China’s economy, which paused earlier this year, is picking up again -- good news for China and for the U.S. and Europe, which need all the external stimulus they can get. China pessimists aren’t convinced, though. They still see a hard landing coming.
“Pause” and “hard landing” have special meanings in China, of course. Growth slowed to an annualized rate of about 7 percent in the first half of this year -- lame by China’s standards, athletic by anybody else’s. Even the most pessimistic analysts talk of growth dropping at some point to 3 percent or 4 percent a year, which would hardly count as a landing, let alone a hard one, in most of the world.
For now, the economy seems to be rebounding. Factory output in November was 10.1 percent higher than a year earlier, beating expectations. Still, the question remains whether China is about to slip to a slower trajectory -- and, if it does, whether the government can handle the political implications.
China’s development model has produced spectacular growth. The fear is that anything less might start a vicious circle and the miracle could start to unravel. Might that happen? The experts are divided, but there’s agreement on several points.
First, under the leadership that just stepped down, pro-market economic reform slowed. China’s third decade of fast growth was powered by the momentum from earlier efforts. Second, the model has to change in any event. China should rely less on investment and more on consumption, a switch that requires bold financial reforms -- and which threatens entrenched interests. Third, the underlying drivers of China’s growth remain strong. If the government does what’s needed, the miracle has further to run.
Pessimists emphasize the stalling, and some say reversal, of reform efforts. State-owned enterprises are no longer shrinking, they say; if anything, the state-run sector, with all its growth-retarding distortions and inefficiencies, is resurgent.
I would say this concern is exaggerated. The pace of restructuring from public to private ownership has slowed, it’s true. That was bound to happen as state-owned enterprises lost ground. They accounted for more than 80 percent of industrial output in the late 1970s; today, between 25 percent and 30 percent.
It’s also true that state-owned enterprises led the government’s stimulus program during the post-2008 global slowdown. This was less a strategic reorientation, however, than a temporary expedient: Fiscal policy had to be eased quickly. State-owned companies’ share of assets rose after 2008 because of the surge of spending on infrastructure. Their share of bank lending, industrial output and exports continued to fall.
Overall, the stimulus was a success. China pushed through the global recession virtually unscathed.
In the U.S., fiscal tightening in the states partly neutralized lower taxes and higher spending at the federal level. In China, higher spending at the subnational level reinforced (and in fact exceeded) stimulus from the center. Fiscal policy had previously been conservative, and high domestic savings meant that China didn’t rely on external borrowing. That created fiscal space for action when it was needed, and the government used it.
China’s public debt is reckoned to be less than 50 percent of gross domestic product. Unlike the U.S. (to say nothing of Europe), China has scope for another big stimulus if one should be needed.
The real danger for China isn’t that the consolidated public sector is flirting with insolvency or that the dead hand of government planning is reaching out to strangle the country’s private sector. It’s that the financing model for subnational public investment has been dangerously overstretched.
The money for all that new infrastructure has mainly come not from long-term bond issuance but from short-term bank lending, opaquely mediated through local financing vehicles. If the investments fail to generate high economic returns, the revenue needed to service the debts will fall short. That’s a real possibility.
China has been here before. Heavy lending to public borrowers exposed banks to big losses in the 1990s, and the central government had to absorb the bad debts. Many observers think that China has lately invested in projects that are marginal, at best. Efficient public investments attract companies, spur activity and boost local tax revenue -- the means to service the debts. Bridges to nowhere don’t.
Local officials are also counting on revenue generated by rising property values. A crash in land or housing prices might not wreak as much havoc as it did in the U.S. China’s borrowers are much less leveraged. A real estate crash would check spending, though, and brake the growth on which everything else depends. It would also deny provincial and local governments the revenue they hope to collect by leasing land.
A lot will depend on the real extent of overinvestment -- and that’s hard to say, reports of “ghost towns” with empty roads and buildings notwithstanding. Rapid growth has a way of justifying apparently excess investment, as China has proved before. (Meanwhile, ask India what too little investment in infrastructure does for your growth prospects.)
There’s no doubt, the pessimists have a point: China’s reliance on investment rather than consumption to fuel growth is testing the limits, and the need to reform public finance is pressing. In the future, spending on infrastructure should be judged more cautiously and financed with bonds. The government should liberalize interest rates and phase out disguised subsidies to enterprises that implicitly tax consumers.
Switching from investment-driven growth to consumption-driven growth doesn’t have to happen all at once. China can make policy gradualism work again, but it has to act deliberately, and the job won’t be easy. Political interests have aligned around the present model. Who knows whether China’s weirdly impenetrable leadership even understands the issues?
So yes, expect setbacks. Yet China’s underlying advantages -- a vast population, a daunting work ethic, the untapped catch-up opportunities and an unsurpassed appetite for capitalism -- are formidable. I wouldn’t bet on its failing.
(Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.)
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