Sunday, March 6, 2011

What's Next For China?

Back in December, I posted a reflection on on the terrible track record of long-term forecasts, and it was mindless euphoria about the Chinese economic miracle that stimulated that post. David Beim of the Columbia University Graduate School of Business has written a paper for the NBER, "The Future of Chinese Growth," that brings a thoughtful eye to the consensus forecasts.

China's economy has had a thirty year run, ended 2010, where real GDP growth averaged 10% per year! This is extraordinary by any measure. Beim points out that this performance was driven by two, high octane sub-periods. The first was the explosion of Chinese entrepreneurship launched by Deng Xiao-Ping in the 1980's in which the central government subsidized and sponsored private enterprises in China's villages. These efforts distributed their benefits widely throughout the country and were domestically focused.

Beim identifies the next phase as being driven by the annexation of Hong Kong and by the political accession of politicians with Shanghai loyalties. These two forces led to the development of large, coastal-oriented enterprise clusters that were export-oriented, with mainland China supplying large, efficient production and distribution facilities and cheap provincial labor, with the Hong Kong Chinese supplying management expertise and finance. Continuing huge capital investments financed by Chinese banks fueled the export boom that has brought us to where we are today. The benefits of this phase have accrued to a new elite, and this drive was one hundred percent export oriented.

Invoking the neo-classical growth model of Solow and Swan, Beim shows that China is already experiencing diminishing returns to capital, and he suggests that Chinese banks may be ignoring balance sheet issues associated with their cowboy underwriting standards during the export-led boom. Everybody, even the popular press, has written about the need for the Chinese economy to shift to domestic consumption growth. Beim's thesis is that this will be easier said than done. If this is the case, it would seem that the bubble inside the Chinese miracle could end badly. It's definitely thinking outside the box.

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