This very good article explains quite well the problems the Chinese economy currently faces, but it should stress more that the model didn’t “break down” recently, when growth rates started to slow sharply. It broke down at least 10-15 years ago.
China’s 40-Year Boom Is Over. What Comes Next?
2/14 In fact this article could have been written any time in the past decade, although it probably wouldn’t have been taken nearly as seriously, because it is only now that nearly everyone – minus a few very angry souls – sees that the model is in trouble.
3/14 The point is that consensus perceptions about the Chinese economy have changed dramatically in recent years not because China’s growth model has only recently stopped delivering healthy and sustainable growth. That happened many years ago.
4/14 They’ve changed because the costs of maintaining high GDP growth rates have become so obvious in recent years, not least in the extent of the debt burden they have created, that is no longer possible to ignore the extent and severity of the underlying imbalances.
5/14 But while most analysts now recognize that China must urgently raise the role of consumption in generating demand, and an increasing number recognize the institutional constraints in doing so, the real shocking imbalance, as this article notes, is China’s extraordinarily…
6/14 high investment share of GDP – now 44% of GDP – for which there is no remotely comparable historical precedent. Among other things this means that China can deliver high GDP “growth” only as long as it maintains impossibly high investment rates. carnegieendowment.org
7/14 The problem is that while massive amounts of investment had been broadly productive for the economy (i.e. their economic benefits exceeded their economic costs) until about 10-15 years ago, since then they’ve become increasingly unproductive in the aggregate.
8/14 One consequence is that a rising share of economic activity has had to shift from sectors of the economy that operate under hard budget constraints (mainly the private sector) to those that can operate under soft budget constraints (mainly government-controlled sectors).
9/14 That’s because unproductive investment must be expensed, just like any other loss, under hard budget constraints, and so must be discontinued. But it can be capitalized, as if it were an asset, in government entities, and so continued as long as financing is available.
10/14 But as this happened, it takes more debt to finance less production. That’s the problem. From the 1980s through the early 2000s, huge increases in investment weren’t associated with a rising debt burden because while debt rose quickly, GDP rose just as quickly.
11/14 It was only when investment became non-productive in the aggregate, roughly 10-15 years ago, that debt associated with investment began to rise faster than GDP. In fact this is almost the definition of non-productive investment.
12/14 This meant that while China’s growth model had “broken down” over a decade ago (as a few frustrated analysts had been arguing for years), Beijing could nonetheless maintain high GDP “growth” as long as it was willing to accept the accompanying acceleration in debt.
13/14 What’s more, because a rising share of this GDP “growth” did not increase economic productivity, it would eventually be reversed once Beijing decided (or was forced to) address its debt burden. This, by the way, is what happened to every country that followed this model.
14/14 Beijing has a limited range of options in managing the economy’s adjustment, perhaps fewer than it realizes, and each will require (or force) substantial institutional changes. This makes the next 3-4 years very important for China’s economy.