The Death of Money (13 page)

China is now nearing this point. This does not mean growth will cease, merely that
it will decelerate to a sustainable level. China has put itself in this position because
of its one-child-per-family policy adopted in 1978, enforced until recently with abortion
and the murder of millions of girls. That drop in population growth beginning thirty-five
years ago is affecting the adult workforce composition today. The results are summarized
in a recent report produced by the IMF:

China is on the eve of a demographic shift that will have profound consequences on
its economic and social landscape. Within a few years the working age population will
reach a historical peak, and will then begin a precipitous decline. The core of this
working age population, those aged 20–39 years, has already begun to shrink. With
this, the vast supply of low-cost workers—a core engine of China’s growth model—will
dissipate, with potentially far-reaching implications domestically and externally.

Importantly, when labor force participation levels off, technology is the
only
driver of growth. The United States also faces demographic
headwinds due to declining birth rates, but it is still able to expand the labor force
1.5 percent per year, partly through immigration, and it retains the potential to
grow even faster through its technological prowess. In contrast, China has not proved
adept at inventing new technologies despite its success at stealing existing ones.
The twin engines of growth—labor and technology—are both beginning to stall in China.

Still, official statistics show China growing in excess of 7 percent per year, a growth
rate that advanced economies can only watch with envy. How can these sky-high growth
rates be reconciled with the decline of labor and capital factor inputs that Krugman
predicted almost twenty years ago? To answer this, one must consider not only the
factor inputs but the composition of growth. As defined by economists, GDP consists
of consumption, investment, government spending, and net exports. Growth in any or
all of those components contributes to growth in the economy. How does China appear
to increase these components when the factor inputs are leveling off? It does so with
leverage, debt, and a dose of fraud.

To understand how, consider the composition of China’s GDP compared with those of
developed economies such as the United States. In the United States, consumption typically
makes up 71 percent of GDP, while in China, the consumption component is 35 percent,
less than half the United States’. Conversely, investment typically makes up 13 percent
of U.S. GDP, while in China investment is an enormous 48 percent of the total. Net
exports are about 4 percent of the economy in the United States and China, except
the signs are reversed. China has a trade surplus that
adds
4 percent to GDP, while the United States has a trade deficit that
subtracts
4 percent from GDP. In concise terms, the U.S. economy is driven by consumption,
and the Chinese economy is driven by investment.

Investment can be a healthy way to grow an economy since it has a double payoff. GDP
grows when the investment is first made, then grows again from the added productivity
that the original investment provides in future years. Still, this kind of investment-led
expansion is not automatic. Much depends on the
quality
of the investment: whether it in fact adds to productivity or whether it is wasted—so-called
malinvestment
. Evidence from recent years is that China’s infrastructure investment
involves massive waste. Even worse, this investment has been financed with unpayable
debt. This confluence of wasted capital and looming bad debt makes the Chinese economy
a bubble about to burst.

■
The Investment Trap

The recent history of Chinese malinvestment marks a new chapter in the repeated decline
of Chinese civilization. This new story revolves around the rise of a Chinese warlord
caste, financial not military in kind, that acts in its own self-interest rather than
in China’s interest. The new financial warlords operate through bribery, corruption,
and coercion. They are a cancer on the Chinese growth model and the so-called Chinese
miracle.

After the 1949 Communist takeover of China, all businesses were owned and operated
by the state. This model prevailed for thirty years, until Deng Xiaoping’s economic
reforms began in 1979. In the decades that followed, state-owned enterprises (SOEs)
took one of three paths. Some were closed or merged into larger SOEs to achieve efficiencies.
Certain SOEs were privatized and became listed companies, while those remaining as
SOEs grew powerful as designated “national champions” in particular sectors.

Among the best known of these super-SOEs are the China State Shipbuilding Corporation,
the China National Petroleum Corporation, the China Petrochemical Corporation (SINOPEC),
and China Telecom. There are more than one hundred such giant government-owned corporations
in China under centralized state administration.
In 2010 the ten most profitable SOEs produced over $50 billion in net profits. The
super-SOEs are further organized into sixteen megaprojects intended to advance technology
and innovation in China.
These megaprojects cover sectors such as broadband wireless, oil and gas exploration,
and large aircraft manufacture.

Regardless of the path taken by state enterprise, corruption and cronyism permeated
the process. Managers of SOEs that were privatized received sweetheart deals, including
share allocations ahead of the public
listing, and executive appointments in the privatized entity. For the enterprises
that remained as SOEs, opportunities for corruption were even more direct. Board members
and executive officers were political appointees, and the SOEs were protected against
foreign and domestic competition. SOEs received cheap financing from government-owned
banks and got orders for goods and services from government agencies as well as other
SOEs. The result was a dense, complex network of government officials, Communist Party
princelings, and private owner-managers, all being enriched by Chinese growth. The
elites became a parasite class gorging themselves at the expense of an otherwise healthy
and normal growth process.

The rise of a parasitic elite is closely linked to the prevalence of malinvestment.
The need for the Chinese economy to rebalance from investment to consumption, as urged
by the IMF and other official institutions, has run headlong into the self-interest
of the elites who favor infrastructure because it keeps the profits flowing at their
steel, aluminum, and other heavy industrial enterprises. The new financial warlords
are addicted to the profits of infrastructure, even as economists lament the lack
of growth in services and consumption. The fact that this problem is recognized does
not mean that it will be managed well. As in all societies, including the United States,
elite interests can prevail over national interests once elite political power is
entrenched.

Specific examples of infrastructure projects illustrate the waste. Nanjing is one
of the largest cities in China, with a population approaching seven million. It is
also one of the most historically significant cities, having served as China’s capital
under several dynasties as well as capital of the Taipei Rebellion’s Heavenly Kingdom.
More recently, Nanjing was the seat of government, intermittently from 1912 to 1949,
during the Chinese Republic of Dr. Sun Yat-sen and later Chiang Kai-shek.

While Nanjing has many of the same problems of pollution and uncontrolled growth of
other Chinese cities, it is altogether more pleasant, with abundant parks, museums,
and broad, tree-lined boulevards built under imperial influence during the late nineteenth
century. Nanjing lies on the Beijing-Shanghai high-speed railway line and is easily
reached from both cities. It is among the most important political, economic, and
educational hubs in China today.

Immediately south of Nanjing proper lies the Jiangning district, site of one of the
most ambitious infrastructure projects now under way in China. Jiangning consists
of seven new cities, still under construction, connected by a highway network and
an underground metro. Each city has its own cluster of skyscrapers, luxury shopping
malls, five-star hotels, man-made lakes, golf courses, recreation centers, and housing
and science facilities. The entire metroplex is served by the Nanjing South Railway
Station to the north and a newly constructed airport to the south. A visitor cannot
help but be impressed with the project’s scale, the quality of the finished phases,
and the rapidity with which the entire project is being completed. What struck one
as odd on a recent visit is that all of these impressive facilities were empty.

Provincial officials and project managers gladly escort interested parties on a new
city tour to explain the possibilities. One laboratory is pointed out as the future
source of Chinese wireless broadband technology. Another skyscraper is eagerly described
as a future incubator for a Chinese alternative asset management industry. An unfinished
hotel is also said to be taking reservations for world-class conferences with A-list
speakers from around the world.

Meanwhile the visitor stares out at miles of mud flats, with poured concrete and steel
rebar footings for dozens more malls, skyscrapers, and hotels. This vision of seven
new cities would be daunting enough—until one realizes that Nanjing is among dozens
of cities all over China building similar metroplexes on a mind-boggling scale. The
Chinese have earned a reputation around the world as master builders to rival the
Pharaoh Ramesses II.

The Nanjing South Railway Station is not empty, but it also illustrates China’s deficient
approach to infrastructure development. In 2009 China was reeling from the same collapse
in global demand that had affected the United States after the Panic of 2008. Its
policy response was a ¥4 trillion stimulus program, equal to about $600 billion, directed
mainly at investment in infrastructure. The United States launched an $800 billion
stimulus program at the same time. However, the U.S. economy is more than twice as
large as China’s, so on a comparative basis, China’s stimulus was the equivalent of
$1.2 trillion applied to the United States. Four years after the program was launched,
results are now visible in
projects like the Beijing-Shanghai high-speed railroad and the Nanjing South Railway
Station.

The station has 4.9 million square feet of floor space and 128 escalators; it generates
over 7 megawatts of power from solar panels on the roof. Ticketing and entry to platforms
are highly automated and efficient. The new trains are not only fast but also comfortable
and quiet, even at their top speed of 305 kilometers per hour. Importantly, the station
took two years to build, using a force of 20,000 workers. If the object of such infrastructure
is to create short-term jobs rather than transportation profits, the Nanjing South
station might be judged a qualified success. The long-term problem is that a high-speed
train ticket from Shanghai to Nanjing costs the equivalent of thirty dollars, while
a journey of similar length in the United States costs two hundred dollars. The debt
incurred by China to build this monumental train station can never be paid with these
deeply discounted fares.

Chinese officials rebut the excess capacity criticism by saying that they are building
high-quality infrastructure for the long term. They point out that even if it takes
five to ten years to fully utilize the capacity, the investment will prove to have
been well founded. But it remains to be seen if such capacity will ever be used.

Apart from the infrastructure’s sheer scale, China’s vision of expanding the science
and technology sectors of the economy faces institutional and legal impediments. The
high-tech wireless broadband laboratory in Jiangning is a case in point. The research
facility has massive buildings with spacious offices, conference rooms, and large
labs surrounded by attractive grounds and efficient transportation. Local officials
assure visitors that fifteen hundred scientists and support staff will soon arrive,
but the most talented technologists require more than nice premises. These scientists
will want an entrepreneurial culture, close proximity to cutting-edge university research,
and access to the kind of start-up financial mentoring that comes with more than just
a checkbook. Whether or not these x-factors can be supplied along with the buildings
is an open question. Another problem with building for the long run is that obsolescence
and depreciation may overtake the projects while they await utilization.

China’s political leaders are aware that wasted infrastructure spending has permeated
the Chinese economy. But like political leaders elsewhere,
they are highly constrained in their response. The projects do create jobs, at least
in the short run, and no politician wants to preside over a policy that causes job
losses, even if it will result in healthier long-run outcomes. Too often in politics
everything is short-term, and the long run is ignored.

Meanwhile the infrastructure projects are a windfall for the princelings, cronies,
and cadres who run the SOEs. The projects require steel, cement, heavy equipment,
glass, and copper. The building spree is beneficial to the producers of such materials
and equipment, and their interests always favor more construction regardless of costs
or benefits. China has no market discipline to slow down these interests or redirect
investment in more beneficial ways. Instead China has an elite oligarchy that insists
that its interests be served ahead of the national interest. The political elite’s
capacity to stand up to this economic elite is limited because the two are frequently
intertwined.
Bloomberg News
has exposed
the interlocking interests of the political and economic elites through cross-ownership,
family ties, front companies, and straw man stockholders. Saying no to a greedy businessman
is one thing, but denying a son, daughter, or friend is another. China’s dysfunctional
system for pursuing infrastructure at all costs is hard-wired.