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Unsustainable China

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COMMENTS

4 February 2010 15:14

Just about everyone agrees that China has played a hugely positive role in keeping the world going through the GFC. In the process it has produced some extraordinary (and abnormal) economic statistics.

Credit has been growing at 30 per cent while the rest of the world was deleveraging. Government stimulus has amounted to 12-14 per cent of GDP (although this isn't all budget stimulus). Perhaps most amazing, investment is running at well over half of GDP. Despite a fall in exports of 30 per cent, GDP showed the briefest of slowing and has bounced back not far short of 10 per cent.

Economists, disciples of the dismal science, are agreed that this is unsustainable, although they disagree on just how it will come unstuck. Will the stimulus be too successful and create inflation (which has picked up already) and asset price bubbles? Alternatively, will the boost run out of steam and the economy fall in a hole? Will there be such over-investment that excess capacity will be ubiquitous and China will be criss-crossed by 'super-highways to nowhere'?

There is, however, a more optimistic view. Herb Stein coined the famous aphorism that 'unsustainable trends will come to an end', so we all agree that things will change. But it is possible that the changes may not be too parlous. Slowing credit growth may impose jerky credit rationing, but that's no worse than the sudden revisions to credit standards that borrowers in other countries experience.

While inflation may have picked up, it is still low. Chinese investors (including those in housing) have been through frequent big-dipper price cycles, so seem well experienced to ride out the next asset bubble. There are still plenty of under-serviced communities in China's hinterland which can use more electricity and roads. Excess capacity disappears quickly if the country is growing at a double-digit rate. In any case, ten per cent growth combined with an incremental capital/output ratio of four (the usual benchmark) suggests that investment should be not far short of half of GDP.

The RMB exchange rate is clearly wrong, but it's not doing too much harm to China and when the authorities decide to let it strengthen (as it did between 2005 and 2008, by 20 per cent), this will help keep inflation down. Whereas the USA has to persuade its people to consume less and save more, while at the same time paying off the huge tax legacy of the GFC, the Chinese authorities have an altogether easier task: to persuade people to consume more. Their government debt is even lower than Australia's.

Bill Overholt has an apt analogy: China is like a person fleeing from a tiger. Watch the person, and they seem to be running fast. Look at the whole picture, and it may not be fast enough. So no-one would want to down-play the enormity of the challenge. But fast economic growth gives the wherewithal to solve a lot of problems, and China has demonstrated the capacity to maintain this growth under taxing circumstances.

Photo by Flickr user npicturesk, used under a Creative Conmons license.

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