Where has the “mother of all bubbles” gone?
Whatever China does or is, pundits seem unhappy. Two years ago, most were stressing the “mother of all bubbles” in the making as Chinese real estate prices skyrocketed, Chinese banks stockpiled bad loans and the broad economy overheated. Today, we see a U-turn; in recent months, pundits have been pondering how hard and long the ubiquitous “soft landing” will actually be.
The Chinese economy has been a source of amazement for years. Never has such a large country grown so quickly for so long – now over 30 years. Obviously this cannot last forever, and fundamental economics can explain why it will not. However, when looking at China, many analysts unwittingly mix the short and the long run. Moreover, they seem to ignore what Chinese officials are saying and how these officials see their own economy.
The short-run story is the following. The financial crisis of 2007–2008 also hit China pretty hard. Its growth rate dropped significantly by the end of 2008, to the extent that it could be called a recession. Then, thanks to very expansive fiscal and monetary policies, China was one of the first countries to reemerge from the global slump and also pulled out many other countries with it. However, the overly strong monetary and fiscal impulses pushed China into overheating by 2010–2011. Authorities reacted again, slowing the economy down by the end of 2011 and into 2012. This sort of countercyclical policy – where officials try to smooth the booms and slumps of the business cycle – is really nothing extraordinary.
The long-run story highlights China as an emerging economy in a convergence process. This means basically that it will grow much more rapidly than developed economies, but also that as it closes the gap with those developed economies, its growth rate will lessen. The convergence process is very well known and studied in economics, and is based upon the fact that the capital stock of an emerging economy is low. This means high returns on capital, in turn inducing a high rate of growth for investments. Indeed, China’s ratio of investments to gross domestic product (GDP) has been among the highest ever registered even for emerging economies, reaching 48% by 2010, twice the usual ratio in developed economies.
This trend is not only poised to reverse, it is also the will of the Chinese authorities to reverse it. In the last five-year plan, a growth rate of “only” 7% was targeted for the Chinese economy, instead of the double-digit rates of recent decades. How would this be achieved? By changing the substantial orientation of the Chinese economy. This means a shift from export/investment towards private consumption. Exports and investments do grow faster, but they are much more volatile than private consumption. Thus, a reorientation of the Chinese economy from the former to the latter would lead to lower growth but also less volatility in its GDP.
Having seen the effects of the Chinese economy’s excessive dependence on the international business cycle in 2007–2008, Chinese officials are now aiming at exactly this shift, in my view. This is probably also what they had on their minds when they decided to deflate the “mother of all bubbles” two years ago. The Chinese economy is far more straightforward than many would surmise.