To Grow Stronger, China Has to Grow More Slowly

Workers assembling shoes in a factory in eastern China’s Zhejiang province. The country will have to revise growth targets to prevent growing too quickly and becoming unstable. Credit CHINATOPIX, via Associated Press
Workers assembling shoes in a factory in eastern China’s Zhejiang province. The country will have to revise growth targets to prevent growing too quickly and becoming unstable. Credit CHINATOPIX, via Associated Press

When President Xi Jinping of China took power in 2012, digital cash hardly existed. Last year, the Chinese made $9 trillion in mobile payments, 80 times more than Americans. Chinese consumers pay for 25 percent of their purchases with digital cash delivered by a mobile phone app, and about one in seven carry no paper currency. In big cities like Shanghai, it’s hard to use paper to pay taxi fares or restaurant bills.

The rapid rise of a cashless society is a vivid example of how China broke out as a tech superpower in Mr. Xi’s first term. Left largely unregulated and free to innovate — on condition that they cooperate with government censors — the New China’s private-sector tech giants have made stunning advances.

The mobile-payment systems were designed and built entirely by private Chinese companies. Already the world’s largest market for e-commerce, solar energy and electric cars, China is also third-largest for venture capital and the fastest-growing for robots. An article in the M.I.T. Technology Review said the future of artificial intelligence is taking shape in China and urges the West to copy rather than fear this “revolution.” China generates more patents than any other emerging nation and is on track to surpass the United States in spending on research and development next year.

Now that the 2017 Communist Party Congress has confirmed Mr. Xi’s complete hold on power for five more years, the question is how will he use this clout in pursuit of China’s ultimate goal: to catch up with the United States as the world’s leading economic superpower.

The answer depends on whether Mr. Xi recognizes that to continue growing stronger, China will have to grow more slowly. In its rush to catch the United States, China has been prioritizing growth that is wildly ambitious for a maturing, middle-income country. To hit its growth target, Beijing has been pumping record amounts of debt into the state-owned industries of Old China. Those debts now represent the biggest threat to the New China and Mr. Xi’s superpower ambitions.

The state-run economy of Old China still accounts for a sizable share of economic output, roughly 30 percent. Since 2008 more and more of the loans intended to prop up Old China have been going to risky investments like stocks and real estate and wasteful public construction projects. While it took one dollar of debt to fuel a dollar of growth before 2008, lately it has taken four dollars of debt.

Much has been said about all the money the United States, Europe and Japan have printed to stimulate the post-crisis recovery, but China has printed more than twice as much as those three combined, expanding its money supply by $16 trillion. A lot of this money has been diverted from industry into stock and real estate bubbles, rattling Chinese investors. By 2015 Chinese investors were sending billions of dollars’ worth of renminbi abroad every month. To prevent a capital flight crisis, Beijing had to slap on new controls.

There is now a great pool of money trapped in China, itching to escape. Foreigners don’t have faith in a currency they can’t move freely, any more than locals do, and today the renminbi accounts for less than 1 percent of the world’s foreign-exchange reserves, compared with over 60 percent for the United States dollar. Beijing had hoped to establish the renminbi as a reserve currency and make China a financial superpower, but it has made no progress.

To create trust in its currency and financial system, China has to quit pumping out debt to hit its unrealistic annual growth target of 6.5 percent. That target reflects the pace required to meet a goal set at the 2012 Party Congress, which was to double the size of the economy by 2020. Every time growth slips below 6.5 percent, the authorities roll out more debt, fearful that slower growth will undermine their geopolitical goals. Continuing on this path, China may double G.D.P. by 2020, but debt (excluding the financial sector) will rise from a precarious 235 percent of G.D.P. today to a potentially destabilizing 280 percent.

The most important step Mr. Xi could take is to scrap the habit of setting growth targets. To stabilize debt at the current level, China would need to accept growth of no more than 5 percent — about the pace of previous “miracle” economies like Japan and South Korea at a similar stage of development. To aim higher is to push China toward a debt crisis that could derail growth for years.

China has been able to keep the debt flowing longer than many people expected because in many cases the state owns both lender and borrower, and can keep shifting the debt from one hand to the other, like a three-card-monte player. Optimists think Beijing can play this game indefinitely, because the debt is domestically held, but eventually the banks will run short of money, in the form of deposits.

For the first time in China’s modern history, total loans in the banking system now exceed deposits and are growing at a rate that will probably push loans to above 120 percent of deposits by 2020. At that point in a debt binge, history shows, a financial crisis of some kind usually breaks out, even in countries like China, where the debt is funded internally and not by foreigners.

Any crisis in Old China is likely to spill over into the vibrant private sectors, which are relatively debt-free. The private sector now accounts for 70 percent of economic output but only 30 percent of corporate debt. The only way to prevent a ripple-effect crisis in the New China is to slow the flow of debt, which means dropping growth targets grounded in political ambition rather than economic logic.

Mr. Xi seems to understand the perils of debt, which has undermined many past empires, including dynasties in China. He recently questioned the official obsession with G.D.P. growth — saying development is “not a numbers game” and that most Chinese care more about quality-of-life issues like pollution. Significantly, in his speech last week at the Party Congress, Mr. Xi did not refer to the 2020 growth target, implying flexibility on the need to achieve it.

But until Mr. Xi outright scraps the growth target, all the players in the Old China are going to put a priority on hitting it, no matter how much debt it takes. Fitful government attempts to tighten credit regulations have merely shifted the flow of debt to new targets, most recently mortgage loans. The International Monetary Fund argues that China is much more likely to “become a rich country in the long run” if it puts more emphasis on slower debt growth and less on hitting high growth targets.

If China’s economy is allowed to slow further — as previous miracle economies did at a similar stage of development — it will take longer for the economy to match the size of the United States economy, certainly much longer than China’s leaders had hoped. Better, though, to be remembered for putting China on the long path to real superpower status than the shorter path to crisis.

Ruchir Sharma, the author of The Rise and Fall of Nations: Forces of Change in the Post-Crisis World, is the chief global strategist at Morgan Stanley Investment Management and a contributing opinion writer.

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