Radical Change versus Administrative Change
What’s more, and the various skeptics’ analyses have explained why, the changes China needs will necessarily create strong political opposition within the system. Arguments by former bulls that the real debate between the bulls and the skeptics is all just about whether China collapses in the next few months or not, weaken the case for reform and will, I suspect, make it harder for Li and the reformers to force through the necessary changes. These changes – and I don’t know if the bulls understand this or not – must come primarily at the expense of the political and economic elite, and I don’t just mean that there must be less corruption, as New York Times columnist Tom Friedman, another former bull, and among the most excitable of the lot, is now arguing.
Anyone who understands the fundamental problem with the growth model that China has pursued, which has many historical precedents, and why its great success in the 1980s and 1990s could not be sustained once certain parameters were breached, as they inevitably must be, also knows that until those parameters were breached, the interests of the elite and of overall growth for the economy were more or less aligned. Since then, they are in opposite directions. This is why the period of adjustment after rapid growth has always been the most difficult stage for a developing country, and one that very, very few countries have successfully managed, and why it will be particularly difficult for China, and this is why corruption – although perhaps of enormous social and political consequence – is not the fundamental problem.
The debate about China continues to rage, although it has taken a strange twist. No one doubts anymore that China’s imbalances threaten the success of the growth model and some are even insisting – very prematurely, in my opinion – that China has clearly failed and will face a collapse (whatever that means). I think the key division now, however, is over debt and over the recognition of previous losses. The bulls have retreated from many of their more fantastic predictions but they mistakenly think that the problem of debt is localized, and not systemic, and can be administratively resolved by the regulators. They also seem to ignore the possibility that there are enormous amounts of mispriced assets on the balance sheets of the banks and that these losses have to be assigned to some sector of the economy or the other, and that this assignation is at heart a political process.
The skeptics believe that an unsustainable rise in debt is key to continued growth in the economy and do not believe that it can be resolved administratively. High growth means, by definition, that debt is rising unsustainably. The bulls say that growth has bottomed out at 7% or 7.5% and that China can restructure the economy, rebalance towards consumption, and arrest the credit expansion while keeping growth rates above 7% or close to 7%. The skeptics argue that this is impossible, and to the extent that Beijing takes steps to keep growth rates high, it simply increases the risk of a debt crisis and economic collapse.
Last year in one of my blog posts I argued that, although I remained very skeptical about the sustainability of the China growth model, I nonetheless believed that China bulls could make a plausible argument but were failing to do so largely because they did not address the three questions that were fundamental to the debate on the sustainability of the Chinese growth model. These questions are:
- How much debt is there whose real cost exceeds the economic value created by the debt, which sector of the economy will pay for the excess, and what is the mechanism that will ensure the necessary wealth transfer?
- What projects can we identify that will allow hundreds of billions of dollars, or even trillions of dollars, of investment whose wealth creation in the short and medium term will exceed the real cost of the debt, and what is the mechanism for ensuring that these investments will get made?
- What mechanism can be implemented to increase the growth rate of household consumption?
I think these continue to remain the key questions if the bulls are going to be credible.