China’s economic growth remains remarkably high even after years of GDP growth exceeding 10 percent in the recent past. The IMF’s growth forecast for China’s 2018 GDP growth is 6.6%. While China’s growth remains substantial, a number of pessimists argue that growth may slow down to a grinding halt in coming years. Moreover, there is a risk that growth would have already come to a relative halt had it not been for the accumulation of debt and the expansion of credit.
Peking University economist Michael Pettis stated that China’s economic growth rate is misleading, even if we assume that official GDP statistics are accurate. He argues that China’s official GDP growth rate is not a measure of value creation but a measure of economic activity as a result of debt accumulation and is, therefore, far higher than it would otherwise be. Pettis argues that real GDP growth, adjusted for debt, is at only 3 percent.
Contrary to popular conception, the Chinese government has a great deal of control over its GDP growth rate on a year-to-year basis. It could probably decide to have a 9 percent growth rate in 2019 (rather than the projected 6.5%), if it chose to accumulate more debt. Therefore, the current GDP growth rate is at its present level due to the large accumulation of debt.
When GDP growth is driven artificially high due to excessive accumulation of debt for an extended period of time, it has always been followed by a painful adjustment period in which growth collapses. In some cases, this is accompanied by a debt crisis, such as Brazil’s debt crisis in the 1990s. In other cases, it involves a decade or more of collapsed economic growth, such as in the case of Japan.
If GDP growth is, at present, so much higher due to the accumulation of debt than it would otherwise be, what are the costs of maintaining and growing this debt burden? One of the major costs would be overinvestment in infrastructure and manufacturing capacity. China is currently facing a problem with manufacturing overcapacity due to overinvestment. It is attempting to solve this problem by building an extensive network of “bridges” to overseas markets. Overinvestment in infrastructure has resulted in the creation of ghost cities, as one example. State-led infrastructure spending accounted for nearly 30% of total investment in 2017, far exceeding the vast majority of emerging market economies. Nonetheless, overinvestment in infrastructure may not be as excessive as some analysts believe. Public capital stock per capita is far lower than that of the US or Japan, while China remains far less developed than these countries.
Another cost is simply the servicing of the accumulated date. Pettis argues that China’s public sector investment has caused real debt servicing costs to rise faster than the countries real debt servicing capacity. This will likely be unsustainable and require urgent deleveraging.
Lastly, the accumulation of debt over an extended period of time may cause investment in unproductive assets and results in waste. Ghost cities and abandoned theme parks are a picturesque example of this. Economic decision-makers may make investments, not on the belief that they will generate future returns based on careful analysis of demand conditions, but because of the excessive availability of funds.
This all raises the question of why debt has continued to grow despite the risks. One possibility is that the debt is not excessive and the risks are overblown. The more likely possibility is that government faces tremendous pressure to keep growth rates high for political reasons. Public opinion of the Chinese government is overwhelmingly dependent on maintaining economic growth. The government is concerned that if the Chinese economy faces far more modest growth rates, there may be a crisis of legitimacy which would cause social and political destabilization.
Another reason for the continued accumulation of debt may be the presence of vested interests. Former Premier Wen Jiaobao claimed that the presence of powerful vested interests were one of the greatest weaknesses of the Chinese economy. In theory, they maintain their influence due to the deep involvement of the government in the economy. Given the role of the government as the economic planner, vested interests may act as ongoing advisers to the planning agencies. Vested interests may be one of the reasons why reforms have been much slower than expected in recent years.