The productivity benefits of less debt could be undermined by Beijing’s expanded control of business sector
By Greg Ip – The Wall Street Journal.
The troubles engulfing Chinese property developer Evergrande have prompted comparisons to the failure of Lehman Brothers in 2008.
Analysts doubt a replay of the contagion that followed Lehman’s collapse is about to happen in China’s more tightly controlled financial system. Yet the two events have something important in common: Lehman failed when a multiyear mortgage bubble deflated. Evergrande is struggling because China is trying to pivot away from a model of economic growth inordinately dependent on debt.
China is hardly alone in its fondness for debt, but unlike the U.S., China doesn’t borrow to cut taxes or finance social transfers. It instead invests in manufacturing, infrastructure and property. It is a logical model so long as the investment genuinely makes the country more productive.
For a long time, it did. But China isn’t immune to the law of diminishing returns. Since 2008, it has needed ever more debt to deliver the same increment to economic output. Between 2008 and 2019, total debt—government, household and business—rose from 169% to 306% of gross domestic product, but GDP growth fell from 10% to 6%. Productivity growth adjusted for the expanding stock of buildings, machinery and other capital was 2.6% a year from 2000 to 2010. It has been negative since 2015, a sign of how inefficient much of that investment has been.
A few years ago Beijing recognized this model was unsustainable and has sought in fits and starts to shift to “higher quality” growth more dependent on consumers. That process was bound to be disruptive; indeed, it triggered a disorderly devaluation of the yuan in 2015, but it did succeed in slowing the buildup of debt.
Last year, to tide the economy through the pandemic, credit was loosened again. Yet Chinese officials see soaring housing prices as a threat to financial and social stability so they laid out a three-year timetable for lending to the red-hot property sector to be reined in. Just as the Federal Reserve’s interest-rate increases eventually popped the U.S. housing bubble over a decade ago, those regulatory restrictions, with a lag, popped China’s, said Gene Ma, head of China research at the Institute for International Finance. Evergrande was an early casualty since it is one of the most leveraged developers, he said.
Economists at Citibank estimate that, directly or indirectly, property contributes 30% of value added in China, and sales of land contribute 27.5% of local government revenue. So the pullback on real-estate lending, if sustained, is bound to slow growth.
If this ultimately funnels credit to more productive uses, that would be positive for Chinese growth in the long run. Yet Beijing is undermining that prospect through its simultaneous expansion of state control of the economy. Regulators have clipped the wings of tech companies involved in online payments, videogames, ride-sharing and education. Those are only the most visible part of a broader campaign by President Xi Jinping to rein in market forces, steer the flow of capital and restrict how entrepreneurs and investors make profits. Big, successful private companies are being forced to make large “charitable contributions” to Beijing’s preferred causes, sell shares to state investment funds and put state officials on their boards.
This creeping nationalization, the latest iteration of socialism with Chinese characteristics, isn’t a return to Mao-era central planning; private enterprise will still be permitted. But companies will increasingly invest according to the ruling Communist Party’s dictates.
This, Beijing believes, will reduce inequality, boost competition and generally serve society better than unfettered capitalism. But there is one big downside. It could actually undercut the broader goal of reducing the economy’s dependence on debt and boosting productivity growth.
In a study published earlier this year, economists at the International Monetary Fund compared thousands of state-owned firms with private-owned companies and found that a company in which state investors had majority control was 30% less productive than its private equivalent. This was because it invested less efficiently: a state-owned firm gets 50% less revenue per unit of capital on average than its private equivalent.
State-owned companies often invest to serve broader social goals, such as preserving jobs or targeting an industry Beijing considers strategic, rather than profits. They can get away with investing less profitably because they can borrow on preferential terms, especially from state-controlled banks, since their debts are assumed to be government-backed. As a result, they are more indebted than their private peers.
Much of China’s advance since the early 2000s reflected the growth of its dynamic and innovative private sector. But a few years ago private companies, which are China’s most successful exporters, bore the brunt of the trade war with the U.S. Mr. Xi’s regulatory crackdown and creeping nationalization seems destined to extend their retreat, watering down whatever productivity benefits come from steering the economy away from excessive investment in property.
Featured article licensed from the Wall Street Journal.