China’s debt being downgraded by a ratings agency, Moody’s, doesn’t matter much. But the fundamental headwinds that the country faces matter a great deal.
As we all learned during the financial crisis a decade ago, having US ratings agencies give debt a triple A rating does not mean the borrowers are good for the dosh. They won’t make that mistake again in a hurry, but their inclination to shut stable doors after the horses have bolted remains. A downgrading of China debt merely confirms what we all knew: that indebtedness in China is a serious problem at all levels – personal, corporate, banking and government. That does not, however, mean that debtors cannot repay.
China is not Greece or even Italy. In the past it has managed to grow through its debt burden in several regards. Individuals who have over-borrowed to buy property usually find that rising values bail them out. Extravagant infrastructural projects eventually are justified: if you build it and wait long enough they will come. And at a national level if the economy grows at 7 per cent plus you can run a 5 per cent of GDP deficit and still cut the overall burden.
There is a further twist. Debt levels that would be troubling in the West are less so in a country whose citizens typically save a third of their income. While the Chinese people keep saving, the country can scramble though.
A lot of people forgot this, predicted disaster in China, and ended up looking seriously stupid as a result. Growth enables a country to make investment mistakes. The issue is not so much the pile of debt – though of course that will remain a concern – but deteriorating prospects for growth.
Growth in China, currently at just under 7 per cent a year, has to slow for a variety of reasons. One of the most important is demography: China has an ageing population, and soon it will have a declining workforce.
There is a new study by Yi Fuxian at the University of Wisconsin-Madison which claims that China has overestimated its population. According to his calculations, the population at the end of 2016 was 1.29 billion, compared with the official figure of 1.38 billion. India’s population is officially 1.33 billion, so it is possible that India has already passed China as the world’s most populous country. Even if that is not correct, India is expected to pass China in the next 10 years.
The point here is not just one of population, it is about the flow of labour. China has been able to grow swiftly because it has been able to meet labour demand, despite its low birthrate, by moving people off the land and into the cities. That flow is now easing off, cutting the sustainable growth rate, just as has happened in Japan.
So the questions now are how fast the long-term growth rate might be, and whether China can make the transition from a 7 per cent canter to, say, a 4 per cent trot without serious disruption.
On the first, estimates vary. Some economists believe that 4-5 per cent growth is sustainable in the medium term. At the moment China is catching up with the West by applying technology developed abroad. Catch-up will continue to propel growth for another generation, but as the labour market tightens it will lose its cost advantage not just over the West, but over neighbouring countries in east Asia and, crucially, the Indian sub-continent.
China stays as the world’s largest economy, but becomes less vibrant as it devotes more of its resources to looking after its people and less to running the factories that drive its exports. Eventually Chinese growth will slow to developed world levels, around 2 per cent a year – but that transition is still some way off.
However, going from 7 per cent to 4 per cent is tricky – especially so in a command economy where key decisions are taken centrally. The Chinese leadership is very aware of the Japan trap of failing to adjust to slower growth. Having an example of what not to do is helpful.
There is a further issue: the quality of the data available. Officially China has maintained growth of around 7 per cent since 2012. Actually growth may have been substantially lower in in 2013-15, before recovering last year. Managing a transition to slower growth is hard enough as it is. Doing so with false information is a nightmare.
But – and a big but – remember how many people have lost money and reputation betting against China. Remember, too, how momentum takes a long while to ease off. China has to continue market-friendly reforms, nudging up productivity, allowing duff companies to fold, making more rational decisions on infrastructure. It has also to maintain its drive to improve environmental standards and performance.
The leadership knows all this. It does not need advice from American ratings agencies of what to do. But managing such a huge transition remains an extraordinary challenge – and the most exciting story in the world economy right now.
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