China’s Economy: The End Game

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The growth of the Chinese economy over the last thirty years has been called “an economic miracle” and “the engine of global growth”. After surpassing Japan’s output a few years ago it is widely expected to rival the United States in the near future.

Is such an outcome likely, or even possible?

First a word of caution: The (now defunct) Soviet Union also exhibited extraordinary growth numbers. While its economy did indeed expand rapidly it gradually became known that Soviet statistics were inflated and offered an overly optimistic picture of the real economic situation. Authoritarian regimes tend to overstate their achievement for propaganda purposes, and China appears to be no exception.

What is then China’s real economic situation? So far there have been three phases in its economic development.

Phase one was communist-style development under strict central planning. While this achieved notable results – as it did in the USSR – China’s economy remained primitive, inefficient, and showed no prospect of ever catching up with the West in output and technical sophistication. Another approach was needed if the Soviet Union’s fate was to be avoided.

The answer was to allow the creation of a “capitalist sector” within the state-controlled economy, coupled with the use of China’s huge mass of low-wage – but hard-working – labor. This mass of workers, coupled with the avoidance of any environmental or legal constraints and mercantilist trade policies, allowed Chinese industries to offer prices far lower than any attainable in the developed world. The result was a massive move of global manufacturing facilities to China, creating a booming export sector and a highly favorable trade balance. At the same time foreign industries were attracted to China by the lure of its potentially huge domestic market. With them they brought their managerial and technical skills, allowing China to short-circuit a learning process that in other countries took generations. The “economic miracle” was well on its way.

It was, however, a “one-off” deal. The transfer of well-paid manufacturing jobs abroad reduced the incomes of China’s new customers and the growth rate of their economies. The lost purchasing power had to be replaced by an expansion of credit, leading to financial excesses and the 2007-2008 collapse. China’s exports plummeted, causing an economic contraction threatening the stability of the regime.

Which led to phase three: export-based growth was replaced by a fixed investment boom: massive resources dedicated to highways, dams, airports, industrial capacity expansion, high-speed rail, and housing, housing, and more housing. Growth picked up again while China became one vast construction site.

This gave the “miracle” a second wind, but with two growing problems. First, all that development was financed with credit at all levels: companies, municipalities, provinces. To restart the economy the government engineered a massive borrowing binge, making China the most internally indebted country in the world. Second, much of the development was done for the sake of immediate economic activity, often without consideration of whether all these investments would ever pay for themselves. China ended up with millions of unoccupied apartments, airports no one used, huge productive over-capacity in almost every industrial sector and debts the borrowers could not afford to pay back.

Growth, once in double-digits, is now – officially – around 7%. A number of observers digging beyond government statistics place it much lower at 3 to 4 %. The “miracle” is gasping for breath.

With internal problems mounting – and a massive environmental disaster threatening – the government has conjured up a possible phase four. This is the “New Silk Road”, a massive infrastructure program that would link east and west Eurasia through a giant complex of roads, railroads, new cities, communication links and pipelines. Foreign investors are invited to contribute, with the hope that this huge project would keep China’s economy churning for another six or seven years.

It might work, and then it might not. If the global response to the project is inadequate, the miracle will be over.

China has milked globalization for all it was worth. In the process it created huge trade imbalances, reduced global wealth and income, ravaged its domestic environment and added an outsized contribution to the global debt pile. Now it hopes the rest of the world will give it another few years of economic expansion.

Whether this succeeds or not, the “miracle” is being revealed for what it really was: a massive exercise in borrowing from other nations coupled with borrowing from the future. The bill is coming due and it is not sure that China can afford it.

Born in Poland, Jacek Popiel was educated in Africa, Canada, and the United States. He speaks five languages. His career spans military and international business development in the Soviet Union, Eastern and Western Europe, North America, and Japan. He is currently a freelance writer and political consultant. His book “Viable Energy Now,” grew out of his military and international business experience and his professional involvement with energy issues.

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