China’s Self-Inflicted Wounds - Vested UK

China faces severe economic troubles. Its former impressive growth momentum has faded. It carries a huge burden of debt, far bigger than that of the United States, relatively. The once-vaunted global reach of its Belt and Road initiative increasingly faces resistance. Western media, after decades of praise for Chinese economic organization and advances, blames Covid and with some justice. But China’s mounting economic problems are more fundamental. Indeed, they are largely self-inflicted. Its planned, centralized approach to economic decision making, often touted as superior to seemingly chaotic market-based approaches, has more and more frequently missed the country’s needs. It has become ever clearer that if and until Beijing abandons its fundamentally Marxist economic system its problems will only get worse. Since such a change hardly seems likely under President-for-life Xi Jinping, China has become a bad economic bet. 

Not too long ago, Chinese central planning seemed capable of no wrong. The economy boomed. From the late 1970s, when then President Deng Xiaoping announced that it was no shame to get rich and opened China’s economy to the world, investment monies poured into the country and each year saw spectacular gains, especially since Beijing used the increasing national income to launch impressive and effective infrastructure projects. Between 1980 and the turn of the century, China’s economy expanded in real terms at about 10 percent a year.  Following China’s 2001 entry into the World Trade Organization, its real GDP growth rate accelerated to over 10 percent a year and kept up that pace on average until 2015. When in 2010 China’s burgeoning economy surpassed Japan’s, it was easy to extrapolate its pace of expansion and speculate that China’s economy would soon surpass that of the United States to become the world’s largest. Everything in China seemed to work. All Beijing’s plans – grand and small — paid off handsomely.

Not surprisingly, these astonishing advances captured the imaginations of western journalists and economists. Their enthusiasm raised speculation that China might possess a superior economic model to the market-based systems of the United States and to a lesser extent Europe and Japan. Canada’s Prime Minister Justin Trudeau went so far as to express envy of China’s dictatorship and how it allowed Beijing to “turn their economy around on a dime.” If this man is not known for deep thinking, other seemingly more sober voices shared versions of Trudeau’s China envy. New York Times columnist Thomas Friedman echoed Trudeau’s preference for centralized planning over the seeing chaos of market-based systems. Articles in the Harvard Business Review heaped praise on China’s approach. One appeared as late as 2021 to explain “China’s New Innovative Advantage.” Only last year, Klaus Schwab of the World Economic Forum described China as “certainly a very attractive model,” one worthy of consideration “for many countries.” In 2020, Jim O’Neill, head of the storied think tank, Chatham House, praised China’s system for its “fast, aggressive” response to the Covid outbreak.  

These are only a small sample of the favorable western commentary on China’s planned, top-down, command and control approach to economic management. The picture that inspired so much China envy was, however, illusory. China’s growth and planning success were more a result of the extremely underdeveloped state of China’s economy when Deng Xiaoping made his change than any planning prescience, much less the superiority of what is effectively a command economy. 

Underdevelopment carries many burdens, but in creating an astonishing growth record and seemingly brilliant planning, it advantaged China tremendously. Flows of investment funds from America, Europe, and Japan had tremendous impacts on the otherwise impoverished China, advancing growth rates that would have otherwise required much greater inflows.  Underdevelopment also made the job of planning relatively easy. For decades, all Beijing’s planners needed to do to see the future was look to the developed world. There they could see that their country’s prosperity required reliable roads, power lines, rail links, port facilities, and the like. The pursuit of these projects paid huge economic dividends and spurred growth at still faster rates. Things changed, however, as China’s economy caught up with the developed world.  Then Beijing’s central planners lost their model of the future. China’s future needs became harder to assess. Mistakes became more common. And because Beijing’s planners have great power to marshal financial, managerial, and labor resources, those mistakes have created great waste.

A perfect example emerges from China’s present difficulties with residential development. Years ago, the nation had an inadequate housing stock. The planners could see the need and encouraged development through subsidies, by arranging financing through state-owned banks, and by expediting permitting as well as licensing. Developers responded to the incentives and produced the vast apartment complexes so frequently pictured in western media outlets. Initially the effort paid off well. But even as the nation met its housing needs, planners continued the effort. China until very recently continued to dedicate between 25 and 30 percent of its economy to residential housing development. (By comparison the United States, in a strong housing year, channels about five percent of its economy into residential construction.) China built more housing than its population could absorb and put it in places that Chinese people did not necessarily want to live. These projects failed to pay off, which is why so many Chinese development firms – the giant Evergrande in particular – have failed.

This is only one of many planning failures, though it is the most dramatic. The record is replete with roads to nowhere, underused rail links, and misplaced port facilities, as well as chronic electricity shortages. In this, China is not alone. Everywhere — except for the underdeveloped that has a model in developed economies — the future is foggy. America also has many examples of wasted effort due to poor planning, usually by business interests. But there is also a big difference from China’s centrally planned system. America’s market-oriented approach keeps the mistakes on a smaller scale.  Because of a greater diversity of effort in a market-oriented system than in a national plan, which by nature is targeted on a few areas, markets are more likely to happen on future needs sooner than centrally planned arrangements. 

Here is how the difference makes itself felt. In a market system, the planning is done separately by thousands of firms and individuals, each trying in its own way and by its own lights to capture the future. To be sure, business managers are no better at seeing the future than government planners, perhaps even less capable. But each mistake is smaller than in the centrally planned approach that can and does marshal huge amounts of the economy to the comparatively narrow range of activities favored by the planners. Also, unlike government efforts, business planners face tighter budgets, are constantly reviewing their efforts, and because they are also closer to their customers, businesses are less likely to pursue a failing project for as long as necessarily distant central planners. Perhaps most significant is the lack of focus in a market system, the very lack of discipline and organization once so admired in China’s centrally planned approach. The thousands of diverse projects typical in markets raise the probability that somewhere in the chaotic mélange of activity one will uncover an otherwise elusive future need, build on it, and spur growth.  

Relative debt levels can give an idea (admittedly a vague one) of the scale of waste caused by centralized planning. Every project, whether promoted by a planning authority or a private firm, needs financing and that commonly generates debt. The debt can be an obligation of the central government, local authorities, or private entities. A comparison of aggregate debt levels to national income can then indicate the scale of projects that have missed the mark and failed to generate an adequate economic payoff. In China, the extent of error is huge. Aggregate debt levels have far outpaced national income. In the ten years up to 2019, just before the pandemic, overall debt in China expanded at a 23 percent average annual rate, while the country’s overall economy expanded only 8 percent a year.  In contrast, comparable data for the United States shows a 5.6 percent annual growth in aggregate debt during that ten-year period, faster than the economic growth of about 4 percent, but a much narrower gap than in China.  

The difference has only expanded since. Even with all Washington’s spending on Covid relief, debt – federal, local, state, and private – in the United States amounted to some $57 trillion at the close of last year, about 2.2 times the nation’s nominal GDP. Comparable debt levels in China amounted to the equivalent of over $51 trillion, almost three times the size of China’s economy. In other words, the relative level of accumulated waste from mistaken projects in China is almost half again higher than in the United States, a difference that is even more striking given that the United States has a much older developed economy than China and so has had a longer time to accumulate planning errors and debt.

Except in those rare instances when the future is obvious, as when China was so horribly underdeveloped, all economic plans – whether made in government or in a private company – are a guessing game. Sometimes they work out, often not. Because central planning unavoidably only focuses on a limited number of projects, almost always drawn from the prevailing headlines of the day, they can easily miss. When they do, economies suffer huge waste and become saddled with debt that the failed project cannot support, a fact to which China’s huge debt overhang testifies. While burdening economies in this way, the central plans divert resources from a diversity of effort that raises the chance that somewhere some effort will happen on that elusive future need. This failure has been China’s fate and would have been even in the absence of the pandemic. If and until Beijing changes – a highly unlikely event – China’s economy will increasingly be a bad bet.

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