Why critics predicting China’s economic demise are wrong

It is hard to believe that highly educated Western journalists, commentators and scholars still believe the Chinese economy will be “buried under a mountain of debt,” having been wrong for more than 30 years.

Well-known economic scholars like Nobel laureate Paul Krugman seems to have bought into the “Chinese economic collapse” narrative, saying China’s “emperors wear no clothes” in reference to the country’s stock-market correction of losing more than a third of its value after a threefold gain in 2017. Then there were critics like Gordon Chang, who gained some dubious fame for predicting China’s “coming collapse” in 2011.

Instead of collapsing, the Chinese economy has in fact sustained relatively high annual growth rates estimated at more than 6.5%, favorably compared with the West’s less than 2% according to the International Monetary Fund. What’s more, the IMF predicts that China’s economy will remain robust for the foreseeable future, precisely because of its government’s economic policies.

China’s economy succeeded for a reason

China’s development path is not perfect. Indeed, many mistakes have been made, such as wasting huge amounts of scarce resources and exposure to external shocks. For example, the 2007 financial crisis drastically reduced an average annual growth rate of 10% to 6.5% in 2008 year on year mainly because of a drastic reduction in exports to the West and Japan, according to China’s National Bureau of Statistics (CNBS).

Over- or mal-investment also took a toll on the economy. The World Bank (and others) estimated the gross investment – new investment plus depreciation – was growing at an annual rate of more than 45%. Though US-based investment bank J P Morgan estimated net investment to be growing at approximately 30%, it was still abnormally high, culminating in huge wastage of scarce capital, overproducing in some sectors and creating shortages in others.

The mixed results produced by the export/investment-led model  prompted former premier Wen Jiabao to declare the strategy as the “four uns”: unstable, uncoordinated, unbalanced, and therefore unsustainable.

The model was deemed unstable because it culminated in unequal wealth distribution, which had led to social unrest and revolutions in the past. The 1937-49 Chinese Civil War was in fact fought on the basis of rampant economic injustice under the Nationalist (Kuomintang) regime. Further, over-dependence on exports contributed to instability.

It was uncoordinated because investment was directed at export-dependent industries and not enough was catered to the domestic market. Not paying attention to domestic demand is unsustainable because consumers are a stable economic constant.

The export/investment-led model was unbalanced because economic gaps were widening between the coastal provinces and hinterland regions.

Thus Wen saw the model as unstable, uncoordinated, unbalanced and therefore unsustainable because it contributed to economic and social instability, environmental degradation, and a shortage of arable land and energy.

His observation spoke well of China’s development policies and the leadership: Leaders are competent, resilient and flexible, able and willing to “shift gears” on policy development and implementation.

For example, the government time implemented a huge stimulus package of US$580 billion in 2009, consequently boosting growth from 6.5% to 9.2% that year according to IMF and CNBS statistics. To some, it was a brilliant application of Keynesian economics. To its critics, however, it was a “debt trap” that they claimed would eventually pull the economy down.

Who is right depends on one’s perspective. But official statistics released by the IMF and World Bank suggested the decision might have played a pivotal role in reversing the economy’s downward trajectory, preventing resource-dependent economies (such as Australia and Russia) from falling into a recession and contributing to more than 30% of global economic growth. The China General Customs Administration revealed that China did buy huge amounts of resources from those countries at the time.

Perhaps more important, the 2007-08 financial crisis also opened China’s eyes, allowing it to rebalance and restructure the economy. The government replaced export/investment with consumption as the engine of growth in the 12th Five Year Plan (2011-2015). The strategy seems to have worked, because CNBS statistics show consumption as a percent of gross domestic product jumped from 34% in 2011 to more than 60% in 2018.

The huge domestic market made up of relatively low consumer debts should afford the economy to weather US President Donald Trump’s tariff threats. According to the World Bank and other organizations, Chinese consumer debt is less than 40%, and most possess large savings.

The Chinese government under Wen Jiabao’s leadeship also made efforts to restructure the economy from low-technology manufacturing to value-added production and innovation. The Organization for Economic Cooperation and Development (OECD) estimates that China spent more than 2.2% of GDP on research and development in 2017, allowing it to leapfrog technology advancement. Indeed, China is at par with or ahead of the West and Japan on artificial intelligence, driverless cars, financial technology, supercomputing and high-speed railways.

In light of the foregoing, there is little doubt that “socialism with Chinese characteristics” is the right model for China. Most organizations (such as the IMF) and objective analysts (such as Joseph Stiglitz) would agree that the Chinese economy will remain robust for years to come. Indeed, it continues to defy the critics’ predictions.

China’s economic development model

“Socialism with Chinese characteristics” is neither communism nor capitalism, it is a hybrid, likened to raising a healthy and strong bird. That is, the bird must not be allowed to fly away (unfettered capitalism) or stifled to death (rigid central planning).

History has shown that capitalism has experienced periods of “boom and bust,” zigzagging between inflation and recession because of increasingly unequal wealth distribution. The well-connected and organized would take increasingly bigger slices of the pie, culminating in reducing total consumption.

Communist central-planning policies proved inefficient and stifled creativity and entrepreneurship. “From one according his/her ability and to whom in accordance with needs” did not give individuals much incentive to be productive. Lack of private ownership destroyed efficient allocation of resources.

After years of studying the Western capitalist and Soviet central-planning models, Chinese leaders came to realize that neither was appropriate for China. They thus embarked on a different architecture  known as “state capitalism,” in which the state sets economic targets, allocates the resources and establishes the guidelines on achieving the goals.

For example, in its bid to eradicate poverty by 2020, the government carries out land reforms, subsidizes personal income and builds infrastructure to promote investment in poor regions. Rural dwellers are allowed to sell or lease their land to big agricultural enterprises as a way to increase disposable income.

State ownership of “strategic” industries was a way to ensure product affordability and increase government revenue. The additional revenue allowed the government to spend on projects that would forestall an economic crisis. For example, the Chinese government has recently announced expenditure of $199 billion on infrastructure projects to counter the financial hardships expected from a trade war with the US.

What’s more, China’s debt is almost entirely internal, and the majority of borrowers and lenders belong to the government. According to the World Bank and the US Central Intelligence Agency, China’s external debt is only $1.4 trillion, which the country could easily pay off with its more than $3 trillion in foreign reserves and $1 trillion in US Treasury holdings.

The CNBS estimates that state-owned enterprises are the majority borrowers from state-owned banks. So even in the most unlikely case of payment defaults by all SOE borrowers, it would only be an accounting issue.

Further, China’s Banking and Insurance Regulatory Commission revealed that the country’s high savings rate of 25% of disposable income has culminated to more than $23 trillion in deposits, allowing the banks to weather any financial crisis. Last but not least, the government can and does impose debt-control policies on local governments and SOEs.

In short, China’s economy might be in better shape than most major countries, including the developed nations.

The assumptions and “facts” critics apply to assess China’s economic performance are highly subjective and have been shown to be at odds with the country’s economic and financial realities. Focusing only on the debit side of the balance sheet distorts the effects debt spending has on the economy. For example, building roads does incur debt, but the roads attract investment and generate government revenue (from tolls).

Indeed, it was the government’s decision to spend lavishly on a comprehensive infrastructure system that led to the “Chinese economic miracle.” China’s economy is getting stronger, not weaker, as insisted by the country’s critics.