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So remind me--why are we so worried that China's economy will slow big time?
07/13/2010 8:30 am EST
I’ve been pondering that question as I watch global financial markets retreat on worries that economic growth in China is going to slow precipitously.
I just don’t think that kind of surprise is very likely given the nature of China’s economic system.
It’s not that I think China’s economic system—nor the people who run is--are perfect. For example, China’s leaders allowed a build-up of bad loans brokered by local governments that would be big enough to bankrupt many of those local governments and a majority of the country’s banks—in another system. In China’s system, however, the government can bury that bad debt—as it did after the Asian Currency Crisis of 1997—and engineer the re-capitalization of the country’s banks. (For more on this debt problem and China’s “solution” to it, see my post Move over Charles Ponzi and Bernie Madoff–China is running history’s largest financial scam .)
In fact, I’d argue that the Chinese economic system is generally bad at short-term economic decisions since the Chinese economy doesn’t provide either fast or accurate signals on pricing, supply, or demand.
And it’s often spectacularly bad at long-term economic decisions because, with no effective brake on government decisions and truly distorted feedback on the results of those decisions from the economy and the lower levels of government bureaucracy, wrong-headed policies can run for years and years as initial evidence of disastrous long-term consequences simply never filters up to top-tier decision makers.
But in a big swath of the middle-term China’s economic system does a spectacular job at making sure that nothing goes terribly wrong. Over a one or two or even three year period China’s unique combination of market and centralized command-style economics has the ability to make decisions far more quickly than most other economic/political systems and the brute power to mobilize a high percentage of the country’s resources behind that decision. And that’s exactly the time frame that includes current worries about China’s economic growth.
Right now I’ve got big doubts about, say short-term (a quarter or so) profits in China’s auto industry. In the long term I’ve got big doubts about China’s ability to solve its terrible demographic problem over the next 20 years.
But China’s ability to keep its economy humming at 8% to 10% a year for 2010 and 2011? Doesn’t keep me up at night. Especially because China has successfully reloaded its stimulus pipelines with enough cash to overwhelm any slowdown in just the way it did in November 2008.
In fact I’d say that current problems operate on a time scale that’s in the sweet spot for China’s economic/political system. These problems play to the strengths of the China’s economic system.
Let’s take a look at China’s Goldilocks’ worries—and at the short- and long-term where China’s system doesn’t work nearly so well.
To understand the draw backs of the Chinese economy in the short-term you don’t need to look any further than China’s auto industry. In 2009 subsidies and credits from Beijing boosted total auto sales in China by 45% from 2008 levels.
In the first half of 2010 sales growth dropped to a 30% annual growth rate.
And the rate looks like it is headed lower. Beginning in April car sales have dropped every month from the month before. In June, for example, sales dropped 5%. That took the annual growth rate down to just 14% from June 2009.
Now that’s volatility. And in a market with many features of a command-style economy volatility gets magnified because everyone jumps in the same direction on orders from the central government. And because there’s very little push back from market signals the initial response to the volatility and the eventual response can get, well, out of control.
For example, in response to the 45% growth rate in 2009 the auto industry in China went on an expansion binge. The top 14 automakers in China, many of them foreign, launched plans to reach a production capacity of 23 million vehicles by 2012—even though demand in China is projected at only 20 million vehicles by then. And that only measures plans by the big guys. China now has more than 100 domestic car companies.
In other kinds of economic systems banks would have pushed back against at least some of those expansion schemes. Financial markets might have pushed back against plans to raise all that capital. But in China in the short-run banks had been officially encouraged to make loans to car buyers with little or no effort to document incomes and banks and the financial markets had been officially encouraged to provide financing to car companies. Only in recent weeks has the central government itself reversed course and started to push back against the trend that it set in motion. Beijing has announced not just an end to some of the subsidies for buying a car but it has also promised an investigation into why it was so easy to get financing to start or expand a car company. (Gee, you think they’ll figure out who’s to blame?)
This isn’t an efficient economic system at work.
At the long-term end of the scale the damage can be much more extreme—because the forces that the command economy can bring to bear are given longer to run. China’s one-child policy, for example, was originally introduced in 1979. More than three decades later, the one-child policy has produced a history of often brutal coercion especially in rural areas, and seriously skewed China’s demographics. As the CIA World Factbook puts it, “One demographic consequence of the "one child" policy is that China is now one of the most rapidly aging countries in the world.”
In 2005 just 7% of China’s population was 65 or older. By 2020 23% of China’s population is projected to be 65 or older. According to projections in the United Nations Population Program’s medium scenario, the median age of China’s population will be 45-years-old in 2050. That would make China’s population as old in 2050 as the populations of developed and already old countries such as Norway or Finland.
Which is the source of what’s called Will China get rich before it gets old? problem. The per capita GDP of Finland was $34,900 in 2009. In 2009 China’s per capital GDP was just $6,600. (In both cases I’m using purchasing power parity figures that correct for differences in prices among countries.) It’s estimated that China’s official one child policy now affects only slightly more than one-third of the country’s population, but the country’s housing shortage, the need for many younger couples to take on the burden of caring for four parents, and, the gender imbalance that has resulted from the selective abortion of girls by families that wanted their one child to be a son now add up to an extremely effective unofficial birth control regime.
I don’t see a way to turn this long-term trend around. A failure to at least shift the demographic course, however, would have massive effects on everything from labor costs in China to the availability of China’s pool of savings to debtor countries around the world in coming decades.
The advantages that China’s command style economy has in dealing with middle-term problems are significant. In the middle-term China can mobilize huge resources to correct short-term mistakes that have resulted from slow or misleading signals from the economy back to government. For example, it would be more efficient in the short-term if China’s economy didn’t produce an over-abundance of unprofitable mining and natural resource producers. In the middle-term, however, raising the national tax on these industries—combined with selective application of takeovers by state-controlled companies and a bankruptcy or two—can correct the problem. Chinese officials have indicated that the country is about to introduce such a policy. In the middle-term the government can switch incentives to get officials to stop lending to unprofitable companies. That’s a whole lot easier fixing a long-term problem that requires dismantling a national population control bureaucracy with an estimated 300,000 officials and local population committees in every village and neighborhood in China.
In the last few weeks I’ve posted repeatedly about the progress of Agricultural Bank of China’s initial public offering. (For more on that IPO see my post China’s stock markets pass a test: Agricultural Bank looks like it raised more than $19 billion ) That’s because this $20 billion plus offering is a critical part of China’s plan to keep its banks lending even as it forces them to put more aside as reserves. (For how that works and why it’s necessary see my post , see my post Move over Charles Ponzi and Bernie Madoff–China is running history’s largest financial scam .)
All the signs are now that China is going to succeed at pulling this off. The Agricultural Bank of China offering is set. And China’s other major—and already public--banks look like they will meet their goal of raising an additional $40 billion within the next few months. That will restock banks with plenty of cash for lending even though the People’s Bank of China has required banks to keep more in reserves against their loans. Beijing has set a target for 2010 of $1.1 trillion in new bank loans. That would be a 22% drop from lending in 2009 but that year set an all-time lending record.
$1.1 trillion in new loans for 2010 would be plenty expansionary, don’t worry. And it would keep China’s economy growing at an annual rate of 9% to 10%.
New bank lending in June came to $82 billion, according to an unidentified bank official quoted in the 21st Century Business Herald. At that rate banks won’t have any problem making that $1.1 target.
And China’s government has gone out of its way in recent weeks to point out that when Beijing officials talk about an end to the stimulus put in place in 2008, they’re really talking about a relatively minor slowdown in spending. On July 5, for example, the National Development and Reform Commission reported that China had $100 billion in investment projects planned for western China alone.
Let’s see: Banks that will lend billions when the national government tells them to, a government that can make the decision to spend billions in stimulus without endless debate, and a country with $2.4 trillion in reserves at the end of 2010—and an economic system that’s good at fixing exactly the kind of middle-term problems it now faces.
So why exactly are investors so worried about growth in China?
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