China’s extraordinary growth over the past few decades has spawned two major lines of analysis. One school of thought holds that China is a rising economic power poised to conquer the world. The other argues that China’s economy has become so distorted that it is bound to collapse or, at least, as a former United States Treasury secretary suggested, “regress to the mean.”
Both views are mistaken.
For one thing, China has never been a normal economy. It experienced an average of nearly 10 percent growth rates for almost four decades, a record; it is the first developing nation to become a great power. So why couldn’t it keep defying expectations?
What some take to be the Chinese economy’s weaknesses have, in fact, been strengths. Unbalanced growth isn’t evidence of a looming risk so much as a sign of successful industrialization. Surging debt levels are a marker of financial deepening rather than profligate spending. Corruption has spurred, not stalled, growth.
At least so far. The central question isn’t whether China might continue to confound norms so much as what, precisely, is required for it to do so. And that, as ever, hinges on whether the Chinese government can strike the right balance between state intervention and market forces.
Centralized authoritarian power has its benefits, including the ability for those who have it, at least in theory, to correct course rapidly. This has allowed China’s leaders to put the economy on a more sustainable growth path in recent years. The gross domestic product growth rate rebounded last year. Foreign reserves are back up as well. Wages have increased. The recent abolition of term limits for the president and vice-president’s terms gives President Xi Jinping more time and leeway to promote his vision of a more prosperous, modern and powerful China, and with the help of trusted advisers: His former corruption czar, Wang Qishan, is expected to be named vice-president and Liu He vice-premier in charge of the economy.
Skeptics about China’s future usually point to the country’s swelling debt. China’s overall debt-to-G.D.P. ratio exceeds 250 percent — but that is a fairly average level: higher than that of most emerging-market economies; lower than that of most high-income countries. More worrisome, though, is the fact that it increased by more than 100 percentage points, or nearly doubled, over the past decade.
The International Monetary Fund has cautioned that other economies that experienced such rapidly rising debt ratios — Brazil and South Korea a few decades ago, and several European countries more recently — eventually succumbed to a financial crisis. Why would China be any different?
One reason is that not all debt is created equal.
As some of the optimists note, China’s debt is public, not private, which means that the risks are largely borne by the state, which has deeper pockets. The borrowing is largely domestic, rather than external. And despite a surge in mortgages, Chinese households have a low overall debt burden compared to their counterparts elsewhere. For all its heady growth, China’s financial system also remains relatively simple, without the exotic securitization that nearly brought down the American economy a decade ago.
China’s debt ratio also seems more worrisome than it really is because its nature is often misunderstood.
China’s banks are no longer just serving state actors; now they also serve the private sector, notably after the privatization of state-owned housing in the late 1990s and early 2000s created a broad-based commercial property market. As much as two-thirds of credit expansion between 2005 and 2013 — including via unofficial or so-called shadow banking — went into property-related assets, helping establish a market price for land. Thus, rapid credit growth largely reflects an increasing financial sophistication rather than a property bubble or wasteful investments.
Still, the official figures can appear to suggest otherwise. By my calculations, property prices in China have grown sixfold since 2004. But property transactions are not included in gross domestic product assessments — which helps explain why debt levels have surged while G.D.P. has not.
That said, high debt levels do represent some fundamental weaknesses. As I detail in my last book, the tax revenues of local governments have not kept pace with their social expenditures, prompting those authorities to borrow from banks to fund public services. China’s large debt isn’t a debt problem so much as a fiscal problem in disguise.
The growing commercial role of local governments has, in turn, multiplied opportunities for graft. But this problem, too, is often misunderstood.
Corruption is said to impede growth by inhibiting investment. Not so in China, where the state controls major resources, such as land and energy, yet generates lower returns on assets than the private sector does. Privatizing those resources was a nonstarter under communism, and so corruption has served as a makeshift alternative, by allowing more private actors to use state-owned resources after striking arrangements with officials. Because those actors’ practices are more profitable, the economy has benefited overall.
Some China observers also are concerned that China’s speedy growth cannot be sustained unless consumption replaces investment as the economy’s main driver. (The Chinese government appears to agree, or claims to at least.) They point out that while investment accounts for an unusually high share of gross domestic product, consumption accounts for an unusually low share.
But to say this is to misunderstand the nature of China’s unbalanced growth.
The main cause of that imbalance is urbanization. Over the past four decades China’s urbanization ratio has increased from less than 20 percent to nearly 60 percent. In the process, workers from labor-intensive rural activities have moved to more capital-intensive industrial jobs in cities. And so, yes, an ever-greater share of national income has gone into investment as a result. But corporate profits have also risen, leading to higher wages, which have spurred consumption. In fact, even as the consumption share of G.D.P. has fallen, personal consumption has grown multiples faster in China than in any other major economy.
Eventually, China’s economy will have to become more balanced, as the government well knows. But the Chinese Communist Party’s plan for that is to have the state play the “leading” role in the economy while the market plays the “decisive” role in allocating resources. Squaring that circle can be tricky.
Mass urbanization is expected to continue, still not out of people’s personal preferences but at the state’s behest, by way of residency restrictions, evictions and forced relocations. Yet China’s planners now seem intent on redirecting migrants from megacities to smaller cities, and this could curb economic growth: As the World Bank points out, labor productivity is much higher in larger cities than in smaller ones.
Then, there is the corruption issue, which will require another delicate balancing act. Corruption has benefited the Chinese economy by, in effect, allowing the transfer of state assets to more efficient private actors. But over time such gains are being outweighed by the social costs of bribes, wasteful expenditures and growing inequities. Allowing corruption to run rampant could undermine the legitimacy of the Chinese Communist Party. Yet combating it with draconian measures could hurt growth by discouraging both officials and entrepreneurs from taking economic risks.
Hence the importance, and sensitivity, of Mr. Xi’s signature anticorruption campaign. It has been cast as an effort to discipline errant officials, but some see it as a means for Mr. Xi to purge political opponents or exert more control over society. It seems to have been popular so far: The general public perceives local officials as taking advantage of the system, and here is the central government appearing to rectify the situation. But some warn that the National Supervision Commission, a new agency designed to institutionalize anti-graft efforts, could signal overreach.
To discourage corruption effectively, the Chinese government will eventually have to leaven the rule of the party with more rule of law. In the meantime, some practical reforms would help, including creating a civil code to define acceptable commercial practices, basic property rights and the status of private companies. More sweeping — and more politically sensitive — reforms will also be needed to ensure that private actors have more access to major resources, like land and financing, without having to rely on personal connections to local officials.
The Chinese economy’s glory days may be over, but even a 6 percent growth rate over the next decade would be remarkable. At that pace, the economy would double by 2030 and likely become the world’s largest in nominal dollar terms. (It already is the world’s largest economy in terms of purchasing power parity.)
China’s remarkable success to date can be credited in part to its leaders’ willingness to set aside communism for pragmatism. Some observers worry that Mr. Xi is now reinjecting ideology into major policies, Mao-style. But he also is concentrating power and promoting action-oriented reformers like Mr. Wang and Mr. Liu — signaling his intention to address China’s social and economic needs even as he gathers the means to do so. China may not become a normal country for some time yet.
Yukon Huang is a senior fellow at the Carnegie Endowment and the author of Cracking the China Conundrum: Why Conventional Economic Wisdom Is Wrong.