Opinion No more bad options
Why China cannot afford to waste another economic crisis
As the sovereign debt crisis in Europe and political gridlock in Washington continue unabated,the risks of another global recession have increased significantly. The only bright spot is the relatively robust growth in emerging market economies,particularly China,India and Brazil. But hopes that these emerging giants can ride to the rescue of the rich countries,either by purchasing their distressed sovereign debt or taking more of their exports,are both naïve and misplaced. Despite talks of de-coupling the insulation of high-growth developing countries from stagnant mature economies a potential global recession originating in the wealthy economies will inevitably drag down economic growth in the so-called BRIC countries.
On the surface,the prospect of a global slowdown,if not recession,is the last thing a country like China wants to face. Yet,in reality,economic crisis often brings rare opportunities for political leaders to take bold action and address deeply embedded structural problems. That is why the Chinese characters of crisis consist of two separate words: one for danger and the other for opportunity.
Unfortunately for China,its record for turning crisis into opportunities for structural reform is spotty at best. While Beijing seized the 1997-98 East Asian financial crisis to recapitalise its fragile banking system and fire more than 40 million workers in state-owned enterprises,it wasted the opportunity for reform provided by the 2008-09 global financial crisis and recession. Instead of mustering the necessary political courage to end its reliance on an investment-driven growth model and shrink the role of the state in the economy,the Chinese government used its massive stimulus programme to further distort the economy and undermine the sustainability of its future growth. As a result,China is now far less well-prepared to weather another global recession.
This assessment may seem overly harsh. In the eyes of foreign observers,Chinas oversized stimulus package,$600 billion in fiscal spending and $1.5 trillion in new bank loans in 2009,is what governments should do to revive growth. Taken together,the net stimulus injected into the Chinese economy in 2009 was equivalent to almost 40 per cent of GDP a veritable display of shock and awe. No wonder Chinese growth did not falter during the depth of the last global recession.
But appearances are deceiving. To the outside world,the Chinese economy seemed resilient. In reality,China paid a huge price for sacrificing structural efficiency for short-term growth.
Before the last global recession hit China through a precipitous fall in its exports,Chinese policy-makers were well aware of the structural imbalances and deficiencies in the Chinese economy: excessive reliance on exports (with net exports exceeding 35 per cent of GDP),an investment-driven growth model that threatens to create excess capacity and undercut sustainability,anaemic household consumption (which accounts for less than 40 per cent of GDP),rising resource-intensity and environmental degradation.
However,the global economic crisis of 2008-09 induced political panic,not political courage,among Chinese leaders. So instead of using the crisis as an excuse to rebalance the economy by reducing investment and boosting consumption,Chinese leaders simply doubled down by pouring money into fixed investment projects,most of which are owned by local governments and state-owned enterprises. To be sure,growth rate was maintained,albeit artificially. But Chinas macroeconomic imbalances grew worse. In 2008,household consumption was a paltry 35 per cent of GDP; in 2009,the ratio remained the same. In the meantime,the share of investment rose from 44 to 48 per cent of GDP from 2008 to 2009. The data for 2010 indicate this distorted macroeconomic picture has hardly improved,with the Chinese economy deriving 54 per cent of its growth from investment and only 37 per cent from consumption.
Even more problematic and potentially disastrous for Beijing is that a significant portion of its investments made during the crisis was wasted. For example,local governments took advantage of low credit standards used by state-owned banks to finance infrastructure projects that are economically unviable. Preliminary research by Chinese economists suggests that perhaps 25 per cent of the loans made to local governments are at risk of default. This alone could mean as much as $350 billion non-performing loans on the books of Chinese banks.
In all likelihood,the costs of Beijings last stimulus folly will be borne by Chinese taxpayers and private entrepreneurs. China has not finished the last round of banking sector clean-up (the government merely hid the non-performing loans in off-balance-sheet special purpose vehicles),so paying another round of banking recapitalisation will mean higher taxes from ordinary Chinese people. As for Chinas long-suffering private entrepreneurs,they saw their competitiveness suffer as the last stimulus package favoured entrenched state-owned enterprises with cheap capital and regulatory protections.
The cumulative impact of structural distortions and wasted investment has placed China in a more precarious position to confront another possible global recession. Its banking sector is much weaker now (that is why Beijings banking regulators are pressing Chinese banks to raise capital). Its fiscal health has deteriorated as well because,ultimately,Beijing will have to bail out debt-ridden local governments. When hidden sovereign debt liabilities (excluding healthcare and pension obligations) are counted,Chinas gross public indebtedness may be in the range of 70-80 per cent of GDP,not exactly a picture of unassailable fiscal fortitude. Further complicating the problem is the coming crisis of the Chinese real estate sector,which contributes roughly 12 per cent of the GDP growth each year. Because of Beijings anti-inflation fight and pledge to reduce housing prices,Chinas highly leveraged developers are facing a collapse in sales and a looming liquidity squeeze. The repercussions of a real estate collapse could be ugly,involving insolvent developers and their panicky creditors (chiefly Chinese banks).
Although Beijings weakened financial positions are unlikely to bring on a full-fledged banking crisis,China will be in no position to repeat its profligate stimulus feat should the need arise in the near future.
But that is not necessarily bad news. In fact,the lack of (bad) alternatives is the midwife of good policies. In the Chinese case,this will require Beijing to force through some of the long-delayed structural reforms,such as reducing its reliance on investment to power growth,cutting subsidies and protection for state-owned enterprises,making capital more accessible to private entrepreneurs and boosting household income to revive consumption. These measures would put China on a more sustainable growth path even though they may entail short-term pains.
Whether China will do the right thing during the next crisis is anybodys guess. But wasting another crisis,to paraphrase Oscar Wilde,would be worse than carelessness.
The writer is a professor of government at Claremont McKenna College in the US,express@expressindia.com
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