Tyler Cowen: The Rise and Fall of the Chinese Economy

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- [Prof. Tyler Cowen]
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 is the most
interesting country in the world

to visit as an economist.

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 built 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
needs more complex investments.

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's 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

from 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 especially 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 1990s 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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