Getting China’s Challenges Right

“China is not an export driven economy. It’s an investment driven economy”, says Michael Pettis, Professor of Finance at the Guanghua School of Management, Peking University. This stance suggests an alternative view on the issues that push the world’s second biggest economy to desperately seek a new growth model. Therefore, what really makes China anxious about reforms is not a fall on exports, but it’s incapability to continue absorbing expensive the investments  that for years triggered miraculous growth.

According to Pettis, China’s case is not unique. There are historical precedents showing the countries that followed this growth model have at some point reached this big wall. “It reaches a point when its ability to absorb this investment is exhausted.  And as you keep investing, you run into the problem that the cost of the investment is greater than the benefits associated with it.” When this happens, there’s only one alternative: “they should stop and switch the growth model”, says Pettis.

When China’s new leadership formally took power in Spring they claimed their top priority would be to guarantee sustainable growth, as the country embraced consumption. For example, by building more and better infrastructures; or by making cities a better place to live. But the challenge of the Communist Party seems to be much greater. “Domestic consumption will increase when social capital is reformed so that household income gets a greater share of growth”, Pettis adds.

This requires a fresh assessment on the mega urban plans that cost China 6 trillion dollar. They have the ambitious aim of urbanizing a 60% of the country. It is indeed planned investment targeting long term growth. But could be China making the same mistakes than in 2008? Could the country be falling into the investment trap again?

“China suffers a lack of respect for rural life”, explains Timothy Beardson author of  the book Stumbling Giants: The Threats to China’s Future. Subsequently there’s a need to take into account what does it mean to encourage urbanization. “People going to the cities is more expensive than encouraging people to stay in their small villages, and invest in them in order to improve lives there,” he says.

In early November, the Central Committee of the Communist Party met at closed doors during four days to decide the fate of the country for the next decade. Under strict secrecy they waged crucial financial, urban, administrative and fiscal reforms. Historically, this plenum celebrated every five years reaches consensus in critical reforms. It was during this meeting, 30 years ago, when Deng Xiaoping announced his revolutionary open up and reform program. “The more developed China is, the more open it will be. It is impossible for China to shut the door that has already been opened. There will never be an end to reform and opening up,” said president Xi Jinping before the plenum.

Among many other issues, the more than 300 members of the Central Committee agreed on markets playing a greater role in allocating resources. This and other decisions suggested a less interventionist model where the private sector should have a greater role. The new leadership doesn’t have many options left. “China’s challenges need to be addresses while there’s still growth”, argues Beardson.