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China’s ‘train wreck’ economy mysteriously stays on track

Should we listen to the pessimists on China who refuse to throw in the towel?

PUBLISHED : Tuesday, 13 September, 2016, 1:35pm
UPDATED : Tuesday, 13 September, 2016, 10:55pm

China is “an economic and financial train-wreck which will rattle the world” wrote the never-shy David Stockman, director of the US Office of Management and Budget under President Reagan, in August 2015. Yet the locomotive that is the Chinese economy continues rolling along the tracks.

Data from the United Nations Conference on Trade and Development (UNCTAD) puts mainland China’s share of the global export market at 13.8 per cent last year, up from 12.33 per cent in 2014, while the figures for the United States were 9.13 per cent and 8.53 per cent respectively.

That 13.8 per cent figure is the highest share for any country, based on UNCTAD data, since the United States cornered 14 per cent of the global export market in 1968, at a time when China’s exports only accounted for 0.96 per cent of the total.

But even if the China export engine is still performing, China’s policymakers need to rebalance the economy away from an investment/export-led growth model.

An International Monetary Fund Working Paper , published last week, argued that “China has reached an inflection point where continuing with the old growth model will likely drag the economy into the middle-income trap or trigger a financial crisis.”

“A comprehensive rebalancing of the economy is thus needed to ensure the sustainability of China’s strong growth and income convergence,” the IMF said, noting that “the [Chinese] government is committed to transform the economy” into one that is “greener, more inclusive, more consumer and service based, and less credit-driven.”

But “implementation is key.”

China’s “exchange rate policy is key to continued external rebalancing” and “going forward, it is important to continue to move to an effectively floating exchange rate regime to prevent future misalignments,” the IMF said.

‘[China] has fashioned itself into an incendiary volcano of unpayable debt and wasteful crazy-ass overinvestment in everything’
David Stockman

Beijing should opt for “higher health care spending,” the paper says, leading to a lower household savings rate and freeing up money for domestic consumption.

The IMF also stresses the need for China to “deregulate the service sector.” That would boost productivity in that segment of the economy even as “labour is re-allocated from the high-productivity industrial sector to the low-productivity service sector.”

That shift toward a services sector, that IMF staff analysis suggests is 85 per cent less energy intensive than the industrial sector, would also bear on China’s environmental problems.

Those environmental benefits, deriving from a rebalancing of the economy, have the added benefit of helping Beijing to meet its obligations under the 2015 Paris climate agreement to cut emissions, an agreement which both China and the United States ratified at last week’s Hangzhou G20 meeting.

Elsewhere, hard decisions on credit will be necessary.

“To improve the efficiency of credit allocation, budget constraints of [state-owned enterprises] need to be hardened. Especially, nonviable firms should exit the market, instead of surviving on rolled-over loans from state-owned banks,” the paper states.

To combat income inequality the working paper advocates a “more redistributive fiscal policy.” The Chinese government “should adopt a more progressive tax structure, increase transfers, and strengthen the social safety net.”

Stockman, in updated views expressed last month, said he remains convinced that China’s attempts to rebalance its economy will end in tears.

With no mincing of words Stockman wrote that China “has fashioned itself into an incendiary volcano of unpayable debt and wasteful crazy-ass overinvestment in everything. It cannot be slowed, stabilized or transitioned by edicts and new plans”.

The IMF is however optimistic that with decisive implementation of the kinds of policies outlined above “China can sustainably maintain strong economic growth and achieve its economic transition”.

In making a judgement perhaps a brief look at where China stood in 1968 can help.

Writing about China’s Cultural Revolution in this month’s edition of the British periodical History Today, Frank Dikötter, chair professor of humanities at the University of Hong Kong, alluded to the Third Front, a huge industrial project which “aimed at nothing less than the building of a complete industrial infrastructure in the country’s interior.”

“Since about two-thirds of the state’s industrial investment went to the project between 1964 and 1971, it constituted the main economic policy of the Cultural Revolution. It is probably the biggest example of wasteful capital allocation made by a one-party state in the 20th century. In terms of economic development it was a disaster second only to the Great Leap Forward,” Dikötter wrote.

Yet the Chinese economy grew from that to the economic powerhouse it is today. Perhaps the IMF Working Paper is not so over-optimistic. Perhaps Stockman’s “train-wreck” scenario will not be realised.

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