What a difference five years make. Back in 2008, as Beijing welcomed the world to its Olympic games, it seemed as if it was the next great, unstoppable superpower. Analysts were, with full confidence, running straight extrapolations of its 8-10% yearly growth rates decades into the future. From that time until now, China has approximately replicated the entire US commercial banking system, with overall credit jumping from $9 trillion to $23 trillion and creating what some analysts have called a credit bubble “unprecedented in modern world history.” China’s surging GDP rates in the past decades have mainly been fueled by investment-heavy growth. This model, however, is quickly losing its power, and China’s falling GDP growth rates raise an interesting debate on the roles of investment and consumption in China’s development.
Whether China will be able to successfully rebalance its economy away from investment, or whether it even needs to, is a question perhaps best answered by two Carnegie fellows seemingly of separate views on the issue. Defending investment, Carnegie’s Yukon Huang sees China’s recent unbalanced growth and massive investment as a positive, following the investment-led development models of other East Asian success stories and laying groundwork for higher productivity in its workers. In short, we shouldn’t worry about the high investment rate. Yichuang Wang, a young economics and math undergraduate at the University of Michigan, has written a compelling argument following Huang’s logic. Wang sees the large development imbalance between the coastal and inner regions of China, and the corresponding productivity differences, and surmises that even though the coast might stagnate, the less-developed inner regions will continue to invest and, therefore, “rescue” China’s economy from stagnation through economic convergence.
While both of these arguments are compelling and are tied to fundamental strengths in China’s situation, they both leave unanswered questions. First, while Huang is correct that China is following a development path similar to Japan and South Korea’s, its version of the path is much more intensely investment focused and raises concerns of what the differences could be between the previous models and the model China is following. (I will go into greater detail on this in my next article.) Second, and related to the first, Huang needs to discuss the impacts of the differing political economies of modern-day China and its East Asian parallels and the possible ramifications of these differences. Third, Huang argues that even as the working population begins to shrink and investment opportunities dry up, opportunities for increased worker productivity remain. But he does not ask who will be the consumers of this increased productivity. Chinese steel mills, already inefficient compared with foreign mills, are dealing with overcapacity and flooding overseas markets. This is also true in many other industries, and the Communist Party itself is warning that this over-capacity “will seriously affect the healthy development of the economy.”
Wang might argue that the inner regions would use such capacity for growth. The problem is that they already have and currently are, but might not for much longer, and that his assumption that these provinces’ record growth rates will continue could fall to the effects of malinvestment. A recent New York Times article sheds some light on the situation developing in Shenmu, Shaanxi Province, where gratuitous investment and state-owned enterprise favoritism led to overcapacity, falling prices, and now an inability to pay back previous debt. One story in particular from this article could serve as a metaphor for much of what the Chinese economy is going through:
Liu Linfei, a government official from nearby Yulin, stood on a Shenmu street corner in a T-shirt and shorts on a recent weekend afternoon, outside two high-rise hotels where construction had been stopped just before the windows could be installed. He said he had borrowed 600,000 renminbi, almost $100,000, from a bank shortly before the collapse, at an interest rate of 4.1 percent a year.
Mr. Liu then lent the cash to moneylenders here at an interest rate of 10.4 percent, planning to pocket the difference.
The moneylenders who borrowed from Mr. Liu defaulted, and now he is struggling to repay the bank. “I’m not going to lose my house, because I’m repaying it little by little with money I borrow from my relatives,” he said.
As one might expect from a country of 1.3 billion, a lot of factors come into play – corruption, poverty, domestic and foreign politics, etc, but a key concern here is the risk of malinvestment. While I agree with Wang that the inland provinces have a lot of room to grow and a lot of capacity to expand their human capital, this can only be done with investments that bring returns, either tangible or intangible. Luxury apartments for industrial workers in industries reeling due to overcapacity are not the best investments.
Michael Pettis, a fellow fellow of Huang’s at Carnegie, shares this concern over malinvestment, and sees no other path for China than curtailing investment and rebalancing towards domestic consumption. However, rather than focusing on macro-level statistics like GDP growth, Pettis argues that officials should concentrate on increasing household consumption and disposable income levels. Additionally, he sees no means of sustaining 7.5 percent or higher growth rates while increasing consumption and decreasing investment’s share of GDP, arguing that 3-4 percent is more likely in the near-to-mid term. (Some already believe that current growth is far lower than official government statistics, and perhaps even negative.)
In another post, Pettis sees a silver lining in lower growth rates, both for China and for the world. First, if China slows while rebalancing (increasing disposable income and consumption), then while the GDP growth rate might suffer, households and individuals would not directly feel the impact due to their higher incomes. Second, a slowdown in China would not be as bad for the world as many have thought. Pettis argues that a true “engine of the world economy” is that country with high demand for goods and services. China’s problem, however, is that it lacks consumer demand for an economy of its size – its consumption to GDP ratio of around 35 percent is among the lowest ever recorded by a major economy. Therefore, a slowdown and economic rebalance would not necessarily hurt the broader world economy, but rather reshuffle China’s demand. Factors related to investment (commodities, construction-related heavy machinery, among others) would suffer, while factors related to domestic consumption would enjoy increases in demand.
The risks associated with a rebalance, much like the risks associated with a lack of rebalancing, are significant. Rebalancing would entail a number of measures: raising incomes, reducing the special status state-owned enterprises receive with credit, eliminating the “hukou” system of internal passports, and more. The problem with many of these is that it would impact stakeholders in China’s current investment-led economic model, and thus lead to resistance (much of which could be intra-party). It would also challenge local governments, which derive a great deal of income from land sales to developers.
Although the image of the Olympic and unbeatable Chinese economy has now matured into a more realistic, human form, the risk of a collapse amidst the downturn is fairly low. Although China’s over-investment has left it many vulnerabilities, it still possesses many significant advantages (capital controls, a low government debt ratio, particularly foreign-held debt) that help stave off catastrophe. Therefore, while many analysts look to China and see either a shining white of unlimited consumer potential or a cavernous black of a coming “debtpocalpyse,” the reality might be more in line with the Beijing skyline: grey.