Early in 2007, Wen Jiabao (溫家寶), premier of China at the time, declared that the country’s economic growth trajectory was “unstable, unbalanced, uncoordinated and unsustainable”. Now, 10 years on, it’s instructive to revisit Wen’s warning and see what has changed. At the time, he was worried by a long and daunting list of problems that included overinvestment, reckless lending, excessive liquidity, unbalanced foreign trade, inequality between cities and the countryside, inefficient energy use, wasteful allocation of resources and environmental ruin.
Many of these problems were blamed on a hell-for-leather investment binge ahead of the 2008 Beijing Olympics. The construction of everything from shopping malls in Shanghai to new local government offices in Inner Mongolia was tied somehow by backers to the summer Games, largely in the pursuit of cheap financing from state banks.
As a result, in 2007 investment made up 38.7 per cent of China’s gross domestic product (GDP), while household consumption contributed just 36.7 per cent. Observers fretted the imbalance was storing up problems for the future. Such heavy credit-fuelled investment, they warned, would inevitably lead to the widespread misallocation of capital to projects that would never generate an economic return.
The upshot would be a rash of defaults, possibly leading to a banking crisis and recession. To avoid that fate, Beijing would have to rein in credit and investment growth, which in turn would lead to a slowdown in overall economic growth.
But things didn’t work out like that. Instead, the following year the international financial crisis struck. To counter the slowdown in global trade, Beijing opened the credit taps even wider, and fixed asset investment surged an astonishing 33 per cent in 2009.
Since then, investment growth has slowed – it had to. But that doesn’t mean the Chinese economy has successfully rebalanced towards consumer demand. As investment growth slowed, so too did household consumption. As a result, in 2015 investment made up 43.3 per cent of China’s GDP, household consumption 38 per cent.
With last year’s upturn in investment, those proportions have not changed for the better. In other words, the imbalances in China’s economy are even more pronounced today than 10 years ago when Wen called the country’s growth mix unsustainable.
Making matters worse, keeping up those levels of investment in the face of slowing growth has required ever more credit. As a result, domestic debt has ballooned from less than 150 per cent of China’s GDP in 2007 to more than 250 per cent today, a run-up uncomfortably reminiscent of other economies on the eve of full-blown economic crises.
The problem is that what was unsustainable 10 years ago looks doubly unsustainable today. And by definition, what is unsustainable must sooner or later come to a stop. With the amount of capital investment needed to procure each incremental unit of output increasing, for China to maintain the current share of investment in its GDP would require the accumulation of ever-increasing quantities of debt. That is impossible. China’s economy must rebalance. The questions are: how quickly will it happen, and how painful will the adjustment be?
After 10 years in which there has been little evidence of rebalancing from investment to household consumption, it would be foolish to bet on an immediate adjustment. A shift in the nature of Chinese investment compared with the pre-crisis years, and a corresponding change in the type of debt being accumulated, suggests no rapid rebalancing is imminent.
The long-standing picture of Chinese investment – driven overwhelmingly by monolithic state-owned heavy industrial companies sinking ever bigger coal mines or constructing ever more vast shipbuilding yards – is largely outdated. In recent years investment has increasingly meant house-building, with the share of residential investment in China’s GDP increasing from less than 10 per cent in 2007 to more than 15 per cent in 2014. Factor in the indirect effects of this investment, for example on the building materials sector, and by some estimates the housing sector now accounts for a third of China’s economic growth.
And reflecting this increase in housing investment, the rise in China’s debt levels seen over the last few years has increasingly been propelled by personal mortgage borrowing. New mortgage lending grew at a blistering 35 per cent last year. As a result, outstanding mortgage debt has shot up from less than 5 trillion yuan (HK$5.6 trillion)in 2009 to 20 trillion yuan in 2016, equal to roughly a quarter of GDP.
None of this makes the composition of China’s economy any more sustainable, or means that the adjustment can be postponed indefinitely. Indeed, as the population ages and the housing market matures, both a downturn in housing investment and a slowdown in mortgage borrowing will become unavoidable. But the switch in emphasis to housing investment and to the relatively new mortgage lending market does have consequences. It means that the skew in China’s economy towards investment and away from consumption – people saving for the down payment on an apartment or struggling to service a mortgage are less likely to spend lavishly – can persist for a while longer yet.
What was unsustainable 10 years ago is still unsustainable. But there is little sign that it will correct any time soon. ■
Tom Holland is a former SCMP staffer who has been writing about Asian affairs for more than 20 years