Time is running out for China to implement vital economic reforms.
In a new working paper published this month, International Monetary Fund researchers Malhar Nabar and Papa N'Diaye warn that failure to make far-reaching policy changes is likely trigger a financial crisis that could derail China's economic development for years to come.
The IMF's staffers are alarmed by the way credit in China is ballooning.
"In other economies, credit expansions of this kind have often been associated with large mispricing of risk and a build-up of crisis vulnerability," they note.
Meanwhile, as new investment continues to rise, overall growth rates are declining, which means returns on capital are diminishing (see chart).
That, argue the IMF researchers, suggests China's long-standing economic strategy of accumulating physical capital and absorbing underemployed workers from the countryside is bumping up against its limits.
"China's extensive growth model may be running out of steam," they write.
Unless Beijing changes direction, there is a danger growth could stall with China falling into the middle income trap which halted the rise to developed economy status of many Latin American countries at the beginning of the 1980s.
"History suggests that failure to adapt … contributes to further macroeconomic and financial imbalances and ultimately ends in crisis," they warn.
That's achieved enormous gains. But after years of heavy investment the country's productive capacity has now run far ahead of its demand.
As a result, in 2011 China used only 60 per cent of its ferrous alloy capacity, and just 50 per cent of its cement capacity.
With demand in the rest of the world sluggish, all that excess capacity is likely to push down prices, further depressing returns on investment.
"This would imply lower profits, rising bankruptcies and large financial losses," warn the IMF staffers.
The danger is that China will find itself trapped in a destructive feedback spiral.
As loan losses force banks to clean up their balance sheets, lending will contract, private sector investment will decline and unemployment will rise.
Higher unemployment, in its turn, will depress domestic demand, leading to even less investment, lower tax revenues and a mounting public debt burden. The result, according to the IMF paper, will be a slump in growth to below 4 per cent a year.
The solution, argue Nabar and N'Diaye, is for the central government to quit simply pouring more capital and labour into the economic cake mix, and instead to focus on maximising the growth of what economists call total factor productivity, or TFP.
TFP consists of the gains that are left when you strip out the growth attributable just to adding capital and labour, and is perhaps most simply described as economic efficiency or innovation.
It's an elusive concept, but the structural reforms the IMF economists recommend are familiar enough.
Provincial governments should open up their local markets, lowering barriers to entry and encouraging competition in order to drive efficiency gains.
Similarly, Beijing should deregulate major service sectors, including telecommunications, utilities and health care, and should embark on household registration and land reform to eliminate economic distortions and ensure the more efficient allocation of capital.
Although growth would suffer in the short run, the longer term result should be a growth trajectory similar to Korea's - not Latin America's.