China Analysts Should Talk to Each Other, Not at Each Other
by Scott Kennedy / August 25, 2016 /China File
On August 12, the International Monetary Fund (IMF) issued its annual report card on China’s economy and gave the country mixed grades, finding that its “economic transition will continue to be complex, challenging, and potentially bumpy.” In particular, the report emphasized the need for China to get its corporate debt under control. That sounds sensible enough. But it does not reflect a consensus among or within the China-watching community. In fact, Western China analysts are caught up in such a long-running debate about China’s trajectory that even a weighty conclusion like the IMF’s is unlikely to change their views at all.
The conflict over China’s trajectory pits three camps against each other: optimists, debt hawks, and policy critics. Their disagreements turn on their varying confidence in the Chinese government’s ability to manage the economy and alternative assessments about the threat that rising debt levels pose to the economy.
Those outside the China-watching community often ascribe these competing conclusions to the opacity of China’s system—the assumption being that it leads to limited and perhaps differing sources of information for analysts, who become like the proverbial blind men touching different parts of an elephant. In fact, China analysts are awash in more data than ever before. China’s official statistics system has improved substantially, and there are alternative sources of information that allow for triangulation. As a result, the stark differences that continue to persist are primarily the result of competing assumptions and analytical frameworks.
Alas, although observers of China’s economy in any given camp occasionally critique the other, they rarely engage in extended head-on arguments. Their debate is instead akin to art critics looking at a landscape painting, with some focused on the rivers, others on the mountains, and still others on the sky. They may nitpick at the brush strokes of other parts of the painting or even admit to their limited beauty, but they generally don’t avert their eyes from what they have decided is most important.
There is not a single analyst that does not recognize both how far China has come and the monumental challenges it still faces. No country has grown as fast for as long. Yet the old sources of growth—an expanding, well educated workforce; extensive investment in industry; and exports—can no longer be sustained or generate the returns they once did. China can’t just pump out more stuff, or make even shinier hi-tech products; it needs to produce at a much more efficient clip and raise domestic consumption.
It’s not only Chinese officials and Chinese think tanks who believe the country can pull it off. Some veteran independent and highly respected analysts believe that the key to relatively high-speed growth lies in restructuring the economy, from investment toward consumption, from industry toward services, and within industry, from low-value-added assembly and manufacturing to high-value-added advanced manufacturing and innovation. They highlight all of the current policies geared to promote this transformation, including reducing overcapacity, encouraging movement into high-tech sectors and greater innovation, promoting household consumption (for example, by encouraging greater mortgage lending), and developing green technologies. And they point to data on the rapid expansion of services and consumption indicating that progress is well underway. To this camp, everything else—stock market volatility, foreign exchange outflows, trade disputes, and elite political intrigue—are all just noise distracting observers from what really matters.
This optimism resembles naiveté to those who focus on an entirely different set of data points: China’s massive debt. Chinese red ink has grown far more rapidly than its economy. Even official data place total debt at around 250 percent of GDP, while some independent estimates put the figure at over 300 percent. Credit is still expanding quickly, and a disproportionate amount is still funneled to state-owned enterprises (SOEs). It’s not just that corporate debt is astronomical, with state-owned banks continuing to funnel cash to SOEs to stay afloat. It’s that the underreporting of bad debt (by rolling over loans and bonds and moving debt off balance sheets), the ambiguity of local government finances, the spread of sketchy wealth management products, and the emergence of online financing all mean that the true extent of leverage is sketchy and that official data on bad loans—under 2 percent—is likely a gross understatement of systemic risk. Read more…