Napoleon famously observed that when China awoke from its long slumber the world would shake.
Now that the Chinese economy has certainly awoken, were he alive today Napoleon might have warned that when the Chinese economy stumbles the rest of the world’s economy will also suffer. He might have done so particularly because there are all too many reasons to believe that China will soon begin a renewed and lengthy period of economic stagnation.
Judging by the cavalier manner in which President Trump has been waging his U.S.-China trade war without much regard for the global economic consequences of that war, one could be forgiven for thinking that the Chinese economy has little systemic importance for the global economy.
But the truth of the matter is that China’s spectacular economic performance over the past 30 years has propelled it from a situation where it accounted for less than 2 percent of the global economy to one where it now accounts for more than 16 percent. In addition, as the world’s second largest economy, over the last decade the Chinese economy has been the principal engine of world economic growth and the driving force for an international commodity price boom.
Anyone doubting China’s importance to the world economy need only consider the fallout of the U.S.-China trade war. As the IMF has recently noted, not only has that trade war caused the Chinese economy to slow markedly, it has also upended the world economy. In 2018, 75 percent of the world’s economies were experiencing upswings; now, 90 percent of the world’s economies are now experiencing downturns.
Sadly, even were the U.S.-China trade war soon to be resolved there are several basic reasons to believe that China’s best economic days are behind it. This does not bode well for the rest of the global economy, and it certainly does not bode well for those emerging market economies that have come to depend on a Chinese-fueled international commodity boom.
Among China’s more immediate economic Achilles’ heels is its highly unbalanced economy. Not only is China an overly export and investment-dependent economy, it has also experienced a credit bubble of epic proportions.
According to the IMF, Chinese investment still accounts for more than 45 percent of the country’s GDP, which is more than double the corresponding ratio in the United States. Meanwhile, over the past decade credit to China’s non-public sector has increased by around 100 percent of GDP, which the Chinese government itself recognizes to be a dangerously unsustainable situation.
This rate of credit expansion exceeds that in Japan prior to the bursting of its bubble in the 1980s and that in the United States in the run-up to its 2008 credit and housing market bust. It has also given rise to a situation where China has a massive amount of unused industrial capacity and an enormous overhang of unoccupied housing and commercial property.
Recent experience with the bursting of outsized credit bubbles, like those in Japan, Spain and the United States, does not portend well for China’s long-run economic performance. In the best of circumstances, China, like Japan before it, is likely to experience a prolonged period of relative economic stagnation. It will do so as its banks’ balance sheets become clogged with non-performing loans and where the need to prop up zombie enterprises will preclude the flow of credit to the more dynamic sectors of its economy.
Another immediate factor that does not bode well for China’s future economic performance is President Xi seeming intention to kill the goose that has laid the Chinese economy’s golden egg. He is doing so by reversing the economic reforms introduced by Deng Xiaoping in 1979 aimed at giving the private sector increased room to breathe dynamism into the Chinese economy. Fearful of the challenge that a thriving Chinese economy might pose to the Communist Party’s political hold on the country, President Xi is now reestablishing party discipline and increasing the role of China’s state enterprises.
Yet another factor likely to sap China’s economic growth in the years ahead is its very poor demographics. Largely as a result of its one-child policy, the Chinese labor force is expected to decline by some 25 percent over the next thirty years. This has prompted Nick Eberstadt, my American Enterprise Institute colleague, to observe that China is set to become old before it becomes rich.
All of this is not to say that the Trump administration is mistaken to exert real pressure on China to level the trade playing field and to have China desist from intellectual property theft and forced technology transfer. Rather, it is to say that in formulating its international economic policy, the administration should not exaggerate China’s long run economic challenge to the United States and should take into account the impact of a slowing China on the rest of the global economy.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.
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