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Is the China Bubble About to Explode?


To many it seems inconceivable that the mighty Chinese economy could be headed for major trouble, but recent news should give even the most bullish something to ponder. Consider this analysis from the Financial Times:

The problems stem from China’s industrial policies and a vast array of subsidies that allow whole sectors to spring up overnight. Ambitious local officials are keen to lavish government money on what they hope will be success stories that can further their careers.

“When you have administrative measures you get huge overcapacity and this country has created overcapacity in a whole lot of areas,” says Hank Paulson, former US Treasury secretary, who often visits China. “It’s not just clean technologies; steel, shipbuilding we can name all the areas.”

From chemicals and cement to earthmovers and flatscreen televisions, Chinese industry is awash with excess capacity that is driving down profits inside and outside the country and threatens to further destabilise China’s already shaky growth.

It is not a new problem; it was exacerbated by Beijing’s response to the financial crisis in 2008 and continues to worsen despite years of government efforts to curtail it. China produces nearly half of the world’s aluminium and steel and about 60 per cent of the world’s cement but new production is being added rapidly, even as the economy cools.

This points to some of China’s biggest problems. Systemic overcapacity, an economy distorted by production subsidies, local officials making reckless decisions in the hopes of advancing their careers: all of these things suggest that China suffers from hundreds of billions of dollars in bad investments that will never pay for themselves.

Indeed, the ratings agencies have noticed. Fitch downgraded China’s long-term currency credit rating in April, and Moody’s quickly followed suit. Yesterday, Charlene Chu, the senior director for Fitch in Beijing, told the Telegraph that China’s “credit-driven growth model is clearly falling apart. This could feed into a massive over-capacity problem…. [It is] beyond anything we have ever seen before in a large economy.”

It’s possible that China will be able to muddle through, or its leaders might be able to manage a soft landing for the ballooning economy, but over time the reasons for concern are multiplying even as overall growth continues to slow. “The next six months,” Chu says, “will be crucial.”

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  • bpuharic

    Isn’t this the “Japan, Inc.” model that so many of us in the semiconductor business saw in the early 80’s? Not sure where it’s headed but it doesn’t look good…

    • Philopoemen

      I don’t remember Japan’s economy being nearly as centralized as China’s…

      • rheddles

        Actually, Japan was probably more centralized as industrial production capacity was controlled by MITI and the keiretsu. That’s why Japan never overbuilt capacity. I get the impression that there are thousands of “military” commanders and party leaders who have independently decided to start businesses with money from state banks that are unregulated, feeding the unconstrained growth in capacity. And it doesn’t look good. Perhaps they can hire Kevyn Orr.

  • Jim__L

    Whether “overcapacity” is a problem depends on the context of the overcapacity, and how it’s handled. If there’s a glut of one particular product on the market, that has the potential to result in new thinking about applications for that product, and new opportunities for businesses that rely on that product for growth.

    On the other hand, if oversupplied products go to waste, that’s obviously bad. If companies producing oversupplied products go bankrupt, that’s bad too, especially if new and innovative companies that crop up to take advantage of the oversupply can’t survive without those products at oversupply prices. (See: solar installation industry.)

    This is just an instance of the old-fashioned virtue of making the best of what you’ve got.

  • Kejda Gjermani

    Innovation—the Philosopher’s stone of economic growth—cannot be planned. Chinese authorities can choreograph rural migrations and erect skyscrapers to prettify city skylines. But that won’t do. It takes something very different to create a lively, self-sustaining modern economy capable of intensive growth: steady property rights, unrestricted labor mobility, developed credit markets, provisions for intellectual property, and limits on bureaucratic interference—all missing in China. Only under such conditions can Hayek’s economic calculation problem be solved, entrepreneurship thrive, and decentralized knowledge direct economic activity. But when all you have is a hammer, everything looks like a nail. So instead of setting the economy free, Chinese central planners continue to experiment with mercantilist schemes and boondoggles of fiscal largess because these are the only tools at their disposal.

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