Why has China’s economy grown at such a fast rate during the last 30 years, and is this growth rate sustainable? These were the two key questions addressed by Zhiwu Chen at a continuing education event for investment professionals that was organized by CFA Society of the UK in London on 22 November 2011.
Chen, who is a professor at the Yale School of Management and an expert on China’s economy, put his insights in a historical perspective. He said that a popular explanation behind the recent growth in China’s per capita GDP is its “vast and cheap labor.” However, Chen suggested that he does not find this explanation adequate. He argued that in 1830 China had about 40% of world population whereas in 1913 it had a third; if a vast and cheap labor force were the reason behind growth in China’s per capita GDP, it should have grown in the past, whereas it remained stagnant.
According to Chen, the growth in China’s per capita GDP in the last 30 years is better explained by changes in the world that have enabled China to benefit from its labor resources — most notably lower transaction costs due to technological developments and, no less importantly, a different global order of trade.
Elaborating on this point, Chen said that the center of global textile manufacturing has moved from England to the United States to Japan to China within two centuries, reflecting how technological developments have enabled a sector in one country to quickly catch up with that of another.
He emphasized that while East India Company, a multinational of the past, needed a large military of its own, General Electric, a multinational of the present, only needs a much smaller army of lawyers, reflecting the change in global order of trade from “gunboats to rules.”
This, however, does raise a larger question: if China was able to grow at a fast pace due to lower transaction costs in a changed world, why haven’t India or other countries with a large population been able to grow at a comparable rate?
Chen thinks that the answer to this question lies in peculiar characteristics of China’s economy, most notably the large share of the government in the economy and its ability to implement things quickly.
He pointed out that unlike many other economies, in China, it is the government that allocates resources and directly or indirectly commands a large proportion of national assets and income. Additionally, the Chinese government is not subject to the same democratic pressures in making unpopular decisions, such as raising taxes. This, according to Chen, has enabled China to industrialize and move at a much faster pace than other countries.
Having shared his explanation of China’s high per capita GDP growth rate, Chen turned his attention to its sustainability. He observed that the large size of government’s share in the economy means that growth in China has been driven mainly by investment by the government rather than consumption by the private sector. Since much of the benefits of growth in GDP go back to the state because of its large size, Chen thinks that the growth in GDP has much less impact on the growth in private consumption than in economies in which the private sector plays a more significant role.
Chen believes that while relying on investment by the state has previously produced growth at the cost of lower private consumption, the same cannot continue in the future as the physical infrastructure in China is already showing signs of overinvestment. Chen suggested that this investment-driven growth in China helps explain the rising prices in real estate, which has come under criticism as of late. He referred to James S. Chanos, a U.S.-based investor known for successfully employing short selling, who has described the rising prices of the Chinese real estate sector as “Dubai times 1,000 — or worse.”
But Chen also disagrees with those who see an imminent banking crisis in China. He thinks that even if real estate prices fell sharply and banks ended up with large nonperforming loans, the government in China has enough resources to rescue the banking sector. This is why Chen sees “no banking or financial crisis in China until there is a fiscal crisis.”
While Chen does not see a crisis in the short term, he also considers it “unavoidable” in about five years. He thinks that such a crisis would perhaps be “healthy” as it could be an opportunity for restructuring China’s economy, with privatization and democratization being Chen’s preferred reforms.
Summarizing some of his views in numbers, Chen said that he expects China’s GDP to grow at 8.5% until 2016, decline by 12% in 2017, and then continue to grow at 5.5%, becoming equal to the US GDP in 2050.
Watch Zhiwu Chen’s presentation, “China: The Economic and Investment Landscape.”