FS Insider recently interviewed Dinny McMahon to discuss his must-read book, China’s Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle. Dinny’s 13 years living in China, working for the Wall Street Journal in Beijing and elsewhere, has culminated into an exceptionally rich account of the many difficulties China faces, both social and economic.
Here’s what he had to say…
China’s Debt Growth Outpaces Most Other Countries
Since the global financial crisis, China launched a massive stimulus plan, encouraging its banks to lend more aggressively and, as a result, debt in China has skyrocketed.
China’s ability to become the world’s leading economic or geopolitical power through an uninterrupted ascent is built on the strength of its economy. But the pace of Chinese economic growth is tied intrinsically to its accumulation of debt.
“Other countries in the world that have accumulated this much debt this quickly have invariably ended up experiencing some sort of financial crisis,” McMahon said. “We’re now at a point that China has accumulated so much debt so quickly that if it continues on this trajectory, it will be genuinely destabilizing for both the financial system and the economy more broadly.”
Economic, Demographic Headwinds
China is now at the point where it needs to change the way it grows, and at the same time deal with entrenched economic problems that will complicate its efforts.
For one, China is no longer a cheap place to manufacture, McMahon stated. The cost of land is rising, and environmental compliance issues are also emerging.
Perhaps the most important issue is the rising cost of labor. The assumption has been that there was an endless supply of cheap labor in China, but it turns out this isn’t the case.
In fact, the pace of China’s internal migration is slowing, and the country has one of the fastest aging populations in the world, which is a direct result of its one-child policy.
“If we put all those factors together — the aging population, the rising costs, debt problems, and the need to change the economic model — it starts to make this perceived inevitability that China will become this great economic power, or even a great geopolitical power, look not only not inevitable, but actually very, very difficult to achieve,” McMahon said.
Growth, Not Profits
From the outside, China appears to be a capitalist economy. However, while it has the trappings of a capitalist system, the state owns many leading companies. All of the major power producers, the major oil companies, heavy industry, and the major telecommunications companies are state-owned.
For these state-owned firms, the basic economic motivations that drive their business model aren’t the same as we expect to see in private or entrepreneurial companies. These companies aren’t exclusively profit-driven, partly because they receive massive subsidies to operate.
Rather, for officials within these companies, their success is measured more by their ability to make the state-owned entity larger and more influential, not more efficient.
“That has led to all sorts of industrial over-capacity problems,” McMahon said. “When you have companies that are driven by the desire to become bigger, then you get this drive across the country to build factories in excess of what is actually needed. … This is a very real problem at the very heart of the Chinese economy. One of the reasons that the US is having issues with Chinese exports is because the Chinese model of economic growth has been so wasteful and is capable of producing a whole lot of things way in excess of what the Chinese economy will ever need.”
Building Ghost Cities
It is these kinds of misallocation of capital that signal difficulties for China ahead. Many in the US have heard of China’s ghost cities, where perverse economic incentives have led to very large cities being built that have been unable to attract residents to fill capacity.
While these cities do have residents — generally those who have been induced to move through state intervention, such as in the case of communist party members — they’ve been unable to organically attract migrants to fill positions within the new city.
Just as with businesses, McMahon stated, the success of local officials in China is measured by the degree to which they can drive economic growth. And the easiest way to stimulate economic growth is to borrow money and build things.
“When you build a new city or new district, it’s not just enough to put up a building and expect that people are going to move in,” McMahon said. “You also need to create jobs. … This issue has propagated around the entire country, and it isn’t going to be resolved anytime soon.”