Robert J. Samuelson: China is at a crossroads

Published: Tuesday, Nov. 26 2013 12:00 a.m. MST

China is at a crossroads. Rapid economic growth underlies the regime's legitimacy at home and its power abroad. But rapid growth is imperiled.

Eugene Hoshiko, Associated Press

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WASHINGTON — It's only a few years since China was widely regarded as an unstoppable economic colossus. For three decades, its economy grew about 10 percent annually; China seemed to be gliding through the global economic storm. Well, maybe not. Many economists — Chinese and foreign — think China's economic model is unworkable. Without a new model, they say, China will someday face a collapse of growth or worse. The outcome has huge implications for China's internal stability and its global economic footprint. The precedent of Japan, a highflier laid low, suggests that rapid growth can't be taken for granted.

First, some background.

China's economic model emphasizes investment and export-led growth over consumption. The idea is simple: Build an industrial base by adopting technologies and production techniques pioneered elsewhere; complement this with a modern infrastructure of roads, rails, ports and airports. All this spending creates jobs and raises wages for millions of poor Chinese who move from rural areas to cities. Exports further bolster jobs. In 2007, China's current account surplus (an expanded trade balance) was an astonishing 10 percent of its economy (gross domestic product).

The formula long succeeded. Average inflation-adjusted incomes rose from $250 in 1978 to $9,000 in 2012. But now, there are problems.

The easiest technologies have been adopted. Increasingly, the economy needs to generate growth through innovation. Next, major export markets — the United States and Europe — have weakened. Demand is sluggish, and resistance to allegedly unfair Chinese trade practices has stiffened. In 2012, China's current account surplus was only 2 percent of GDP. Last but not least: Much private and public investment has been debt-financed and seems wasteful. The infrastructure (roads, bridges) may be overbuilt. The same is true of industry.

"China's high investment levels have led to overcapacity in multiple industries, including steelmaking, shipbuilding and solar panel manufacturing," reports the congressionally created U.S.-China Economic and Security Review Commission.

What dooms today's model, argues economist Michael Pettis of Peking University in his book "Avoiding the Fall," is the debt buildup. At some point, some borrowers — state-owned companies, local governments, property developers — won't repay, banks will sharply curtail lending, or both. Investment spending would plunge. On paper, the solution is obvious: Switch to a consumption-led economy. In practice, it's not so easy.

So dominant is investment spending in China that consumption — household spending for food, clothes, cars and all personal goods — amounted to only 36 percent of GDP in 2012. By contrast, consumption's share in the U.S. economy was 69 percent.

Wage increases, though large, have lagged behind overall economic growth, slowed by weak unions and plentiful workers. Government interest-rate ceilings on bank deposits punish savers — reducing their incomes and causing them to save more to offset the low rates. With deposit rates suppressed, banks then provide cheap loans to industry, fueling more investment. Finally, China undervalues its currency, the renminbi, to promote exports and deter imports.

As with Japan in its boom years, China is too wedded to investment and exports. Distortions feed on themselves. Consider housing. Denied adequate returns on their savings, many Chinese invest in real estate, driving prices up and prompting fears of overbuilding and a "bubble."

China is at a crossroads. Rapid economic growth underlies the regime's legitimacy at home and its power abroad. But rapid growth is imperiled. China's leaders acknowledge the problem. Their latest effort to fix it occurred at the recent "third plenum" of the 18th Communist Party conference, which — among other things — relaxed the one-child per couple restriction and provided farmers more freedom to dispose of their land.

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