Can China Save the World?

Can China Save the World?
by Brian P. Klein

Posted April 2, 2009

Optimism for near-term China recovery, fueled by the widely reported $587 billion two-year stimulus package, is running high heading into the G-20 summit this week. Many countries are expecting Chinese demand to spur a new round of increased consumption. These hopes are unfortunately misplaced at the moment. The stimulus is neither large enough to stimulate demand lost from plummeting exports and declining investment, nor is it focused on addressing the concerns of the fragile middle class that might help China spend its way out of crisis.

And yet the spate of positive news is impressive compared to the U.S., EU and Japan—retail spending growing at 15%, car sales rising, bank lending expanding, energy use picking up and a 30% gain in the Shanghai composite index this year—all signs the stimulus and “the China Model” of controlled growth is working. Official confidence remains high that recovery is just around the corner and GDP growth of 8% is attainable. China seems most concerned about whether the U.S. will remain solvent enough to repay interest on its Treasury bills.

Taking a closer look at the numbers an 8% growth rate means an additional $360 billion in output, all other inputs to gross domestic product remaining the same. According to recent official Chinese statements only $173 billion of the stimulus is actually new spending. How much will be central government funded remains unclear (local government, banks and enterprises are expected to contribute 70% of the stimulus—though which stimulus, the previously announced $587 billion or just the new spending is equally uncertain.)

Doubts persist as to whether the announced stimulus will be sufficient, or timely and accurately spent. The World Bank now estimates GDP growth of 6.5%, down from 7.5% in November. The OECD and IMF are expecting slightly lower growth. The last time GDP expansion slipped below 7% was 1989-1990.

Additional downward pressures are increasing as well. Many western companies are scaling back or postponing expansion plans. Foreign investment has been dropping for five consecutive months versus the same period last year (down 26% for January-Febuary). Oversupply in the real estate market continues to suppress prices in residential and commercial property. Some apartment prices in Beijing are down as much as 25% this year and vacancy rates in Shanghai are on the rise even as additional office space is slated to come on the market later this year.

Domestic consumption, another driver of growth, does not appear to be expanding as robustly as top-level statistics suggest. Broad price deflation and declining imports indicate that except for some very specific and highly incentivized market segments (like automobiles and rural purchases of housewares), people are not necessarily shopping more than last year.

Over 80% of the stimulus also focuses on infrastructure projects with state-owned enterprises the most likely beneficiaries. And while China certainly needs new transportation, power generation, and grid improvements there are also many half-empty industrial parks and technology centers from the days when the special economic zone model was in vogue. Provinces outside coastal regions built facilities that attracted little investment. The lessons of Japan’s struggle with a flagging economy should not be forgotten—bridges to nowhere and well paved roads to get there have had very limited sustained impact on growth.

Even lending figures are raising concerns. Several Chinese banks have reported a significant drop in profits as a result of non-performing loans and write-offs. Doubts also persist about loan recycling—new borrowing to pay off old debt, and leakage into the stock market. None of this helps build the real economy. A focus on loan quality not just rapid and increasing volume is needed. If economic necessity is overrun by political expediency, China may soon have its own financial bubble to contend with.

The stimulus also leaves two of the biggest concerns facing average Chinese households largely unaddressed—significant financial hardship if they become seriously ill, and saving for their children’s education. Spending on healthcare and education is a meager 4% of the entire stimulus (raised from 1% in an earlier version). It is highly likely this will become an unfunded mandate for local government, many of which are incapable of funding such initiatives. If so, cities and provinces most in need will continue to be the worst off.

For countries hoping that the stimulus will lead to a near-term China recovery and expanding export opportunities, there is little on offer outside of construction and transport equipment, power generation and to a lesser extent manufacturing equipment. Technical upgrading and research and development account for 9% of stimulus—though again it is unclear whether this denotes subsidies for new equipment purchases, tax rebates, or some other incentive).

Chinese companies are becoming increasingly competitive with foreign manufacturers in these market segments and the domestic climate shows signs of a protectionist “buy China” sentiment. Stimulus oriented sales won’t make up for the overall slowdown. Developing countries, heavily dependent on feeding the global supply chain running through China to western consuming nations will have a very slow road to recovery.

Even modest growth these days is better than nothing at all and in the mid- to long-term hopes for potential commercial opportunities in China remain strong. It is increasingly uncertain, however, how long a wait this might be. When new and real stimulus is needed later this year a focus on small and medium-sized enterprises—the most efficient users of capital, health-care and environmental technology will go a long way towards sustainable recovery and growing opportunities for China’s trading partners.

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