China’s heavy dependence on soaring debt in recent years has rendered the country’s economic model unsustainable, according to a growing consensus in Beijing. China has just four alternative economic paths, each with its own needs and limitations.
This stage of the development model, and every other country that has taken a similar path, cannot continue high growth due to systemic investment misallocation. When a country reaches this point, it needs to develop a new growth plan, including income redistribution and demand-side support.
A nonproductive investment might inflate growth until the country begins its difficult transition. False growth must be amortized, and rectification reversed much of the rise in every past case. False growth makes it harder and costlier to pay off.
There are few economic paths if it’s understood that China’s increasing debt is due to nonproductive investment and must be decreased. Consumption, investment, and trade surpluses promote economic growth. As a result, there are five paths the Chinese economy may take in the future.
1. China may continue on its current path and allow significant nonproductive investment to keep its debt burden indefinitely.
For China to continue on its present course of high-level development supported by unprofitable investment, the country would have to permit a consistent, endless rise in its debt load.
Rising debt has been argued to be of no importance to China. Some critics say debt is only a concern if it’s foreign and not covered by local savings. But the fact that the government has a growing debt backed by domestic savings instead of deposits from other countries shows that it has a current account surplus.
2. China can replace many nonproductive investments on which it currently relies to drive growth with new, investment-worthy technologies.
By substituting investments in more productive economic sectors for nonproductive ones, Beijing might be able to limit its debt levels while sustaining rapid economic development. Chinese officials have said for many years that this is the most likely thing to do, but they haven’t done what they said they would.
Such a course of action would, at the very least, require Beijing’s leaders to have a thorough knowledge of why other countries that used this development model found it challenging to implement this change.
3. China may reduce the significant amount of nonproductive investment that it now uses to drive growth and substitute it with rising consumption.
By substituting increasing consumption as a percentage of GDP for nonproductive investment, Beijing could reduce debt while maintaining strong growth rates. Beijing has been pushing for this at least since March 2007, when the then-prime minister, Wen Jiabao, told a news conference at the end of the Two Sessions parliamentary sessions that Beijing’s economic planners would pay a lot of attention to rebalancing domestic demand toward consumption.
With Chinese businesses maintaining a similar percentage of GDP as in other nations, it would be expensive for Beijing to compel them to absorb the required transfer, leaving just the government. Rebalancing China’s consumption needs considerable local government subsidies to households.
4. Another approach for Beijing to reduce debt while maintaining high growth rates is to replace nonproductive investment with a growing trade surplus. Although this is a viable choice in principle, when it comes to reality, it is not.
China’s trade surplus at the end of last year was equivalent to about 1% of the rest of the world’s GDP, and by my estimates, it would need to raise the surplus every year by at least 3% of the Chinese GDP to replace domestic nonproductive investment. This may work for a smaller economy, but China’s trade surplus is too huge. The rest of the world would not accept a system in which China’s prosperity depends on meeting more global demand.
5. China can also reduce the vast amount of nonproductive investment on which it depends to drive development and replace it with nothing, in which case growth would inevitably decline considerably.
Given that investment makes up between 40 and 45 percent of China’s GDP, with infrastructure and property investment making up nearly two-thirds of that total, it is obvious that a significant reduction in nonproductive investment, if not offset by another source of growth that is equivalent, must lead to a sharp contraction in China’s GDP growth. If that turns out to be the case, then a rough estimate indicates that the GDP growth cap for many years would likely be 2 to 3 percent.
These are the same five paths faced by any country that has adopted the concept of high savings and high investment. Each of these approaches has its systemic challenges, and except for the first, they all need considerable changes in economic institutions, which similar changes in political institutions must accompany. This may be why every country took the last of the five pathways in the end.