While Barack Obama and Mitt Romney have spent months locked in a sophomoric scuffle on who can come across as the toughest on China, people with a serious interest in the world’s second largest economy have been engaged in discussion about the country’s future. While China is frequently portrayed as the greatest threat to American hegemony, there has been increased concern that the economy is on the verge of a new economic crisis. With the vital position China currently holds as a main driver of the global economy, it is important for anyone with a serious interest in the economy of any nation to have a basic understanding of some of the domestic variables at play in the Eastern giant.
On its surface, most of the concerns about the Chinese economy are extremely basic. The Chinese government increased the availability of credit, most of which was driven into investments made into Chinese real estate and infrastructure creating a bubble which has shown signs of collapse. These sorts of cycles are among the most common spurs of booms and busts, as anyone in America should be able to appreciate following 2007. There are, however, some unique characteristics to Chinese investment that are worth examining.
For one, the Chinese housing and American housing bubbles are different. While the volatility of the American housing bubble was in part fueled by subprime loans, Chinese mortgages are characteristically conservative – Chinese homeowners are usually required to make a down payment of at least 20%. More important to understanding China however is getting to the “Why” of the underlying political motivations in spurring this investment. While American policy makers were driven by a singular goal of increasing home ownership – the American Dream – the Communist Party’s top goal is different – job creation.
A government placing an emphasis on job creation hardly seems unique, but few go to the lengths of China. As James Rickards explains in his book Currency Wars:
No one knows better than the Chinese Communist Party leadership what would happen if those jobs were not available. The study of Chinese history is the story of periodic collapse….This is why the Tiananmen Square demonstrations in 1989 were as troubling to the Chinese leaders as their violent suppression was shocking to the West….The Chinese leaders also understood that the Tiananmen protests were fueled not just by prodemocracy sentiments but by student and worker resentment at higher food prices and slower job growth.
American politicians fear their re-election chances when unemployment rises. Chinese leaders fear the very social stability of their country. The result has been China to engage in a form of hyper-Keynesianism, putting Keynes’s infamous example of paying individuals to dig ditches into practice.
Bloomberg Businessweek provides one example of this government policy in practice:
Wang Mengshu, deputy chief engineer at China Railway Tunnel Group, says that rather than use advanced technology to carve out railroad tunnels, the group often prefers to hire millions of pairs of hands “to solve the national employment problem.”
Nearly every month brings news of an infrastructure failure, dramatic or mundane.
This coincides with widespread reports of the demolishment of bridges, buildings and other construction projects which are merely a few years, sometimes even months, old.
This problem is further exacerbated by widespread cronyism within the financing of these projects. Though China has made great strides towards a more market based economy over the last few decades, the government still maintains significant control of the economy, such as the existence of state-owned enterprises (SOEs). Gao Xu, a former analyst for the World Bank, identified these massive institutions as controlling around 30% of all total assets in the country. It should not be surprising that the SOEs enjoy many competitive advantages due to their government with the state, including below-market interest rates for funding. The result is massive inefficiency amongst China’s largest market participants. In a separate study, Xu found “that if SOEs were to pay a market interest rate, their existing profits would be entirely wiped out.” That is a massive section of the economy dependent artificially upon cheap credit.
The combination of a policy of hyper-job creation and inefficient government-backed corporations has lead to the creation of full cities that stand as a testament to waste. Standing as modern day ghost towns, Chinese building projects have let to the construction of entire cities – homes, apartment, retail buildings – with no residents to put them to use. Writing for the World Bank, Holly Krambeck describes:
In Chenggong, there are more than a hundred-thousand new apartments with no occupants, lush tree-lined streets with no cars, enormous office buildings with no workers, and billboards advertising cold medicine and real estate services – with no one to see them.
As my colleagues and I wandered, on–foot, down the center of Chenggong’s empty 8-lane boulevards and dedicated bus lanes, never seeing a single person, we marveled about the fiscal and political conditions that would have to exist to create something like this.
Interestingly enough, these types of projects are spreading outside the country as Chinese SOEs expand their reach. As the BBC reports, “Perched in an isolated spot some 30km (18 miles) outside Angola’s capital, Luanda, Nova Cidade de Kilamba is a brand-new mixed residential development of 750 eight-storey apartment buildings, a dozen schools and more than 100 retail units…nearly a year since the first batch of 2,800 apartments went on sale, only 220 have been sold….When you visit Kilamba, you cannot help but wonder if even a third of those buyers have moved in yet.”
With such warning signs, it should be no surprise that China’s economy has begun to cool down over the last few years. As The Wall Street Journal reported on October 18th, “Growth in China’s gross domestic product fell to 7.4% in the third quarter compared with a year earlier, China’s National Bureau of Statistics said Thursday, down from 7.6% in the second quarter and the weakest since the beginning of 2009.” The expectation is that even these numbers are inflated by the Chinese government. In a separate WSJ article mentioning second quarter GDP numbers, “Skeptics think the real number is closer to 4%. (One London research house says 1%.)”
If we can identify that there is a great deal to be concerned about regarding China’s economic outlook, the next question is how bad can things get, what can be done about it and how should we feel about the nation’s long-term future. For that we must continue a broader look at the Chinese political structure, facing a once-in-a-decade transition of power, as well as the intellectual trends within the country.
For that, I will need another post.