China’s New Economy (pt. 1/3)

2 February 2016. A “yes” answer to the first question is by no means unlikely. The answer to the China question seems less uncertain: “No.”

Prof. Dr. Tomas Casas discusses China and the global economy in this three-part series.

Part I: China’s Real Economy

Hyman Minsky’s speculative bubbles attributed to lacking regulators and institutions replace the classical capitalistic cycles of over-investment in industrial capacity and their subsequent own adjustments. The Dot-com burst with its October 2002 NASDAQ low of 1,114.11 points representing a nearly 80 per cent value loss vis-à-vis its peak 30 months earlier, was a classical industrial bubble of overcapacity.

On the other hand, the crisis of 2008 was a different animal; a Minsky speculative collapse nicely rendered in this year’s Oscar nominee Big Short. To understand whether China could be the trigger for the next financial crisis as recently suggested by many pundits, media and George Soros, one has to examine both the state of the real economy and its finance sector. We might end concluding that China is actually one of the brighter spots of the global economy with growth around 6 per cent, and thus adding to world GDP a Turkey-sized chunk … per annum.

Demand for steel and electricity is heading downwards

And yet China’s economy is fundamentally challenged beyond GDP growth deceleration. China’s PMI (purchasing managers index), a critical gauge in a manufacturing-based economy, is below the critical point of 50. Demand for key inputs like steel and electricity is likewise heading downwards. More worrisome are indicators of sentiment. Despite huge trade surpluses to the tune of 50 billion Euro a month, China’s mesmerizing foreign reserves are being eroded (from a high USD 4 trillion to about 3.3 trillion last month). Capital flight is driven by real economy players in search of dollar safety, America’s famed dollar trap. As a result the renminbi’s dollar exchange rate (less so the euro rate) is under pressure, its defense costing the central bank dearly.

Three fundamental issues that caused the slowdown
Behind the slow down three fundamental issues are widely recognized, (i) overcapacity, (ii) old economy inefficiencies, and (iii) the middle-income trap. Overcapacity is present in both private and public manufacturing industries such as textiles, solar panels, steel, real estate and many others now burdened by past capital investment euphoria. Nothing new or surprising in capitalism; capacity finds a new optimum via creative destruction process. Provided governments don’t support the weak crying out for subsidies, once the painful storm is over and the fat is trimmed the survivors will emerge all the more competitive.

The old economy inefficiencies have at their core state owned enterprises (SOEs) and a market dominance challenge, that cannot be addressed by laissez faire and market forces alone. We know that despite their privileged positions, the return on equity of SOEs is a slightly over 10 per cent while for private enterprises it is 20 per cent, the latter also having less leverage and being more efficient. It is true that SOEs in China need to be reformed, maybe privatized further, but most importantly they need to face competition like their healthier private and entrepreneurial counterparts.

To calibrate this reform challenge in China one might refer to Robert Litan wonderful work on America’s political economy. Trillion Dollar Economics shows that to usher the massive social and economic growth benefits – Internet and Silicon Valley included – of the latest boom required blowing up the stranglehold of AT&T. That is, a monopoly position was broken up into seven regional “baby bells” and equipment manufacturer Lucent. This process started with the Johnson administration and was only settled in 1982 by William Baxter, Assistant Attorney General for Antitrust at the Regan administration. 

Get rid of monopolies
The competition solution is only easy for economists. From a practical perspective pushing completion onto monopolies is in the People's Republic of China, as in the West, a Sisyphean task. After all, this is a political economy game. Today neither the US nor the EU can do to Microsoft or Google what was done by Reagan to the telecommunications corporation AT&T. And yet in China the job needs to be done. For instance, there should be 30 mobile operators, not the present three, a move which could add an extra 0.5 per cent growth points to China’s GDP for a decade. Yet reaction always lurks and enormous resistance must be overcome. Regan’s Secretary of Defense Weinberger and Secretary of Commerce Baldrige fought hard on the side of AT&T and almost won the day (credit goes to Reagan’s Chief of Staff James Baker). As the tenacious anti-corruption drives shows, China is capable too of mustering determined leadership.

Picture: zanthia / photocase.de