Podcast Transcript for 'China's Economy—Headed for a Crash?'

Two cleaners have a rest on a bench at the Bund before the Huangpu River and the skyline of the Lujiazui Financial District in Shanghai. (Johannes Eisele/AFP/Getty)
Two cleaners have a rest on a bench at the Bund before the Huangpu River and the skyline of the Lujiazui Financial District in Shanghai. (Johannes Eisele/AFP/Getty)

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Donald Trump: We can’t continue to allow China to rape our country, and that’s what they’re doing. It’s the greatest theft in the history of the world.

Eric Fish: That’s American presidential candidate Donald Trump at a campaign rally, where he repeated a message he’s been delivering for years...albeit usually in less colorful language. Here he is again on Fox News.

Donald Trump: One of the reasons they’re able to do it is they devalue their currency to such an extent. They are the single greatest currency manipulator that’s ever been on this planet.

Eric Fish: Trump argues that China is eating America’s lunch. By artificially lowering the value of its currency, the yuan, it keeps goods artificially cheap and gives itself a competitive advantage over the United States. This advantage, he says, helps it take jobs and grow at a pace that America could only dream of.

That viewpoint was once common across the political spectrum. But lately, many people say Trump has it backwards — that the world should be worried not about China’s economic prowess, but about its vulnerability.

George Soros: I think there’s an eerie resemblance of what’s happening in China to what happened here leading up to the financial crisis, 2007-2008.

Eric Fish: That’s hedge fund manager George Soros, who’s built a $24 billion fortune, in part by making timely bets against markets and currencies.

George Soros: It’s similarly fueled by credit growth and an eventually unsustainable expansion of credit. …The problem has been deferred and it can be deferred for maybe another year or two. But it’s growing and it’s growing at an exponential rate.

Eric Fish: After China began to embrace capitalism [MS - See Above change to 'market reforms'] in 1979, it enjoyed three decades of rapid growth that shocked the world. Even in 2009 during the Global Financial Crisis, China steamed ahead and grew by more than 9 percent. It was called “The China Miracle.”

But in the past few years, that miracle has begun to sputter. China’s growth has been slowing, and a host of problems have begun to emerge in the economy. So is this just a temporary hiccup, the prelude to a major crisis, or something in between?

Jamil Anderlini: No economy in history has ever seen that quick a ramp up in debt without a financial crisis.
Ann Lee: Their demographic issue is going to be extremely challenging. …They don’t have the luxury of being a rich country like Japan when this happened.
Lucy Hornby: The problem that they’re worried about is the middle-income trap. …They’re not entirely confident of their ability to make that transition.
Ruchir Sharma: I come to the conclusion that the next global recession could well be made in China.
Richard McGregor: When it comes to the economy, the sort of increasingly authoritarian style of leadership that we see in [Chinese president] Xi Jinping doesn’t work.

Eric Fish: Today we’ll dive into China’s economy — how stable is it, and what would a meltdown mean for the world? I’m Eric Fish and this is the Asia Society podcast.

[Music]

Eric Fish: Let’s start with the person who’s been driving China’s growth for the past three decades: the Chinese worker, who, these days, isn’t always necessarily even from China.

Jamil Anderlini: If you’d said to any of us 10 years ago that China, the source of all cheap labor in the world, the workshop of the world, was going to be importing workers, we would have all said you were completely crazy. But that’s what’s happening.

Eric Fish: That’s Jamil Anderlini, a long time Beijing correspondent for the Financial Times. He was speaking at an event in New York about China’s economy hosted by Asia Society’s online magazine ChinaFile.

Jamil Anderlini: We estimate anything, 50,000, 100,000, possibly more, workers have snuck into China through Myanmar, Vietnam, other border states, mostly those ones, and are now working in the factories.

Eric Fish: Anderlini said that this suggests labor shortages, and that China has begun to enter what’s called the Lewis Turning Point. When an economy is still poor and developing, factories and other producers still have plenty of workers to fill jobs as labor needs increase. As this happens, wages stay pretty cheap because there’s still a pool of untapped workers to draw from.

China has been able to do this for decades now. As it’s grown, it’s had hundreds of millions of rural laborers to draw off farms and into the country’s industrial revolution.

Jamil Anderlini: It’s astonishing when you think about it, and that movement of people is really one of the main things that has led to this extraordinary growth in China over the last 30 years. Just the fact of moving people from very low productivity jobs in the countryside to much higher productivity jobs in factories, in construction sites. Just that shift has created enormous, enormous wealth. And our hypothesis, which we believe to be, most of us believe to be absolutely correct, is that this supposedly endless flow of migrants is now drying up.

Eric Fish: This is the Lewis Turning Point — when there are few surplus workers left, so employers must start competing for them, namely, through raising wages.

Earlier this year, the Asian Development Bank projected that China’s GDP growth will fall to 6.5 percent this year and 6.3 percent in 2017. Asian Development Bank Chief Economist Shang-Jin Wei says this is to be expected. Here he is at an Asia Society event in New York.

Shang-Jin Wei: Seeing a gradual decline in growth rate is not a reason to be panicked. And why do we say that? Number one is China's past success — precisely because the growth rate had been stellar in the last three-plus decades, living standards have increased tremendously, wage rates have increased tremendously. That's wonderful for anyone working in the country, but it also means simultaneously that many things China used to be globally competitive in — toys, assembly of phones and other consumer electronics and garments — have become much less competitive today. India, Bangladesh have much lower wages, Vietnam, than China.

Eric Fish: He compared China to what are known as the four Asian dragons: Singapore, Hong Kong, South Korea, and Taiwan. Each also experienced so-called economic miracles followed by slowing growth rates. But China has an extra problem to deal with that the four dragons didn’t: artificially skewed demographics.

During the early rule of Mao Zedong, Chinese families were encouraged to have a lot of children to make the country stronger, and they did. China’s fertility rate peaked in the mid-1960s at more than six children per woman. But in the 1970s, worried about overpopulation, the government changed course and encouraged fewer births. Then in 1980, it solidified its family planning policy, or as it’s more commonly known, the One Child policy.

Shang-Jin Wei: That simultaneously explains why in the previous three decades China seems to be going very very fast relative to other countries’ experience and why now the fall seems to be more dramatic than we see elsewhere. …From 1980 to 2011, China had a very favorable ratio of working age people to dependents. Today, fewer people are entering the labor force every year than nature intended. Therefore, China has flipped, from unusually unnaturally favorable demographics, to unusually unnaturally unfavorable demographics. The ratio of working age people and dependents has become much less favorable. Fewer people enter the labor force, yet their parents, grandparents, and grandparents’ cohort continue to retire.

Eric Fish: Since 2011, China’s labor force has been shrinking by millions per year as the Mao-era baby boomers are replaced in the workforce by the smaller one child generation. 2015 was the most extreme yet, when the working age population declined by 4.9 million people.

Ann Lee: I think their demographic issue is going to be extremely challenging.

Eric Fish: That’s Ann Lee, an economist at New York University and author of the book What the U.S. Can Learn from China.

Ann Lee: They went from like, 1975 to 2010, the dependency ratio was probably like six-to-one, and going forward it's going to drop to like two-to-one. So they're going to look more like Japan's aging society except at an accelerated pace — it's probably going to happen 10 years faster just because of their one child policy. And they don’t have the luxury of being a rich country like Japan when this happened. So they’re going to face serious challenges with that. How they pull it off remains to be seen.

Eric Fish: In 2015, the Chinese government, cognizant of its demographic challenges, announced it would be further loosening its family planning policy and allowing all families to have two children. But even if this results in a baby boom, which most demographers predict it won’t, Shang-Jin Wei points out that it would do little to help with the current economic predicament.

Shang-Jin Wei: Interestingly, the relaxation of the family planning policy in the short run and the medium run will make growth performance worse. Why? Because no family can produce a 20-year-old child right away. So that in the next two decades, the relaxation will only add more dependents to the population and the total number of working people will not change until two decades later.

Eric Fish: When you have a shrinking workforce, you need to get more economic productivity out each remaining worker if you want to keep growing. One way to do this is to eliminate inefficiencies by making the economy more competitive and market-driven, rather than state-directed. China’s private sector now accounts for roughly 60 percent of the country’s GDP, and 80 percent of its jobs. But state-owned enterprises, or SOEs, are disproportionately powerful. Although they’re far less productive than private enterprises, they gobble up the lion’s share of loans and maintain monopolies in key industries like telecom, oil, power, and banking.

An increasing number of these companies are operating at a loss, especially in hard hit industries like steel and coal. But in order to avoid disruptive layoffs, the government, through its state-owned banks, often keep these so-called “zombie factories” alive by directing loans to them — loans that could be much better spent by private companies.

Zhu Chaoping: Xi [Jinping] proposed a lot of very bold plans, like the SOE reform, the rural land reform, even on the political side, reform to build a more transparent system and the rule of law.

Eric Fish: That’s Zhu Chaoping, China economist at the financial services firm UOB Kay Hian in Shanghai. He says that when Chinese President Xi Jinping came to power in late 2012, he appeared to be the bold economic reformer China needed to smooth out the grave inefficiencies in the economy.

Zhu Chaoping: But the issue is we did not see any very concrete progress in these reforms; the reforms are still on the paper. so we're actually disappointed by the progress of the reforms.

Eric Fish: He says there are basically two reasons for this. One is struggles between different interest groups. Even when the central government is determined to enact reforms — whether to eliminate zombie factories, cool the real estate market, or reconfigure banking mechanisms, local governments may have compelling local incentives to resist. And even at the national level with the biggest state owned enterprises, some very powerful, well-connected people owe everything they have to the system the way it is.

Zhu says the other reason reforms have stalled is likely that fears of instability have made the government very hesitant to give up levers that it can use to control the economy when it needs to.

Zhu Chaoping: For example, Xi Jinping always reiterates that SOEs are the pillar of Chinese economy. When there is difficulty in the economy, they want to rely on the SOEs. For example, in the latest round of stimulus, most of the government spending was through the SOEs. They are using SOEs as a tool.

Eric Fish: Over the past few years, Xi Jinping has shocked many with the speed at which he’s consolidated power and eliminated rivals through an anti-corruption campaign. But when it comes to control of the economy, it’s a different story.

Richard McGregor: I think if you look at Xi Jinping, you can divide his power or his behavior into two areas.

Eric Fish: That’s Financial Times journalist Richard McGregor, who wrote a book on China’s Communist Party. He was speaking at the ChinaFile event.

Richard McGregor: One area is the Party area. If you think he has control of the three P’s: the P.L.A. [People’s Liberation Army], personnel, and propaganda — whether in fact you like what he’s doing in those areas, he can be very effective, very decisive, very nimble in controlling those levers of power. When it comes to the economy, the sort of increasingly authoritarian style of leadership that we see in Xi Jinping doesn’t work. It may work a little bit. We’ve had a slight uptick in property prices and everything in the first three months of this year; I think that’s a temporary thing. But China is a vast, sprawling, continental, complicated economy. Xi Jinping is the chairman of everything, as we know. He’s the chairman of the Party internal group overseeing the economy, but I doubt he has that much time, as people tell me, to actually focus on it.

He has a very tight inner circle, but within that inner circle on the economic side, he has very cosmopolitan, worldly, market-oriented advisors. I don’t see any sign that he’s really listening to that. But in any case, he can’t click his fingers on the economy as he might be able to click his fingers and get the governor of this or that province removed. And that’s difficult. Now, if we go one step beyond that and ask the question of whether Xi Jinping is comfortable with an economy ever-reliant on the markets, which go up and down, and in developing countries, with great alacrity. Does he really want to take that risk?

Eric Fish: This isn’t the first time China has needed serious market reform. In the 1990s, the government began dramatically privatizing or dismantling state owned enterprises, and more than 40 million workers were laid off as a result. It was highly disruptive, but ultimately helped the economy keep growing. Recently the Chinese government announced it would be laying off 1.8 million workers in coal and steel sectors. It’s part of a plan to lay off 5 to 6 million over the next few years.

Richard McGregor: Obviously that’s difficult for anybody who does lose their job, but compared to what the economy went through before, that’s almost a rounding error. And in terms of Chinese employment it’s almost a rounding error, it’s almost like attrition. And if that’s a difficult decision now compared to what the Chinese leaders managed to push through before, then you do sense a sort of loss of nerve in really transforming the economy completely. And I don’t think they want to do that in any case.

Eric Fish: This gets to more fundamental political challenges with overhauling China’s economy, because cleaning up inefficiencies is only part of the struggle. You also have to innovate ways for each worker to have more economic output. You need to not just assemble products, but design them, market them, and come up with other services higher up the value chain.

Jamil Anderlini told the story of a Chinese acquaintance who illustrates part of why China is ill-prepared to make that leap. The man, who had studied at MIT, was wealthy from a previous business he’d sold and later paid some of his old colleagues to innovate new products.

Jamil Anderlini: They’ve come up with some amazing stuff, including, it was several years ago now, they came up with this wonderful software which could live broadcast from your iPhone straight to your WeChat or your Weibo account. They were the first in the world to come up with this. It was really innovative — live streaming to your Twitter account. Anybody could go on and see what you’re doing or what you’re looking at. Now think about the implications of that for a police state, for an authoritarian system, where I could be sitting while Xi Jinping picks his nose and I’m live streaming that to everyone on the internet. Or there’s a protest down in this village or that village I’m live streaming. So he recognized immediately the huge potential for this, but also the huge danger he was in having come up with this technology. And so what he ended up doing is selling it to the state security system for like a pittance. ...Very innovative, but killed at birth. And obviously that technology is now available, others have come up with it. But he was the first. I mean that’s really sad. You do have an extremely innovative society, which can’t really properly bring it to market.

Eric Fish: And that problem leads us to this one.

Lucy Hornby: The problem that they’re worried about is that that is the middle-income trap.

Eric Fish: That’s Beijing-based Financial Times journalist Lucy Hornby, invoking a term you hear a lot these days in regards to China. It refers to the trouble that comes an economy moves past low wage labor-driven growth, but can’t innovate enough to become high income.

Lucy Hornby: You could have a scenario where those low wage jobs even themselves out worldwide — the price of a t-shirt doesn’t change — but then China is kind of stuck as well unless they can make the leap as, say, Korea has done, Japan has done, as the British empire did, as the Americans did. Unless they can make that leap to a more complex economy that is not reliant on textile and low-income factory jobs. And they’re not entirely confident of their ability to make that transition.

Jamil Anderlini: I would argue that all the examples you give — Japan, Taiwan, South Korea — just in the region, that transition, that evasion of the middle-income trap, is generally accompanied by democratization and political reform. So I mean, call me a zealot, but I think those two things go together. I think that’s also part of the inexorable market forces that are driving. So either China is going to get stuck in this middle-income trap, or it’s going to be driven or accompanied by natural political reform I think.

Eric Fish: Authoritarian systems do have a bad track record of moving to high income without democratic reform. Political scientists and economists point to reasons like a lack of rule of law and impartial courts, which scares would-be innovators away from taking risks. Then there’s also restricted access to information, an inability to challenge authority and the status quo, and a general level of social distrust that inhibits collaboration.

But beyond demographic problems, lack of innovation, and the middle-income trap, there’s one pressing issue in China’s economy that seems to worry analysts more than any other: debt. Here’s Jamil Anderlini again.

Jamil Anderlini: China has already had the most incredible debt explosion over the last six or seven years. Depending on whose numbers you look at, it’s gone from 130-140 percent of GDP, the overall debt load, to 260, 270. That’s not necessarily a problem in itself; the absolute debt level is not a huge issue, although it’s approaching Japan levels, which is the highest levels in the world. The key problem is the speed at which you’ve gone from 130 percent of GDP to 260 percent. No economy in history, as far as we’ve been able to find, has ever seen that quick a ramp up in debt without a financial crisis.

Eric Fish: When the global financial crisis hit in 2008, China initiated a $580 billion stimulus program to help weather the storm, and over the following two years, it directed state-owned banks to hand out trillions of dollars in cheap loans. Much of it was lost to malfeasance and fruitless infrastructure projects, but overall, it initially seemed to work. It kept construction going and factories humming. The country maintained more than 9 percent annual GDP growth, and after the worst of the crisis was over in 2010, debt briefly stabilized.

But as economic growth began to slow, heavy lending resumed and now it’s reaching new heights. That brings us back to George Soros’ observation that China’s prolific extension of credit bears an "eerie resemblance" to the U.S. before its financial crisis.

George Soros: It feeds on itself. ...Since it feeds on itself, it can reach the turning point later than anybody expects. This happened in America, where 2005-06, a lot of people like Paul Volcker saw it coming, but it went on to 2007-08 and most of the damage actually occurred in the last years, because it’s kind of a parabolic cycle. More and more credit is needed to sustain growth. …Most of the money that the banks supply is needed to keep the bad debts and the loss making enterprises alive. You can close branches, you can close a factory, but you can’t close an entire company without having to write off the debt.

Eric Fish: In early 2016, some analysts were relieved when many economic indicators unexpectedly turned around and beat expectations. These were things like housing prices, employment, industrial output, and retail sales. But for others, it was a signal that China was leaning back on credit to fuel growth. Chinese banks issued more than $200 billion in new loans just in March of 2016 — double the month before. According to an FT analysis, this credit stimulus is bigger as a proportion of GDP than the one in response to the financial crisis, and this time, it’s not having nearly as much of an impact at boosting growth.

George Soros: It is a bubble, but it can grow, and it can feed on itself. And markets are not infallible, and they buy into it. And that of course is another factor that makes it grow. And that is in fact what has happened. So the markets are reassured. When I see in March credit grew by an enormous amount, that is taken as a sign recovery is on the way. To me, I think it’s a warning sign, because it shows how much more credit is needed to stop a decline.

Ruchir Sharma: The next global recession could well be made in China.

Eric Fish: That’s Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management and author of the book The Rise and Fall of Nations.

Ruchir Sharma: Because until the last decade there was no other economy which could cause a global recession apart from the United States. So every global recession originated from the United States. What’s changed in the last few years is China has become a big economy. So in a way that’s a good thing, but there’s a downside to that also, and that’s if something happens in China, that can lead to problems elsewhere and it’s an idea the world isn’t used to. ...I say there’s more than a 50 percent probability of a global recession in the next couple of years caused because of the debt problems in China.

Eric Fish: Sharma says this doesn’t necessarily mean a major economic collapse in China. The country could experience something less dramatic, akin to Japan’s so-called “lost decade” of long-term stagnation in the 1990s. But that’s not necessarily much better of an outcome.

Ruchir Sharma: Till 2008, China’s debt profile was quite stable. Until the last decade I was a big optimist on China as well, but I’ve changed my mind the last few years. What changed my mind is that, the amount of debt that China has taken to grow in the last 5-7 years is the largest amount that any developing country in history has ever taken. And the consistent predictor of financial crisis and economic troubles in the world has always been if a country takes on too much debt over a short amount of time. That’s gotten every country into trouble. Now what the trouble would be is hard to define — some have a crisis or a Japan-like thing where for years and years you have no growth because too much debt just clogs the system. In some ways a crisis is almost better, like in the U.S. it cleans the system. It’s very painful, then you move on to the next stage.

Eric Fish: Not all experts see catastrophe for China. Lucy Hornby agrees that China’s ability to rely on credit is coming to an end.

Lucy Hornby: But I don’t necessarily think that means a super hard landing. I think that you can visualize it in a way that if you assume there is a general level of organic growth that should have happened given China’s population growth, general increase in wealth, let’s say from 1949. It should have gone at a certain level. Instead it went way down, then there was sort of a boomerang effect like pulling an elastic band, where it shot way up, started to moderate and come back to the mean. And then as Mr. Soros just said, they juiced it. Now it’s coming back to the mean again, and they juiced it again. Sooner or later, I think it will always come back to the mean. I think the mean is still going to be growing though. There’s still a number of Chinese that don’t have our standard of living, and aspire to that, which is quite normal. The question is just whether in juicing it, whether they’re willing to accept a time where it should go below that mean again before it reverts to a more sort of organic or natural stage. And I think as you say, they’re very afraid of that.

Eric Fish: If there were to be a financial crisis in China, it would be felt around the world. It could lob nearly 1.8 percentage points off collective global growth, according to Asian Development Bank estimates. For context, that’s more than half of the 3.1 percent growth the world experienced in 2015.

Partly out of fear of economic trouble, partly because overall growth and investment opportunities are already dwindling, and partly because of inflation fears due to banks pumping money into the markets, among other reasons, many Chinese businesses and individuals have been moving their assets out of the country. During China’s boom years, far more money was pouring into the country than leaving it. As recently as 2013, China had a net inflow of $283 billion. But in 2015, it had an unprecedented outflow of $676 billion. And that brings us back to Donald Trump’s claims that China is eating America’s lunch.

Donald Trump: One of the reasons they’re able to do it is they devalue their currency to such an extent. They are the single greatest currency manipulator that’s ever been on this planet.

Eric Fish: In a recent New York Times commentary, Ruchir Sharma said that the narrative of China keeping its currency artificially low to boost exports is “so last decade.” The enormous capital flight has coincided with the yuan’s value quickly depreciating. So last year, China burned through more than half a trillion dollars of its foreign currency reserves to buy up yuan and prop up its value. It’s the reverse of the sort of currency tinkering that Trump complains about, and it’s now likely made the yuan over-valued.

If the government took a hands off approach and the yuan’s value were allowed to fall substantially, it could have major adverse effects on the economy. It would reduce the purchasing power of Chinese consumers at a time when the government is trying to shift to a consumption-driven economy. It would make it more difficult for businesses and governments to repay foreign currency debts, leading to defaults. It would also likely erode confidence in China’s economy further, deter investment, and prompt even more capital flight, creating a kind of vicious cycle.

But the depletion of reserves in order to prop up the currency isn’t sustainable in the long run, so it becomes another one of the major dilemmas the government faces in managing the economy. Is it willing to yield control to unpredictable market forces? And can it ultimately risk serious pain and instability in the short term in order to make the economy more sustainable in the long-term? Here’s Zhu Chaoping.

Zhu Chaoping: I think the mindset of those leaders is still at the old stage of the planning economy and they are not moving to the direction of marketization and liberalization of the economy. ...It will be very hard to push forward reforms. Another issue might be in politics. There are a lot of discussions recently that Xi might not be so consolidated in his power and he might need a new round of reshuffling in the central leadership, and after that he will consolidate his power and announce more aggressive reform measures.

Eric Fish: In late 2017, there will be a once-per-five-year shake up in China’s politburo — the country’s highest decision-making body. Historically, this has been preceded by intense jockeying for power among different factions, and strict clampdowns on anything that could breed politically disruptive social unrest. But the government — which owes much of its legitimacy to delivering economic growth to its people — may be running out of time and options. Here’s Ann Lee.

Ann Lee: Of course it's vulnerable. They need to certainly continue to show the population that they have their best interests at heart and that they’re delivering, otherwise it's too easy for other folks to say we need other options, why can't we create another party to challenge you if they don't deliver. So economic growth is going to be their achilles heel.

Ruchir Sharma: Listen, I have great faith and respect for what the Chinese leadership has done in the last 30 years for achieving one of the most powerful economic miracles in history that has been transformative, but the fact that China can achieve whatever it wants, and can get whatever growth it wants in a single year, to me is a bit of an illusion. I don’t agree with that.

Eric Fish: That’s all for today, if you want to hear more episodes you can go to asiasociety.org/podcast or subscribe on iTunes. You can also follow us on Facebook and Twitter @AsiaSociety. Our music is by Thiri Maung Maung and his ensemble Shwe Man Thabin Zapway. They were performing live at Asia Society New York as part of a season of Myanmar. I’m Eric Fish and we’ll see you next time on the Asia Society podcast. 

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