An article in this week’s economist has done a fine job of picking up on a new trend in China bear analysis – the long time horizon.
But some economists believe this is all too much. Among the bears is Michael Pettis of Peking University, who believes that investments are becoming increasingly inefficient and that China is heading towards a “brick wall” of government debt. Growth, he says, will remain high in the early half of the decade but could drop off sharply thereafter as loans turn sour. Even in the best case, he says, growth will fall below 5%.
Nouriel Roubini of New York University, a chronic bear, is in this camp. In a recent article he argued that the brick wall will most likely be hit between 2013 and 2015. He noted that China was spared a recession in the wake of the financial crisis because investment in fixed assets, such as transport infrastructure and factories, increased from an already very high 42% of GDP in 2008 to nearly 50% in 2010. No country, he says, could be productive enough to invest 50% of GDP in new fixed assets without eventually facing “immense overcapacity and a staggering non-performing loan problem”.
Elsewhere, perma-bear Andy Xie has been arguing that China’s soft landing was “a trap”:
If the right reforms are undertaken, China could become the largest economy in the world within fifteen years. But, if the government pursues a muddling through strategy and maintains stability above all else, China could become a poor version of Japan.
As the Economist indirectly points out earlier in the story these sort of time horizons are necessary for many of the bear arguments to make sense, as they are dependent on growth levels in debt and fixed-asset investment, rather than absolute levels, the former being quite high, and that latter being fairly low given China’s current stage of development:
Arthur Kroeber of GK Dragonomics, a consultancy, says the country still enjoys a considerable tailwind from urbanisation and a huge potential for productivity gains as it adopts new technology. He says a scattering of white-elephant projects (including the odd ghost-town of uninhabited new housing and office developments) does not concern him: “There’s no question that there are excesses, but the basic thing they are doing is sensible.” Louis Kuijs of the World Bank agrees. He sees the trend growth rate easing over the coming decade, but not dramatically. New infrastructure is generally being put to good use. Even though investment as a proportion of GDP is high, China’s accumulated investment in fixed assets is still low. Real wages have been rising strongly, which should help boost consumption. Standard Chartered, a bank, says that although China’s public debt is considerably higher than the 17% of GDP officially cited, it remains manageable. Even after allowing for bad loans to local-government investment companies, it runs at 80% of GDP, the bank estimates, about the same as Britain’s last year and well below Greece’s.
The problem is that talking about any debt problem over such a long time horizon is dependent upon things that happen… over a really long time horizon. In China more so than in the United States, as more spending in China is discretionary, and debt problems have a tendency to go away really quickly when you grow at 10% per year. Roubini’s argument is more convincing than Pettis or Xie as he is talking about specific fallout from the stimulus package rather than larger balance sheet problems. But overall, most of these arguments come down to the assumption that China’s balance sheet will degrade from its currently fairly healthy position.
China is going to collapse… eventually… but at the moment it still has one of the strongest development stories in the emerging world.