How Genuine is China’s Growth Story?

The Chinese economy has received a lot of positive press in the past two decades. The rapid economic growth that China has registered is being touted as an economic miracle. It is incredible how China rose from being a desolate third world country to being the second largest economy in the world. However, the Chinese growth story seems to have its share of problems. Many experts around the world believe that China is trying to exaggerate its growth story in a bid to get more and more foreign investment.

These experts have been warning that the Chinese growth story has disturbing parallels to the Japanese bubble. During the 1980’s, Japan was considered to be on the cusp of economic growth. At the peak of this growth bubble, the price of one square mile of land in Tokyo was more than the entire state of California! However, in the long run, this was not sustainable. The result is that Japan’s economy has been stagnant for more than two decades now. It turned out that Japan’s economic growth was largely driven by zero interest rate debt and hence was not sustainable.

In this article, we will evaluate the basics of the Chinese economy to understand how sustainable the growth is likely to be.

Factors in Favor of China

The Chinese are saving money at an exorbitant rate. The household savings rate in China is close to 50% of income. China, therefore, has a huge capital reserve to deal with economic problems. Also, most of China’s debt is denominated in the renminbi. Since the Chinese government has 100% control over the Yuan, they can pay off the debt by printing more money. This would not be advisable. However, it would save China from defaulting on their debts. China also holds considerable power over the United States since they are the ones buying treasury bonds in large numbers. In the absence of Chinese investments, the Fed would have a hard time selling its debt.

It is for this reason that the world has a vested interest in the solvency of China. Countries like the USA will go to any lengths to bail out China.

Opaque Numbers

The biggest argument leveled against China is that the numbers expressed by the country are opaque and often inaccurate. China has now declared that they had a 6.8% growth during the fiscal year 2017. Critics believe that the actual rate of growth is being overestimated. This is because there is a huge difference in the numbers reported by international agencies and the numbers reported by China. It is alleged that China has been reporting phony numbers to continue the growth illusion. Every economist knows that growth cannot continue forever. The Chinese economy has been in the state of growth for over a period of two decades. If the business cycle theory holds any truth, this would now be the time for the Chinese economy to at least stagnate.

Massive Debt

The biggest problem facing China is that of massive debt. China had to add more than 14% to its money supply to achieve the 6.8% growth. The government is, therefore, diluting the value of the Yuan by printing too much of it. Apart from this, China has been borrowing way too much money in the past. In the year 2017, the amount borrowed by China alone exceeded the borrowings of major countries like United States, United Kingdom, European Union and Japan combined! This is happening because of China’s obsession with growth numbers. China now needs to invest much more money than earlier to maintain the same level of growth. This is because the GDP is already large. Hence, the same percentage of GDP means a larger amount. This is also because the Chinese economy is moving towards stagnation. Keeping the growth rate high is a daunting task.

It seems like the Chinese government and corporations are falling into a debt trap. It has been estimated that the proceeds of over 40% of the debt that has been issued will be used to repay existing debt. Hence, the borrowings are not being used for productive purposes.

Overcapacity

The original Chinese growth was largely built on commodities. There are several state run organizations that have developed massive capacities in the production of steel, cement, coal etc. However, the world has moved away from the commodity boom. Much of the economic growth is now coming from the services sector. This has created a difficult situation in China.

China has to carefully unwind its overcapacity and move towards the services economy. This is challenging because China needs to avoid layoffs and bankruptcies during this transition. Correcting the overcapacity without causing any economic pain is almost an impossible task!

Housing Bubble

China is in the middle of a massive housing bubble. Some cities like Shenzhen have a median income to price ratios in the 40’s. These numbers indicate that a bubble is underway. Most of the workers in China are not able to afford homes in the urban center thanks to this bubble. If this bubble does burst, the impact on China’s finances will be unimaginable. Instead of growing at a rapid pace, the GDP would suddenly collapse.

To sum it up, China has achieved growth at an astounding pace. However, the growth has not been of a very high quality. There are still major concerns about the solvency of what is now the second largest economy in the world.


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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.


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