Busting the myths about mighty Chinese economy

Study makes a strong case that the country is much healthier than the bears believe but fails to dispel fears that capital is being misallocated on an epic scale

PUBLISHED : Thursday, 16 August, 2012, 12:00am
UPDATED : Thursday, 16 August, 2012, 12:06pm

China, we are constantly told, is misunderstood in the rest of the world.

This is clearly true. Just consider China's economy.

One lot of outside observers believes China will continue to grow rapidly, and that it is on track to overtake the United States as the world's largest economy by the end of this decade.

Another lot is convinced that China is an enormous bubble just about to burst. They believe the economy is heading for a debt crisis and a growth slump so severe that China will not succeed in catching up with the US for decades, if at all.

Obviously, one or other group has failed to understand what is really going on.

In an attempt to clear up some of the confusion, Andy Rothman at brokerage house CLSA has set out to explode some of the more common misconceptions foreigners hold about China's economy.

Rothman inclines very much towards the sustainable growth camp and makes a strong case that China's economy is much healthier than the bears believe.

Rothman points out that China's economy is powered by dynamic entrepreneurs rather than the state. In this he is surely right.

According to the People's Bank of China, small private companies account for 60 per cent of gross domestic product, employ 75 per cent of the work force and create 90 per cent of new jobs.

And in global terms they are highly competitive. Although manufacturing wages have risen by around 15 per cent a year over recent years, productivity has grown almost as quickly at a rate of around 12 per cent. As a result, China has lost little of its competitive advantage.

Meanwhile, the growth in incomes has ignited a boom in consumer demand. Rothman dismisses worries that private consumption is fatally weak in China, pointing out that consumer spending is growing at a 12 per cent rate in China's cities and even faster in the countryside.

He also has little time for talk of a dangerous property bubble, arguing that the residential market is driven by owner-occupiers rather than by speculators, and that leverage among buyers is low.

Similarly, Rothman has few fears of an impending financial crisis. He argues that the shadow banking system has evolved only under the close supervision of the regulators, and that it remains small.

At the same time he says that although local governments' debts - typically estimated at around 10 per cent of gross domestic product - are a burden, thanks to Beijing's strong fiscal position, they are not a ticking time bomb.

In consequence Rothman believes there is little chance of a banking crisis in the near future. Closely controlled by the state, and insulated from international markets by strict capital controls, China's banks are simply not as vulnerable as those in the United States or Europe.

As a result, CLSA is forecasting robust growth of around 8 per cent for 2012. That's slower than last year's 9.2 per cent rate but well above the 7 per cent rate bearish analysts would consider a hard landing.

Yet for all the strength of his arguments, Rothman's upbeat message isn't as solid as he would like us to believe.

Least convincing is his assertion that "for those who are waiting for the day when the household consumption share of GDP begins to rise and the investment share begins to fall, that day has arrived. China's transition away from investment-led growth will begin this year, as fixed-asset investment growth will slow."

Consumption may well be growing rapidly at close to 15 per cent a year. And growth in fixed-asset investment may well be moderating to between 21 and 22 per cent from the 25 per cent rate seen in recent years.

But it doesn't take a mathematician to work out that if investment is still growing at a faster pace than consumption, then the overall share of investment in the economy will increase, not fall.

In other words, China is becoming more, not less, dependent on investment. The only way for the economy to rebalance is for consumption growth to overtake investment growth.

And given that household consumption is unlikely to accelerate much beyond its current rapid pace, the only way that is going to happen is for investment growth to drop below 15 per cent a year.

Of necessity, that would involve an abrupt slowdown in China's overall rate of economic growth; something Beijing is determined to avoid.

None of this may matter very much in the short term. Rothman himself believes there is no ideal ceiling to the share of investment in GDP.

But with investment already making up close to 50 per cent of the economy and continuing to grow, his arguments will be unable to dispel the bears' fears that in China capital is being misallocated on an epic scale.

There may well be no outright debt crisis. State control of the banking system and restrictions on capital flows allow Beijing to disguise all sorts of problems.

But by continuing to pursue rapid investment-led growth, the government is running the risk that the eventual adjustment in China's economy will be all the more painful when it finally happens. That cannot be misunderstood.