Five paths for China – none of them look good

The what-will-happen-to-China’s-economy debate seems a bit stale these days.  

So thanks are due to Michael Pettis,  a professor of finance at Peking University’s Guanghua School of Management, for coming up with one of the more plausible models of the Chinese economy.

His insight is in his analysis of the relationship between the private and state sectors.  And it seems a little more convincing than the far-seeing technocratic genius stuff so attractive to international bureaucrats and journalists.

In particular, Pettis tries to clear away the fog hanging around Chinese official statistics for investment, productivity and debt.  

In his piece for the Carnegie Endowment ’The Only Five Paths China’s Economy Can Follow’, he explains:

“Investment in property and infrastructure doesn’t inherently cause an economy’s debt burden to rise. If the investment is broadly productive—that is to say, if the direct and indirect economic value it creates exceeds the cost of the investment—then any increase in debt will be more than matched in the short term to medium term by an increase in GDP, which is usually a proxy for the value of goods and services produced by the economy.”

His contention is that the pattern of investment in China is currently very different to that we might expect in a Western market economy:

“Investment in China can broadly be divided into two categories that mirror the distinction between genuine and inflated growth.

  • private business investment: investment by entities that operate under hard budget constraints, activity that tends to be productive because nonproductive investment eventually lead to insolvency;
  • investment by entities without hard budget constraints: investment by local governments, state-owned enterprises, and, until recently, the property sector—whereby loss-causing activities can be subsidized or ignored for long periods.”

Hmm – this sounds a little too much like what’s been happening in Europe’s recently-socialised energy markets, but let’s put that to one side for the moment.

Pettis sees in China’s rapidly rising debt-to-GDP ratio “a strong case for a claim of systematic malinvestment”.  

And this is not just something which can be tweaked, China’s current growth model is both institutional and unsustainable. And what can’t go on forever, won’t – so there will need to be institutional change.

This would put in perspective arguments about whether the Chinese property market will have a soft landing or not.

For the full range of Pettis thinking, it’s well worth reading the whole article to understand the five ways in which the eventual failure of a state-directed growth model can be tackled (or more usually not, in his opinion).

But if you’re too busy, two trains of speculation may suffice.

First, what might be the implications for us of a long stagnation in China’s economy (similar perhaps to Japan’s lost generation after the collapse of its growth miracle in the late 1980s)?

And secondly, what would be the consequences for China’s political and economic institutions of a comprehensive failure to deliver the expected – if not promised – results.

Meanwhile, those of us who favour markets over bureaucrats as information signalling mechanisms, will be reinforced in our suspicion that President Xi Jinping got it disastrously wrong when he asserted control over China’s businesses and entrepreneurs (most obviously seen in the cutting down to size of Alibaba’s Jack Ma).  This was precisely the point when the party needed to let more power fall from its grasp.  One guesses that it will be even harder, the next time the question is re-opened. 

Perhaps more people will be joining Bloomberg in hedging their bets as to when – or even if – China becomes the world’s largest economy.

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