The Chinese red flag superimposed upon and image of Xi Jinping's face

The Chinese Economy: Still Going Strong

There has been media noise in recent times about the possibility of a Chinese economic slowdown or crash. This is nothing new; swathes of spectators have persistently claimed over the past decade that China’s miraculous growth will come to a halt, due to an ever-changing myriad of variables resulting in this ‘inevitable’ economic calamity. But criticisms often fail to capture a wider understanding of the heterogeneous and complicated systems of China’s economy. Upon examining a few criticisms, while they have validity, they also reveal that these perceived threats only pose an ostensible danger. In fact, an efficient government with a unique balance of ideas has allowed China to consistently meet its
growth targets, and will be the key to overtake the US in economic power. We have so much to learn from China’s approach to economics; if we choose to not be dismissive and examine issues closely, we may gain insight into our own economic woes.

Possibly the most common issue commentators have with China is its high levels of debt. China’s economy has primarily grown through the proliferation of government-funded investment projects (investment alone made up for 60 per cent of GDP in 2017), which have been utilised in domestic spending, such as high-speed rail construction and housing. Over the years, this has brought on ever- mounting levels of debt that have persistently increased as more spending has taken place. Efforts to avoid the financial crisis in 2008, which saw the government pour billions of renminbi into a stimulus package, only added to this debt – manifesting in the debtto-GDP ratio soaring to 300 per cent. As this debt is now rising considerably faster than GDP (which has recently slowed relative to previous years), China’s economy will begin to slump – much in the same way that western economies did when their debt began to grow faster than their GDP, in the prelude to the GFC.

The distribution and origin of this debt, as well as the health of relevant institutions, are far more indicative variables than the debt figure alone. In China’s case, debt is largely public (meaning that it essentially owns its own debt), while only 10 per cent of it is external (debts owed to foreign bodies). This means it is highly unlikely, as some commentators claim, that China will be unable to pay external debtors as per conditions and endure a sudden economic recession. Further, most of this debt was created through smart investment and spending operations that tangibly improved the real economy. In the case of the fiscal stimulus package during the GFC, most resources went to local governments and state businesses to keep employing workers and thus keep economic activity going. Meanwhile, credit growth in the US was largely due to financial engineering and an increase in private debt from the proliferation of loans and mortgages with high credit risk, which had no direct benefit to the real economy.

However, critics are quick to point out potential credit risks, brewing within the banking sector, as the most serious concern stemming from China’s debt. Due to strict regulations surrounding loans from public banks (which make up nearly half of Chinese banks), private institutions have turned to less regulated financial entities for funding and financial products. This less regulated industry is called the ‘shadow banking’ industry – an area characterised by less government regulation. Even local governments have relied on shadow banking for additional funds, since issuing bonds and stock was previously illegal. Steady privatisation coupled with the maintenance of tough loaning policies by public banks has seen the shadow banking sector reach just over 75 per cent of GDP from 30 per cent in five years, stipulating that shadow banks are helping to create substantial amounts of credit. Even if this credit is going towards real economic activity, there is concern that much of this debt is short term but funding long term projects – creating a liquidity mismatch that adds to the overall credit risk. Further, as the sector is largely unregulated, defaults do not carry government guarantees of assistance and there is great uncertainty regarding the interconnectedness of these institutions. A possible marked rise in defaults by shadow banking customers has the potential to send seismic ripples throughout the economy, if left unchecked.

These issues have not gone unnoticed by the government. The introduction of municipal bonds in 2016 for local governments took away the reliance on shadow banking and encouraged funding from more transparent sources. Many non-performing or ‘bad’ loans have long since been taken out and sold off, while the central government reinvigorated banks with additional capital. Today, the number of non-performing loans is minuscule, making it unlikely for Chinese banks to suddenly find themselves lacking the ability to pay. Regardless, the dangers of shadow banking in China have been exaggerated. Unlike the rest of the world, China’s shadow banking assets lie entirely within its own borders and well below the OECD average (which is 128 per cent of GDP compared to China’s 78 per cent). This gives government authorities total freedom over monetary and fiscal policy to deal with any defaults. Hence, critical credit channels can be kept open to maintain activity and prevent economic downturn, restricting loans to overheated industries with liquidity mismatch and the tightening of interest rates in these sectors.

An article touching on the many varied critiques of China’s economy would likely be enormous in size, covering multiple policy areas in greater depth. A final criticism worth concluding on is that of China’s slowing growth. It is true that China’s GDP has not grown as rapidly in previous years – decreasing from the record high 15.4 per cent in 1993 to that of 6.6 per cent in 2018. The engines of investment that drove the last 30 years of record-breaking growth have indeed begun to taper off, as China now searches for more fuel for the economic fire. But the commentators are wrong to suggest that this signifies the beginning of the end, nor will it mean a transition to a consumption-based economy when still much of the population is yet to enter the middle class (especially in the rural western regions). In any likelihood, the government’s current plan, focusing on the development of western China coupled with an investment in renewables, will create a new but slower burst of economic growth that will lead to the transition to an innovative and stronger economy on par, if not superior to, the US.

The underlying notion in these criticisms, whether about debt, credit risk or slowing growth, is that China has been able to overcome these common economic problems. To do so, China has directed its spending to improve the real economy, be its key infrastructure, creating jobs or combatting pollution – improvements that have a real return and long-lasting economic utility. Furthermore, China is not afraid to act to protect all aspects of its economy; it recognises that a healthy banking sector is essential alongside an efficient, committed government. China demonstrates the power of competent economic management coupled with an increasing balance of privatisation. The lesson for us is simple: there is little downside to investing in ourselves economically, particularly in infrastructure. Rather than relying on credit growth from any and all sources (such as high-risk lending), we must be conscious of what kind of growth our economy is generating – especially whether it is sustainable and impactful in the real economy. We can learn much from China’s economic achievements, which shows that foresight and efficiency in government, along with harmony between economic agents, are critical for success.