Analysis: China risks following Japan into economic coma

Let us hope that this analysis is incorrect.  Because if it is then the world economy will experience a tailspin that will make the 2008 recession seem like a picnic!  Any of you, my readers, have a strong view one way or the other?

Reuters: “After decades of emulating Japan‘s export-driven economic miracle, China appears in danger of following it into the same kind of economic coma that Japan is trying to wake up from 20 years later.

A salesperson, dressed as the Chinese god of fortune, hands out leaflets for a jewellery shop at a shopping district in Beijing July 26, 2013. REUTERS-Kim Kyung-Hoon

China is struggling to wean itself off a habit picked up from its more advanced neighbor: relying for growth on exports and credit-fuelled investment. That has left its economy lopsided, economists say, with massive over investment in property and industries rapidly losing their cost advantage, from mining and electronics to cars and textiles. Wages are rising, the return on investments falling.

With growth slipping, China’s President Xi Jinping and Premier Li Keqiang seem determined to avoid a U.S.-style financial crisis, complete with widespread bankruptcies and job losses.

Preventing such a crisis though could embalm diseased sectors, stifling efforts to make growth more sustainable and instead create the kind of “zombie” banks and companies that sucked the life out of Japan’s economy, economists say.

Add a population graying faster than Japan’s did, and economists worry China may be attempting the impossible.

“There is a huge amount of denial. People think that demographics don’t matter,” said Chetan Ahya, chief Asia economist at Morgan Stanley in Hong Kong. “I’m worried about the deflationary risk.”

Deflation may seem unlikely in an economy still growing at a 7.5 percent clip and where consumer prices are rising 2.7 percent a year. But economists warn that China in many ways resembles Japan in 1989, two years before its crash.

Like Japan, China relied on banks to funnel investment into export industries to create jobs and finance development. In return, interest rates were regulated to ensure banks a healthy profit. Because the most profitable loans were those to the least-risky borrowers, banks concentrated their lending on big state-owned companies.

As Japan did in the 1980s, China tried to remedy this by partially liberalizing the financial sector, creating new avenues of finance, a bond market and other non-bank lending. But as in Japan, this encouraged banks to lend more, not more wisely, helping fuel a property bubble. Things got worse in 2009, when China launched a 4 trillion yuan, credit-powered stimulus to ward off the global crisis.

While Japan saw credit expand from 127 percent of GDP to 176 percent between 1980 and 1990, China’s credit rose from 105 percent in 2000 to 187 percent of GDP last year, JPMorgan Chase in Hong Kong says.”

via Analysis: China risks following Japan into economic coma | Reuters.

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6 Comments to “Analysis: China risks following Japan into economic coma”

  1. Thanks for the link to your previous post. As an aside, I came to learn about your blog from an RSA podcast where you posed a question: you will of course remember it (http://www.thersa.org/events/audio-and-past-events/2012/why-nations-fail) –regarding extractive instituions in China and India; you effectively put James A. Robinson on the spot regarding his and Daron Acemoglu’s over-rated book, Why Nations Fail, and their related thesis. Your question and insight was, in my opinion, spot on while their marginalist rendering of political economy should be critiqued further..

    Arijit

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  2. Minxin Pei has argued that China’s challenge is in the medium term rather than immediately. The growth model has depended upon the repression of the household sector in favor of state owned enterprises so while the financial sector is replete with non performing loans, the local governments, railway system and real estate developers are most vulnerable to serious downturns dependent upon the flow of and access to credit. Yet, is credit an issue when it is backed by the government? Personally, I have argued that Chinese state owned enterprises exist and will be supported via fiscal stimulus and will continue to play a large role for sometime for a number of reasons: (i) they are strategic to the Politburo; (ii) they remain a self fulfilling patronage machine for the princelings, children and relatives of the CPC; and (iii) a healthy mistrust in Western style capitalists (and capitalism) persists.
    What keeps the China’s vendor financing of America sustainable is China’s capital controls. Of course, there are ways around this but for the majority of Chinese those measures are out of reach hence the asset inflation in real estate in China.
    The latter point is articulated by Kevin O’Gallagher” “.. at this point China’s investment rates are too high and China needs to consume more. Low rates moved households to over-invest in real estate, and have caused a real estate bubble in the country. If China de-regulated cross-border financial regulations before reforming its interest rate policy, there could be enormous capital flight out of China.” Source: (The Globalist, Should China Deregulate Finance?, July 17, 2013)
    There need not be a worldwide downturn but the current economic system refuses to recognize that global imbalances cannot continue forever and adjustments cannot simply occur via exchange rate adjustments and ‘re-structuring’. America played the part of consumer of last resort since the collapse of the Bretton Woods gold standard but no-one is able to do that now. China is in danger of not escaping the middle income trap and growing old before growing rich but its policy makers are hoping to avoid what Japan (Brazil and the Soviet Unions before it) could not.

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