly.
The complicating factor is that China, despite all its reforms, is still a country where the government controls large segments of the economy, including much of the financial sector. If there’s a crisis, optimists say, the government will step in and rescue lenders, writing off many of their bad loans. And the fact that people are aware of this will help prevent a crisis in the first place. (When depositors and investors know there’s a safety net in place, there’s less incentive for a bank run.) “Even if a huge swathe of loans go bad, the consequence is unlikely to be a Lehman-style financial collapse,” the editors of The Economist argue in this week’s issue. “For that, thank the Chinese regime’s vice-like grip on its financial system.”
The Conference Board analysts aren’t reassured. They argue that, as the rate of economic growth falls and bad debts pile up, there may well be too many stricken lenders for the state to rescue. And, even if the government does step in, the economic consequences will be severe. “While it is difficult to determine with precision when the breakpoint will be reached … a major deleveraging must occur at some point—it cannot be forestalled forever,” the report says. “Nor can China grow out of the problem. Anticipated nominal GDP growth comes nowhere close to being able to service the debt that has been accumulated since 2009. Something’s got to give.”
It shouldn’t be very long before we know which side in this debate is right. However, it could be decades before we know whether China has succeeded in adopting a new growth model. The pessimism that runs through the report is based on two questionable assertions: that China has already exhausted much of its potential for “catch-up” growth—the sort that comes from getting a late start in industrializing—and that its Communist government is incapable of introducing productivity-enhancing reforms.
Even after all the progress China has made, it isn’t a rich country. According to World Bank data, its per-capita G.D.P. in 2013 was $6,807, which puts it on about the same level as Iraq and South Africa. By comparison, per-capita G.D.P. in the United States was $53,143; in South Korea, it was $25,977. Looking at the experience of South Korea and other “Asian tiger” economies, there is no obvious reason for the rate of economic growth to slow down dramatically at the income level China has reached. Unless, of course, the government puts a wrench in things.
That’s what the report says is likely to happen. The Communist regime is so tied up in the current system, it argues, that it won’t be able to introduce necessary changes. Rather than dealing with the debt problem, modernizing the tax system to encourage consumption, and promoting competition, the government will stall and stall, “because of the impact reforms would necessarily have on the business interests and financial fortunes of elites and their families across all levels of government in China.”
This is a powerful argument: if you run a state-owned bank in a provincial Chinese city and your brother is the biggest real-estate developer in town, you may well be reluctant to refuse him a loan. But the report may push the critique too far. In addition to corrupt local officials, the Chinese Communist Party contains plenty of highly educated technocrats who are devoted to expanding the country’s power and influence, and they aren’t just sitting on their hands. Credit has been tightened, the value of the currency has been allowed to rise modestly, and a vigorous anti-corruption campaign has been launched. The reforms haven’t gone far enough, but they can’t be wholly dismissed.
China shouldn’t be underestimated. Whatever one thinks of the authoritarian state-capitalism model, its success in building industries from scratch cannot be denied—and I’m not just talking about low-value-added activities, such as manufacturing clothing and assembling electronic devices. In inviting foreign companies to operate in China only if they did so in partnership with local companies, Beijing helped lay a basis for industries that now produce everything from automobiles to electric power to commercial aircraft to high-resolution liquid-crystal displays. These new industries provide plenty of avenues for raising productivity. China is already the world’s biggest purchaser of industrial robots, for example, outpacing both Germany and Japan.
Rather than focussing on China’s record of success, Hoffman and Polk emphasize over-investment, cronyism, and discrimination against foreign competitors. “Local champion firms now span all sectors, from industrials to consumer to services,” the report laments. “They enjoy opaque, non-market competitive advantages that serve to smother the real private sector and its dynamism. In many sectors, these firms have emerged as the chief competitors for MNCs.” (“MNCs” stands for “multinational companies,” such as General Electric, Monsanto, and Intel, all of which happen to be financial supporters of the Conference Board.)
If you speak to senior executives from some of the big firms that have set up operations in China, they will tell you, off the record, that China’s success was built in part on the theft of their intellectual property. If that’s true, it’s pretty similar to what American textiles manufacturers did to British market leaders during the early nineteenth century. The jackdaw strategy worked for the Americans then, and it has worked for the Chinese over the past twenty years; but it’s only part of the story. In addition to bringing in Western expertise, the Chinese invested heavily in infrastructure and education, particularly scientific education. This strategy provided a platform for rapid growth which, once China gets through its current problems, could well prove more durable than the Conference Board report acknowledges. But it’s an interesting and provocative study.
