core sector communique

China’s decline is a question of when, not whether

The world has always been in denial about the prospect of China’s impending decline. Dragonomics – a fairy-tale growth story scripted over the last three decades – will sooner (or, maybe, a bit later) be history. Reason: no one can sustain double-digit growth rates indefinitely. Something has got to give. It will.

The fact is China’s miracle economy did not script anything new – except for mastering the art of economies of scale. It became a factory to the world because it was so huge and could do it larger and better than its predecessors who followed the same capital-intensive route to growth. Communist Russia, Japan and the Asian Tigers also had done more or less the same thing: curbed consumption at home, invested like crazy and turbo-charged growth by exporting it all to America. Barring Japan, which had a paternalistic, feudal culture, all were authoritarian regimes. Russia exported military hardware and steel plants to its client regimes and friends (including India) at extortionate prices.

Solution: China needs to definitely slowdown and redistribute income. Reuters

All miracle economies have a common ending: dramatic slowdown or crash. Sometimes, the crash happens due to political crises (as in Russia, South Korea), sometimes due to economic tsunamis (Malaysia, Indonesia). The question about China is: what will cause its downfall? An outpouring of internal dissent or an economic crisis? Or overinvestment in its own military as it tries to flex its geopolitical muscle?

Gordon Chang, author of The Coming Collapse of China told Firstpost: “China cannot escapethe laws of economics.” A Stratfor Global Intelligence report sees China crashing by 2015. It says: “China’s economy, like the economies of Japan and other East Asian states before it, will reduce its rate of growth dramatically in order to calibrate growth with the rate of return on capital and to bring its financial system into balance. To do this, it will have to deal with the resulting social and political tensions.”

One may ask: how has China been able to defy economics for so long? The answer is obvious: it’s authoritarian structure.

The reason why authoritarian regimes are able to prolong the growth cycle is simple: since they bottle up dissent, they can divert resources from consumption to investment for longer periods of time than democracies. But when you have 50 percent rates of saving and investment, the probability is that you are investing in projects without much of an economic return as capital is plenty and consumption is low. We have already heard of China’s ghost towns, with mothballed infrastructure waiting to be used.

The miracle economies solved this investment-consumption equation by exporting to the US and lending even more money to that country to buy their products. You can keep this kind of bargain going for a while, but sooner or later the music will stop – and the US has to stop consuming excessively and start saving. The US will want to balance its books, and China can’t export too much to a slowing world. It has to prime the domestic consumption pump. It is trying to do that by pouring money in, and this is feeding inflation.

Now consider what happens in democracies. The process is almost dialectic. After liberalisation, India’s economy has boomed and slowed – in turn. In the first five years after reforms, the economy boomed. Then it slowed – all the way till 2003, if one were to exclude the dotcom blip. Then it picked up steam. It is losing steam again.

This happens because politicians in a democracy have to heed the voice of the poor. They can’t send them away to Gulags or imprison them in rural areas. You need to throw money at NREGA schemes and forget about reforms to allow the poor to close the income gap for a while before a slowing economy forces you to reform again. My guess is that by 2013-14, India will be ripe for the next raft of reforms for by then we would have reached the limits of growth, given our infrastructure bottlenecks and poor agricultural productivity. We won’t see double-digit growth till after that, whatever Manmohan Singh may say.

So, the question is not whether China will have a dramatic slowdown, but when. Says the Stratfor report:

“China faces a quadruple bind. First, China’s current economic model is not sustainable. That model favours employment over all other concerns, and can only be maintained by running on thin margins. Eventually, manufacturing margins turn negative as they did in Japan in 1991 and Indonesia in 1998.

“Second, the Chinese model is only possible so long as Western populations continue to consume Chinese goods in increasing volumes. European demographics alone will make that impossible in the next decade.

“Third, the Chinese model requires cheap labour as well as cheap capital to produce cheap goods. The bottom has fallen out of the Chinese birthrate; by 2020 the average Chinese will be nearly as old as the average American, but will have achieved nowhere near the level of education to add as much value. The result will be a labour shortage in both qualitative and quantitative terms.

“Finally, internal tensions will break the current system. More than 1 billion Chinese live in households whose income is below $2,000 a year (with 600 million below $1,000 a year). The government knows this and is trying to shift resources to the vast interior comprising the bulk of China. But this region is so populous and so poor — and so vulnerable to minor shifts in China’s economic fortunes — that China simply lacks the resources to cope.”