Confronting the China challenge

The world’s economic fortunes depend more than ever on China’s performance. So when an expert claims that the Asian giant is facing formidable challenges his arguments should be considered carefully.

Fraser Howie certainly qualifies as a specialist in Chinese finance. He has written three books on the subject including most recently Red Capitalism:The fragile financial foundations of China’s extraordinary rise. In addition, he was worked in Asian stockmarkets for two decades, is fluent in Chinese and is married to a Chinese woman. I was therefore particularly interested to hear him speak at a recent Lombard Street Research seminar.

The thrust of his argument is that China’s growth model is changing. “China for many years was a miracle growth story has now become a debt story,” he says. ‘We’re just at the beginning of the problem of bad debt in China”.

Despite a laudable reform agenda relatively little has changed over the past 18 months. The Chinese authorities recognise the need for extensive legal and regulatory change but its implementation is painfully slow. One notable exception is the tie-up between the Shanghai and Hong Kong stock exchanges.

Even the liberalisation of the currency is going far more slowly than many breathless headlines suggest. The renminbi is still relatively little used for international transactions considering the size of the Chinese economy.

Howie draws a vivid analogy between Beijing’s Forbidden City and the country’s financial system. The huge grounds of the former imperial palace are divided into numerous distinct palaces and courtyards. In a similar way the financial markets are segmented into multiple isolated areas. For that reason he regards the system as “dysfunctional”.

Charles Dumas, the chairman of Lombard Street Research, also discussed China at the event but from a macroeconomic perspective. He described the economy as “wildly out of balance” with its extremely high levels of investment – accounting for almost half of GDP – and low levels of consumption.

Dumas also pointed to the likely impact of a Chinese slowdown on the global economy. For example, Germany’s bonanza from selling capital goods to China is likely to come to an end.

China’s economic slowdown is a huge subject and it would be unfair to expect too much to be crammed into a single morning’s session (which covered other topics in the global economy as well). However, it was surely right to ask awkward questions on the subject rather than embrace the orthodoxy that China is enjoying an orderly slowdown.

Nor is the common assertion that China is coming to the end its catch-up growth phase as helpful as is often assumed. The same claim could have been made a few years ago and will still probably be plausible in a few years’ time. After all China is still far poorer in terms of income per head than the advanced economies. The challenge is to substantiate the argument if it is indeed true.

Perhaps the most difficult task is to divine what exactly is happening on the productive side of China’s economy. Unfortunately conventional economic measures are of even less use here than in the developed world.

Understanding these trends is perhaps the single most urgent task confronting those who want to understand the global economy.

This blog post was first published today on Fundweb.