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So why is the Chinese economy [br]in so much trouble right now?

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Well actually, this shouldn't come as a surprise. [br]If you've been watching China over the last several decades,

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you can understand how the current problems [br]actually fall out of a lot of their earlier successes.

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The story starts in 1979. And in 1979,

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you have Chinese reformers starting to do [br]a good deal to put the Chinese economy on

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a sounder track. At that time, [br]Chinese per capita income

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was only a few hundred dollars a year, [br]almost everyone was very poor,

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people would ride bicycles rather than driving [br]cars, and even starvation was still a possibility.

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So China introduces more private [br]property, more capitalistic

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incentives, it privatizes some of its [br]agriculture, it allows more manufacturing,

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more exporting. Overall, China starts [br]moving toward being a modern

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economy, a normal economy. [br]And once these reforms are underway,

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China is growing at really an astonishing [br]pace. For a lot of the last 35 years,

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China has been growing at around 10% a year.

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That's amazing! The American economy typically [br]doesn't grow at much more than 2% a year.

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At 10% a year growth, that means that [br]living standards double about every 7 years.

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So if you go back, you keep on visiting [br]China, it's as if every 7 years,

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every 10 years, you get to see an [br]entirely new country. For me personally, China

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They have grown at a pace that no other place [br]has matched. Imagine about 10% a year growth

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for almost 35 years. That has [br]transformed everything. So even

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year to year, parts of a city or a neighborhood [br]can simply change before your eyes.

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So you see human progress at work, you [br]see what took some parts of the world

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centuries to achieve, happening [br]in decades or even years.

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You see human hope and faith and progress, and [br]a deep underlying optimism about what is possible.

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So the Chinese economy during these years[br]of rapid growth - it had some very notable features.

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It had high levels of savings, it [br]had super high levels of investment,

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and they build lots and lots of infrastructure. [br]And those were all very positive.

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It's wonderful how good the infrastructure is [br]in China. I would much rather ride on a Chinese

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high-speed rail train than take the [br]Amtrak from Washington, D.C. to New York City.

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The Chinese train is quicker, nicer, [br]and it's far more likely to be on time.

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But here’s the thing - for a long time China [br]has been investing almost half of its GDP

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every year, half! That's astonishing. [br]When you think about it,

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it is remarkably hard, every year, to [br]invest half of your GDP and to invest it well.

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In the early years of China's economic [br]growth, the required investments were pretty simple

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and straightforward. They needed to build more [br]homes, they needed to put in more train lines,

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they needed to build more roads, they [br]needed to equip their urban centers with

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all of the normal features of everyday modern [br]life. And the Chinese government did a really good

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job at all of those things. It's a big reason [br]why, actually, China's growth has been so strong.

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But the problem is this - the way [br]decision making in China is set up -

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it's very good for achieving things [br]with a kind of checklist - known tasks

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that require a lot of resources and a lot of effort, [br]and you throw everything you have at getting it done,

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and you get it done pretty quickly. [br]China has been great at that.

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But now, a lot of that low-hanging fruit is gone. [br]A lot of the infrastructure which China needs

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already has been built, but now their [br]economy need more complex investment.

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They need a better healthcare system, they need [br]better retail services, they need more startups.

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And in these areas, there’s not a simple [br]checklist way to get it done. It's

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not just a question of throwing resources at the [br]problem. You need more trial and error, more experimentation,

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you need more of a market discovery [br]process to figure out which

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are the profitable investments and which [br]are the unprofitable ones. And it’s hard

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to plan and manage those the same ways that the [br]Chinese did that with all of their infrastructure.

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Here is another problem with the Chinese [br]economic model. If your economy grows 10% a year

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or so for so long, businessmen and also [br]your governments, they start thinking

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there isn't much risk. At 10% growth, [br]there so much forward impetus.

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You can have a business plan with a lot of mistakes, [br]you can have a lot of debt, you can be very poor on execution,

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but a lot of those investments are still [br]going to make money at about 10% growth.

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So what happens is, the underlying economy loses some of its discipline. People get sloppy, they overextend, they become too optimistic.

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They think they can make any investment or any [br]decision and somehow it will pay off or be validated,

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just because everyone else is [br]pushing on that 10% rate of growth.

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A turning point for the Chinese economy comes [br]in 2009 when there’s a significant recession in

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many other parts of the world. At the [br]time, a lot of observers thought,

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"Well, there’s going to be a big recession [br]in China too." But there wasn't.

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The Chinese government undertook some very special steps [br]to avoid or maybe just postpone that recession.

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So the Chinese government spent a lot [br]more money on infrastructure at a time

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where maybe less infrastructure [br]investment was called for.

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The Chinese government, the state-owned banks, [br]the state-owned companies, acted in concert

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to encourage a lot more borrowing, a lot more [br]debt. And it's true - this did spur spending,

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it boosted investment, kept the [br]economy running at a higher level,

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but actually debt rose to the point where [br]it was too high relative to the rates of return

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available on those projects. [br]So now, we don't have very exact

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measures, but it seems that total Chinese [br]debt of all kinds is well over 200%

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of GDP. Possibly as high as 300% of GDP. And

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maybe that can work when your underlying rate [br]of growth is 10%, but as your underlying rate

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of economic growth falls, it's harder and [br]harder for that debt to be sustainable.

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So how much is China growing today? [br]Well it depends who you listen to.

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The Chinese government, circa 2015, is [br]claiming China is still growing

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at about 7% a year. But not many [br]external observers believe this,

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because they’re looking at other pieces of data. [br]No one is sure what the real rate of economic growth is,

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but what we know is that [br]it is probably sharply lower

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and China is now entering [br]a great recession.

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To track this recession, we can keep [br]in mind five issues or problem areas:

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the real estate bubble, the stock market [br]bubble, the excess level of municipal debt,

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excess capacity among Chinese businesses, [br]and finally, the risk of capital flight.

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The first of these is - the real estate bubble.

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Chinese property prices became too high in [br]many Chinese cities and China overbuilt.

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I took a train trip from Beijing through the [br]center of the country, a six hour train trip.

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And along the way, I kept on [br]seeing city after city

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with dozens and dozens of apartment blocks. [br]You would see so many buildings, but so few people,

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so few retail stores, so few cars. [br]Many of those cities are

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grossly overbuilt, relative [br]to what can be supported.

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The Chinese stock market bubble is another [br]potential problem. For a while, Chinese stock prices

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were rising rapidly, but [br]then they fell rapidly too.

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Too many people were encouraged to buy stocks [br]on margin, the ratio of prices to corporate earnings

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has been extremely high, and probably those stock [br]prices will continue to fall at a pretty rapid pace.

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That will depress consumer [br]spending, lower confidence

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and it also will be a problem for some Chinese [br]banks. The third problem is municipal debt.

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No one really knows exactly how big a [br]problem this is. We do know that Chinese

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municipal governments were not supposed to [br]be able to borrow money, they were supposed

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to run balanced budgets. But in fact, a lot [br]of them ended up borrowing money off the books,

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and in fact they were encouraged by the [br]central government to do this, to keep

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up that expenditure on all the infrastructure. But [br]what’s happened is, they borrowed a lot more than right

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now they are able to pay back. And the central [br]government in Beijing is feeling the need

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to try to bail out these municipal governments. [br]Another big problem in the Chinese economy

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is what I would call "excess capacity". That is, [br]in too many sectors you have too many firms,

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you have too much overconfidence, too much [br]stimulation of investment, and a lot of those companies

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probably are not profitable. They're being kept [br]afloat by cheap credit by Chinese

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state-owned banks, or they may be Chinese [br]state-owned companies themselves, which

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have political privileges of various kinds. [br]But a lot of those companies right now,

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They’re not making really productive investments [br]in the kinds of things that Chinese consumers want.

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If you look at price indices, if you look at [br]the index for producer prices in China,

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that's one measure of this excess capacity.

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That index actually has been falling now for over three years [br]running, falling every month. That's a sign that too many

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producer goods have been built [br]for what can be sustained profitably.

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So maybe the biggest potential problem is capital [br]flight. There’s a risk that capital within China,

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foreign capital, but specially domestic capital, seeks to [br]leave the country out of fear of China's economic problems.

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But if too much of this capital leaves the country, that actually makes the problems much worse. As we saw with the Asian financial

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crisis in the 1990's for other countries. [br]The big danger in China is simply that

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capital flight accelerates. But in the meantime, [br]think of the problems the Chinese government

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has trying to manage all of this. There are [br]a lot of firms which are no longer profitable,

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but the government’s reluctant to let them [br]go bankrupt because of fear of unemployment

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and also alienating special interest groups. There’s [br]too much credit and too much borrowing in the economy,

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but if that bubble is burst, well then [br]economic activity will fall all the more.

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There's been too much investment in real estate, [br]there’s too much continuing reliance on infrastructure,

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and somehow the government is supposed [br]to juggle all of these balls at once

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and stop the recession from getting worse. [br]When you put all of those issues together,

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it is indeed a very complex picture, [br]very difficult to understand. But what we see

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is that the world's number two economy really [br]is running a very serious risk of a recession

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which will be deep, and also may last [br]really quite some number of years.

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My personal view is that, at this point, these [br]problems are so deeply baked into the Chinese economy,

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there is no way to set this all right. [br]But still there are some major reasons

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to be optimistic looking forward. First, [br]the most important source of wealth in any economy is

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human capital. The Chinese have [br]done a fantastic job investing

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in their own human capital. So from [br]the economist’s point of view, which values

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human capital above all else, as the most fundamental [br]source of national wealth. When we look at the future

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of China in the medium-term prospects, [br]we really should be optimistic

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or even cheery. Because China has [br]invested very well in human capital.

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Those investments will survive the [br]current recession intact, and we have

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every reason to believe that China will be extending the [br]talents, energies, drives, and ambitions of its people,

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