Don't hand China the economic crown just yet

Don't hand China the economic crown just yet
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China is hardly the first country that the U.S. has feared might economically eclipse it. In the 1960s, it was a rising Russian economy that the U.S. feared might outpace it. Then, in the 1980s, it was the Japanese economic miracle that caused the U.S. to shudder.

Just as our Russian and Japanese economic fears proved to have been groundless as those economies burnt out, so too is there good reason to expect that we will be proved to have been worrying unduly about China’s economic rise.

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Among the more immediate reasons not to be unduly concerned about China’s economic emergence is that much of its recent economic growth has been the result of a credit bubble of epic proportions. Indeed, since 2008, China’s non-government sector credit has increased by a staggering 100 percent of GDP.

The credit expansion that preceded Japan’s lost decade in the 1990s and that preceded the 2006 U.S. housing-bust pale in comparison.

Experience teaches that credit bubbles inevitably lead to large misallocation of resources. That in turn is normally followed by a painful and prolonged economic hangover as the financial sector becomes clogged with a mountain of non-performing loans.

China would seem particularly vulnerable to such a fate considering the degree to which it has experienced a credit bubble, a housing boom and a build-up in excess industrial capacity.

One indication of the degree to which China has over-invested is the fact that it is estimated that over 50 million Chinese housing units remain unoccupied. Another indication is that it is estimated that in three recent years, China poured more cement than the United States did in the entire 20th century.

This is not to say that China is soon headed for an economic crisis like the one the U.S. experienced in 2008-2009. The Chinese government would seem to have too many levers of control over the Chinese banking system for that to happen.

Rather, China is likely to experience a lost decade as Japan did in the 1990s. It will do so as its banking system’s balance sheet becomes clogged with non-performing loans that will prevent it from extending credit to the dynamic part of the Chinese economy. 

A more fundamental reason for believing that fear of China’s economic rise is overdone is that China now seems to be turning away from the 1979 market-oriented reforms of Deng Xiaoping that put China on its rapid economic growth path.

Seemingly afraid of losing political control as China’s private sector booms, China’s current leader, President Xi Jinping, is now reversing those reforms by promoting China’s inefficient state enterprises at the expense of its dynamic non-public sector. By so doing, he would seem to be killing the goose that has been laying China’s golden egg.

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Yet another reason to think that China will not constitute a long-run threat to the U.S. relates to its very poor demographics. As a result of the one-child policy instituted in 1979, China’s working-age population has already peaked and is now projected to be in steady decline over the next few decades.

This might not have constituted much of a brake to economic growth when China had a vast pool of underutilized agricultural labor on which to draw for its industrial development. However, it does matter now that those days of an army of underemployed agricultural workers are long since over.

All of this is not to argue that the U.S. should not continue pressuring China to open up its economy and to refrain from intellectual property theft and forced technology transfer. Rather it is to say that U.S. economic policy should not be motivated by an overblown fear of the inexorable rise of the Chinese economy to a point of international economic hegemony.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.