Friedman on China

George Friedman notes China’s continuing economic slowdown:

Chinese Premier Li Keqiang told the National People’s Congress that China’s GDP growth rate would drop from 7 percent in 2016 to 6.5 percent this year. In 2016, the country’s growth rate was the lowest it had been since 1990. The precision with which any country’s economic growth is measured is dubious, since it is challenging to measure the economic activity of hundreds of millions of people and businesses. But the reliability of China’s economic numbers has always been taken with a larger grain of salt than in most countries. We suspect the truth is that China’s economy is growing less than 6.5 percent, if at all.

The important part of Li’s announcement is that the Chinese government is signaling that it has not halted a decline in the Chinese economy, and that more economic pain is on the way. According to the BBC, Li said the Chinese economy’s ongoing transformation is promising, but it is also painful. He likened the Chinese economy to a butterfly struggling to emerge from its cocoon. Put another way, there are hard times in China that likely will become worse.

China’s economic miracle, like that of Japan before it, is over. Its resurrection simply isn’t working, which shouldn’t surprise anyone. Sustained double-digit economic growth is possible when you begin with a wrecked economy. In Japan’s case, the country was recovering from World War II. China was recovering from Mao Zedong’s policies. Simply by getting back to work an economy will surge. If the damage from which the economy is recovering is great enough, that surge can last a generation.

Here’s his peroration:

Faced with this same problem in the past, Japan turned into a low-growth, but stable, country. But Japan did not have a billion impoverished people to deal with, nor did it have a history of social unrest and revolution. China’s problem is no longer economic – its economic reality has been set. It now has a political problem: how to manage massive disappointment in an economy that is now simply ordinary. It also must determine how to manage international forces, particularly the United States, that are challenging China and its core interests. One move China is making is convincing the world that it remains what it was a decade ago. That strategy could work for a while, but many continue viewing China through a lens that broke long ago. But reality is reality. China no longer is the top owner of U.S. government debt, an honor that goes to Japan. China’s rainy day fund is being used up, and that reveals its deepest truth: When countries have money they must keep safe, they bank in the U.S.

I don’t believe that the similarities between China and Japan are quite as strong as Mr. Friedman appears to. Japan became rich before its growth slowed; and China is enormously larger than Japan. In this case a difference in degree is really a difference in kind.

China is over-built in a huge number of sectors and expanding into more. It has enough excess capacity to supply the entire world with steel or cement or television sets or any number of other goods for years to come.

I think the better comparison is with the Soviet Union. The Soviet Union became the marvel of the world in the 1930s by moving relatively unproductive labor resources from agriculture into industrial production. That’s what China did, too. Unlike the Soviet Union China was able to accomplish that while actually increasing agricultural production. But that has largely ended:

And China’s working age population has peaked, largely due to the One Child Policy:

China can rescind the OCP but regardless more workers will still be decades away. And can China continue to abuse its soil, air, and water without reducing agricultural yields?

China may need to choose between its official policy of food independence and plowing money into industrial capacity. But will additional capacity actually yield more growth? Or has China’s already vast over-capacity effectively forestalled its future growth?