The world should stop panicking over China’s economic slowdown. It’s actually a good thing.
This advice won’t go down well in Australia, which has made a big leveraged bet that China will keep growing 10% forever. It won’t comfort exporters in Japan, Singapore, South Korea or Taiwan. Traders won’t be happy to see prices of oil, gold and steel plunge as demand from the mainland shrinks. Asia, as a whole, will shudder if China weakens the yuan. Europe might have to find a new benefactor for its debt markets.
Yet if China is to avoid a major crash, a minor setback right now may be just what the country needs. Everyone agrees the country’s old growth model is unsustainable. Its economy is perilously addicted to exports and inflated property prices. Massive investments in smokestack industries have led to overcapacity and blackened China’s skies. A tight labour market is driving up wages, just as global demand for Chinese products is dwindling. Local governments are piling up dangerous levels of debt.
Chinese leaders have said for years that they needed to move the economy toward a growth model led by services and household spending, not exports. So why did the country make so little progress during former President Hu Jintao’s 10-year term? Zero political will. Rather than challenging vested interests or risk sparking public anger, Hu anesthetized his 1.3 billion people with easy credit and history’s biggest building boom. A humming export engine deadened the urgency for change.
Fear could now be cathartic. Chinese Premier Li Keqiang expects growth to slow to 7% this decade. Even that may prove optimistic—and in any case, anything less than 8% growth could prove disastrous if handled poorly. That changes the calculus for China’s much-vaunted economic managers: It may be more dangerous to avoid painful economic reforms than to institute them.
Historically, like their counterparts from Washington to Tokyo, Chinese leaders have responded best in a crisis. The horrors of Mao Zedong’s Cultural Revolution drove Deng Xiaoping to build a market economy. Recession and soul searching after the Tiananmen Square massacre led to Deng’s 1992 southern tour to bolster restructuring efforts. The 1998 Asian financial crisis empowered Premier Zhu Rongji to shake up state-owned enterprises.
President Xi Jinping now has a chance to change China’s course just as dramatically as his predecessors. How? First, China must ensure that capital is priced realistically. That means banks must stop shovelling loans to deadbeat state enterprises and unnecessary real-estate projects. Fitch Ratings says financial lending totalled 198% of gross domestic product last year, compared with 125% four years earlier. Banks can’t grow their way out of that kind of debt.
Xi must rein in local governments, too. A glut of borrowing, much of it off-balance sheet, has raised the specter of a Japan-like bad-debt disaster. Recently, former finance minister Xiang Huaicheng let slip that local debt may have reached $3.3 trillion. That’s a bad omen for China’s credit rating.
Better household-registration policies would help workers moving to cities to get social benefits and education—critical if China is to transition from an economy dominated by manufacturing to services. Xi also must act fast if the country is to avoid choking on its own development. Of the 20 dirtiest cities, 16 are in China. Pollution is rapidly replacing corruption as the main cause of social unrest.
Massive investment in wind turbines and solar panels is a good start, but China must think bigger. It should learn from Japan’s postwar environmental example, and enact laws to reduce emissions, demand greater energy efficiency across industries and consider a carbon tax.
On each of these measures, Xi will run into resistance from Communist Party bigwigs who have gotten fat off the status quo. True reforms will also depress GDP growth, perhaps to as low as 5% or 6%. Xi will face great pressure to paper over China’s daunting to-do list by offering fresh fiscal stimulants, a few new dam and airport projects and nationalistic rants to deflect attention.
The previous administration basically promised the same reforms, says Jim Chanos, the president of New York-based Kynikos Associates Ltd and a prominent China bear investor. The entire Chinese political system is tilted to the current model. Truly changing it will bring on a serious economic contraction. It remains to be seen if Xi/Li have the political will to risk that outcome as a by-product of reform.
Fair enough. The weaker the current outlook grows, though, the less of a risk that seems. There are still bulls talking about how China can reverse the slowdown by stepping firmly on the credit accelerator again, but this is like saying that you can prevent a hangover by drinking even more, says Michael Pettis, a finance professor at Peking University. We may get a small pop in growth now and then, but the overall trajectory is for growth to continue slowing.
That’s a bleak prospect—for the world as well as China. But by bringing home the stakes for Chinese leaders and bolstering the case for reform, it may also turn out to be a bright one. Bloomberg
William Pesek is a Bloomberg View columnist. The opinions expressed are his own.