The Chinese miracle

A study on how China tackled the financial crisis amid global meltdown

As an economist, one cannot but envy the great miracle of Chinese growth, breathtaking in its pace and scale, an occurrence without historical precedent. For nearly 35 years, China’s economy has grown at nearly 10 per cent per annum, doubling in size every six years. Between those 30-odd years, per capita GDP in current US dollars shot up from $193 in 1980 to $6,091 in 2013.

Just to compare, Pakistan’s per capita GDP during the same period grew from $296 to $1,257.

In matters of numbers, China never ceases to amaze.

The Chinese growth model depended largely on its ability to export massive amounts of goods, which in turn fostered investment and economic growth in the country.

For years, this model worked perfectly. China became the poster boy of mass production, churning out hundreds of billions of dollars’ worth of goods every year, at unimaginably low costs. As long as China could produce cheaply in a world which was growing at a relatively steady pace, Chinese exports were going to grow too.

In true Chinese fashion, mustering the sort of political will only possible in one-party states, China shifted gears, heralding in an era of unprecedented infrastructure investment. The Communist Party actively pushed various banks, mostly state-owned, to open their vaults and lend without let or hindrance.

The West especially, was hooked, loathing and loving China in equal measure.

The export as growth model was nothing new, several other Asian countries such as Taiwan and Japan had emulated it successfully but China’s scale, drive and intensity were at a different level all together.

Save for a few crises, the world was spared the gut-wrenching trauma on the scale of the great depression. The good times were here to stay, or so the world thought. Come 2008, however, and that illusion would be shattered.

A debate about the very core, basic principles of the modern economy would ensue. The crisis struck deep at the roots of the economic system, triggering a period of intense soul searching. The savage force of the crisis took many by surprise and what followed was a period of plummeting growth across the world, especially the developed world.

The Chinese, not the ones to be left behind, are taking policy measures in order to overcome the overinvestment issue by trying to increase levels of domestic consumption and move China’s economy from one led by exports and investment to one led be domestic consumption.

The Chinese were faced with a very difficult problem. China’s largest trading partner was the developed world. And with growth slowing down, the foundations of the export led growth model began to shake. What then was to become of China’s economy and more importantly, the Communist Party, which drew a large measure of its legitimacy from being able to give its citizens more and better economic opportunities?

Without improving its citizens’ standard of living, the Communist Party would likely face increased opposition and dissent. The toxic spillover from the financial crisis had the potential to threaten the very survival of the Chinese Communist Party.

In true Chinese fashion, mustering the sort of political will only possible in one-party states, China shifted gears, heralding in an era of unprecedented infrastructure investment. The Communist Party actively pushed various banks, mostly state-owned, to open their vaults and lend without let or hindrance.

China became the poster boy of mass production, churning out hundreds of billions of dollars’ worth of goods every year, at unimaginably low costs. As long as China could produce cheaply in a world which was growing at a relatively steady pace, Chinese exports were going to grow too.

The result: a flurry of investment spending by the Chinese that powered China’s growth while the rest of the world was stuck in an economic limbo. In 2009, Germany, the great bulwark of the European economy, recorded a 5.1 per cent fall in its GDP. During the same year, China posted a blistering, show-stopping, national growth rate of 9.2 per cent. During the same period, the world GDP fell by nearly 3.0 per cent.

This shift towards investment as a source of growth clearly manifests itself in the country’s investment to GDP ratio. In 2008 China’s investment to GDP stood at 42 per cent. By 2013, this had been ratcheted up to 49 per cent, a seven percentage point increase in barely six years. In dollar terms it comes to nearly $600 billion in additional spending on investment each year –‘additional’ being the key word here.

This additional spending is close to three times the size of the Pakistani economy.

This model of fostering growth through investment has a major downside.

As more and more capital is added, diminishing marginal returns set in. The return on every additional unit of capital goes down. At some point, where the marginal benefit of capital falls below the magical cost, such that further spending on capital brings about negative returns.

While the Chinese seem confident that it is not a danger to the Chinese economy, Robert Peston of the BBC in his documentary ‘How China fooled the World’ is less sure about this model being sustainable.

Peston points to the large amounts of debt that local governments have taken on in order to finance their projects. This debt, according to Robert Peston, might end up being unserviceable and might lead to something of a Chinese financial meltdown.

Kenneth Rogoff, professor of economics at Harvard University, seems certain that it will be the case. While speaking to the New York Times, Rogoff contends that the property bubble in China will burst and debt will grow to a point of unsustainability within this decade, leading to not only slowing growth in China but triggering an Asia-wide recession. This is also likely to severely impact local governments’ borrowing, seeing how state land is often an important source of debt collateral.

The export as growth model was nothing new, several other Asian countries such as Taiwan and Japan had emulated it successfully but China’s scale, drive and intensity were at a different level all together.

The Chinese, not the ones to be left behind, are taking policy measures in order to overcome the overinvestment issue by trying to increase levels of domestic consumption and move China’s economy from one led by exports and investment to one led be domestic consumption.

Consumption in China is low by most international standards, standing at 35 per cent in 2013, compared to upwards of 60 per cent for most middle-income and developed economies. Some contend that China simply does not have the time for such a shift to change place, such moves generally take time. Others, though, are more optimistic and feel China has enough space to implement such a move.

In either case, there is growing realization that China cannot depend upon its past models anymore and if China is to continue to grow economically, it will have to successfully implement this shift from exports and investment to domestic consumption.

Failure to do so might lead the Chinese to their little financial crisis. Except it would not be their own to suffer, nor will it be little in any sense of the word.