China’s economy is not in serious danger of collapse. This needs to be said first because so many people immediately misunderstand the following: China’s economy is nonetheless in serious danger. The danger is stagnation and the best way to avoid it is renewed pro-market reform.
Since the onset of the global financial crisis, the major Chinese economic event has not been growth, it’s been debt accumulation. As a percentage of gross domestic product, debt has risen as much in the last five years as it did in the previous 15. Corporate indebtedness is now worst among major economies.
Such facts encourage claims that China looks like the US in 2008 (or 1928), but warnings of “another Lehman crisis” represent a fundamentally flawed view. China does not have a commercial financial system – the vast majority of its banks are effectively arms of the state. They can’t fail for commercial reasons. China therefore does not look anything like the US now, 10 years ago, or 90 years ago.
What the debt actually represents is waste, waste China can’t afford. If loans are put to good use, they can be paid back. Sustained increases in debt means money was not put to good use. And disposable income per person is only about $4000 this year, less than 10 pre cent of the US level. The worry for rich countries running up debt is they fall back toward middle-income. China has not even risen from middle-income, and it will not happen unless debt accumulation is checked.
If the debt burden weren’t daunting enough, China is ageing rapidly. Demographic changes are measured in decades not years, but China is less than a generation from being an old country, with few workers supporting many retirees. The dearth of workers means low unemployment and no angry protests. It also means economic growth will be harder to come by – see Japan’s example, among others. The debt-ageing one-two punch knocks growth out.
There are two non-market responses China can adopt, one hard and the other very hard. The merely difficult choice is controlling debt through financial deleveraging. This is discussed endlessly but all that has been managed so far is slower leveraging. Borrowing continues to increase and there is no historical or policy reason to expect that today’s borrowing won’t be tomorrow’s debt, just as yesterday’s borrowing is today’s debt. Beijing hasn’t had the nerve to implement true deleveraging because it would hit growth for several years.
Deleveraging is scary but simple. Perhaps the single most important step to support long-term growth is not at all simple: improve rural education. Current levels of education for hundreds of millions of Chinese could limit growth to half its current speed, and that’s excluding the impact from debt.
Over the last 15 years, China has demonstrated a tendency to throw money at problems. And that is what it has already done with rural education. Money matters but it hasn’t delivered the improvements needed in rural China, where disposable income per capita will barely touch $2000 this year. This level of development for 600 million people is not compatible with a country that aspires to be advanced. Rural China needs to be transformed.
The way to bring about that transformation is with pro-market reform. It has happened before. Limited rural land-ownership rights in the late 1970s laid the foundation for the Chinese miracle by boosting farm productivity and allowing rural to urban migration. Full ownership rights to the land they work could again lead to double-digit income increases for farmers. It’s at least possible that rising educational attainment would follow.
There is also a market-based solution superior to deleveraging: partial financial privatisation. There’s no point pretending China will privatise all, or even most, of its financial system, but it can go much farther than it has. Private banks are minuscule and most “shadow” finance stems ultimately from assets moved off state banks’ books. A genuinely private financial sector at 30-40 per cent of assets would curb the non-commercial lending that causes debt to pile up.
The debt burden can also be eased through pro-market reform on the borrower side. Private borrowers are less generously treated by state banks and more sensitive to customer and third-party doubts about financial liabilities. Being subject to competition they could actually lose, private firms are also more innovative, which China is relying on for future growth. Shrinking the state corporate sector would thus doubly boost the return on capital.
Through sharper property rights and greater competition, pro-market reform could raise China from middle-income to rich, just as it raised the country from poor to middle-income. But such reform simply isn’t happening. The desire to control the economy has to this point trumped willingness to empower farmers, to permit banking privatisation, and to reduce the number of sectors that state enterprises must dominate.
Instead, there are tweaks in land rights, only new, tiny banks can be privately owned, and giant state firms are made still larger through government-mandated mergers. Xi Jinping is fiddling while China fades.