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♪ [music] ♪

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

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in so much trouble right now?

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

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

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you can understand
how the current problems

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actually fall out of a lot
of their earlier successes.

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The story starts in 1979.

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And in 1979,
you have Chinese reformers

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starting to do a good deal
to put the Chinese economy

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on a sounder track.

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At that time,
Chinese per capita income

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was only a few hundred
dollars a year,

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almost everyone was very poor,

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people would ride bicycles
rather than driving cars,

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and even starvation
was still a possibility.

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So China introduces
more private property,

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more capitalistic incentives,

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it privatizes
some of its agriculture,

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it allows more manufacturing,
more exporting.

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Overall, China starts moving
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
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
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
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
double about every 7 years.

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So if you go back,
you keep on visiting China,

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it's as if every 7 years,
every 10 years,

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you get to see
an entirely new country.

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For me personally, China is the most
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
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
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
of the world centuries to achieve,

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happening in decades or even years.

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You see human hope
and faith and progress,

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and a deep underlying optimism
about what is possible.

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So the Chinese economy
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
levels of investment,

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and they built lots
and lots of infrastructure.

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And those were all very positive.

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

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

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than take the Amtrak
from Washington, D.C.

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to New York City.

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The Chinese train
is quicker, nicer,

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

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But here’s the thing --

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for a long time
China has been investing

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almost half of its GDP every year.

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Half!
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
and to invest it well.

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In the early years
of China's economic growth,

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the required investments were
pretty simple and straightforward.

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They needed to build more homes,

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they needed
to put in more train lines,

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they needed to build more roads,

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they needed to equip
their urban centers

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with all of the normal features
of everyday modern life.

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And the Chinese government
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,
China's growth has been so strong.

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But the problem is this --

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the way decision-making
in China is set up --

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

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known tasks that require a lot
of resources and a lot of effort,

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and you throw everything
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
low-hanging fruit is gone.

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A lot of the infrastructure
which China needs

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already has been built,

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but now their economy
needs more complex investments.

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They need a better
healthcare system,

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they need better retail services,
they need more startups.

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And in these areas,

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

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

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You need more trial and error,
more experimentation,

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you need more
of a market discovery process

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to figure out which
are the profitable investments

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and which
are the unprofitable ones.

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And it’s hard to plan
and manage those

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the same ways
that the Chinese did that

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with all of their infrastructure.

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Here is another problem
with the Chinese economic model.

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

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businessmen
and also your governments --

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they start thinking
there isn't much risk.

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

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You can have a business plan
with a lot of mistakes,

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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 going to make money

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at about 10% growth.

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So what happens is,
the underlying economy

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loses some of its discipline.

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People get sloppy,
they overextend,

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they become too optimistic.

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They think they can make
any investment or any decision

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and somehow
it will pay off or be validated,

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just because everyone else

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is pushing
on that 10% rate of growth.

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A turning point
for the Chinese economy

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comes in 2009

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

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At the time,
a lot of observers thought,

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

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But there wasn't.

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The Chinese government
undertook some very special steps

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to avoid or maybe
just postpone that recession.

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So the Chinese government

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spent a lot more money
on infrastructure

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at a time where maybe

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less infrastructure investment
was called for.

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

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

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

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

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

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measures, but it seems that total Chinese 
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 
of growth is 10%, but as your underlying rate

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

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

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The Chinese government, circa 2015, is 
claiming China is still growing

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

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

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but what we know is that 
it is probably sharply lower

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and China is now entering 
a great recession.

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

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

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excess capacity among Chinese businesses, 
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 
many Chinese cities and China overbuilt.

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

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And along the way, I kept on 
seeing city after city

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

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

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grossly overbuilt, relative 
to what can be supported.

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

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were rising rapidly, but 
then they fell rapidly too.

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

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

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That will depress consumer 
spending, lower confidence

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

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

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

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

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

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up that expenditure on all the infrastructure. But 
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 
government in Beijing is feeling the need

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

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

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

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

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

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

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

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If you look at price indices, if you look at 
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 
running, falling every month. That's a sign that too many

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

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

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foreign capital, but specially domestic capital, seeks to 
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. 
The big danger in China is simply that

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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human capital. The Chinese have 
done a fantastic job investing

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

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

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

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

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

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

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