LET ME start by repeating my conclusion from the main article: to argue against China’s eventual rise it’s not enough to point to vaguely perceived imbalances or assert that the economy can’t go on exactly the way it was before. We need more than a little grit in the wheels to slow the country down—instead, we need a definitive, fundamental crisis that pushes China off the growth path for a long time to come. And we need it soon, ideally within five to ten years.
Now, as an avid follower of Minxin’s work, it’s a pleasure to have a chance to comment on his views, and he clearly provides an engaging review of long-term challenges for the mainland economy. But has he made the case for a looming crisis? Unfortunately, the answer is no—and on most counts the arguments fall very wide of the mark indeed.
One of Minxin’s main propositions is that the state’s role in the economy is unhealthy and out of proportion, that Beijing created a false sense of economic well-being and a flawed set of economic structures. He asserts that the government creates massive economic distortion by manipulating key input prices such as those of energy, capital and land. Yet to start, I must ask, what energy mispricing? For the past two decades Chinese fuel prices have been set more or less at world levels, with the exception of the short-lived 2007–08 subsidies as a response to global crude price spikes, and, as I write, Chinese consumers are paying more for fuel than their U.S. counterparts. There is no “world price” for electricity, which makes comparisons harder here, but while China regulates prices, it does not subsidize electricity production or distribution.
He talks too about the government’s heavy hand in the corporate sector. But here again, where are the chronic subsidies Minxin mentions? With the exception of the 2007–08 payments to oil refiners, China has not given cash handouts to industrial state firms for a very long time. As I noted, quite the opposite is true; SOEs today face a much-larger tax burden than the private sector and are the largest provider of funds to the government.
The government does provide an implicit subsidy to banks by putting a ceiling on deposit rates and a floor on lending rates. But while this artificially depresses the return to Chinese savers, it also imposes an artificially high cost of funds on corporate borrowers. In other words, China is not subsidizing capital; if anything, it is taxing it.
Minxin is correct that there was a time when SOEs were not expected to repay loans, but as a macroeconomic phenomenon this era effectively ended in the mid-1990s when the government began to shut down debtors and impose hard budget constraints on banks and firms. As a result, the vast majority of China’s “massive” nonperforming loans (NPLs) were extended before 1997—and, following a subsequent extensive cleanup, mainland state banks now have very low NPL ratios by emerging-market standards.
As for the argument that China is getting a decreasing return on investment, Minxin is not so much wrong as misguided. One of the very definitions of long-term economic development is the accumulation of capital, which in turn automatically means falling returns on new investment; if RMB 100 of new capital spending yields less new output than before, this is more likely a measure of success than failure in a rapidly growing economy.
How can we know for sure? For serious economists, the answer is to look at the returns to labor as well. If labor efficiency is rising faster than capital returns are falling, the economy is healthy; if not, then there is a stronger case that growth is imbalanced and distorted. The one numerical indicator that captures both capital and labor efficiency—and thus the single best measure of long-term economic success—is total factor productivity, and as I discussed earlier nearly every available study done on this basis finds very high rates of TFP growth in China.
Most important of all, if we look at bottom-up measures of corporate returns for any given sector, it’s difficult to find even one industry where net margins, return on equity or return on invested capital failed to rise on average over the past decade, i.e., precisely the period during which Minxin claims China should have been careening into hopeless overcapacity.
Minxin also cites demographics as a potential source of economic stress. However, although there’s no question that China faces an eventual decline in labor-force availability, this is a profoundly long-term process, particularly when we consider that China still has another 75 million or so underemployed rural workers waiting to come into industry and services. And remember that labor growth contributed only around two percentage points to trend growth in the first place; the majority was explained by capital investment and rising efficiency. So while demographics can slow the mainland down at the margins, this is hardly a revolutionary turning point.
Minxin is also correct that aging societies generally save less, and I have little argument with his estimate of 5 percent of GDP for eventual household-savings losses—but this can hardly matter for China today, which exports a full 10 percent of GDP in excess savings to the rest of the world. By any reasonable calculation the economy could lose three times Minxin’s figure in terms of lower savings and still grow very comfortably at 8 percent or above.
In addition to economic factors, Minxin also addresses what he sees as deep societal fissures, from inequality to the environment. As a long-term resident of China, I have no interest in downplaying the considerable environmental problems plaguing the country. However, it’s one thing to point to bad air and bad water and quite another to argue that this will lead to economic crisis. If we accept that water availability is the most serious potential issue, then the math becomes surprisingly simple: by far the biggest user in China is the agricultural sector, and we will know that water is becoming a meaningful economic constraint when we see food production under pressure. And it may surprise many readers to discover that China is still a sizable net agricultural exporter, with no sign whatsoever to date of this trend reversing.
And now we come to what I believe are the most serious issues, where I agree with Minxin that the trends of the last decade—falling social expenditures and rising inequality—if left unchecked, could lead to grave trouble. And the figures he quotes are a broadly accurate reflection of reality . . . up to, say, 2003. As I discussed in the main article, these two problems were not failings of governance so much as adverse economic shocks (the late-twentieth-century collapse in government revenue and falling rural incomes). Over the past five years the underlying momentum has already changed dramatically. Again, Chinese government revenues have skyrocketed since the near-starvation days of the late 1990s and are now back on a par with most emerging markets, allowing for a significant ongoing expansion in social spending and transfer payments. And rural income growth between 2004 and 2008 was the best in nearly fifteen years, reflecting the economic impact of demographic changes and urbanization as well as greater government support. If the present renaissance continues, then what looked like an intractable dilemma five years ago could well become a distant memory in another five years’ time.
In sum, China is a good deal more market oriented than Minxin assumes in his writings—and the market is already sorting out China’s most pressing remaining problems.
1 Think, for example, of India and the Soviet Union. In the 1970s and 1980s both grew at exactly the same annual pace (4.2 percent)—but while the Soviet Union got there by artificially depressing consumption and throwing ever-greater amounts of capital into investment, India enjoyed high consumption rates and much lower capital-investment needs. To capture the difference between these two cases we have to measure TFP growth (which was positive in India and negative in the Soviet Union).