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The Chinese Boom Can't Last / Artikel mises.org, engl.

verfasst von - Elli -, 30.07.2004, 10:18

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http://www.mises.org/fullstory.asp?control=1567
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The Chinese Boom Can't Last
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by Nicolas Bouzou

[Posted July 23, 2004]

<img alt src="http://www.mises.org/images3/boom.gif" align="right" border="0" width="182" height="237">The
Chinese economy has undergone extremely substantial growth rates over the past
few years. According to official data, real GDP has increased at annual rates
constantly in excess of 7% since 1996. Of course, no one is totally obliged to
believe these statistics which are rendered unreliable due to a lack of means
and political pressure <a id="_ftnref1" title href="http://www.mises.org/fullstory.asp?control=1567#_ftn1" name="_ftnref1">[1]</a>. However,
the inspection of corporate accounts and investor sentiment seem to show that,
since 2003, official growth rates have been underestimated to avoid pressure
exerted by the American administration in favor of a revaluation of the renminbi,
the Chinese currency.

We do not intend here to question
the robust growth that the Chinese economy is experiencing, growth which is in
great part related to extensive saving (around 45% of GDP) and to the influx
of direct investment since 1992, when Deng Xiaoping called for more economic
freedom. Furthermore, China benefits from an international comparative
advantage due to its low labor costs (there is an abundant workforce, most of
which remains unemployed) which allows the country to profit from dynamic
exports. We are rather more concerned about the short term economic situation
of China.

<img alt src="http://www.mises.org/images3/Bouzou/1.gif" border="0" width="400" height="251">

More generally, a purely
macroeconomic appreciation of the Chinese economy shows a rapidly growing
country with promising prospects for investors and companies who wish to
establish themselves there. Consumer price inflation is contained, growth is
strong and the current account is positive.

<img alt src="http://www.mises.org/images3/Bouzou/2.gif" border="0" width="400" height="252">

<img alt src="http://www.mises.org/images3/Bouzou/3.gif" border="0" width="400" height="253">

A microeconomic approach leads to
a more nuanced analysis. Indeed, a lot of sectors are suffering from
overcapacities due to extremely dynamic investment over the past few years.
This has been the case especially for the durable goods, steel, cement, and
more recently, automobile industries. Conversely, some sectors have suffered
from a lack of investment such as maritime transport, energy and water. Return
on equity is also globally weak, as is shown by Guoguang [2002].

The state of the banking system is
also worrying. The financial sector has accumulated an extremely large amount
of nonperforming loans taken out by state-owned companies. The four main
state-owned banks represent over 70% of China's banking assets. As of April
1999, four asset management companies were created to contain the
nonperforming loans of state-owned banks. The State then recapitalized several
banks with uncertain results. The four main state-owned banks are still
insolvent according to current international accounting standards [NGO, 2004].

The reasons behind this
malinvestment make the continuation of this boom unlikely. Indeed, three
factors have generated distortions of the production structure. First, through
its expansionist monetary policy (the Fed lowered its fed funds rate from 6.5%
in January 2001 to 1% in 2003 and the first quarter of 2004), the US central
bank has allowed a massive development of carry trade strategies which consist
in borrowing short term funds to purchase long-term assets, in China for
instance. Hence a good many companies have made the most of the 2001-2004
period to establish themselves on a market of 400 million potential customers
(out of 1.3 billion inhabitants). The problem is that this credit expansion
which originated in the US has generated malinvestment in the Chinese industry,
because this credit was"cheap", i.e: during this period the Fed
probably lowered its key policy rates below the natural interest rate
<a id="_ftnref2" title href="http://www.mises.org/fullstory.asp?control=1567#_ftn2" name="_ftnref2">[2]</a>.

<img alt src="http://www.mises.org/images3/Bouzou/4.gif" border="0" width="400" height="253">

<img alt src="http://www.mises.org/images3/Bouzou/5.gif" border="0" width="400" height="253">

As is the case in the process
described by the French economist Charles Coquelin for the crises of the 19th
century, and by the Austrian school in the 20th century, the
expansion of credit has allowed massive investment in certain sectors which
has led to an increase of Chinese GDP, thereby generating increasing optimism.
Hence, the risk premium reached an all time low in the last two quarters of
2003.

<img alt src="http://www.mises.org/images3/Bouzou/6.gif" border="0" width="400" height="253">

This malinvestment was made worse
by the multiple distortions generated by the intervention of the Chinese state
(mainly via fiscal and tariff incentives). As a result, credit was directed to
the so called"strategic" sectors for the State: new technologies (electronics
and telecommunications), automobile and exporting industries.

Second, the money supply has been
growing rapidly in China which has boosted this credit expansion and the
distortion of the production structure. This is largely due to nonsterilized
foreign exchange market interventions aimed at keeping the exchange rate
between the renminbi and the dollar stable. The credit expansion can
also be put down to the fact that the Chinese financial market remains quite
rudimentary, which means that most savings are merely deposited in banks (and
are hence guaranteed by the State).

<img alt src="http://www.mises.org/images3/Bouzou/7.gif" border="0" width="400" height="252">

<img alt src="http://www.mises.org/images3/Bouzou/8.gif" border="0" width="400" height="252">

Third, the Chinese production
structure is all the more unbalanced since the investments of local
companies have been mostly financed by the state-owned Chinese banking system,
in which credit is allocated according to the aims of an industrial policy and
not according to profitability expectations (even in companies belonging to
the private sector which represent 45% of the total) <a id="_ftnref3" title href="http://www.mises.org/fullstory.asp?control=1567#_ftn3" name="_ftnref3">[3]</a>.
This explains that depending on the source (Morgan Stanley, Moody's,
etc.), the share of nonperforming loans is estimated at over 50% of total
loans [Pei, Shirai, 2004]. According to Rawski [2001], the share of interest
paid on interest owed stood at 84% in 1994, below 60% between 1996 and 1998
and under 50% in 1999. As a result, when they develop an industrial project,
companies in China worry less about projected profitability or the competitive
environment than about the State policy in favor of regions, fiscal incentives,
or access to public credit [Huan &alii, 1999].

The Austrian analysis of the cycle
can be applied in two ways to the Chinese case. First, we know that a credit
expansion distorts the production structure in favor of the upstream sectors,
i.e., mainly raw materials. That the Chinese growth has been one of the main
factors behind the increase in raw material prices since 2002 is undisputed;
however, what is less often noted is that all in all, the Fed's expansionist
policy, by allowing the generalization of carry trade strategies, has also
greatly contributed to increasing prices on the main raw material markets.

<img alt src="http://www.mises.org/images3/Bouzou/9.gif" border="0" width="400" height="253">

The second originality of the
Austrian analysis is the importance it gives to the real estate market. Indeed,
we know that when there is an expansion of credit, prices and output in the
construction sector grow very quickly because they depend on long-term
credit-funded investments (a small decrease in the long term interest rate
entails a huge decrease of the total cost of a real estate credit, and a surge
of demand and supply). That is why over the last few years the Chinese real
estate sector has been extremely dynamic, especially in Shanghai. Real estate
has now become the"core business" of Shanghai, as is the case of
finance in London or of automobiles and electronics around Tokyo. Hong Kong or
other large cities could also be mentioned. In 2003, investment in real estate
contributed to 18.3% of China's total fixed asset investment. But what
Austrian theory shows at the same time is that the downturn, due for instance
to an increase in the US fed funds rate, can be violent. So, investing in this
sector in China today seems very risky.

Hence, the strong Chinese growth
contains a substantial cyclical component (which unfortunately can't be
quantified). The aim of the Chinese government must now be to manage the
economy in such a way that the cyclical component can be removed by:

<ol>
~ lessening the number of
authorizations for the construction of new capacities in the sectors which
have had the most invested over the past few years (aluminium, steel,
cement, construction, automobile, etc.;
~ increasing interest rates
progressively;
~ increasing the reserve
requirement rate for banks;
~ relaxing capital controls in
order to encourage investors to remove their liquidities from China and to
repatriate them in their home country.</li>
</ol>

Of course these measures could
turn out to be counterproductive because they will not solve the main problem
of malinvestment. Likewise, transferring once again some of the nonperforming
loans to asset management companies won't solve anything in the absence of a
proper liberalization of the banking system. The only possible solution would
be to allow prices (prices of goods and services but also salaries and
interest rates) to be freely set on the markets, and to stop managing
production factors arbitrarily. There is no apparent reason for this to be
more destabilizing than a policy of production control, quite the opposite.

 

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Nicolas Bouzou in an economist in
Paris. He is also director of Eventura (www.eventura.net),
a company which republishes the works of classical 19th century French
liberalist economists. You can join it at nbouzou@eventura.net.
Comment on this article on the blog.

 

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<div id="ftn1">
<a id="_ftn1" title href="http://www.mises.org/fullstory.asp?control=1567#_ftnref1" name="_ftn1">[1]</a> C.f.
Rawski T. What’s happening to China GDP Statistics, available in PDF.
See also Wang Yan Zhong. The puzzling phenomenon of China’s high economic
growth and the decline of energy consumption, 2001, Institute of Industrial
Economics, Chinese Academy of Social Sciences. He shows that the official
macroeconomic data does not correspond to the change in energy consumption
as is the case in the other Asian countries.

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<div id="ftn2">
<a id="_ftn2" title href="http://www.mises.org/fullstory.asp?control=1567#_ftnref2" name="_ftn2">[2]</a> This
means that the interest rate would balance demand for short-term funds with
supply in the absence of a monetary policy. At least two elements lead us to
conclude that the Fed Funds rate was below the natural rate over the course
of this period. First, the formation of the Internet bubble and its
subsequent bursting show that the credit expansion of the 1990s led to
investments that were mostly nonprofitable in the medium term. Second, as of
November 2002, the Fed Funds rate was lower than US inflation, which means
that short term loans were not profitable, something that would be
impossible on a totally free market.

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<div id="ftn3">
<a id="_ftn3" title href="http://www.mises.org/fullstory.asp?control=1567#_ftnref3" name="_ftn3">[3] </a>
According to Wangjun [2002], investment decisions, and not only for
infrastructures, take into account land use planning, national defense,
harmony between ethnic groups, the fight against poverty.... Furthermore,
in 2002, 79.5% of the financing of economic agents came from the banking
system against 16.5% for bonds and 4% for shares (Contemporary Banker,
page 10, April 2003).

Huang K., Shu Jutao, Houcai S., Positive
analysis of the reasons for entreprise investment errors, 1999, Touzi
yanjiu No. 8.

Liu Guoguang, An analysis of
China’s economic growth situation, 2000, Jingji yanjiu No. 6.

Ngo N.N., Le cycle
chinois : entre surchauffe et surcapacitÃ©s, 2004, Conjoncture BNP
Paribas, avril-mai.

Pei G., Shirai S., The
Main Problems of China’s Financial Industry and Asset Management Companies,
2004.

Rawski T., What’s
happening to China GDP statistics, 2001.

Wang Yan Zhong, The puzzling
phenomenon of China’s high economic growth and the decline of energy
consumption, 2001, Institute of Industrial Economics, Chinese Academy of
Social Sciences.

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Zhou Wangjun Suggestions
for the reform of project analysis for railway construction funds,
2002, Jiage lilun yu shijian, No. 5.


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The Chinese Boom Can't Last / Artikel mises.org, engl. - - Elli -, 30.07.2004, 10:18