Yasheng Huang On China's Growth

Image: Vikas Khot

Yasheng Huang is professor, MIT Sloan School of Management

It is dizzying how fast and how far the sentiments about China have changed. In the wake of the 2008 Great Recession, Western analysts then hailed Chinese response as daring, visionary and inspirational, especially when contrasted with the hesitancy of the US political establishment in tackling the multitude of its own economic challenges. This was to presage a dominant theme that was to emerge in the next two years in the Western media.

Prominent pundits from Thomas Friedman, Fareed Zakaria to Nicholas Kristof competed to heap praise on China. Their focus was typically on how fast China could roll out its infrastructure and its massive building programmes. Even President Obama held up the construction of China’s high-speed railway as a model to be emulated.

Then the bad news hit. First, the minister of railways, who single-handedly oversaw the rollout of China’s massive network of high-speed railways, was arrested for corruption. Then, a former chief engineer of the railway ministry revealed that the disgraced minister of railways downplayed the safety concerns in the rush to roll out the high-speed rails. Another noteworthy development has been the revelation of the widespread corporate fraud among those Chinese companies listed on overseas stock exchanges.  

In one dramatic case, Sino Forest, a Canadian-listed Chinese company, lost more than 80 percent of its value after the revelation that the company massively overstated its true holding of forest assets. Nasdaq-listed Chinese companies all took a severe beating in the last few months.
What is important this time around is the coincidence of macroeconomic, policy concerns with the rising doubt about the health of the Chinese
corporate sector.

 In the past, foreign investors were amply exposed to China’s macroeconomic risks — such as concerns about the sustainability of its investment-driven strategy — but they had very little knowledge about the actual workings of the Chinese companies.

Now the macro and micro stories are conspiring together to put a spotlight on some of the fundamental and structural weaknesses of the Chinese economy and the effect on investor sentiments is understandably dramatic. The macro picture, at the same time, is getting more and more worrisome. There is now a belated recognition that China’s massive stimulus programme, put in place in the wake of the financial meltdown of Wall Street, has done some substantial damage to the health of the Chinese financial system.

We now know that the size of the stimulus package dwarfs even some of the most alarmist estimates given by the independent analysts. Officially, the stimulus programme is 4 trillion yuan. At that size, the scale of China’s stimulus programme is already bigger than the US stimulus programme after adjusting for the difference in the size of GDP.

Recent government reports, provided by different agencies, added another 10 to 14 trillion yuan to that price tag. Local governments, as it turns out, have accumulated a massive level of debt in the last three years. When all of these programmes are put together, the size of the Chinese stimulus programme now dwarfs the US stimulus programme in both relative and absolute terms, a remarkable fact considering that the US, not China, was the epicenter of the financial crisis.

It is now a certainty that the non-performing loans in the Chinese banking system will mushroom and that its growth will slow down not due to the structural, long-term causes such as lower fertility rates and ageing, but due to the policy mistakes made by the Chinese government.

The fundamental problem is that in the last 10 years truly market-conforming structural reforms have all but stalled and the policymakers have become addicted to administrative fiats and financial mobilisation to grow the GDP. That strategy can provide good GDP numbers but it does relatively little in terms of promoting the true welfare of the Chinese people and in raising the long-run productivity of the economy.

Several academic studies have shown that the total factor productivity — a measure of overall productivity of an economy — has slowed down in the last 10 years and some studies even show negative growth. Thus, to maintain the same 8-9 percent GDP growth requires investing more resources. This is simply not sustainable, financially, economically and politically.

The only remaining question is whether the economic slowdown will presage a deeper transformation of the Chinese political and economic system and the manner by which this transformation will occur. The Chinese policymakers could have used the 2008 financial crisis to implement the much needed reforms. They did not and, in fact, they moved in the opposite direction by strengthening the state sector. It looks like the price for these mistakes will be paid sooner rather than later.

Yasheng Huang is professor, MIT Sloan School of Management, and founder of China Lab and India Lab.