China’s debt problems have emerged so much more rapidly and severely this year than in the past that a growing number of analysts believe that this may be the year that China’s economy breaks. There is no question that China will have a difficult adjustment, but it is likely to take the form of a long process rather than a sudden crisis.
Most of the discussions among economists about the impacts of tariffs and trade intervention are more ideological than logical. While tariffs may cause households to pay more for tradable goods, there are many other ways households, and the overall economy, are affected, positively and negatively. What matters are the conditions under which trade intervention policies are made.
Policies that increase income inequality can in some cases lead to higher savings, higher investment, and greater long-term growth. But, in other cases, such policies either reduce growth and increase unemployment or force up the debt burden. What determines which of these outcomes takes place is whether or not savings are scarce and have constrained investment.
In a recent much-remarked-upon and very short op-ed, George P. Shultz and Martin Feldstein argue that the only way, or at least the best way, to cut the U.S. trade deficit is for Washington to cut the U.S. fiscal deficit. It is at least as likely, however, that cutting the fiscal deficit will simply increase debt or increase unemployment.
Contrary to conventional thinking, a savings glut does not necessarily cause global savings to rise. A savings glut must result in an increase in productive investment, an increase in the debt burden, or an increase in unemployment.
The three scenarios listed in a recent Financial Times article set out the range of plausible economic outcomes available to China. The most likely is that China experiences a long, but orderly, growth deceleration as it grinds away at its debt burden, but under easily specified conditions each of the three is possible.
China’s success will depend Beijing’s ability to centralize power, to begin to sell off government assets, to rein in credit growth, and to accept much lower GDP growth rates.
China’s rebalancing can only occur in a limited number of ways, and each of these has a fairly predictable impact. The path Beijing chooses to follow will likely be based on political decision-making.
China’s problem is excessive debt in the economy, not a banking system facing insolvency. Beijing’s reform strategy should reduce the debt burden as quickly as possible to minimize the economic costs.
There is no way Beijing can address its debt problem without a sharp drop in GDP growth, but as unwilling as Beijing may be to see much lower growth, it doesn’t have any other option.
China is embarking on ambitious economic reforms to boost its growth prospects. What is the rationale behind these new reforms and what are the prospects for their success?
A simple model can help illustrate the problems that China will face over the coming decade.
While it is difficult to predict the nature and timing of the shocks buffeting China’s economy, China’s difficult economic situation makes such crises inevitable.
The structure of investment strategies in the Chinese stock markets had always guaranteed that this would be a brutally volatile market that trades almost exclusively on “the consensus about the consensus”, and therefore prices will reflect very rapid shifts in this consensus.
The value placed on current and future growth says a lot about the quality of that growth. It also has important policy implications, especially for reforms.
While China is a more integrated optimal currency zone than the EU, there are still frictional costs across provinces that will require Beijing to make some adjustments, which have their own costs.
Instead of a hard landing or a soft landing, the Chinese economy faces two very different options, and these will be largely determined by the policies Beijing chooses over the next two years.
The past two decades of Chinese growth have disproportionately benefited a small elite that has become increasingly entrenched; the next stage must focus on liberal reforms to build social capital more broadly.