Dragging the dragon

China’s immense promise will not be fulfilled, thanks to its government

I was recently asked the following question. Will China be the future engine of global economic growth? The answer is no. Almost every economic forecast predicts China’s economic growth in every area and places it in the forefront if not the top spot as a global economic superpower. However, every economic forecast at some point will be wrong and sadly China’s immense promise will not be fulfilled.

The reason is simple, China’s government. Its government and the communist party have no intention of giving up power. This is hardly surprising. What political party would voluntarily give up power? But political power is only part of the problem. The real problem is that the communist party does not want to give up economic power. China is still not a market economy. As long as the communist party remains in power, China will not be a market economy and that is why it will not fulfill its promise.

Let us start with something simple, information. Markets are about choice. To make a good choice, whether it is a car or an investment, requires good information. In China information is restricted and tightly controlled. The government believes that it understands the difference between important and dangerous information and that it always has access to both. It doesn’t.

Information has enormous value. It is not provided except for consideration or because there is an enforced legal requirement of disclosure. In societies with protected speech and free press, it is often difficult to cover up fraud, corruption, misdeeds, and even mistakes, because there is a market for their disclosure. In China and other restrictive societies the flow of information is severely regulated if not totally curbed. As a result everyone from investors to consumers and even bureaucrats do not have timely, accurate and complete information. The result is that investors make inefficient allocations of capital. Consumers buy poor sometimes even poisonous products and government officials make and execute ill-informed decisions. Over time the result of this information control can be disastrous.

The second problem is the banking system. In China almost the entire banking system is in the hands of the State. As we saw in the past year Chinese banks lent an amount equal to $1.4 trillion, which any sane economist would question. Much of this money was lent to local governments and other State-owned companies, all political entities. During this spree about 20% of the private export sector went under and another 20% was in danger of doing so. While inefficient State-owned companies were given more money than they knew what to do with, the more efficient private sector, which is responsible for much of the employment, was systematically starved for capital.

The result is two-fold. More of China’s economy has been transferred from the efficient private sector back into State hands. Economic development and economic growth is based on productivity growth. Productivity growth requires gains in the efficiency with which capital, labour and technology are used in an economy. More output from a given input. The Chinese banking system impedes productivity growth; because it has failed in its role as a financial intermediary by allocating capital inefficiently, while restrictions on information impede productivity growth through technological inefficiency. Restrictions also fail to provide a free exchange of ideas and protection for intellectual property.  
The second problem is that much of the money lent by the banks will never be repaid. Many of the bad debts left over from the last recession are still on the books of the banks and listed as part of their capital. The bad loans from this recession are sure to be enormous.

Much of the money that was lent was lent to local governments. According to Victor Shih, a professor at Northwestern University the amount of bad loans could be as large as 11 trillion yuan, or about $1.6 trillion.

Toxic assets normally indicate the potential for a banking collapse followed by an explicit bailout often with taxpayer dollars. In China this does not happen, but it does not mean that growth will not be affected. As Professor Pettis of Guanghua University points out, a banking collapse will not happen in China because they are the result of a liquidity crisis. This does not mean that toxic assets will not affect growth. “The bailout implicitly requires that bank depositors subsidise the cleaning up of the banking industry. This in effect represents a large transfer of income from the household sector to the banks, to government and to businesses, equal annually to several percentage points.”

To continue growing China must either continue to export its surpluses or rebalance its economy in favor of consumers. It cannot do the former in a world awash with debt and it cannot do the latter with a system that favours banks, government and business over consumers.

In China power is wielded by the few without question or challenge. These few have and will continue to reap enormous benefit from the system they created and see no reason to change.

(The writer, William Gamble, is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected]).

Pramod Bidkar
1 decade ago
I have the experence in 4 year finance sector sales & Require
Bart Williams
1 decade ago
Stay away from investing in foreign companies trying to make inroads in China. Many investors and companies who attempt to do business in China are cheated , assets are effectively siphoned off , Foreign investors lose control of the company, and the Chinese government turns a blind eye just as our own SEC does.. What am I talking about.. go learn about New Dragon Asia,, ask yourself how can a chairman continue to be chairman after announcing to the public his intentions of buying a million dollars worth of shares only too 4 days later sell 6 million shares for .10 a share when the day he sold them the market value was .45. On top of this the 6 million shares accounted for at that time 7.7% of the total outstanding shares but no one has ever come forward to report being a more than 5% holder of the shares. What made the chairman after claiming how confident in the operations of NWD to sell at such a low price 4 days later unless he knew something that the rest of the public did not and took advantgae of that information? can you say insider trading? What about the directors who have stayed silent ? certainly not only has a law been broken but also ethics does . Mr heng Jing Lu is not the only one. Then we have a CFO that is gifted 2 million shes in return for her servcie to increase the performance of the company only to see her sell 2 million shares before the ink was dry. Why did the directors not have a restriction on selling them prior too her providing at lest half her term such as linmting her sale of the sahres to no more than x percent in x number of months?
Clearly the Directors are not protecting the investors?
After having said all that not a peep from any government agency SEC or any of the large institutions that had at one time pumped this company and some that are still caught with millions of shares?
What would make a accounting firm fire there client? What were they running from?
Why has NWD failed to have a annual meeting and refuses to respond to questions from shareholders?

After having said all that do you really want to invest in China?

When the SEC and tehe PRC collabrorate and remove the criminals then maybe you could eventually think it is safe to invest in China.
Praful Vora
1 decade ago
I am not a world economist but I find some of the statements and conclusions specious. If one were to consider the economy in USA, here too the national debt is enormous, the free press and easy info-sourcing did not help in preventing the toxic home-debt instruments, the power wielded by a few from either side of the political divide is not about to be given up to the citizen who are the real owners of the nation, the control that the system has on the citizens by various means does not allow them to choose freely even from their platter of wide choices - witness the medical services and the legal system that imprisons millions. So does one conclude that the economy will never do well in USA? I think not. All systems have their checks and China has had a taste - remember their Tiananmen Square, the religious movements and the widespread internet hacking. In China, their export economy is gradually shifting to the consumer side and so the world had better watch out on cheap products. Many nations are going to have to tighten their belts and learn to do without their own cheap choices.
1 decade ago
How easily the author has written off China ... by his logic China should not have grown as large as it is today, nor is any tipping point mentioned for its demise. There is no data in the article and his logic can be countered by double the logic be amateurs like self.

It appears that the author has his own preconceived notions as the arguments put forward are not convincing. Mr. Gamble jumps straight from the out come to the negation as quoted verbatim below:

"However, every economic forecast at some point will be wrong and sadly China’s immense promise will not be fulfilled."

"As long as the communist party remains in power, China will not be a market economy and that is why it will not fulfill its promise."

"The government believes that it understands the difference between important and dangerous information and that it always has access to both. It doesn’t."

A huge let down of an article.
1 decade ago
It is a small wonder: is China already the engine of the growth? In China, power isn't wielded without questions or challenge. Those questions or challenge are in different forms for better or worse. I am not sure anyone will consider endless fighting in the congress and political gridlock is a good thing. Does this kind of fighting generate more growth in green energy investment or stimulating economy?
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