Shocked by the sub-prime implosion in the Western financial sector, an overwhelming majority of economic commentators take solace from the relentless growth of China, which they happily extrapolate at recent 10% rates into the indefinite future even as the US slides into recession. Think again. Impressive headline growth rates have been masking falling productivity and inflationary stresses in a development model that despite stunning success has now become dangerously unsustainable. A few telling statistics can help dispel any complacency.
1. For every dollar of incremental income, China needs to invest $5.5, about 3 times higher than that of a developed country like the UK. Returns on investment have been falling steadily for a decade and are now at levels last seen at the end of the Mao era in the 1970's.
2. For every dollar of income China needs 8 times the energy input of Japan and 4 times that of the profligate US, resource inefficiency that generates shocking environmental damage.
3. In fact, environmental degradation is one area where China has become truly world-class; 25% of the country is already desert which is now lapping at the suburbs of Beijing; 90% of urban areas face chronic water shortages while 80% of all rivers are by UN standards severely polluted.
4. Inflation is now officially over 8% and closer to 25% for key foods like pork; food accounts for 33% of household income. Labour shortages are pushing up wage levels by 20-30% annually in key manufacturing areas like Schenzen.
5. China has sustained globally unprecedented investment levels of 35-40% of GDP for 25 years. This is sustained by a massive savings rate, and investment combined with merchandise exports accounts for about 60% of the economy, leaving consumption at about that half that in the developed countries (70% in US for example).
6. Demographics are destiny. China is aging as fast as Europe if not quite Japan, and 15% of the population will be over 60 within a few years and the elderly will outnumber children by 6 to 1 by 2040. Chinese demographics as a result of the one-child policy and longevity are radically different to India, Brazil or any other emerging market apart from Russia and has huge implications. It explains in large part the huge savings rate, particularly given the appalling social provision.
7. Business competiveness is slumping, slipping from 42nd in the worl in 1998 to 64th in 2006 according to the World Economic Forum.
Empty MagLev trains from Shanghai airport and vast kitsch ghost town housing developments like Thamestown speak of gross resource misallocation at all levels. State owned or indirectly controlled banks channel loans, via a web of formal and informal links to SOE's and semi-private corporations, to industrial and infrastructure projects that would not bear scrutiny under any conventional cost benefit or ROI analysis. Rampant corruption, particularly at the local level where residual state enterprise shareholdings often reside, is the rule rather than the exception, exacerbating a generally primitive level of credit risk analysis. China is very different in economic structure from countries like Taiwan and Korea at a similar stage in their development 30-40 years ago, but also from its emerging market peers because of its demographic and political structure which creates a dysfunctional allocation of economic resources. Health care, education etc have been effectively if crudely privatised in China and are a frightening burden driving the high savings rate. Complacent assumptions that China will become a nation of consumers more like Japan and the US us are belied by these facts. Meanwhile, despite inordinate media attention to relatively tiny local technology companies such as Lenova or Huawei, the fact remains that China has failed so far to develop credible global companies and brands when compared even to India or Russia. Innovation and R&D are overwhelmingly concentrated in foreign enterprises outsourcing to local affiliates in China. According to the OECD, China accounts for just 0.3% of world technology patents extant on the broadest definition against 36% for the US. And yet the current model is running out of growth; for instance if China sustained the export led growth model at current rates it would account for all net global merchandise exports within a decade, and that's allowing for 3% plus global growth in the interim. Imagine what the protectionist lobby in the US and Europe would make of that!
Equally, rampant excess investment in 'me-too' industrial projects has led to unprofitable overcapacity in many sectors, and cities in close proximity to each other will often replicate grandiose conference or sporting facilities which sit like empty monuments to Communist hubris. Unproductive investment and unprofitable exports can no longer sustain China's development and growth rates will begin to rapidly decline in the near future, raising serious political risks as inflation continues to soar and a stock market bubble implodes. There are limited policy responses to these challenges that do not directly undermine the legitimacy of the one party state system, which is at root the problem. To be continued...
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