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China: soft or crash landing?

by Kevin Rafferty

Special To The Japan Times

Economists who believe that China can come to the rescue of an increasingly troubled global economy are now in a decided minority, with questions increasingly being asked whether China can save itself: Will China’s economy achieve a soft landing, a hard landing or even suffer a crash landing?

If Larry Lang Hsien Ping, professor of finance at the Chinese University of Hong Kong and a television personality, is to be believed, China’s economy has already crashed, but the damage has not yet been recognized.

According to the Epoch Times, which broke the news of Lang’s four-hour closed-door speech in Shenyang, China, he warned that the country’s growth is already 10 percent below official statistics — still showing 9 percent a year — and inflation is raging way above the official claims.

Lang added that once China’s “economic tsunami” starts, the regime will lose credibility and China will become the poorest country in the world. Lang has been unavailable for comment and his office said he was on leave until next year and they had no idea of his whereabouts.

Most China economists are not as pessimistic as Lang. However, an argument rages between China bulls and bears: Bulls believe that any property bubble or bad loans disruption will be merely a short-term cold that will not interrupt China’s rise to become the world’s mega-power; bears fear that the economic chill will produce fever and pneumonia that could endanger the political and economic life of the Communist Party if not the country itself.

Optimists often claim that “China is not Japan”. On Nouriel Roubini’s EconoMonitor this month, Alessandro Magnoli Bocchi admitted that powerhouse China today “looks as invincible as Japan did in the ’80s.” He concedes that Japan then and China today have similarities: state intervention and long-term corporate thinking; a reliance on a “dual economy” of export-led growth by efficient overseas-oriented companies alongside highly-subsidized protected domestic companies; and high savings rates and low consumption, which provide cheap capital for investment.

But he believes that China enjoys key differences in having “strong fundamentals, excellent demographics, a rising middle class, massive urbanization and high savings. If coupled with the benefits of free trade, market reforms and economic integration, these fundamentals will bring about higher salaries and an increased standard of living.”

China, so the bulls assert, is also trying its best to avoid export dependence and to promote local consumption. In addition, they say, China’s property bubbles are likely to be deflated quickly by the country’s immense growth potential.

Bocchi has confidence in the Communist Party, which he says is unlikely to repeat the mistakes of Japan’s Liberal Democratic Party, in bed with protected and inefficient economic interests.

However, China’s Communist Party, whatever its good intentions, is locked in a dance with vested interests, particularly local leaders with property developers, so that it is hard for the central leadership to root out corruption — which is at least as bad as Japan’s was and unchecked by democratic processes. Lang, as reported by Epoch Times, complained while wearing his TV performer’s hat that says China’s media “cannot report anything at all. As long as something is related to the government, we cannot report on it.” Added to this was the “insufferable arrogance” of party officials.

China bulls often mistakenly assume that China is different and immune to the normal norms of economics or to the inevitable power-corrupting processes of politics. China is certainly bigger than any other country and its modern development started from a lower level.

But as Peking University professor Michael Pettis — a self-proclaimed “China skeptic” and not a “China Bear” — pointed out recently in Australia: “There’s nothing in economics that we’ve never seen before. China is a version of an old development model that has been taken to an extreme that we haven’t seen before.”

He suggests that the French developed the model in the 1820s and 1830s to try — unsuccessfully — to catch up with the U.K. Later, Spain, Greece, Italy, the Soviet Union, Brazil and, most recently, Japan, all developed forms of this model.

The model’s hallmark is generating great, sometimes miraculous, investment-led growth in the early stages and then “stopping growth in the middle of a huge amount of debt,” Pettis notes.

I remember being in Brazil in the 1970s and raising such critical questions about the “Brazilian miracle” that the deputy editor of the Financial Times refused to publish my articles, claiming I was too critical. I was right and he was wrong: It was the start of Brazil’s lost decades.

In China’s case, the demographics are still with the country, but will soon begin to turn as the “one-child” policy causes both a decline and an aging of the population.

Key damaging factors in China’s case are the low contribution of consumption to GDP and limited levers within government control. For years, the mythical market of China’s 1.3 billion consumers has bewitched foreign commentators and businesses, even as the share of consumption in gross domestic product has fallen to an unprecedentedly low 35 percent by world standards.

McKinsey and Co. often pointed out the potential for Chinese consumption, and declared that “The Chinese have taken to consumerism with ease, embracing thousands of new products, services and brands”, while noting that they were also notoriously fickle. But in terms of consumption as a contributor to GDP, 35 percent is a drag on the economy, especially when exports are coming under pressure from slow to no growth in the main markets for China’s goods.

McKinsey Global Institute recently calculated that without further government action, consumption would reach only 39 percent of GDP in 15 years time. With policy changes, they might push it to 45 percent, well below the levels of major economies. McKinsey Global Institute urged that aggressive and comprehensive reforms are needed to bring consumption to 50 percent, which would also put China in better economic shape.

Sadly, however, confronted with falling economic growth, which some economists predict to drop to 5 or even 3 percent, the government’s temptation is to reach for the easiest levers to pump-prime more loans for investment, detracting from consumption growth and adding to the bill to be paid later.

Kevin Rafferty is editor in chief of PlainWords Media.