Two wrong ways to think about China’s slow­down

The Pak Banker - - OPINION - Noah Smith

WESTERN ob­servers strug­gle to make sense of what's hap­pen­ing to the Chi­nese econ­omy. Since China is slow­ing, drag­ging down com­mod­ity prices and forc­ing a num­ber of other coun­tries into re­ces­sion, this in an im­por­tant prob­lem to puz­zle out. But how should we eval­u­ate China's econ­omy? I find that Western writ­ers tend to sub­scribe -- ex­plic­itly or im­plic­itly -- to one of two folk the­o­ries of China. Both have se­ri­ous de­fi­cien­cies.

The first of th­ese folk the­o­ries is "re­bal­anc­ing." This is the idea --pro­moted by Michael Pet­tis of Pek­ing Univer­sity -- that China has been in­vest­ing too much in in­fra­struc­ture and fac­to­ries, and needs to switch to ser­vices and to con­sump­tion. The the­ory says that this ad­just­ment is nat­u­ral and in­evitable, but will lead to slower growth.

It is prob­a­bly cor­rect that re­bal­anc­ing is nec­es­sary. Ad­vanced economies are heavy on ser­vices and con­sump­tion, lighter on in­vest­ment and man­u­fac­tur­ing. There is no ob­vi­ous rea­son to think that China's de­vel­op­ment will turn out any dif­fer­ent. As for whether this ne­ces­si­tates slower growth, that ques­tion is less clear. Af­ter World War II, the U.S. shifted from man­u­fac­tur­ing to ser­vices, but growth re­mained at about the same rate through­out. Maybe China's shift will force growth to be slower than it would have oth­er­wise, but it seems far from cer­tain.

But where re­bal­anc­ing the­ory re­ally falls apart is when we rely on it to ex­plain re­cent de­vel­op­ments in the Chi­nese econ­omy. China's slow­down is forc­ing the shut­ter­ing of a large num­ber of fac­to­ries, throw­ing peo­ple out of work and forc­ing many to re­turn to ru­ral ar­eas where they will be semi-em­ployed and much less pro­duc­tive. This is a clear sign of eco­nomic dis­tress, and is a rea­son we should be a bit skep­ti­cal of of­fi­cial Chi­nese gross do­mes­tic prod­uct num­bers (they have fallen only slightly, to about 7 per­cent). It is wrong to in­ter­pret this as a pos­i­tive sign, as some do. Eco­nomic shifts should be slow and grad­ual, not rapid and dis­rup­tive.

We also should be cau­tious about the growth in the Chi­nese ser­vice sec­tor. Much of that has come from the ex­pan­sion in fi­nan­cial ser­vices, much of which just rep­re­sents banks help­ing floun­der­ing com­pa­nies roll over their loans. Some part may even rep­re­sent fake ac­tiv­ity. This isn't the "re­bal­anc­ing" Pet­tis talks about, but the sign of a sick econ­omy that will take years to work through its prob­lems. The se­cond folk the­ory that peo­ple use to un­der­stand China is based on debt lev­els. The idea here -- which is rarely ar­tic­u­lated, but seems to in­form much of the writ­ing about China -- is that lend­ing drives growth, but en­tails the buildup of bad debt that ul­ti­mately causes slow growth. This is sort of a "sin and pun­ish­ment" view of the econ­omy.

This idea prob­a­bly de­scribes some episodes and time pe­ri­ods in some coun­tries, but this isn't gen­er­ally true. If it were, you could use debt lev­els -- or the change in debt lev­els, or the ac­cel­er­a­tion of debt lev­els -- to pre­dict re­ces­sions. But you can't. Though there are some debt-re­lated vari­ables -- such as in­ter­est-rate spreads and debt qual­ity -- that re­ally do help pre­dict down­turns, ab­so­lute debt lev­els have al­most no pre­dic­tive power. So look­ing at the amount of debt in China is prob­a­bly a bit of a dis­trac­tion.

Be­cause the folk the­ory of debt-driven growth is in the back of peo­ple's minds, there is a lot of con­tra­dic­tion in the way we talk about Chi­nese lend­ing and what it means for the econ­omy. For ex­am­ple, I read bullish ar­ti­cles say­ing that the in­creases in Chi­nese lend­ing are good news. And I read bear­ish ar­ti­cles trum­pet­ing the ex­act same lend­ing surge as a sign of im­pend­ing doom.

Fo­cus­ing on debt lev­els dis­tracts peo­ple from the real is­sue, which is the qual­ity of that debt. If loans are be­ing made to fi­nance sus­tain­able eco­nomic ac­tiv­ity, that's good. If they are be­ing made at below-mar­ket rates be­cause the govern­ment wants to sup­port GDP growth, that might be OK in the short term. But if new loans are be­ing is­sued to roll over old loans to com­pa­nies that in­vested in un­suc­cess­ful projects and are now re­fus­ing to rec­og­nize their fail­ure and go bank­rupt, it is very bad. The eter­nal rolling-over of bad debts would hold down Chi­nese pro­duc­tiv­ity in the fu­ture, the way it sad­dled Ja­pan with zom­bie com­pa­nies af­ter that coun­try's bub­ble burst in the early 1990s.

As of now, credit qual­ity in China doesn't look so good. Ex­actly how bad it is, we can't say, but it's al­most cer­tainly worse than is be­ing re­ported. So the pes­simists are prob­a­bly right. But it is wrong to see China's debt prob­lems as in­evitable -- it isn't the buildup of debt that poses the big dan­ger, but the dis­tor­tions caused by bad lend­ing.

Newspapers in English

Newspapers from Pakistan

© PressReader. All rights reserved.