Andy Xie: Chinese Government to Limit its Size Or Face A Financial Crisis

Andy Xie, our renowned Chinese economist, opines that the Chinese government has to limit it’s size or the country will face a financial crisis.

Andy Xie observes that bank loans and money supply rose sharply in January. There are signs that many local governments with new leaders want to try an old trick, pushing fixed-asset investment (FAI) to create GDP and fiscal revenue. This would turn bank loans into GDP and fiscal revenue.

Local governments are already heavily in debt. Pushing FAI would keep them liquid through new loans. It is essentially a pyramid scheme and can go on as long as the banks are willing and able to lend. But constraints have appeared.

Says Andy

On top of the rising FAI, severe air pollution, corruption and the shirking blue-collar workforce all adds to the possible financial instability.

China’s growth potential is plentiful, just not through more FAI. In an economy with fully employed factors of production, growth comes from productivity. When one closely studies industrial growth, the breakthrough often comes from someone or a company localizing the production of key equipment or a component. Some product then could be made in China at Chinese cost. Subsequently, export growth and import substitution happen. China’s labor cost, though having risen substantially, is still one-sixth to one-seventh of the Organization for Economic Cooperation and Development level. As China loses unskilled labor-intensive industries to other developing economies, there is ample room for it to move into skilled labor-intensive industries. The demographic trend still gives the country an advantage in capital cost for another two decades. China has plentiful of room to realize US$ 20,000 in per capita income before 2030.

Unless the government chooses to limit its size through a spending freeze, the current trend is sending China towards financial crisis and currency devaluation. When that day comes, the economic adjustment would be chaotic and may throw the country into a vicious cycle. Freezing government spending at today’s high level should not be too much of a hardship for all involved. If that much pain is not acceptable, we can only wait for the crisis.