The Case for and Against China
When two respected organizations—plus a famous Harvard economist—tackle the question of China’s growth, they come up with widely different answers.
In The Long Soft Fall in Chinese Growth, published on Oct. 20 by the Conference Board, China managing director David Hoffman and economist Andrew Polk write that the economy will stagnate as policymakers drag their feet on needed changes. The business group predicts annual growth in China’s gross domestic product will fall to 4 percent by 2020. The New York-based Asia Society Policy Institute expects China to expand 6 percent that year—not as robust as in the past, but still pretty fast. In its study, Avoiding the Blind Alley, released on Oct. 22, the Society cites progress in China’s reforms. Both reports appeared the week China announced third-quarter GDP grew 7.3 percent, the slowest rate in five years.
Earlier in October, former Treasury Secretary Larry Summers and fellow Harvard economist Lant Pritchett produced Asiaphoria Meets Regression to the Mean: “China’s experience from 1977 to 2010 already holds the distinction of being the only instance, quite possibly in the history of mankind,” they write, of such rapid continuous growth. “Why will growth slow? Mainly, because that is what rapid growth does.” They also say that in China’s case, “a high degree of government discretion vis-à-vis businesses and an authoritarian regime add to the likelihood of a growth slowdown.”
The bears and bulls agree that China must change its economic model. Rapid productivity gains followed sweeping restructuring of the state sector in the late 1990s. Starting in 2001, productivity was further boosted by the new technology and manufacturing processes introduced by foreign investors who swarmed into China after it entered the World Trade Organization. But since the global financial crisis began in late 2008, Steven Barnett, chief of the China division at the International Monetary Fund, points out, growth has been driven by government-directed investment, while productivity gains have slowed. That reliance has saddled China with debt exceeding 200 percent of GDP. Prices in the overbuilt property market have slid for five consecutive months, fanning fears of a spillover effect. “China’s structural property downshift [has started] to have a bigger impact,” affecting heavy machinery, cement, steel, home decoration, and auto sales, warned the China economists at UBS Securities in an Oct. 24 research note.
There’s no controversy about where China should head: to a more consumption-driven economy in which services play a larger role. Consumption made up 48.5 percent of GDP growth in the first nine months of this year, up from 45.9 percent in 2013. These are “positive and profound changes,” Premier Li Keqiang said in October.
The key difference between the bulls and the bears is the level of faith they have in the leadership to carry out productivity-boosting but deeply destabilizing reforms. Chinese leaders say the most-needed steps include giving farmers more rights to sell the land they own or borrow against it, and promoting urbanization by loosening the rules that keep people tethered to schools, hospitals, and pensions in their hometowns. Also important is allowing banks to lend according to the soundness of a business rather than for political reasons. The reforms are “very painful and even feel like cutting one’s wrist,” Li said in March 2013.
“We all agree that the key to getting the needed productivity boost is through reform,” says Daniel Rosen, author of the Asia Society report and a founding partner of the China- and India-focused consultant Rhodium Group. “But while we see that reform happening, [the bears] say they see no evidence at all.” Rosen cites as positives the moves to strengthen local government finances, increase dividends from state enterprises, and target some of the most powerful state companies in an anticorruption drive.
The bears sometimes compare China to Japan in the late 1980s. Like Japan, China has pumped up the money supply, with much of it flowing into real estate. China’s banks now face a growing pile of bad loans. Japan’s bubble isn’t the right analogy, say more bullish observers such as Barnett of the IMF, who predicts China will grow at 6 percent per year through 2030 if it continues to liberalize its economy. “China is still below where Korea and Japan were in income levels relative to the U.S. when they took off. So China could continue to grow rapidly for quite some time as it catches up with U.S. income levels,” he says.
Summers and Pritchett say no country can grow forever at China’s pace, including China. “If a hitter has a hot streak with a batting average up 50 points over the past 20 at bats, then we would forecast a return to the average … over the next 20 at bats,” they write. “If pressed to say why the batting average would be lower one could speculate about why it currently is so high and predict those factors will diminish or predict future events will causally explain the lowering, but mainly, that is just what happens.”