Tyler Cowen: The Rise and Fall of the Chinese Economy

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

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

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

The story starts in 1979. And in 1979,

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

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

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

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

So China introduces more private
property, more capitalistic

incentives, it privatizes some of its
agriculture, it allows more manufacturing,

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

economy, a normal economy.
And once these reforms are underway,

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

China has been growing at around 10% a year.

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

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

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

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

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

for almost 35 years. That has
transformed everything. So even

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

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

centuries to achieve, happening
in decades or even years.

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

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

It had high levels of savings, it
had super high levels of investment,

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

where maybe less infrastructure
investment was called for.

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

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

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

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

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

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

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

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

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

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

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

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

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

but what we know is that
it is probably sharply lower

and China is now entering
a great recession.

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

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

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

The first of these is - the real estate bubble.

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

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

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

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

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

grossly overbuilt, relative
to what can be supported.

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

were rising rapidly, but
then they fell rapidly too.

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

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

That will depress consumer
spending, lower confidence

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

that's one measure of this excess capacity.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

human capital. The Chinese have
done a fantastic job investing

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

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

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

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

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

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

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