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7 Deadly Stories: Crash landing for China?

How can a country’s economy grow so fast for so many years without significant chance of collapse?

Seven deadly stories china crash landingEnlarge
A tour dragon boat sails on Kunming Lake at the Summer Palace on October 8, 2005 in Beijing, China. (Guang Niu/AFP/Getty Images)

Editor's note: 7 Deadly Stories is a GlobalPost series on the main drivers of the global economy, all of which are facing severe challenges at once. Will the U.S. economy relapse? Is Europe finished? Will China, Inc. crash? Can Japan recover from disaster? How will the Middle East emerge from the ashes? How did the world become awash in debt? What is the true cost of climate change? These are the stories that are pushing the world economy, once again, to the brink.

BEIJING, China — When one of China’s showpiece high-speed trains derailed last month with catastrophic results, the accident struck many as a warning metaphor for the country’s breakneck economic growth.

How can a country’s economy grow so fast for so many years without significant risks of a crash?

Indeed there is plenty of risk contained within what is now the world’s second-largest economy. The question now is whether and which of those risks might derail China’s growth miracle or slow it on the tracks.

More from 7 Deadly Stories: With the Euro in crisis, is Europe finished?

“Basically, here’s two issues — bad debt and there’s inflation. These are actually two heads of the same monster.”
~Patrick Chovanec, economist and professor at Tsinghua University

Already, China’s strong economic interdependence with the United States has proven problematic for this country.

When the U.S. economy ground to a standstill amid the global financial meltdown in 2008, so too did much of China’s manufacturing for exports. China’s factory base recovered somewhat, but in recent months, orders have again tapered off and thousands of factories across the Pearl River Delta manufacturing zone have slowed or shuttered their operations.

“I don’t think we’ll ever get back to the level of orders we saw in 2005 or 2006,” Zhang Haishan, a textile factory manager in Guangzhou, told GlobalPost earlier this summer.

China’s method of coping with the 2008 crash is now coming back to haunt its economic health, creating the newest and potentially dangerous risks: debt and inflation.

The country poured billions into infrastructure investments, creating jobs in the hinterlands for those who might have lost work in factories. As a result, government officials and analysts are now worried about mountains of potentially bad debt incurred by local governments to boost their economies amid the meltdown.

The ratings agency Moody’s warned earlier this summer that as much as 8-10 percent of China’s $1.3 trillion in loans to local governments last year could result in bad debt. Meanwhile, inflation continues to rise far faster than government planners want.

More from 7 Deadly Stories: Can the Japanese economy recover?

Patrick Chovanec, an economist and professor at Tsinghua University in Beijing, explained how the spending spree that carried China through the bleak times has now created its biggest potential problems.

“Basically, here’s two issues — bad debt and there’s inflation,” said Chovanec. “These are actually two heads of the same monster. It essentially has to do with how China has been able to pump up its GDP and keep it going over the past two years.”

He said that over the past few years, the government’s strategy was to “shovel as much money out the door,” to boost the country’s GDP.

“That is now beginning to show up in stresses to the banking system,” he added.

Chovanec said while he doesn’t foresee a U.S.-style collapse for China’s banking system, the government now needs to make some tough choices moving forward. Current growth rates, on the back of large loans, are simply not sustainable.

“The problem for China right now is that since it’s generating over half of its GDP expansion from this lending boom, and if it doesn’t keep lending, it doesn’t keep growing,” he explained.

The Wenzhou train accident on July 23, which killed 40 people and left nearly 200 injured, served as a cautionary tale for many that too much development, too quickly, could be disastrous.

“We believe the high-speed rail tragedy…will slow the pace of investment at least in the near term, not only in high-speed rail, but also on subways bridges and roads,” Minggao Shen, Citi’s chief economist for Greater China, said in a research note.

Shen warned of farther reaching consequences, as the accident could serve as a sign of things to come to Beijing ahead of the planned 2012 transition in the country’s top leadership.

“The tragedy could well become a turning point in the China growth model, becoming a painful lesson for officials,” Shen wrote. “Authorities may choose intentionally to slow GDP growth gradually but firmly to 7-8 percent in following years and spend more time to fix the problems created by artificial fast growth.”

With unrest potentially on the rise in China, as evidenced by a new spate of labor strikes and ethnic violence this summer, economic growth and stability are more important than ever. China's challenge will be to balance its growth against risks while maintaining its delicate hold on social stability.

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http://www.globalpost.com/dispatch/news/regions/asia-pacific/china/110801/china-economy-crash-inflation-debt-growth