2006 March 05 Sunday
Will China Pull World Into Global Depression?

In an article in Foreign Policy Minxin Pei spells out the problems facing China's economy.

But before we all start learning Chinese and marveling at the accomplishments of the Chinese Communist Party, we might want to pause for a moment. Upon close examination, China’s record loses some of its luster. China’s economic performance since 1979, for example, is actually less impressive than that of its East Asian neighbors, such as Japan, South Korea, and Taiwan, during comparable periods of growth. Its banking system, which costs Beijing about 30 percent of annual GDP in bailouts, is saddled with nonperforming loans and is probably the most fragile in Asia. The comparison with India is especially striking. In six major industrial sectors (ranging from autos to telecom), from 1999 to 2003, Indian companies delivered rates of return on investment that were 80 to 200 percent higher than their Chinese counterparts. The often breathless conventional wisdom on China’s economic reform overlooks major flaws that render many predictions about China’s trajectory misleading, if not downright hazardous.


The Chinese state remains deeply entrenched in the economy. According to official data for 2003, the state directly accounted for 38 percent of the country’s GDP and employed 85 million people (about one third of the urban workforce). For its part, the formal private sector in urban areas employed only 67 million people. A research report by the financial firm UBS argues that the private sector in China accounts for no more than 30 percent of the economy. These figures are startling even for Asia, where there is a tradition of heavy state involvement in the economy. State-owned enterprises in most Asian countries contribute about 5 percent of GDP. In India, traditionally considered a socialist economy, state-owned firms generate less than 7 percent of GDP.

The Chinese government still owns most of the economy.

But China’s tentacles are even more securely wrapped around the economy than these figures suggest. First, Beijing continues to own the bulk of capital. In 2003, the state controlled $1.2 trillion worth of capital stock, or 56 percent of the country’s fixed industrial assets. Second, the state remains, as befits a quintessentially Leninist regime, securely in control of the “commanding heights” of the economy: It is either a monopolist or a dominant player in the most important sectors, including financial services, banking, telecommunications, energy, steel, automobiles, natural resources, and transportation. It protects its monopoly profits in these sectors by blocking private domestic firms and foreign companies from entering the market (although in a few sectors, such as steel, telecom, and automobiles, there is competition among state firms). Third, the government maintains tight control over most investment projects through the power to issue long-term bank credit and grant land-use rights.

This strengthens my belief that Western capitalists looking to build up big markets in China are going to come to tears. The Chinese government will prevent any of them from becoming too successful. Meanwhile, China's pursuing a strategy for capital accumulation that has as much in common with Stalin's rapid industrialization of the Soviet Union as it does on Western models of free market capitalism.

Pei sees the state corporations as vast patronage systems that the government depends on to maintain control of the economy as a whole. The thing that strikes me about this is just how little countries change. The Arabs are not about to become liberal democrats. The Russians are sliding back toward the pattern of authoritarian central control that has marked the country for centuries.

Tyler Cowen fears an economic depression China and America.

More specifically, how about a bone-crunching, bubble-bursting, no soft landing, Chinese auto crash-style depression within the next seven years? This is also my biggest worry for the U.S. economy, I might add.

If you are not convinced, raise your right hand and repeat after me: "China in the 20th century had two major revolutions, a civil war, a World War, The Great Leap Forward [sic], mass starvation, the Cultural Revolution, arguably the most tyrannical dictator ever and he didn't even brush his teeth, and now they will go from rags to riches without even a business cycle burp."  I don't think you can do it with a straight face.

While the US industrialization process was marred by some severe economic downturns optimists can argue that our understanding of macroeconomics and monetary policy are much greater now. So the Chinese ought to be able to avoid our past mistakes. However, by that logic they should already have taken steps to avoid huge losses in their banking system. Also, their corruption and government involvement in their economy are both far greater than was the case in 19th and early 20th century US history.

If China goes down I have a hard time seeing how the US will manage to avoid a parallel depression. Picture the Chinese suddenly stopping the purchase of US bonds and instead selling them to use the money to bail out their own collapsed economy. The US would experience very high interest rates, a sharp rise in import prices, and even though the US Dollar might decline export sales would still drop as the whole world economy contracted.

Looked at in this light the lowering of Western trade barriers to Chinese goods may turn out to have been a reckless and irresponsible move because it allowed the major economies of the world to become vulnerable to events in an unstable state. Of course, the same can be said about Western dependence on Middle Eastern oil. The West might be one well placed bomb attack on Saudi Arabia's main oil processing facility away from at least a severe recession. But a severe recession in the West would probably drive China into a depression which would probably then suck the rest of the world even further down.

Here's what I want to know: If the Chinese experience an economic meltdown will they switch to a more private system of capital ownership in response? If they do then they will emerge from their depression more firmly on course to become the most powerful country in the world.

Also, will a future economic crisis catalyze reform demands for democracy? Will the tough times of a depression so reduce the ability of the government to buy off potential opponents that a democratic revolution becomes possible? Or will any revolution just lead back to authoritarianism? Read Pei's whole article and make your guess.

Share |      By Randall Parker at 2006 March 05 03:44 PM  China

mik said at March 5, 2006 5:34 PM:

A very large goverment sector - generally a bad thing, would serve as a dumper during downturn, would it not? Goverment industry doesn't react to economic conditions, so they will keep on producing providing some safety net to the whole economy.

Also it is not clear why in depression ChiComs will drop their exports to US. One would think they will try to keep their factories running no matter what.

Amount of risk Western companies take in respect to China is truly astonishing. One would think that US Gov would be concerned about that and try privately to communicate with them. Security blanket provided by US Navy and Marines might be severely weakened one day by a more patriotic/isolationist US prez. Do investors in Intel and Dell understand that?

Randall Parker said at March 5, 2006 6:37 PM:


Chinese exports are driven by Chinese purchases of US bonds. Said purchases keep the US dollar high versus the Chinese Renminbi I figure they won't be able to maintain those purchases if they suddenly find they need to do other things with the money.

Wolf-Dog (formerly the Invisible) said at March 5, 2006 9:57 PM:

Randall Parker,

I have the following questions:

0) I agree that a depression in the US would definitely cause a depression in countries that depend on exports to the US, but is it true that the reverse is necessarily true? Since the US is importing more than it is exporting, perhaps a depression in other countries does not necessarily mean trouble for the United States because of the following:

1) If there is a depression in China (or for that matter in many other countries), is it possible that the price of imports into the US would decline dramatically since the depressed countries would be desperate to earn more money? In this case, the US would benefit.

2) Would “Helicopter Ben” Bernanke keep his promise and buy all the treasury bonds in the world in case there is a panic? If the Fed keeps its promise, this would remedy the situation. Note that the Fed is systematically buying a percentage of the US government deficit every year already…

3) Since the Treasury Bonds are fungible all over the world, can the Chinese Government use these bonds to purchase raw materials? For instance, if you wanted to buy a house from a seller, but wanted to pay with Treasury Bills instead of cash, would the seller refuse?

John S Bolton said at March 6, 2006 2:23 AM:

The business cycle analogy could be wrong though. The situation with the $600+ billion dollar support from foreign central banks is not really analagous to capitalism, but to war finance. Like 1917-8 or 1943-6, you get a build-down on a government schedule. China finances its export surplus by receiving funds from Taiwan and Japan, which are forced savings from central banks. In 1931, America simply stopped financing Germany and Austria, causing an unavoidable series of insolvencies. The Bank of Japan and the other central bank dollar supporters will not likely all stop abruptly. They can reduce their level of support as much as they dare, over five or more years. This is not a system which hunts its equilibrium.
Likewise, China is described as having capitalism or communism, and as being ever so pragmatic. No one says that the term for a pragmatic mix of half capitalism and half communism, enforced by dictatorship, and driven by considerations of military aggrandizement; is nazism or fascism, though. Why are these traitorous elites trying to get us to applaud a fascist success story in China; do they long for world war?

John S Bolton said at March 6, 2006 2:35 AM:

Also, when the captive media tell us about China's bad loans, or those of Japan or any other country which is doing dollar support, is it mendacity or honesty on their part? It is as if they felt a duty to inform us that these countries have a peacable reason why they should accumulate collectively over $600 billion a year in US governemnt securities and hold them in such a way as to allow no expansion of credit from them. The whole process is aggression, intended to build up or maintain a level of export manufactures' production; and the media slavishly follow the party line that there is some banking system justification for it.

Kenelm Digby said at March 6, 2006 2:38 AM:

Don't you believe it.
China will continue on its trajectory toward global industrial pre-eminence (and possibly financial and military), due to one not so subtle fact, that in the final analysis, is the only factor that really counts, and is routinely ignored by conventional pundits.
That factor is, of course, race.
The elevated IQ of the East Asian strains represented in China is well known, also to be considered are the racial qualities of self-discipline, hard-work for little reward, law-abidness and respect for government authority - and add in a certain entrepeunarial genius for making and pitching just the right product for the right market.
Yes, we've been here many, many times before.Over the last 25 years you can look back at the archives of the New York Times, Time magazine, Newsweek, The Economist etc etc and read stories, published on a weekly basis throughout that period with the upshot the "Japan is finished".
On the contrary Japan has attained the status of the tertiary nation that lives soloely from its genius at design and technological excellence - the grunt work is left to others ie Britishers to do.

Gary Glaucon said at March 6, 2006 4:43 PM:

What a wonderful world! China keeps pumping products to the US and we keep sending money borrowed from them back over, thus lowering the money supply in this country and keeping inflation lower. During this exercise, they continue to build up their military power and world influence, just like German companies did before WWII and steal as much technology as possible.

The upside to this is that we have enough socialists and communists in this country, that any form of Red China supremacy would relieve their depression.

Gary Glaucon said at March 6, 2006 4:43 PM:

What a wonderful world! China keeps pumping products to the US and we keep sending money borrowed from them back over, thus lowering the money supply in this country and keeping inflation lower. During this exercise, they continue to build up their military power and world influence, just like German companies did before WWII and steal as much technology as possible.

The upside to this is that we have enough socialists and communists in this country, that any form of Red China supremacy would relieve their depression.

ziel said at March 6, 2006 5:06 PM:

I didn't find this article very convincing, either. There was little hard data - about the only specific example of gross inefficiency proferred was that "the country’s steel industry, the world’s largest, has 116 million tons (or about 30 percent) of excess capacity" - too much steel - what a horror!
Other unconvincing anecdotes: "The results of these mistakes—gleaming office complexes, industrial parks, landscaped highways, and public squares—tend to impress Western visitors, who view them as further proof of China’s economic prowess." I bet they're not importing millions of Cambodians to do the work.
Rampant corruption - without context, it's hard to tell how bad this is. Still, rampant corruption in New Jersey or Illinois hardly dooms those states to be underperformers.
"China underinvests in crucial social services, especially education and public health." An underinvestment in education is an unconvincing example of Chinese problems. It may rather be a sign that China is spending its education money wisely - ie., as needed, rather than 'wasting' it on people unlikely to use it to contribute to the nation's growth. Ditto for health care - why spend money to keep marginal or negative contributors alive?
Democracy Delayed - how is this relevant to economic performance? Wouldn't a democratic system force inefficient public expenditures?
Not very convincing. I agree that the bigger danger facing China is steep recession in the US - not the other way around.

Randall Parker said at March 7, 2006 6:37 AM:

This is a test after a severe spam attack and database repair.

Note that some March 7 comments were lost due to the spam attack's effects on the MySQL database. Sorry.

scottynx said at March 7, 2006 9:46 AM:

Ziel writes:
[Still, rampant corruption in New Jersey or Illinois hardly dooms those states to be underperformers]

I seriously doubt there is any comparison between corruption in China and corruption anywhere in America (except possibly small exceptions, not a single whole state).

noone said at March 10, 2006 5:14 AM:

I've never underestood the free market right and particularly libertarian,infatuation with ethnic facist China and it's mercantile economics.Just as I've never understood the belief that the current,massive,transfer of wealth from West to East by way of debt is a "good thing",that China does what it does to benefit us.This from people who believe that total self interest is the ultimate moral good.

Much as leftists tout Cuba as a paradise of human rights and socialist utopia,the facts just don't fit the theory.

"I seriously doubt there is any comparison between corruption in China and corruption anywhere in America"

In China,politically connected business people take the land and homes of peasants to enrich themselves.How is this so different from post-Kelo America?

Of course,in China they build factories to make things to sell,in America we build....spas.

Arnie said at March 10, 2006 5:54 AM:

I will never understand how multinational companies, whose owners and executives enjoy a life free from oppression, sleep at night. Obviously, greed is a great sleep aid. While they sleep, millions of Chinese people slave under the communist dictatorship of their PRC slave masters. I read all these comments about China and not once is there an acknowledgment of China's terrible oppressive dictatorial government. No free press, monitored and filtered Internet, monitored telephone, Chinese citizens murdered by the Police for holding peaceful demonstrations. This is the face of China that the world must not forget. Why the hell are we in Iraq? Is not China a bigger threat to our security? Our nation is doomed as a result of the most ignorant leadership the world has ever known.

Boone said at March 10, 2006 12:20 PM:

The high intelligence of ethnic chinese won't compensate for a monstrously corrupt political system--never has never will. Look at Lynn/vanhannen IQ and Wealth of Nations book. Lots of factors involved to modulate IQ, especially political/economic system. US not the highest IQ, but put the IQ together with economic opportunity and you get the top dog. China is very sick fundamentally. Lots of makeup makes her look like a sweet whore, but she's got the pox.

Søren Renner said at March 11, 2006 8:55 AM:

If China adopted true democracy and a free market, it would become the most powerful nation, according to Mr. Parker. I disagree, but only because I do not think there is enough time for this to happen before the end of (global) growth; does anyone have a theory about what happens at that point?

Marvin said at March 11, 2006 9:46 AM:

The end of global growth? Like "the end of the world as we know it?" (and I feel fine)
You need to clarify what you mean by that. Are you expecting another cosmic extinction event such as an asteroid or comet impact? Nothing else would qualify for "the end." There have been a lot of hiccups in global growth. There will be many more brief interruptions that a lot of people will interpret as "the end." Even Ray Kurzweil will admit that in the midst of his exponential growth scenario there might be brief dips, recessions, depressions.

If you say there isn't time for China to adopt freedom and become the most powerful nation before the singularity hits, you might be saying something more interesting and less doom-cult sounding. (not dumbkopf, doom-cult)

Reynold said at March 26, 2006 1:06 PM:

I'm a little late to this comment party, but I just got back myself from a business trip to China. A couple quick thoughts.

- There still is irritating corruption and intellectual property theft in China's public and private sectors, but for the first time in the ten years I've been in and out of China, there are actually some serious crackdowns on corrupt officials and boneheaded mine/business owners who endanger their own and public safety. Plus, there's a sort of de facto patent and trademark system in place even if not quite as developed as in USA, which is finally starting to protect intellectual property and do a better job of spurring R&D.

- The CCP isn't monolithic anymore, and there've been enough splits and debates among the members lately on a variety of issues that we're really seeing the genesis of something like a multiparty system in China, or at the very least some sort of open discussion and debate. IIRC, many "one-party democracies" (such as Mexico, Japan, South Korea where one party basically dominated the political system) also more or less became pluralistic following internal debates within the dominant party, also seems to be happening in China. BTW, seems like at least the villages really are having competitive elections, though still not happening at the national level.

- China on verge (or in danger of) a depression? Uh uh. Noooo way. 5 years ago I might have said that because of the pathetic state of the banking system and stock market here. But guess what China's been doing with all those surplus dollars from the US trade deficit? Now I've started to understand why China kept trading so many real goods for otherwise worthless US treasury paper-- they were plugging the gaps here in the banks, sorta like the way a new homeowner caulks up the cracks in a new home built a bit too fast.

- To the commenter above who gave that formula of high IQ plus economic opportunity-- well, China's now really got both in spades, b/c the authoritarian central power of the CCP has been plummeting as people get richer. Heck, CCP members themselves are less beholden to the Party because of it. The CCP these days seems to be little more than a sort of front corporation with a few inspiring and numerous lame proverbs to give a patina of legitimacy to whoever is the ruler de rigueur. Entrepreneurs are the big drivers here and they're the ones who've been pushing a lot of the changes to loosen up capital flows. Party connections still help of course, but in stark contrast to Shanghai in 2001, the level of corruption and kickbacks in Shanghai in 2006 is no worse than in, say, a political machine town like Chicago, Hartford or Boston-- that is to say, it's there and you can see the glad-handing in front of you, but not so bad as to be oppressive, and there's plenty of room for upstarts even if an occasional crumpled currency note with your handshake gives you an edge here and there.

- Nobody follows the One Child Policy anymore, if it ever really was followed at all. I took a trip out to the countryside once, and folks there still have 5-6 kids pretty commonly, they just do a good job of hiding them and not reporting them (especially the girls, accounting for most of the young gender gap), and the census takers wink at this because they get a few extra renminbis if they report lower numbers. Every single Chinese province has a big under-count in the census, and one of my Chinese statistician friends says, the real population in China is much more than 1.3 billion, probably 1.45 billion or so. In the city there is a bit more of a tendency to smaller families, but this is almost entirely on the part of the couples themselves whatever the government wants. Ironically, many of the more prosperous urban couples have the most kids and the largest families as a way to flaunt their wealth-- notice that this is direct opposite of the case in the USA.

- Chinese people seem to have a "language chip" implanted in their heads because in the big cities at least they seem to speak 5 or 6 languages or something besides Chinese. Lots of folks speak Japanese to keep drawing in these yen, Chinese businessman very commonly speak English and German very comfortably, the more culturally oriented speak French, many folks are into Spanish these days, a few of the older once-apparatchik types still speak Russian, many are even into Hindi or Arabic. That being said, to really get the best business here, it's gotten to the point where you've gotta speak Mandarin, period. Fortunately, they make it reasonably easier for you these days by printing up the signs in pinyin Romanization besides the characters, but you have to at least know the pinyin (which actually isn't that hard). There's been a massive growth in Chinese print publications and other media, and now South Korea, Thailand and Singapore are switching away from English and toward Chinese as the big language learned in schools. (Vietnam still seems to use a hodgepodge of French from colonial days, as well as English and also Chinese.) This is a language you have to know, folks.

That's all for now. More updates after my next jaunt.

Bruce Josloff said at March 9, 2008 12:34 PM:

China depends upon copying western designs and engaging in industrial espionage. Its genius is in mass production that is undescored with an enormous and cheap workforce. With regard to the so-called "Asian IQ" China has not invented anything since "gun powder." and has relied on western imports i.e. Marxism, capitalism, Western Design, etc. to modernize, along with the Stalinist propensity for murder and imprisonment on a mass scale. As the masses of Chinese "proles" increasingly demand "western style" comforts and luxuries, labor costs will increase and the Chinese economy will begin to slow.

SNAFU said at October 15, 2008 6:27 PM:

In my years I have seen Made in Japan, Made in Taiwan (ROC), Made in etc., etc., etc., and they all come to the same fate. These all change as the economy of the "made in" country changes toward a capitalist economy. The workers want a higher wage and the companies want to pay lower wage so the companies move on to the next exploitable country. China is the latest of these that will fade with the rest along with their economy.
As of this moment in time the global recession and possible depression will show China to be nothing more than what it is, another "made in" country being used by the Wal-Marts of the world for cheap labor. Who will be the next "made in" country?

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