STOCK MARKETS continue to respond strongly to China’s economic woes, fearing a crippling slowdown since China suddenly devalued its currency two weeks ago — a move widely interpreted as a desperate attempt to support growth.
But Chinese growth in the future will be limited until the government makes fairly substantive structural reforms.
China’s growth model is one in which the role of the state in the economy has become more intrusive. For years, many US observers hailed China’s government-led and investment-heavy model as a pillar of strength. Their favorite comparison is between the spunky new airports in Beijing and Shanghai and the supposedly dilapidated New York JFK and Los Angeles airports. While comparison has an element of convenience to it — you have to depart from a US airport and arrive at a Chinese airport when you visit China — the “airportology’’ is flawed, because it doesn’t take into account that China has clearly overbuilt, and at a considerable cost to its middle class.
The lasting contributions of infrastructures come from their usage, not from their construction. This is why a bridge to nowhere can boost GDP temporarily, but it has no long-run positive effect. On that, China falls short. It has several “ghost cities,” rows and rows of apartment buildings that are unsold and vacant, and lightly utilized highways and airports.
And then there is the impact that the building boom has on the income of ordinary Chinese. One reason why the Chinese can build things quickly is because the government can forcibly relocate a large number of residents at a fraction of the cost that would have been required in a democracy. Foreign executives are among the most enthusiastic about this authoritarian efficiency because it allows them to open and operate their businesses at low costs. The hard economic logic provides a different perspective. Keep in mind that a cost to one person is an income to another person. The Chinese way of building infrastructures reduces the costs to the businesses but also the income to Chinese households.
The Chinese way of reducing business costs is not sustainable, because it is not enriching those Chinese households. Despite all the hype about a Chinese middle class, the labor share of income — wages and salaries accruing to ordinary Chinese as shares of GDP — is one of the lowest in the world. The miracle of Chinese growth is that it is all supply but no final demand. This is the context in which the recent devaluation move is significant. When an economy is so efficient at producing things but so inefficient in consuming them, there is one solution — you export the surplus. Keeping your exchange rate undervalued is a way to subsidize foreign consumption as a way to absorb that surplus.
Since 2008, the Chinese government has attempted to reduce export dependency, but it is using the wrong tool. It believes that China exports too much, when in fact it is because Chinese household income is too low. It put in place policies that inflated real estate prices, often in regions such as Guangdong, which are China’s export engines. The rising real estate value has crowded out Chinese exports while doing little to boost Chinese income. The ensuing massive investment boom is no different from an export-driven strategy, except that there is a time delay. Between 2008 and 2015, the Chinese trade surplus did shrink, but so did the GDP growth rate. The devaluation earlier this month is a final acknowledgment that China has to choose between restructuring and growth, but it cannot have both.
To get out of this bind requires more economic and political reforms and less stimulus measures. The most dangerous aspect of China’s growth model is its addiction to debt and to the idea that gimmicks, such as inflating asset bubbles, are real policy solutions. The most meaningful reforms call for a less intrusive and a more accountable state and a government that earns its legitimacy not by impressive GDP statistics but by the public services it provides.
Yasheng Huang is a professor of international management and founder of China and India Labs at the MIT Sloan School of Management.