Over my two decades of writing about economics, I’ve devised a list of simple maxims that I’ve found generally hold true. One is that history repeats itself. If one country tumbled into a financial crisis, there is a very good chance another, facing similar conditions, will as well. A second rule: What doesn’t work, doesn’t work. A policy that failed isn’t likely to achieve any better results if tried again. I developed these little rules as a journalist watching what works and what doesn’t—from Japan to Russia to Spain—and attempting to understand why things just go so wrong so often, whether during the 1997 Asian crisis or the turmoil that nearly ripped apart the euro zone earlier this decade.
[Michael Schuman | January 24, 2018 | Bloomberg]
But recently, my faith in this corpus of collected wisdom has been badly shaken. By China.
The more I apply my rules of economics to China, the more they seem to go awry. China should be mired in meager growth, even gripped by financial crisis, according to my maxims. But obviously it’s not. In fact, much of what’s going on right now in that country runs counter to what we know—or think we know—about economics. Simply, if Beijing’s policymakers are right, then a lot of basic economic thinking is wrong—especially our certainty in the power of free markets, our ingrained bias against state intervention, and our ideas about fostering innovation and entrepreneurship.
Yet as China marches forward, we can no longer dismiss the possibility that it’s rewriting the rulebook. Beijing’s policymakers are just plain ignoring what most economists would recommend at this point in its development. And, so far, they’re getting away with it.
The problems that China confronts today are immense. The easy catch-up growth that fueled the nation’s rapid gains since the 1980s has been tapped out, and the costs of doing business are rising, eating away at China’s low-cost edge. For its economic miracle to continue, China must become more innovative and competitive, and allocate financial and other resources more efficiently. And it also needs to tackle the flaws created by its previous boom, most of all the mountain of debt that continues to get heavier and potentially more destabilizing.
Traditional economics would mandate that China overhaul its current economic system. Only a greater role for market forces will sort out the country’s problems and set the economy onto the correct path for development. That entails withdrawing the state’s heavy hand in the economy: stopping meddlesome bureaucrats from messing around with the allocation of capital and credit, opening protected sectors to competition, allowing money to flow more freely in and out of the country, releasing the currency from state manipulation, and reforming or even closing blundering state-owned enterprises.
Officially, that’s where Beijing is headed. Its leaders repeatedly stress how China will continue “opening up” and become more “market-oriented.” In practice, however, Beijing is charting an entirely different course. Rather than stepping aside, the Communist Party is entrenching itself even more deeply in the management of state companies. Regulators have determined that they, not corporate executives, know best how Chinese companies should invest overseas. Capital controls remain as tight as ever; the currency is still under the thumb of the central bank. The opening of China’s market to foreign business is going nowhere fast. Nor does the state allow the market to choose winners and losers. It dominates the financial industry and doles out large subsidies to favored industries and companies. Even its censoring of the internet has intensified, constraining the free exchange of information supposedly indispensable to innovation. In one 2017 study, China was the worst of 65 countries in abuse of internet freedom.
And the result? Nothing like the disaster many of us would expect. Growth, though sharply reduced from the levels of a few years ago, is still powering ahead at almost 7 percent a year, according to official statistics. Incomes continue to rise nicely. Exports are strong. China has sped ahead of the rest of the world in developing an electric car market. And that strangled internet? Not an issue. China’s digital economy is exploding, with online shopping, mobile payments, and internet-based financial services advancing at light speed. Whole neighborhoods of startups are popping up in Shenzhen, Beijing, and elsewhere.
About that debt. Yes, it’s still rising, to 256 percent of gross domestic product in mid-2017. History tells us that countries that experience a rapid surge of debt like China has over the past decade inevitably stumble into some sort of banking crisis. If my maxims are still valid, history should be repeating itself in China. But it’s not. The accepted outlook is that China will avoid the full-on meltdown we’ve come to expect from debt-gorged emerging markets and instead will peacefully manage its way through the problem with a state-guided process to bring down leverage.
A traditional view would insist none of this should be working. The state is supposed to screw up economies: Japan, India, the entire Soviet bloc—the list seems endless. In China, the state seems to be preventing screw-ups. When companies have expanded too quickly and possibly taken on too much risk, such as property developer Wanda Group or the mysterious Anbang Insurance Group, the government has played watchdog and apparently pressed them to scale back. State ownership of the financial sector maintains a degree of confidence in the economy that might be lost under similar, debt-heavy circumstances in a freer market. When investors did get spooked by a stock market implosion in 2015 and cash gushed out of the country, regulators tightened capital controls and squelched the turmoil.
In addition to preventing bad outcomes, the government also seems to be engineering good ones. Continued public investment in infrastructure is opening up remote regions of the country to greater business opportunities, expanding incomes in rural areas and small towns, and adding fresh sources of consumer spending. The subsidies dished out by local governments are helping entrepreneurs start companies and create jobs.
Of course, we can’t know for certain where these policies will take China. Nor can we tell what’s really happening in the economy. Bank balance sheets may not expose the full extent of the financial damage being done by state practices. Nor can we trust government data, which almost certainly fails to represent the country’s real economic conditions. And it remains far from certain that China’s leadership can successfully transform the country from a factory floor that makes lots of cheap stuff to a center of innovation that generates real technological advances and breakthrough products. Failing to do that will likely make it much harder to keep improving the welfare of China’s aging 1.4 billion people, who are still much poorer than those in the most advanced economies. But if things continue as they are, we have to take seriously the possibility that China has found a way to coordinate state action with just enough market influence to target and achieve positive results that a more open economy may not be able to match. Perhaps China really is refashioning capitalism.
Perhaps. I, for one, am still clinging to my maxims. My favorite: You can’t escape math. Eventually, the weight of numerical reality has to come to bear. Maybe China can escape a financial crisis others could not, but as debt mounts, it drags down potential growth. And there is an unavoidable cost, too. Someone will have to pick up the tab for the bad loans at Chinese banks, many of them still likely unrecognized because of a lack of transparency. Another downside of continued state meddling is the stunting of productivity gains, without which sustaining healthy growth will prove almost impossible. Maybe my rules of economics will hold firm after all. But thanks to China, I’m prepared to edit them.