Danger in China's Rapid Growth

The Times, The Times January 22, 2010

Grab a sneak peek at Alice in Wonderland

Stephen Bayley

Where am I?

Japanese trading practices are an unlikely villain for a best-selling thriller. But Rising Sun by Michael Crichton dramatises a threat to the West from unfair Japanese competition. It was published in 1992, but it might as well date from the Jurassic for its relevance today.

Japan turned out to be not a juggernaut of wealth creation, but a bubble economy on the point of collapse and prolonged stagnation. Twenty years on, it is China that is the economic superpower of the East. Its economy grew by 8.7 per cent in 2009. It is set to overtake Japan as the world’s second-largest economy.

The shift in fortunes is dramatic. It is testament to the power of the market. The greatest risk to the world economy from China’s ascendance is if the country’s policymakers stop short in liberalising the economy. China might replicate the features that have brought Japan low.

Japan experienced so fantastic a bubble in asset prices in the 1980s that the Tokyo Imperial Palace was said to be worth more than the entire state of California. The way that the crash then happened will sound familiar. Banks made loans where the collateral was property. But property prices bore no relation to any realistic assessment of value. There was particularly aggressive speculation in, of all things, golf club memberships. The stock market soared too. Few questions were asked about the quality of collateral. One huge speculator was a former waitress known as the Dark Lady of Osaka. Banks vied to lend her massive sums on the basis of forged documentation. She held mystical ceremonies at the restaurants she owned to seek divine inspiration for her investment decisions.

When it happened, the crash was almighty. Property prices fell by 80 per cent between 1990 and 2003. The economy went into a decade-long recession. Prices fell, with the result that consumers continually put off their purchases. What sparked this economic collapse was a failure to make decisions based on economic criteria. Banks made loans without regard to the return on them. Businesses pursued sales rather than profits. Above all, there was no cost of failure. Incompetent bankers held on to their jobs. Bad loans (known as “zombie loans”, because they were worthless) stayed on the books. Huge sums of public money were wasted trying to stimulate an unreconstructed, collectivist economy.

China has grown rapidly through economic reform. The country has remained politically autocratic; but in the economy, central planning has been increasingly superseded by incentives for private producers. By the mid-1990s most agricultural and industrial output was sold at market prices, and the State had ceased to be the dominant sector. The build-up of Chinese savings, which have been invested in the Western financial system, has allowed American consumers to live beyond their means.

The danger in rapid Chinese growth is that too much is being saved. There are not enough profitable projects where it can be invested. China needs to stimulate domestic demand and integrate its banks with the international financial system. That way, Chinese living standards can rise and savings can be put to good use. But if banks make loans without asking rigorously how much profit can be generated, then the next speculative bubble will be only a matter of time.

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