China's Future: Neither Boom Nor Bust
The debate over how China’s economy might evolve over the next decade generally breaks down into two opposing cases. Bulls are confident that Chinese leaders will make the hard reforms needed to clean up local government debt, reform state companies, open more markets to private-sector competition and liberalize the financial sector. This should enable China to achieve another 10-15 years of rapid growth. Bears are equally convinced that the government will fail to enact any real reforms, provoking either a drastic plunge in economic growth or an outright financial crisis.
In fact, the likeliest scenario is far less dramatic. Rather than curing its economic woes and cementing its position as an economic superpower, or suffering a devastating collapse, China looks set to spend the next decade in genteel decline, much as Japan has since the 1990s.
If that outcome seems implausible for an economy of China’s size and dynamism, consider the similarities. By 1990, Japan, too, had enjoyed a nearly four-decade run as the world’s fastest growing economy, thanks to a growth model fueled by investment and exports. It also ranked second in the world in GDP and total trade. Its companies were moving rapidly up the technology ladder and seemed poised to supplant their U.S. and European rivals. The financial market was opening; Tokyo was anointed the next major center of global finance. The national saving rate was high and public finances were prudently managed: Japan had the lowest sovereign debt of any OECD country.
At the same time, problems lurked under the surface. Corporate debt had piled up, largely because of skyrocketing land and equity prices in the late 1980s. Then, after the land and stock-market bubbles popped in 1990, asset prices fell by three-quarters over the next few years. Corporate Japan got caught in a debt trap. As companies desperately deleveraged, the government had little choice but to step up its own spending and borrowing to fend off economic collapse. The government failed to execute market-oriented reforms that could have boosted growth and eased the transition out of the debt trap.
Of course, in other respects China resembles a much earlier and more vibrant Japan. Demographically, it lines up more with the Japan of 1980, with six people of working age for each person over 65. Developmentally, it looks like the Japan of the early 1970s, with a per-capita GDP barely a fifth that of the U.S.
That relatively low per-capita income means China probably has plenty of “catch-up” growth left, as it continues to move people from subsistence farming into the more productive modern economy. Its relatively young population structure also gives it more room to maneuver than Japan, which by 1990 was already well into its aging problem. (China’s date with demographic destiny is rapidly approaching, though: By 2040, it'll have only two workers for every retiree, the same as Japan today.)
Whether China can avoid a Japan-like slide from world-beater to also-ran will ultimately depend on the courage of its leaders. Unfortunately, on that front, the Chinese regime also seems to be repeating Japan's mistakes.
One is hubris. By the end of the 1980s, Japanese officials, and many analysts, were convinced that Japan had come up with a new, hybrid economic model superior to traditional free-market capitalism. This proved not to be so. Foreign diplomats and businessmen consistently say that today's Chinese leaders are similarly self-righteous, deaf to criticism and convinced of the virtues of their model of state-led development. Public discussion of the debts weighing down state companies is muted. Ambitious plans to introduce private shareholders into the state sector have diminished into a timid reshuffling among existing players. History teaches that when the captain and his mates start congratulating themselves on the superior design of their ship while ignoring obvious icebergs, it's time to haul out the lifeboats.
Another fatal mistake is timidity. The obvious solutions to both countries' problems all involve a scaling back of state control. Japan could probably have achieved higher growth in the 1990s if it had deregulated services, opened up the financial sector and permitted much more foreign investment. It chose not to do so, for fear of upsetting the cozy ties between government and corporate elites.
The same reluctance is obvious today in Beijing, where Communist leaders say they intend to let market forces “play a decisive role in resource allocation,” but in practice have intervened in the equity and foreign exchange markets to prevent prices from falling. The reluctance to reform the state sector reflects a fear of letting markets, rather than the Party, decide who gets to control important assets.
China is still fundamentally an economy with a lot of dynamic potential. Vigorous policy in the next few years could arrest the rise of leverage and enable growth to stabilize at around 5 percent by 2020. The crucial steps would be to shut down or privatize the least productive state-owned enterprises (cutting the state sector roughly in half), open up protected service sectors to private and foreign competition, and liberalize the financial system so that it reliably channels credit to the most productive firms. The problem, from the Party elite’s point of view, is that these reforms would require that the regime surrender much of its ability to direct economic activity. China may yet be able to avoid the Japan trap, but only if its rulers learn to lighten up.
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