Economist Nicholas Lardy has a new book out called Sustaining China’s Economic Growth After the Global Financial Crisis, a lucid and pithy exploration of China’s economic weaknesses, and how Beijing can grapple with them.
In Lardy’s analysis, the Chinese economy is “unbalanced”; it relies too much on exports and residential property prices to fuel its economy, two distortions and dependencies that favor certain interests at the expense of the nation.
Consider exports. China has created a global addiction to its cheap goods, but with consequences for its environment and to its economy, as well as the global economy. China subsidizes its exporters with cheap power and water, as well as easy access to bank loans. Then there’s how China undervalues its currency, which in turn has led to distortions in the global economy. But despite government subsidies, China’s export industries make little money if at all, which forces the government to subsidize them even more; the Chinese have raised “corporate welfare” to a whole new level.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
Then there are the urban real estate bubbles, fueled by what Lardy calls “financial repression”: low bank interest rates that tax depositors, and a scarcity of investment vehicles. To put in perspective the real estate bubble, consider this statistic: “After 2003, the urban population increased by an average of only 19 million annually, but average residential housing investment of 6.8 percent of GDP was two-thirds larger than in 2000-2003, and annual residential housing starts soared from 490 million square meters in 2004 to 1,290 million square meters in 2010.”
These economic trends have led Premier Wen Jiabao himself to call China’s growth “unsteady, imbalanced, uncoordinated, and unsustainable.”
Lardy frames the problem and solution more technically and diplomatically, while calling for a bold shake-up of China’s economy:
“The central thesis of this study is that the evidence from the past seven or eight years shows that modest, marginal, incremental economic reforms will not lead to a fundamental rebalancing of China’s economy. Underlying financial distortions – including administrative controls that keep deposit interest rates low, an undervalued exchange rate, subsidized energy, and so forth – are contributing to a significant ongoing misallocation of resources throughout the Chinese economy. These distortions contribute to a low share of wages and a high share of corporate profits in national income; a low share of household disposable income in GDP; a high share of savings and a low share of consumption in household disposable income, and thus a low share of private consumption in GDP; a high share of household savings allocated to housing; an elevated share of investment in GDP; and a still large external surplus. A much more concerted and sustained effort is needed to remove underlying financial distortions if China’s economic imbalances are to be reversed.”
Lardy lists four fiscal policy measures to “re-balance” the Chinese economy from one that’s driven by exports and real estate bubbles to one driven by domestic spending and services. First, the government needs to stimulate private spending by cutting personal taxes, as well as spend more on social goods such as health, education, welfare, and pensions. Second, the government needs to stop controlling interest rates on both deposits and loans, allowing capital to flow more efficiently to entrepreneurs instead of directing it towards state-owned enterprises. Third, it needs to increase the value of the renminbi. Finally, it needs to stop subsidizing state-owned enterprises with cheap commodity prices as well as cheap access to capital.
While these solutions sound both complicated and expensive, Lardy makes a compelling argument they’re neither.
Beijing itself has the power and mechanisms to liberalize bank loans and the renminbi’s exchange rate, and needs not convince the provinces to go along (which would be politically impossible).
More important, the costs of not doing anything are just too great for China’s political system to bear. Currently, China’s economy is structured to benefit state-owned enterprise and real estate companies, creating a situation where China is helping the rich get richer at the cost of a vibrant society, a clean environment, and a healthy economy. Financial liberalization would break this stranglehold of the vested interests, and help build a more rational and robust economy: depositors’ money would go to companies that actually make money, creating more jobs, increasing real wages, and slowly weaning China off its unsustainable dependency on exports to fuel growth.
So, if the solution is this straightforward and simple – and the consequences of the problem so dire and dangerous – then why hasn’t China acted already?
Is it because financial liberalization isn’t a priority for the team of President Hu Jintao and Wen? Is it because they’re not powerful enough to enforce their views on the rest of the Politburo? Is it because they’re heading out the door, and would rather have the new team of Xi Jinping and Li Keqiang deal with the problem?
I have my own theory, which I explained in a previous post: Considering how poor and populated, chaotic and unmanageable China is, it’s in the long-term best interests of China’s elite to behave like parasites and predators.
China’s elite are enriching themselves by bankrupting the state, and, already having shifted assets and family abroad, will continue to do so until the state itself collapses.
We’ve seen this behavior consistently throughout Chinese history, most recently with Chiang Kai-shek’s misrule that permitted the Communists to rise to power.
And now, as the Chinese would say, history is about to complete yet another circle.