An Old “New Story” Draws Closer to the Climax: Perplexities of China, Part I
May 16, 2011At a recent Shen Yun Performing Arts show in Atlanta, my family watched in amazement as the talented artists danced, sang and played their way through legends and events that shaped the rich culture of China; stories of war and peace and romance that have played out over the millennia. I was reminded of just how young we are as a society in America. The thought also occurred to me that in one very important way, it is the United States that is the “old hand” and China the neophyte — economic development and widespread prosperity. America has built the greatest wealth for the greatest number of people the world has ever seen. And we’ve been working on it for hundreds of years; starting with a constitutional framework that unleashes human creativity and potential like no other. There have been plenty of bumps and bruises along the way, and the system is far from perfect even today. However, in addition to being the largest economy in the world by a factor of almost three, the qualitative and structural aspects of the U.S. economy stand in even more dramatic contrast.
Stephen Roach of Yale University wrote recently in an article entitled China’s Turning Point: “Premier Wen Jiabao laid the groundwork four years ago, when he first articulated the paradox of the ‘Four Uns’ — an economy whose strength on the surface masked a structure that was increasingly ‘unstable, unbalanced, uncoordinated, and ultimately unsustainable’ … China can no longer afford to treat the Four Uns as theoretical conjecture. The post-crisis era is likely to be characterized by lasting aftershocks in the developed world — undermining the external demand upon which China has long relied.” In short, global demand is a gale-force headwind against China’s growth prospects. And, without a return to the growth in demand we witnessed up until 2008, China is left with only two very shaky paths to maintaining even the status quo GDP. Importantly, experts consider 5-6% GDP growth in China to be the minimum needed to avoid civil unrest. So the status quo is not good news. We will discuss those two paths to redemption in the final article in this series, but unfortunately, we assign a low probability to either one occurring.
GDP by Over-Investment — Understanding the Problem
From 2000 to 2010 China’s GDP grew from around $1.5 trillion to $6 trillion. How? Predominantly three ways: 1) government-controlled exporting of cheap labor products at a time of massive, global, consumer demand, followed by 2) government-controlled investment of the proceeds of exporting and 3) foreign direct investment into China. The point was to rapidly create jobs and a domestic economy for the billion rural Chinese who desire a better standard of living. With that many mouths to feed, economic viability and profitability of government investments are not even a secondary consideration. The cost of such rapid export/investment growth is an economy that is much more vulnerable to outside forces — global financial crises, trading partner recessions, etc. An economy driven by domestic consumption (think U.S. and Europe at almost 70%) will be more self-sustaining than one dependent upon exports to other countries. Similarly, GDP from manufacturing and exports can be more readily continued than GDP from investment. Chart 1 shows a 20 year history of consumption, exports, and investment as a percentage of GDP in China.
Chart 1
The numbers are startling when you consider the implications. First, the Chinese consumer has fallen from 50% of the economy to around 35%. This is a major imbalance caused by the state-owned factories, banks and other sources of production. At the same time, investment has grown as a percentage of the economy to an estimated 48% in 2010 (CIA Factbook). In fact, of the 10% growth in China’s economy last year, I’ve seen estimates that 90% of that growth was from investments (building projects, infrastructure, railways, etc.). Investment GDP can be good for the future of a country, but the trillions that have poured into Chinese infrastructure (often borrowed money) over the past few years raise serious doubts about the economic viability of the projects. At some point — and many experts believe we passed the point years ago — the money is just going down a hole. Further, the ability to grow GDP by investment counts on a continuing flood of cash entering the country via exports or outside investors. Therein lies the rub. Mathematically, without a strong consumer, China must get cash from the outside just to maintain its GDP, much less grow.
Size of GDP is Only the Beginning
The transformation in China over the last couple of decades, measured in GDP as well as along other lines, is nothing short of amazing. Millions of Chinese have been lifted out of poverty and given hope for a brighter future. But, the breathless commentators who rush to predict the Chinese eclipse of the U.S. in economics and world affairs miss a critical point that is slowly becoming evident here in 2011: there is no shortcut to greatness in nation-building.
The very process of tripling the size of an economy in such a short period creates tremendous imbalances that threaten, and in my opinion, eliminate the ability to keep growing at high rates. In preview of the coming series of articles, it is the qualitative and structural differences faced by China that represent overwhelming challenges to continued fast-paced growth. These are perplexing both because of the scale of the Chinese economy and the worldview underlying its architects’ vision. The world has never seen an economy so big, managed by so few, philosophically driven by so convoluted a mix of capitalism and statism; Interesting times indeed.
