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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,[br]the state-owned banks,

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the state-owned companies,

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acted in concert to encourage[br]a lot more borrowing,

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a lot more debt.

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And it's true --[br]this did spur spending,

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it boosted investment,

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

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but actually debt rose to the point

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where it was too high

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relative to the rates of return[br]available on those projects.

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So now, we don't have[br]very exact measures,

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but it seems that[br]total Chinese debt of all kinds

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is well over 200% of GDP --

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possibly as high as 300% of GDP.

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And maybe that can work

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when your underlying[br]rate of growth is 10%,

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but as your underlying[br]rate of economic growth falls,

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it's harder and harder[br]for that debt to be sustainable.

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So how much is China growing today?

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Well, it depends who you listen to.

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The Chinese government, circa 2015,

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is claiming China[br]is still growing at about 7% a year.

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But not many external[br]observers believe this,

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because they’re looking[br]at other pieces of data.

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No one is sure what the real rate[br]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,

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we can keep in mind[br]five issues or problem areas --

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the real estate bubble,[br]the stock market bubble,

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the excess level of municipal debt,

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excess capacity[br]among Chinese businesses,

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and finally,[br]the risk of capital flight.

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The first of these[br]is the real estate bubble.

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Chinese property prices

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became too high[br]in many Chinese cities

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and China overbuilt.

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I took a train trip from Beijing[br]through the center of the country --

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a six hour train trip.

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

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with dozens and dozens[br]of apartment blocks.

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You would see so many buildings,[br]but so few people,

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so few retail stores, so few cars.

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Many of those cities[br]are grossly overbuilt,

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relative to what can be supported.

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The Chinese stock market bubble[br]is another potential problem.

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For a while, Chinese[br]stock prices were rising rapidly,

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but then they fell rapidly too.

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Too many people were encouraged[br]to buy stocks on margin,

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the ratio of prices[br]to corporate earnings

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has been extremely high,

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and probably those stock prices[br]will continue to fall

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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[br]for some Chinese banks.

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The third problem is municipal debt.

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No one really knows exactly[br]how big a problem this is.

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We do know that[br]Chinese municipal governments

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were not supposed[br]to be able to borrow money --

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they were supposed[br]to run balanced budgets.

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But in fact, a lot of them ended up[br]borrowing money off the books,

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

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to keep up that expenditure[br]on all the infrastructure.

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But what’s happened is,

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they borrowed a lot more than[br]right now they are able to pay back.

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And the central government[br]in Beijing is feeling the need

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to try to bail out[br]these municipal governments.

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Another big problem[br]in the Chinese economy

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is what I would call[br]"excess capacity".

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That is, in too many sectors[br]you have too many firms,

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you have too much overconfidence,

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too much stimulation of investment,

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and a lot of those companies[br]probably are not profitable --

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they're being kept afloat[br]by cheap credit

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from Chinese state-owned banks,

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

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which have political privileges[br]of various kinds.

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But a lot of those[br]companies right now --

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they’re not making[br]really productive investments

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in the kinds of things[br]that Chinese consumers want.

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If you look at price indices,

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if you look at the index[br]for producer prices in China --

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that's one measure[br]of this excess capacity.

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That index actually[br]has been falling now

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for over three years running,[br]falling every month.

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That's a sign that too many[br]producer goods have been built

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for what can be sustained profitably.

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So maybe the biggest[br]potential problem is capital flight.

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There’s a risk that capital within China,

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foreign capital,[br]but especially domestic capital,

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seeks to leave the country

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out of fear of China's[br]economic problems.

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But if too much[br]of this capital leaves the country,

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that actually makes[br]the problems much worse,

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as we saw[br]with the Asian financial crisis

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in the 1990s for other countries.

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The big danger in China

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is simply that[br]capital flight accelerates.

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But in the meantime,

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think of the problems[br]the Chinese government has

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trying to manage all of this.

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There are a lot of firms[br]which are no longer profitable,

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but the government’s reluctant[br]to let them go bankrupt

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because of fear of unemployment

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and also alienating[br]special interest groups.

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There’s too much credit and too much[br]borrowing in the economy,

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but if that bubble is burst,

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well, then economic activity[br]will fall all the more.

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There's been too much[br]investment in real estate,

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there’s too much continuing[br]reliance on infrastructure,

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and somehow the government

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is supposed to juggle[br]all of these balls at once

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and stop the recession[br]from getting worse.

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When you put[br]all of those issues together,

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it is indeed[br]a very complex picture,

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very difficult to understand.

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But what we see is that[br]the world's number two economy

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really is running a very[br]serious risk of a recession

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which will be deep,

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and also may last really[br]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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