China’s Economic Crisis

There has been much speculation about power struggles in China in the wake of the ouster of Bo Xilai, the powerful Communist Party boss of Chongqing who used populism, money and intrigue to rise to the top. Had he not been brought down this year -- by a series of mistakes, revelations and bad luck -- Bo might have rattled the technocratic-authoritarian system running the country. China might well survive its political crisis, but it faces a more immediate challenge: an economic crisis.

Every year for two decades, experts have told me that China’s economy was set to crash, felled by huge imbalances and policy errors. They would point to non-performing loans, bad banks, inefficient state-owned enterprises and real estate bubbles. Somehow, none of these has derailed China’s growth, which has averaged an astonishing 9.5 percent annually for three decades.

Ruchir Sharma, who runs Morgan Stanley’s Emerging Markets Fund, makes a different and more persuasive case in his new book, “Breakout Nations,” pointing not to China’s failures but to its successes: “China is on the verge of a natural slowdown that will change the global balance of power, from finance to politics, and take the wind out of many economies that are riding in its draft.” Evidence is accumulating to support his view.

China’s growth looks remarkable. But it isn’t unprecedented. Japan, South Korea and Taiwan all grew close to 9 percent annually for about two decades and then started to slow. Many think that China’s fate will be like that of Japan, which crashed and slowed down in the 1990s and has yet to boom again. But the more realistic scenario is Japan in the 1970s, when the original Asian tiger’s growth slowed from 9 percent to about 6 percent. Korea and Taiwan followed similar trajectories.

What caused these slowdowns? Success. In each case, the economy had produced a middle-income level. It becomes much more difficult to grow at a breakneck pace when you have a large economy and a middle-class society.

Sharma does the math: “In 1998, for China to grow its $1 trillion economy by 10 percent, it had to expand its economic activities by $100 billion and consume only 10 percent of the world’s industrial commodities -- the raw materials that include everything from oil to copper and steel. In 2011, to grow its $5 trillion economy that fast, it needed to expand by $550 billion a year and suck in more than 30 percent of global commodity production.”

All the factors that pushed China forward have begun to wither. China became an urbanized country last year, with a majority of its people living in cities. The rate of urban migration has slowed to 5 million a year. This means that soon the famous “surplus labor pool” will be exhausted. This decade, only 5 million people will join China’s core workforce, down dramatically from 90 million in the previous decade. And thanks to the one-child policy, there are few Chinese to take the place of retiring workers.

Sharma’s picture is largely shared by the Chinese government. For years the leadership in Beijing has been preparing for a slowdown. Premier Wen Jiabao argued in 2008 that China’s economy was “unbalanced, uncoordinated and unsustainable.” He sounded a similar note this week, calling for government measures to stimulate the economy.

In some ways, China still has a lot of gunpowder in its arsenal. Its central bank can lower interest rates and the government can spend money. But even its firepower has limits. Sharma argues that on paper China’s debt to gross domestic product is a modest 30 percent but that when you add up the debt of Chinese corporations, many of which are government-owned, the numbers look alarming. The government will spend more on infrastructure but will get diminishing returns for these investments. Chinese consumers are spending more but -- in a country with no safety nets and an aging population -- saving rates will remain high.

Sharma predicts trouble for countries that have been buoyed by a booming China -- from Australia to Brazil -- as its demand for raw materials drops. He even predicts a decline in oil prices, which, coming on top of the shale boom, should worry oil-producing states everywhere.

As for China, Sharma suggests that 6 percent growth should not worry the Chinese; these would be enviable rates for anyone else. The country is richer, so slower growth is more acceptable. But China’s authoritarian regime legitimizes itself by delivering high-octane growth. If that fades, China’s economic problems might turn into political ones.