Could China's Economic Miracle End Soon?
HONOLULU (Dec. 9, 2010) -- Since 1978, China’s economy has been growing rapidly. But will China’s “economic miracle” come to an end sometime in the near future?

That’s the provocative question economist Paul Gregory and political scientist Kate Zhou examined during a recent presentation at the East-West Center in Honolulu, Hawai‘i.

Gregory, a University of Houston professor and East-West Center visiting scholar, started off by recounting examples of other economies that at one point had been pegged to overtake the U.S. Examples include the USSR in the ’50s, France’s postwar Trente Glorieuses period, and more recently Japan.

All these economies were strong for a period of time, Gregory said, yet fundamental flaws in their economic planning and management led to their systemic decline. Noting that China is currently being touted to be the dominant economic power of the 21 st century, he asked whether China might also succumb to internal flaws as these countries had done earlier.

Gregory cited urbanization and demography as key issues with respect to China’s future growth. China’s economy has grown extensively by transferring labor from low-productivity agriculture to high-productivity industry, he said. But there are signs now that productivity differentials are disappearing, and with this the end of “easy” growth for China.

Signs of this include the tightening of labor markets, upward pressure on wages and the declining use of migrant labor, he said, concluding that China cannot continue to grow extensively through the expansion of labor and capital inputs, but must learn how to extract productivity improvements from existing resources.

“There comes a time when you cannot continue a path of extensive growth,” Gregory said. “As an economist, the question I pose is whether China has exhausted or will soon exhaust the two-sector model by running out of unlimited [low-wage] labor?”

Zhou, a professor of political science at the University of Hawai‘i, described a number of fundamental weaknesses in China’s political/economic system that she said could lead to its economic downfall. These include:

  • State monopolies. Despite reforms, large scale industries are still predominantly based on the state monopoly system, she said, thereby discouraging competition and actually weakening state-owned enterprises.
  • Bad loans. China’s financial institutions have traditionally given out loans based on political interest, not economic calculations, Zhou said. Local governments have borrowed huge amounts from state-controlled banks for big projects with little intention to pay the loans back, she said, citing a report that outstanding loans to local governments’ financing platforms stood at 7.38 trillion yuan by the end of 2009, rising 70.4 percent year-over-year.
  • Inflation. Zhou said inflation in China is already high and will likely get worse, creating political and economic uncertainty.
  • Continuing high dependency on exports, despite recent efforts to expand domestic consumption.
  • One-party political monopoly. Consolidation of economic power by the political elite has made the state rich but people poor, Zhou said, adding: “This model cannot last long because it will not create domestic market demand, while at the same time, developed countries cannot continue their big demand for Chinese products as prices rise due to inflation, higher wage costs and the lower dollar.”

Adding to Zhou’s points, Gregory concluded by noting that the origins of China’s state capitalism date back to Lenin in Russia, with his concept of state control of what he termed the “commanding heights” of the economy. In the USSR, he said, state capitalism was taken to an extreme with a command planned economy, while in France and Japan, it took the form of industrial policy and control of finance. In each case, Gregory said, the weaknesses of the “commanding heights” economic approach became apparent only after a fairly extended period of time.

Since China’s control of large-scale investment remains in the hands of the state, Gregory said, its entrepreneurial private sector is deprived of capital. He added that in 2009 the amount of foreign direct investment in China was less than half of what it was at its peak, but he could not say whether this was a trend or a shorter-term effect of the financial crisis.

“Is smart money taking long-term gambles in China?” Gregory said, noting the title of his presentation with Zhou: “Why China's Economic Miracle Will End – And Soon.”

“The minute you see that money disappearing,” he said, “you’ll get the answer to this provocative title.”