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How bad is China¡¦s
downturn?
By Henrique Schneider
Every now and then, an army of experts goes around proclaiming the end of
China¡¦s economy. Since the middle of this month, the new song is about China
being a bubble and the bubble bursting. Giving the answers right away: Yes,
China¡¦s economy is weakening; Yes, there are troubling signals; No, China is not
a bubble; No, the bubble is not bursting.
What is wrong with China?
Chinese economic authorities have revised their growth-forecast from 8 percent
to 7.5 percent for this year. This rate, taken at face-value, does not mean
anything. It is important to compare it with inflation, which has been estimated
at between 4 and 5 percent. This leaves room for a yearly real growth rate of
about 3 percent. Not bad? Not good.
China needs more than 4 percent-growth to pull its citizens out of poverty and
to accumulate capital to invest in all those new branches of innovation and
technology in which it aspires to compete. Most importantly, China needs more
than a 4 percent real growth-rate to fulfil the Chinese Communist Party¡¦s
promise to its people and therefore for the party to stay in power.
So, it is true that China will be facing downturn risks this year. The weakening
of its spectacular growth may entail the country getting stuck in the middle
income trap. Even a mild recession is possible. However, it does not mean that
it will decline or fail.
A bubble? Bursting?
The best definition of a bubble was given by former US Federal Reserve Bank
chairman Alan Greenspan when he described it as speculative ¡§irrational
exuberance.¡¨ This means that a bubble is fundamentally speculative and driven by
mostly (macroeconomic) irrational actions. However, China¡¦s economy is the
contrary of speculation. Its profit rates ¡X if anything ¡X are lower than the
high yields of exuberance. Its economic planning is too rational not to scare
notorious risk-takers. The very fact that the whole country is constantly
analyzing data and looking for flaws to remedy them tells us that it is not a
bubble.
There is value in China. Over the past decades, the country has come a long way.
Today, Chinese companies are world-players, universities innovate, the
labor-market has know-how, banking and finance thrives and there is a relatively
high rate of new investment. China still has strong fundamentals that allow a
rational pricing of its assets. Therefore, it is not a bubble and it is not
going to burst.
Is anything wrong at all?
Yes, and it is important. China¡¦s remarkable resilience to crisis (so far) and
the value it is building up come at high cost. The more the government
intervenes to create value and to avert downturns, the bigger the economic
imbalance it creates.
First, it is diverting almost all investment into infrastructure,
telecommunications and construction. This crowds out more interesting options
like technology or pharmaceuticals. The logic is simple: If the government gives
me a safeguard to build a road at a return rate of 5 percent, I will not be
investing in technology at a rate of 8 percent, but without a safeguard.
This massive accumulation of investment in some sectors not only diminishes
capital gains, but also influences the allocation of labor to lesser-paid jobs,
therefore keeping the value of labor below the market threshold. These two
market distortions ultimately lead to less growth.
Second, China is making its provinces pay for these massive investments. This
leads provinces into debt; some have already a debt to GDP ratio of more than
100 percent. If there is anything to learn from Europe: sovereign debt is the
enemy of growth and stability.
What does this all mean? China is about to go through a soft-patch. This is not
as worrisome as the prophets of doom make-believe. However, the Middle Kingdom
has economic challenges that need to be addressed, the sooner the better.
Henrique Schneider is chief economist of the Swiss Federation of Small and
Medium Enterprises and a researcher on the Chinese economy.
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