China’s leaders are hanging tough in their fight over the South China Sea, but are less resolute when it comes to reforming the domestic economy. The WSJ reports:
Chinese growth held steady at 6.7% in the second quarter after a flood of stimulus in the first quarter lent at least temporary stability to a slumping economy. […]In a bid to boost growth, China has flushed funds through the financial system, ramped up infrastructure spending and reduced red tape and corporate taxes. The Finance Ministry reported Friday that government spending rose 19.9% year over year in June compared with a 17.6% increase in May.However, more credit also risks adding to overcapacity in China’s industries and boosting already worrisome corporate debt levels as Beijing continues to face a host of other challenges.
The problem is one of tradeoffs. The world economy is slow and many of China’s most important industries struggle with massive excess capacity built up over years of a systemic distortion: in the rush for industrial growth, the credit sector was used to promote the construction of new factories without enough regard for whether the factories were actually economically viable.Now China is stuck. Reforming the economy and the credit system, necessary for long term health, means cutting loose thousands of factories and millions of workers. That’s hard to do; China’s zombie economy of state-supported and often state-owned worthless factories (and the firms who service them and the local governments who have gone into debt to help them flourish and grow) is politically powerful.So far, every time a clear choice has come between suffering the pain of reform and flinching, Beijing has flinched. Worse, it continues to stimulate the old system with directed credit and government spending and policies aimed to prop up stock bubbles, housing bubbles and factory and infrastructure bubbles.This is a not untypical fate for countries who engage in state capitalism. The system almost always looks good for a while, but the political incentives ultimately lead to poor investments, a corrupted system of economic decision making and a series of ugly policy dilemmas. China rode the state capitalism cycle up; now the cycle is turning down and China is struggling for a way out.There’s a connection, unfortunately, between the economic problem and the international intransigence. The leadership is worried about the unpopular economic steps it knows that at some point it must take; in that climate it is unwilling to buck the nationalist trend in public opinion. The Nine-Dash Line and the Great China Bubble are linked.