China’s economic success under the Chinese Communist Party has prompted many to reevaluate their strongly held belief that a unitary single-party system was doomed to fail and that it was inferior to free-market democracies. However, its rising level of debt is raising questions about the future of its strategy for growth.
An Undeterred Giant
The main reason why it has been regarded as an indestructible powerhouse of economic growth is its unwavering performance after the 2008 crisis, which saw the world’s economy devastated, whilst the Chinese tiger stood like a rock in the wake of the global financial crisis, making the world’s elite doubt the versatility of capitalism.
The Chinese Communist Party, in an attempt to maintain this growth and protect its political footing, produced a stimulus plan that was worth 12% of its GDP, as its strong performance was endangered by the fall in global demand for its exports, forcing the government to seek growth from within.
Other countries also resorted to the same type of stimulus packages to keep their economies moving, but no other country’s political regime’s stability depended so much on the success of these as much as China’s. The People’s Republic of China sets itself an official GDP growth target both at the national and provincial levels. When it succeeds at meeting these figures (which it usually does), proudly announces its achievement to its people.
The Communist Party
Thanks to their obsession with GDP, the Communist Party has been able to boast about lifting millions of Chinese out of poverty while expanding the middle class to an unprecedented degree in the history of the country.
Economic achievement has been closely tied to the achievement of the political regime; a lot is on the line for the Communist Party of China as the memory of Tiananmen Square is still fresh in people’s minds. As much as the high population of China could be an asset, it could also become a curse for the party officials if discontent with the regime became widespread.
As a consequence of all this, the stimulus package was heavily geared towards real estate development and infrastructure as these are considered locomotive sectors with high and quick impact. The country needed an immediate and strong boost, and the package can be deemed successful in the short-run for providing that.
The Other Side of the Coin
It may have been a success in some respects, however it also made China’s debt reach nearly 250% of its GDP, turning its private sector into a highly leveraged one. Of course, this level of leverage does not seem as calamitous as it may seem when one looks at the indebtedness of the private sector in economies like the US, Netherlands or the Euro Area, but there are a few factors that differentiate China’s position. The first thing is the difference between the financial deepening between China and the other aforementioned countries.
As one can see from the graph, China’s GDP per capita is well below the level of other countries’ whose level of private sector debt is as alarming as China’s. When adding China’s institutional structure and regulatory framework that lag well behind the ones in the developed nations, one can clearly see the mismatch between China’s credit growth and the advancement of its financial sector.
Another factor that puts China at a disadvantage is its pace of credit growth. Although the US’s debt level is as worse as China’s, as one can see from the graph below, the US has been able to stabilise its credit growth while in China it continues to accelerate. This has been labelled as the real problem with China’s debt levels.
Now the reason that the acceleration of credit growth can be attributed to the structure of the initial stimulus plan. This plan has been heavily focused on investment in real estate development and infrastructure, which must have worked until some point. However, as the news of China’s ‘ghost cities’ began to surface, the investment emphasis on these sectors began to be questioned.
These investments seemed to be inefficient after a certain point, as they presented no real return other than creating an oversupply in real estate and infrastructure while resulting in overcapacity in upstream sectors.
This is the most significant source of anxiety for its policymakers: the fact that the credit that has been granted to the private sector has not been able to produce efficient enough outcomes to justify the dramatic credit expansion in the country. There are two levels to detecting this inefficiency: the micro and macro level.
Within the microeconomic scale, this inefficiency presents itself in the private sector as a decline in profitability and an increase in leverage, while in the macroeconomic scale it is the increasing amount of credit required for creating growth in GDP (also called credit intensity).
Is China Learning from History?
The IMF stated in one of its research reports about the credit growth of China that this aforementioned relationship between credit and investment inefficiency mirrors that of the previous pre-crisis development in countries like Spain and Thailand.
There are of course ways China could make its way out of this middle-income trap, following in the footsteps of other previously emerging economies that were ensnared by the same phenomena after years of rapid growth that was followed by stagnation.
This could involve getting rid of loss-making SOEs, liberating the banking sector to determine the resource allocation in a more efficient way and transforming its economy from a manufacture-driven, state-led investment model to a more consumption driven and higher value added growth.
Any of these actions would require a transitioning phase during which the Communist Party would need to soften its grip on the economy and risk a period of low GDP growth. How the Communist Party will choose to deal with its problem and how this will change the political and economic dynamics of China is a matter of intense concern for now.