Beijing trying to make a virtue out of dire economic necessity
High leverage and a shrinking bang for every additional investment buck point to a steep and protracted slowdown for China's economy
President Xi Jinping says Beijing has deliberately engineered the current slowdown in the mainland's economic growth in order to push ahead with structural reform.
It's always a good idea to try to make a virtue out of a necessity.
But in this case, no one is fooled. Xi didn't choose this slowdown. It was forced on him by past government policy decisions.
At the end of 2008, with China's biggest export markets sliding into financial chaos, policymakers in Beijing opted to pursue high growth at all costs.
In response to government orders, the country's banks opened their lending taps. Companies, especially big state sector corporations, needed no other encouragement, and borrowed with a will to fund an investment boom.
In 2009, infrastructure investment leapt more than 40 per cent. The following year investment in the property sector jumped almost 35 per cent. And in 2011 manufacturing investment surged over 30 per cent.
This credit-fuelled investment binge succeeded in keeping growth up at near double-digit rates. But the inescapable consequence was a sharp build-up in leverage within China's economy as corporate balance sheets ballooned.
According to Helen Qiao, the chief greater China economist at investment bank Morgan Stanley, between 2008 and 2012 total liabilities in the Chinese economy shot up from 150 per cent of gross domestic product to 220 per cent (see the first chart).
To put that degree of leverage into perspective, it's not far off the peak level of non-financial sector debt the United States hit in 2007, immediately before the financial crisis.
Among the most eager to borrow and invest were big state companies in heavy industrial sectors. As a result, today, China's miners, steel mills, aluminium smelters, and petrochemical companies boast some of the highest leverage ratios in the country. And thanks to all that investment, they also suffer from the greatest overcapacity.
Unfortunately, excess capacity erodes pricing power, which means all that investment has failed to produce an increase in productivity growth.
Different analyses come up with different figures, but broadly they tend to agree. Over the past five years, China's productivity growth has slumped by half, falling to modest single digit rates (see the second chart).
Over the same period, however, a combination of currency appreciation and generous wage increases has pushed China's unit labour costs sharply higher. According to a study by Lombard Street Research, China's unit labour costs have now risen by some 50 per cent from pre-crisis levels. In contrast, Korea's have fallen 20 per cent.
This is an ominous combination. High leverage, a shrinking bang for every additional investment buck, and declining competitiveness all point to a steep and protracted slowdown for China's economy - whether Xi and other policymakers like it or not.
It's true that they could attempt to keep growth high by sanctioning even greater leverage to fund yet more investment.
But with returns diminishing rapidly, that approach would soon trigger a devastating financial crisis.
As it is, Xi and his cohorts are going to be faced with the daunting challenge of steering China's deleveraging. That's going to be tricky, because deleveraging, by its nature, is deflationary, tending to crush demand.
Happily, there are plenty of structural reforms Beijing can make to unleash new sources of demand and keep the economy growing at healthy - albeit modest - rates.
But to claim the slowdown is intentional - that really is a bit rich.