By John Richardson
NO LONGER is the promotion of local government officials in China being solely measured by their success in hitting GDP growth targets. What is instead taking priority is how successful local authorities are in cleaning-up the environment. That’s the carrot. The stick of China’s “carrot and stick” approach to dealing with pollution is disciplining local government officials who fail to hit their pollution targets.
This focus on quality over quantity of grow may result in a mild contraction in 2018 GDP growth of just a few percentage points. But this assumes that Beijing is able to manage this slowdown without major economic disruptions. What are the chances of a debt-induced full-scale economic crisis, if not in 2018 then at some point over the next few years?
It used to be fashionable in 2015 and 2016 to predict a debt crisis in China. Not any longer. The consensus view is that booming domestic consumption – via, for example, mobile internet sales – is creating such strong growth in the new economy that this will more than compensate for problems in the old and bad economy. We can define this old and so bad economy as manufacturing plants in oversupplied sectors such as some chemicals, steel and aluminium that are also spoiling the environment.
Please, though, pause for thought, amidst of all today’s hype about of the strength of the Chinese economy. Just because an idea has gone out of fashion, and/or runs counter to conventional thinking, doesn’t mean that it is wrong. Think of the lessons of the Big Short here and the US Sub-Prime Crisis.
Losing control of events
Professor Michael Pettis of Peking University wrote in the FT that most economies have two mechanisms that force GDP data to align with underlying economic performance. Firstly, hard budget constraints result in companies out of business that systematically waste investment. And secondly, there is a “market-pricing factor” that forces bad debt debts to be written down.
He added: [In China] bad debt is not written down and the government is not subject to hard budget constraints. It is the government sector that is mainly responsible for the investment misallocation that characterises so much recent Chinese growth.
This wasted investment should be factored into estimates of real GDP growth to such an extent that if GDP growth was officially reported at say 6%, real growth would be 3%, he said.
Real, underlying GDP growth may not have an immediate effect on petrochemicals consumption, as dealing with overinvestment and debt problems can be delayed for many years. In other words, if say GDP growth is officially reported at 6%, this is reflected in levels of petrochemicals consumption. But might just reflect an artificial inflation of consumption ahead of an eventual collapse.
Pettis compared China to Japan in the early 1990s when the consensus view was that its economy would become the biggest in the world by 2000. As we all know, this didn’t happen because of Japan’s debt crisis.
Does the same fate await China? Quite possibly, according to a blog post by economists at the US Council on Foreign Relations. They wrote: In the short-run, growth, as defined by changes in GDP, can be increased by more lending and investing. In the longer-term, however, lending and investing can’t boost GDP if it results in bad debt that is properly written down.
Profits of Chinese private-sector firms rose 18% between 2011 and 2016, while profits at state-owned enterprises that are far less efficient fell 33%, their research shows. At the same time, the share of corporate liability growth accounted for by the state sector soared from 59% in 2010 to 80% by 2016, which is bad news for productivity growth.
The country’s total non-financial sector debt, which includes household, corporate and government debt, will surge to nearly 300% of GDP by 2022, up from 242% in 2016, they added.
The risk is that some unforeseen event triggers a major debt crisis in China which would, of course, bring to an end the “synchronised global economic recovery”. Petrochemicals companies – as they do their scenario 2018 planning – should add this risk to the other risks I have identified over the last few weeks, which are coordinated withdrawal of stimulus by central banks, rising protectionism and global inflation running out of control.
Is this such a tale risk, one of such low probability, that it isn’t even worth considering? Not according to Zhou Xiaochuan, governor of the People’s Bank of China, who warned last October: If there are too many pro-cyclical factors in the economy, cyclical fluctuations are magnified and there is excessive optimism during the period, accumulating contradictions that could lead to the so-called Minsky Moment.
A Minsky Moment is a sudden collapse of asset prices after a long period of growth, sparked by debt or currency pressures. The theory is named after economist Hyman Minsky. Such a moment led to the Global Financial Crisis.
If the Chinese government is worried, the rest of us should also be worried.