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- [Prof. Tyler Cowen][br]So why is the Chinese economy

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in so much trouble right now?

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Well, actually,[br]this shouldn't come as a surprise.

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If you've been watching China[br]over the last several decades,

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you can understand[br]how the current problems

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actually fall out of a lot[br]of their earlier successes.

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The story starts in 1979.

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And in 1979,[br]you have Chinese reformers

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starting to do a good deal[br]to put the Chinese economy

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on a sounder track.

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At that time,[br]Chinese per capita income

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was only a few hundred[br]dollars a year,

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almost everyone was very poor,

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people would ride bicycles[br]rather than driving cars,

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and even starvation[br]was still a possibility.

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So China introduces[br]more private property,

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more capitalistic incentives,

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it privatizes[br]some of its agriculture,

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it allows more manufacturing,[br]more exporting.

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Overall, China starts moving[br]toward being a modern economy,

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a normal economy.

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And once these reforms are underway,

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China is growing[br]at really an astonishing pace.

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For a lot of the last 35 years,

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China has been growing[br]at around 10% a year.

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That's amazing!

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The American economy typically

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doesn't grow[br]at much more than 2% a year.

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At 10% a year growth,

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that means that living standards[br]double about every 7 years.

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So if you go back,[br]you keep on visiting China,

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it's as if every 7 years,[br]every 10 years,

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you get to see[br]an entirely new country.

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For me personally, China is the most[br]interesting country in the world

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to visit as an economist.

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They have grown at a pace

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that no other place has matched.

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Imagine about 10% a year growth[br]for almost 35 years.

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That has transformed everything.

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So even year to year,

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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,

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you see what took some parts[br]of the world centuries to achieve,

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happening in decades or even years.

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You see human hope[br]and faith and progress,

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and a deep underlying optimism[br]about what is possible.

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So the Chinese economy[br]during these years of rapid growth --

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it had some very notable features.

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It had high levels of savings,

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it had super high[br]levels of investment,

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and they built lots[br]and lots of infrastructure.

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And those were all very positive.

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It's wonderful how good[br]the infrastructure is in China.

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I would much rather ride[br]on a Chinese high-speed rail train

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than take the Amtrak[br]from Washington, D.C.

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to New York City.

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The Chinese train[br]is quicker, nicer,

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and it's far more likely[br]to be on time.

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But here’s the thing --

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for a long time[br]China has been investing

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almost half of its GDP every year.

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Half![br]That's astonishing.

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When you think about it,

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it is remarkably hard, every year,

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to invest half of your GDP[br]and to invest it well.

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In the early years[br]of China's economic growth,

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the required investments were[br]pretty simple and straightforward.

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They needed to build more homes,

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they needed[br]to put in more train lines,

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they needed to build more roads,

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they needed to equip[br]their urban centers

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with all of the normal features[br]of everyday modern life.

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And the Chinese government[br]did a really good job

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at all of those things.

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It's a big reason why, actually,[br]China's growth has been so strong.

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But the problem is this --

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

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

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known tasks that require a lot[br]of resources and a lot of effort,

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and you throw everything[br]you have at getting it done,

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and you get it done pretty quickly.

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China has been great at that.

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But now, a lot of that[br]low-hanging fruit is gone.

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A lot of the infrastructure[br]which China needs

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already has been built,

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but now their economy[br]needs more complex investments.

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They need a better[br]healthcare system,

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they need better retail services,[br]they need more startups.

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And in these areas,

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there’s not a simple [br]checklist way to get it done.

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It's not just a question[br]of throwing resources at the problem.

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You need more trial and error,[br]more experimentation,

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you need more[br]of a market discovery process

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to figure out which[br]are the profitable investments

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and which[br]are the unprofitable ones.

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And it’s hard to plan[br]and manage those

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the same ways[br]that the Chinese did that

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with all of their infrastructure.

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Here is another problem[br]with the Chinese economic model.

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If your economy grows[br]10% a year or so for so long,

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businessmen[br]and also your governments --

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they start thinking[br]there isn't much risk.

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At 10% growth, [br]there's so much forward impetus.

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You can have a business plan[br]with a lot of mistakes,

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you can have a lot of debt,[br]you can be very poor on execution,

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but a lot of those investments[br]are still going to make money

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at about 10% growth.

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So what happens is,[br]the underlying economy

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loses some of its discipline.

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People get sloppy,[br]they overextend,

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they become too optimistic.

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They think they can make[br]any investment or any decision

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and somehow[br]it will pay off or be validated,

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just because everyone else

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is pushing[br]on that 10% rate of growth.

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A turning point[br]for the Chinese economy

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comes in 2009

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when there’s a significant recession[br]in many other parts of the world.

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At the time,[br]a lot of observers thought,

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"Well, there’s going to be[br]a big recession in China too."

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But there wasn't.

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The Chinese government[br]undertook some very special steps

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to avoid or maybe[br]just postpone that recession.

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So the Chinese government

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spent a lot more money[br]on infrastructure

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at a time where maybe

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less infrastructure investment[br]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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