“Desperation and resignation in Shanghai”
“China’s upcoming recession.”
“The greatest growth story in human history coming to an end.”
Headlines like these are now commonplace in the global media, and for good reason.
For months, China’s state media had been encouraging people to invest in stocks amid skyrocketing share prices, making Shanghai the world's best performing market.[i] Today, it shows all signs of a textbook bubble on the verge of popping. As the $6.8 trillion equity market collapsed drastically last month, wiping out almost $4 trillion in market value, government interventions failed to inspire confidence, challenging the long-held conviction that Chinese authorities have a firm grip on the economy.[ii]
China's debt is now over twice its GDP[iii], and the total trade has slumped far below Beijing’s official target.[iv] If the $10 trillion economy were to go into recession, it would be the first global slump over the past 50 years without the U.S. contracting. And neither the Chinese government nor the rest of the world seems to be prepared for it.
While it is understandable that the country cannot maintain the astronomical growth rates of the past forever, and that economic growth in a capitalist system is inherently uneven with brief periods of economic contraction, this only raises further questions about China’s economic governance and its uncertain future.
The Chinese Dominoes
Over the last 60 years, countries such as Japan, South Korea, and Taiwan have emerged to close the gap with the developed world by depending on export-led growth. This, however, is not a possibility for China. Home to almost 20% of the world population and responsible for 15% of global output, China just cannot depend on the rest of the world’s import demand. For any export-driven system to work, the seller’s economy needs to remain weaker than those of its buyers. As China's growth accelerates and European and American growth slows, China's wages are catching up faster than anyone had anticipated. As China gets too wealthy to continue exporting cheap products, and developed economies simultaneously become too weak to keep buying them, the Chinese economy needs to transition rapidly. As premier Wen Jiabao put it in 2007, China's economic model of skyrocketing export-based growth is "unstable, unbalanced, uncoordinated and ultimately unsustainable."
Having pioneered a manufacturing industry making cheap products for the world, China's next attempt at keeping the economy moving was to funnel huge amounts of money into massive state-run infrastructure projects. While this investment boom kept China’s urban employment growing strongly for a while, a lot of that spending is now seen as waste, and the growth unsustainable. After all, a country needs only so much in terms of empty housing projects, airports, and hotel complexes. China has now surpassed Japan and South Korea in square meters of housing per capita, and is at a level near or above the European average.
As with export industry, the infrastructure sector is also at saturation point, and is no longer a productive place to put your money in. As Beijing kept dumping money into real estate projects, it looked like they would grow forever, encouraging Chinese consumers to pour their savings into such unwise investments. The lack of a liberalized financial sector limited their options as it is, and given the abnormally high participation of retail investors (85% of trades), Chinese markets have always been driven by rumor and emotion with high volatility.
China seems to be mimicking the Japanese economy’s path to its “lost decade”, which was marked by a real estate market crash. In Japan, land served as collateral on loans so as land values plummeted and the economy went into a tailspin.
By 2011, 13% of Chinese GDP came from real estate investment, and urban housing stock constituted 41% of Chinese household wealth. There were far too many elephants in the room to count, and the fact that Chinese leadership didn't take any steps to avert these disasters is more revealing than any other: perhaps it’s just not in their power.[v]
While China's growth created some very powerful industries, it also built powerful interests. State-run industries and rich elites hold an awful lot of power in China, as firms that made a lot of money became politically connected, and vice versa. They benefited generally from the status quo, leading to prioritization of state-owned enterprises (SOEs), and industries such as export and construction, that are not considered healthy outlets for economic growth.
Today, SOEs are a haven for unsustainable debt, and overinvestment is rampant thanks to open access to subsidized credit and lack of incentives to contribute dividends to government social security funds. As the elite resisted all attempts to redistribute wealth among the general population, Chinese households have been forced to maintain high precautionary savings, undermining the domestic consumer economy.[vi]
Whose Market Is It Anyway?
Another not-so-normal aspect of the Chinese economy is the low level of domestic consumption (about 35% of GDP[vii], compared to the US’s 70%). Switching over to a consumption model more focused on wage increases, productivity, and efficiency thus makes sense for China, the world's biggest market of consumers.
But in order to boost domestic aggregate demand, China needs a shift in the distribution of income toward households. Given that China’s economic rise has seen a mostly jobless growth, households seem to have largely missed out.
Even the manufacturing sector did little to create jobs, largely because relatively high productivity growth constrains demand for more workers. China’s industrial production is also extremely capital-intensive due to the distortions wrought by preferential access to cheap credit, favourable tax treatment, and public investment support. The government’s interventions have also limited the growth of private-sector firms by impeding their access to finance. Thus, SOEs employing only 13% of the workforce absorb half of all investment.[viii]
As China rose in the late 70s by imposing its plans on the people, chaotic democracies such as India were left struggling, and it seemed that a repressive model is conducive to economic development, an assumption that no longer holds water.
For every fundamental challenge faced by the Chinese economy, its only response has only been repression, with the vision being limited to maintaining the status quo. This top-down approach functions well only in a predictable environment, which cannot coexist with today’s dynamic and globalised economy.[ix]
Thus, China's leaders have simply been kicking the can down the road, reaching a point where maintaining power through censorship, propaganda, and riot police alone is no longer possible. While democracies can vote incompetent governments out of office, popular discontent in autocracies can be far more dangerous.
This also exposes the irony of China’s mutant communistic capitalism. While Adam Smith believed that impersonal markets ensure the most efficient allocation of scarce capital, the Chinese leadership wants markets that operate only on their terms. They want a stock market without the possibility of large losses that can shake confidence in the government’s credibility and control. But that is a market that has never been known to exist. One may depend on the markets, but one is not supposed to trust them.[x]
At least as far as China’s short-term problems are concerned, Beijing’s ample financial resources should be able to able to ensure recovery through slower, continued economic growth. China’s high national savings rate also means that it does not have to borrow liquidity from abroad or print large amounts of money.[xi]
China’s greater integration with the global economy has also provided a cushion. For example Chinese efforts to stem recent market volatility were backed by the IMF, who maintained that the turbulence is just a reflection of an immature market, and is continuing the process to get the yuan included in its basket of reserve currencies, which could spur greater market liberalization.[xii]
As liberalization occurs, China should also accelerate the shift about to a services-led growth model for curbing unemployment, thus containing potential resentment among migrant workers (about 300 million people – or the entire US population[xiii]). As the services sector requires fewer commodities and less energy, this transition will also help address the country’s growing environmental problems.[xiv] Moreover, bolstering employment growth can also up the domestic consumption leading to improved Chinese citizens’ wellbeing, and greater social stability.
The Chinese roller-coaster ride also serves to prove that while authoritarian systems may have short-term successes and offer cosmetic solutions to irresponsible policies, they are unsustainable in the long run. No matter how strong the party line may be, a lack of accountability inevitably produces corruption and inefficiency.
For China, accepting lower growth provides a crucial opportunity to support stable and sustainable development. If China’s leaders stay the course of reform and rebalancing, the entire global economy will be better off.[xv]
[i] Steven Jiang, “‘Ground Zero’ China’s Stock Crash up Close - CNN.com,” CNN, July 9, 2015, http://www.cnn.com/2015/07/09/asia/china-stock-market-ground-zero/index.....
[ii] Ye XieGavin Serkin, “China May Tip World Into Recession: Morgan Stanley,” Bloomberg.com, July 14, 2015, http://www.bloomberg.com/news/articles/2015-07-13/china-may-tip-world-in....
[iii] Ye Xie and Belinda Cao, “China’s Debt-to-GDP Ratio Just Climbed to a Record High,” Bloomberg.com, July 15, 2015, http://www.bloomberg.com/news/articles/2015-07-15/china-s-debt-to-gdp-ra....
[iv] Agence France-Presse, “China Trade Slumps in First Half of Year, Dealing Blow to Global Economy,” The Guardian, July 13, 2015, http://www.theguardian.com/business/2015/jul/13/china-trade-slumps-first....
[v] Max Fisher, “China’s Authoritarianism Is Dooming Its Economy,” Vox, July 9, 2015, http://www.vox.com/2015/7/9/8916609/china-economy-crash.
[vi] Adair Turner, “China’s Real Reform Challenge,” Project Syndicate, June 12, 2015, http://www.project-syndicate.org/commentary/china-reform-challenge-by-ad....
[vii] Michael Spence, “China’s Slowing New Normal,” Project Syndicate, April 28, 2015, http://www.project-syndicate.org/commentary/china-new-normal-investment-....
[viii] Keyu Jin, “China’s Jobless Growth Miracle,” Project Syndicate, June 1, 2015, http://www.project-syndicate.org/commentary/china-jobless-economic-growt....
[ix] Shashi Tharoor, “China’s Brittle Development Model,” Project Syndicate, July 14, 2015, http://www.project-syndicate.org/commentary/china-authoritarian-and-indi....
[x] Pranab Bardhan, “The Contradictions of China’s Communist Capitalism,” Project Syndicate, July 16, 2015, http://www.project-syndicate.org/commentary/china-stock-market-crash-com....
[xi] Zhang Jun, “China’s Credit Overdose,” Project Syndicate, March 28, 2015, http://www.project-syndicate.org/commentary/china-credit-overdose-by-jun....
[xii] Ian Talley, “IMF’s Lagarde Says China’s Economy Can Withstand Market Turmoil,” Wall Street Journal, July 29, 2015, sec. Markets, http://www.wsj.com/articles/imfs-lagarde-says-chinas-economy-can-withsta....
[xiii] Zack Beauchamp, “China’s Real Economic Problem Is Way Bigger than the Stock Market,” Vox, July 9, 2015, http://www.vox.com/2015/7/9/8922727/china-economy-stock-market-problem.
[xiv] Stephen S. Roach, “China’s New Normal and America’s Old Habits,” Project Syndicate, March 30, 2015, http://www.project-syndicate.org/commentary/china-new-normal-risks-by-st....
[xv] Yu Yongding, “China’s Slow-Growth Opportunity,” Project Syndicate, April 9, 2015, http://www.project-syndicate.org/commentary/china-economic-slowdown-by-y....
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