After many years of 7 to 10 per cent growth, economies tend to overheat, creating bubbles that burst. That's what happened to South Korea and Japan in the 1980s and 1990s. But China's economy keeps plugging along (though probably not at its published growth rate of 6.7 per cent), defying the predictions of doomsaying pundits. Some indicators show a recovery this year.
That doesn't mean that the danger of a crash has passed, however. There is growing evidence of a real-estate bubble, and the economy seems increasingly dependent on government stimulus and private-sector credit growth.
I see a few reasons why the Chinese economy really is different from most Western models, and these imply that forecasting the Chinese economy is more like predicting the winner of a race than analysing a bubble.
Unlike the US, China is full of large, state-owned enterprises. That gives the Chinese government the ability to manipulate a large stock of asset wealth. The US government is more dependent on flows of revenue from taxation and the private sector.
When bad economic news arrives, the Chinese government can instruct the companies it owns to spend wealth to keep workers employed. Think of this as using the companies to conduct fiscal policy rather than laying off workers, building another bridge or erecting another steel plant. Whereas Western economies take an immediate hit to income in bad times, the Chinese have been converting this into a hit to wealth, insulating themselves from major downturns.
That can be useful, but it also can be abused. Indeed, China has ended up with too few bankruptcies and significant excess capacity and lots of low-performing firms. One problem comes when the stocks of corporate wealth are nearly exhausted, or perhaps sooner when managers of state-owned companies rebel against this policy and demand alternatives. Another problem is that too many low-productivity firms survive. So when the dramatic Chinese recession finally does come, it will be without the protective buffers of wealth that the US had during its financial crisis.
Not only is China a poorer country to begin with, but it has been spending down its buffers to postpone a crisis. The decline in foreign-exchange reserves and the recent rapid run-up in debt levels are further signs of this phenomenon, namely that adjustments to wealth are substituting for shorter-run declines in income. In the meantime, one of the biggest truths economists have learnt over the last dozen years is that the Chinese economic system can postpone recessions for much longer than American or European systems. At least by traditional metrics, the Chinese system has shown signs of trouble and excess capacity at least since 2006. Given that capacity for protection, might there be a chance that China can avoid an economic crack-up altogether?
China has several factors going for it here, including increases in labour productivity, productivity-enhancing migration of labour to cities and technology transfers from abroad. A fourth set of factors, which has operated in the past but not so much now, is liberalisations and improvements in government policy. Even when Chinese businesses get into trouble, and might otherwise go bust or be forced to lay off workers, these broad rising tides often have come to the rescue.
So if you think China can reach the proverbial soft landing, your basic take should be that government-run fiscal policy will keep matters afloat long enough for underlying pro-growth forces to validate once more most of China's struggling investments and debt burdens.
If you are more pessimistic, your core scenario might run like this: Most Chinese have not yet lived through a true economic crash, and policymakers seem to have an increasing focus on the short term and maintaining political power. Given that dynamic, each time China postpones a major recession, it encourages more debt and a greater over-extension of investment. That requires stronger underlying positive forces to come to the rescue each time, whereas productivity improvements and urbanisation probably are slowing down, although Chinese data as usual do not yield definitive answers.
In any case, there is a race on, and much of the global economy depends on the outcome. It's a question of ticking debt and bad investment decisions against the forces favouring Chinese economic catch-up. For all the talent of Chinese economic policymakers, it seems that the race keeps getting harder. I don't expect the forces of catch-up to win every time.
I am optimistic about the longer-run prospects of the Chinese economy, given the extraordinary talent and ambition in that country. In the shorter run, I would not be surprised if China's 1929 moment still awaits. I'm not sure if the passage of another year without major incident, as 2016 seems likely to be, should make me feel better about that.
BLOOMBERG VIEW
