July 10, 2012


The End Of China's Economic Miracle : China has prospered From double-digit growth--but the bubble is about to burst. (Minxin Pei, 7/09/12, Newsweek)

To put it differently, if not starkly, the recent deceleration means the end of the so-called Chinese economic miracle. The era of rapid economic growth driven by investments and exports is over for China.

To many veteran China watchers, China's economic slow-down is all but inevitable. For the past decade, liberal economists, international financial institutions like the World Bank and the IMF, and China's major trading partners have been urging China to change its state-led development model that has relied excessively on fixed- asset investment and export for growth, at the expense of household consumption. They have repeatedly warned that channeling resources to projects favored by the state would crowd out the private sector and waste precious capital, while squeezing the income for average households and reducing their capacity for consumption. In addition, such a strategy was almost certain to raise trade tensions with the West since rapid growth in investment, by creating industrial overcapacity, would force Chinese companies to dump their excess production on the global markets.

Sadly, for many years, such warnings fell on deaf ears in Beijing. Giddy with the apparent success of the much-touted "Chinese model" and unwilling to undertake the reforms that would make growth more balanced and sustainable, Chinese leaders paid mostly lip-service to rebalancing the Chinese economy. Macroeconomic indicators for the past decade show worsening domestic imbalances, with investment rates consistently in excess of 40 percent of GDP since 2004 and household consumption falling to around 35 percent of GDP in the same period, the lowest for a major economy (by comparison, household consumption accounts for 70 percent of GDP in the U.S.). In the meantime, China's external imbalances, reflected mainly in huge trade surpluses, have grown as well. In 2007 and 2008, China's trade surpluses reached an astonishing 8 to 9 percent of GDP. In the last three years, as Western demand for Chinese goods fell and labor and material costs rose, China's trade surpluses have dropped below 2 percent of GDP.

The deterioration in growth could not have come at a worse time for Beijing. The ruling Chinese Communist Party is in the middle of a leadership transition. Contrary to the popular perception of a decisive leadership, the jockeying for power inside this political oligarchy typically paralyzes policymaking. Outgoing leaders may want to revive economic growth at any cost in order to strengthen their hands in picking successors and save their reputations. But incoming leaders fear that their predecessors' policy may lead to wasteful investments and a build-up of bad loans in the banking sector, a financial mess they do not want to inherit.

A significant part of the problem with the Chinese economy today originated in Beijing's outsized stimulus package in 2009-2010. In response to the global financial crisis in late 2008, the Chinese government stimulated the economy with 4 trillion yuan ($600 billion) in fiscal spending and about 12 trillion yuan ($1.9 trillion) in new bank lending. Altogether, the injection of 16 trillion yuan into the economy, equivalent to 35 percent of GDP over two years, lifted the Chinese economy and earned Beijing plaudits around the world at the time. But most of the money went into fixed- asset investments and real estate, fueling a property bubble, causing inflation, and creating a mountain of bad loans in the banks. In the meantime, Chinese households did not benefit. Their consumption level has barely budged.

Because of the botched stimulus package four years ago, China today faces an excruciating choice. It can certainly make the same mistake again by using a combination of fiscal spending and government-directed loans to inflate growth through more investments. Such a strategy would provide enormous relief to state-owned enterprises (SOEs), local governments, and well-connected real-estate developers sitting on unsold property. SOEs can use the free money from Beijing to expand their empires, local governments can build more white elephants, and real-estate developers can roll over old debts and avoid liquidation. The costs of this option are obvious. While growth in the short term can be raised artificially, it is bound to crash again. Worse still, China's financial system will be saddled with even more nonperforming loans. At present, the government's total debts, both explicit and implicit, are estimated to be around 70 to 80 percent of GDP. As a middle-income country with a per capita of $5,000 but a rapidly aging population, China does not have much room to take on more sovereign debt.

Posted by at July 10, 2012 5:10 AM

blog comments powered by Disqus