China bears have had a bad decade. Repeated predictions that China’s large and growing pile of debt would lead to an economic crash have been wrong so far. The country sailed through the global financial crisis. It has weathered the slowing global demand for its exports, the drying up of its excess rural labor supply, slowing coal production, and the peak and decline of its working-age population. In 2015 and 2016 it experienced the bursting of a stock-market bubble, followed by more than a year of capital flight. And though the country’s growth has slowed from an unsustainable 9 or 10 percent to a more measured 6 or 7 percent, there has been no crash, no hard landing and no collapse of what is proving to be an extraordinarily resilient political and economic system.
Some China bulls attribute this impressive stability to the fact that the country’s economy is much more government-controlled than that of the US or of most developed countries. As long as the ruling Chinese Communist Party carries out wise, level-headed policies, and as long as the country’s business leaders and investors continue to believe that policy will support the economy, the argument goes, a crisis of the type that afflicted the US in 2008 or Japan in the early 1990s is unlikely. For example, many cite China’s ability and willingness to bail out its banks, as it did in the 1990s. As long as private-sector actors are certain that such a bailout would be forthcoming, it will be hard for a panic to begin.
China’s government seems to have developed a highly effective new form of economic stabilization. Its extensive control of the financial system allows it to turn on a flood of bank loans when the economy looks weak, and restrain credit when the danger has passed. China’s avoidance of recession in at least the past three decades suggests that this form of credit-based stabilization is more effective than traditional, more indirect stimulation of the economy through government deficits and central bank monetary easing.
Combine these two policies, and you get a picture of how the Chinese government works its magic. When a recession threatens, the government tells banks to lend -- to local governments, construction companies and real estate developers. Then, if the credits go bad, the government swoops in and takes the nonperforming loans off of financial companies’ books. Uninterrupted rapid growth then shrinks the government debt as a percentage of gross domestic product, and the system sails blithely forward into a future of certainty and optimism.
This playbook will now be put to the test once again. A number of indicators suggest that China is headed for a slowdown. Indicators of factory activity are down. Tax revenue is falling. Foreign companies’ sales in China are dropping. Factory prices and profits are both down.
The reason for the slowdown isn’t clear. Uncertainty over trade with the US -- including tariffs, but also export controls and investment restrictions -- could be a factor, especially as other countries show signs of wariness toward Chinese technology companies. Bad investments in real estate and infrastructure could be coming back to bite. A crash in the peer-to-peer lending industry might be contributing.
But whatever the reason, the approach will probably be the same as in the past. Credit policies will be eased and banks encouraged to lend more. Much of the credit will go to state-owned companies, local governments and well-connected businesses in industries such as real estate and construction. The real activity supported by the stimulus will end up creating a lot more apartment complexes, roads, bridges and office towers. On top of this, China will probably add fiscal stimulus, much of which will go toward building those same physical assets.
There’s a good chance this may resuscitate the Chinese economy once again, and prevent a painful recession. Once more, China’s leaders will be hailed as wise, competent and in control. But the stabilization may come at a price. Resources will be directed ever more toward construction and real estate. Banks will become more dependent on, and accustomed to, lending to these sectors.
A country already awash in empty apartments will get more empty apartments. Workers will have jobs, but the jobs won’t produce as much real value as in the past, or push forward the country’s level of technology.
And after the danger has passed, China will find itself with slower productivity growth than before, as it did after 2008.
The danger of the Chinese model, then, is that a high degree of macroeconomic control may come at the cost of long-term economic weakness. In exchange for stable growth today, China could get less growth tomorrow, ending up as a middle-income country instead of a rich one. The China bears will be proven wrong yet again, and the Communist Party will have another victory under its belt. But eventually, such victories can add up to a loss.
Noah Smith
Noah Smith is a Bloomberg Opinion columnist. -- Ed.
(Bloomberg)
