By Peter G Hall, VicePresident and Chief Economist
Size matters. We were all grimly reminded of that in 2008, and then repeatedly in the precarious months following the onset of crisis. Financial institutions exposed by years of loose lending and experimentation with ill-understood instruments came to the brink of failure, but were rescued by expansive bailouts. Why? They were too big to fail. Single institutions were so large that their complex integration with other institutions – many of them large, too – made their weaknesses an instant virulent epidemic. Failure of one key institution could easily bring down the entire system. We don’t typically think of countries in the same way, but are there similarities? Is the ailing Chinese economy somehow actually too big to ail?
When the wealthy world wobbled, eyes shifted east. Myriad pundits waxed lyrically about the miracle of China’s resilience. It seemed immune from the contagion gripping the big guns, and talk of the economic pivot to Asia, the rising influence of emerging markets, the new engines of the world economy and so on, permeated the press – and China was usually a centerpiece of the thesis. It seemed to have it all.
But the story has suddenly shifted. With a somewhat eerie disbelief, stories of cities no one lives in, malls with no shoppers, industrial parks completed but vacant, and rising inventories of finished goods are seeping out, causing onlookers to question the prior pronouncements. Today’s stories sound more like the cynical satire leveled at Japan in the 1990s, as it struggled to come to terms with its late-1980s collapse. Those who heralded the virtues of China’s mixed command-market economic system are looking a bit hasty. How did things get so messy?
The answer lies in China’s initial response to crisis. While GDP growth through the worst of the world’s woes looked as smooth as silk, it was anything but under the surface. By any measure, China’s trade collapsed along with the global cycle. At the peak, trade accounted for almost 70 per cent of GDP; two years into the global crisis, and the ratio had plummeted to under 50 per cent. What filled the vacuum? Not consumption; its share of GDP was ruler-flat over the period. As far as we can tell, the economy remained on the level thanks to a massive infusion of investment – relying heavily on public funds – and to a lesser extent, extra government spending.
That shouldn’t come as a shock; after all, every economy of note was doing the same at the same time. China stands out for the sheer size of its public programs, though. While the average OECD economy shelled out government spending and investment to the tune of 3.9 per cent of GDP, China’s initial program was reputed to amount to 13 per cent of GDP, and within the first two years, combined fiscal and monetary stimulus was estimated at 20-25 per cent of GDP. That’s nothing if not impressive, but is it sustainable?
Whether or not it is, China doesn’t seem to have much option. The sheer size of its programs speaks to their importance. In mid-2008, China was almost the first to notice faltering world growth. Thirty years of uninterrupted dramatic growth naturally created an expectation of perpetual upward movement. This was jarred in 2008, as an unthinkable drop in real estate values fomented anger that threatened to spread everywhere. Policy solved the problem, but revealed another: China is not currently wired to weather recession – the macro-political fallout would soon become unmanageable. As such – at least for the time being – China will avoid recession at all costs.
This gives rise to the more existential question: can China pull it off? Recent history is replete with examples of governments that embraced ‘at all costs’ policies, only to run out of cash and erupt into chaos. No government has endless access to recession-fighting resources. China has succeeded thus far, no small miracle, and is also actively encouraging its consumers to step up. If global growth revives in time, China just may do it.
The bottom line? China indeed seems too big to ail. Signals suggest that the world economy is on the verge of a U.S.-led recovery, and it can’t come soon enough for China. If so, it will enable its leaders to shift from treating the symptoms to a true cure. If not, we could all eventually succumb to the bug.
This commentary is reprinted courtesy of EDC. It is presented for informational purposes only. It is not intended to be a comprehensive or detailed statement on any subject and no representations or warranties, express or implied, are made as to its accuracy, timeliness or completeness. Nothing in this commentary is intended to provide financial, legal, accounting or tax advice nor should it be relied upon. Neither EDC nor the author is liable whatsoever for any loss or damage caused by, or resulting from, any use of or any inaccuracies, errors or omissions in the information provided.