Last week I highlighted a new report arguing that China’s combined public-private debt burden — which (excluding financial-sector debt) had reached 217 percent of GDP as of 2013 — “makes it one of the candidates for the next episode of the debt crises that have plagued the world since the early 1990s.” Even if the worst-case scenario (a full-blown financial collapse) doesn’t come to pass, China’s debt load poses very real dangers to future prosperity and social stability. “The biggest risk,” notes The Economist, “is complacency: that China’s officials do too little to clean up the financial system, weighing down its economy for years with zombie firms and unpayable loans.” Such passivity and inaction could conceivably lead to a Japan-style malaise — in a country whose ruling dictatorship derives much of its legitimacy from the rapid economic growth it has overseen since the late 1970s.
The debate over China’s debt buildup should occasion — both in Beijing and elsewhere — a broader debate over China’s current economic model. Professor Keyu Jin of the London School of Economics reminds us that Chinese policies have created a dangerously imbalanced economy that will eventually have to be restructured, and probably sooner than the Communist Party would prefer.
As Jin writes:
“China’s distortionary policies have helped to perpetuate a dysfunctional growth model. Wage suppression, financial repression, and an undervalued exchange rate subsidize exports and production, at the expense of households, which are thus compelled to save, weakening domestic demand. In order to achieve growth targets, the government thus must depend on exports and investment — an approach that leads to the accumulation of massive reserves, which subsequently need to be sterilized. Low interest rates help to contain the cost of sterilization at the national level and reduce costs at the firm level — again at the expense of households.
“Breaking the cycle will not be easy, but there is no other way to address many of the most pressing problems confronting China’s economy. Indeed, the current growth model is also taking a heavy toll on the environment, with pollution threatening the population’s health, especially in urban areas.
“Moreover, the bias toward manufacturing and export industries leads to a severe misallocation of capital. Less efficient industrial sectors have accumulated significant excess capacity, destabilizing the entire economy, while more productive, efficient sectors lack access to the resources they need.
“Restructuring the economy is perhaps the most urgent — and most difficult — challenge facing China’s leaders today. Given that the current distortions are interlinked, they may need to be addressed simultaneously. China’s gradualist approach may no longer work.”