Charting China

Going into a self-chosen reading relating to IPE in or after the economic crisis that emerged in 2007-08, it wasn’t a hard choice. I chose to read Nicholas Lardy’s “China’s Economic Growth: After the Global Financial Crisis”. Seeing as China has pulled out of the worst recession since the Great Depression nearly unscathed (it maintained economic growth in the excess of 9% annually – World Bank) there have been murmurs around the community of developing countries that China might be the better model. That is, better than the American model that seemed to cause the crisis in the first place.

In evaluating China’s model in the context of the American, however, it is necessary to understand where the Chinese success came from. I don’t propose to do that here as even Lardy couldn’t have gotten at such a broad question in a single, well written book. The book is an insight into China’s economy’s inner workings, though, and for that reason it is an important read that will get us going in understanding China’s economic success over the past 5 years.

The title of the book can be somewhat misleading – it is not a story of China after the crisis. It should be clear to everyone (Yes, especially us Europeans) that the crisis isn’t quite over, or at least that it has not been over long enough that it would be meaningful to analyze the period. The book instead examines China’s behavior during the crisis and what the consequences will be for the Chinese economy in the aftermath of the crisis – its central thesis is that China is not on the right track for sustained medium term growth. In the words of professor Smitka (of East Asian Economics at W&L), Lardy has been an observer of China’s economy from before there was much an economy to observe; this book is a sharp portrait of an economy in trouble that is tethered in China’s economic history as much as its future.

To Lardy, China’s success rests largely on an attribute which rests on the authoritarian nature of Chinese government. When it came time to pass legislation for a Chinese stimulus package a lá the one pushed here in the US, it acted swiftly and in adequate measure. Lardy points out, as did Shambaugh when he was recently on campus, that China’s stimulus was well timed and of an effective size. Consumption did not fall significantly in China as it did in so many other places and China accordingly pulled out of the crisis before it truly hit.

Much of the book is devoted to a technically heavy analysis of specific initiatives that the Chinese government took, most of which I will not recount here. However, in the context of the recent class discussion about China’s housing bubble and its economic prospects it is in order to mention the most important. China rolled out a 586 million dollar stimulus as opposed to the American 787 billion, a small difference considering that the American economy is more the twice as large as the Chinese (p. 6). Beyond the size, however, the structure was also different. Whereas much of the American stimulus consisted of tax cuts (supposedly to incentivize consumption) the Chinese government poured money into the economy by government spending. This was actually a reversal of past Chinese initiatives which had worked to slow Chinese growth, which was perceived to be out of control. Moreover, the Banks’ reserve requirements were slashed and they were able to lend more, and at lower rates spurring consumption as well.

The implication for the housing market was an exacerbation of the housing bubble, since house buyers could access fund more readily where they had before been restricted. Accordingly, the housing prices rose drastically. This is one of Lardy’s concerns: increased bank lending has helped along economic growth, but it has also made worse the possible burst of the bubble – one which could send the Chinese economy spiraling like the American did.

Lardy offers remedies which are almost exclusively along traditional economic lines: stop regulating and let the market take care of it. If the lending rate was not artificially high, the bubble wouldn’t exist. A host of other policies followed, as if read out of a Washington Consensus red book.

Lardy himself notes that China’s political environment is somewhat at odds with these policies. Although we attribute a lot of central control to the communist party, most policy is carried out locally where local governments have a slew of good reasons to ignore central economic policy. Most local government revenue, for example, stems from property taxes which grow larger with the housing prices. Until the bubble bursts, locals are best off leaving it alone.

But Lardy misses the mark in his attempt at discussing the political implications of the economy’s future. It is overwhelmingly clear today that the party’s legitimacy is carried far by its ability to lift the living conditions of the population rapidly. To slow the Chinese economy back down, especially by shutting the vast public out of the market for loanable funds, is a politically dangerous step. Arguably, a burst of the housing bubble would be even worse for the public’s belief in the communist government, so the party is faced with walking a very fine line. Leaving the economy up to the market – even though it may well be the best economic policy – is simply not feasible in China. The books conclusion thus falls apart a little, being impractical and bordering on irrelevant. The economic analysis is sound, but it is a poor attempt at meshing it within Chinese politics.