China’s Inward Tilt Could Cripple It

By Nathaniel Taplin


As Chinese leaders head to the G-20 meeting this weekend, they’re in a confident mood. A trade deal with President Trump would be nice, but they seem to think it would do just fine without one.

That is probably right for a little while. The long-term outlook is far less positive. Without continued rapid export growth, China will struggle to achieve high-income status.

China has sturdy bulwarks against trade pressure at the moment: Consumption drove 65% of growth in the first quarter, despite recent hints of weakening. As Wang Jinzhao of the Beijing-backed Development Research Center pointed out in mid-June, exports just aren’t as big of a factor in China’s growth machine any more. They were 18% of gross domestic product in 2018, down from 35% in 2006.

This apparent strength, however, conceals big weaknesses. China still hasn’t proven that it can grow at close to current rates without strong exports or falling deeper into debt. Beijing is counting on its large domestic market to nurture new technology titans and boost productivity to ward off a debt crisis, but it is rife with local protectionism, hostage to an inefficient financial system, and offers questionable legal protection for innovators.

Export markets are important not just for growth, but to compensate for the inherent weaknesses plaguing China’s “socialist market economy” by enforcing market discipline. Without that discipline, the results often aren’t pretty.

Houze Song, at the Paulson Institute, cites the example of Liaoning, one of China’s slowest-growing and most indebted provinces. The rust-belt region lagged behind new economic powerhouses such as Guangdong province in the early years of China’s reforms, but was still a substantial exporter to the rest of China and the world in the early 2000s, with a trade surplus of about 12%. In recent years that has evaporated. Liaoning’s market share for a range of industrial goods within China—from air conditioners to beer to chemical fibers—has collapsed.

Mr. Song pins much of Liaoning’s malaise specifically on the pernicious combination of overinvestment and protectionism. Liaoning companies such as Brilliance Auto have stumbled, according to Mr. Song, in part thanks to pressure to buy from indebted local firms—and easy sales to the government, which discouraged a focus on exports.

It isn’t hard to see echoes of this in China’s much-maligned industrial upgrading plan, formerly known as China 2025, which emphasizes state investment and high targets for local content. The Huaweis of the future might be real technology leaders, but they also could be weighed down purchasing expensive, inferior Chinese chips or robotics from state-backed companies that need to recoup massive investments.




A statue of Mao Zedong looms outside the railway station in Dandong, Liaoning province. Photo: Dake Kang/Associated Press


Protected industries with a large captive market, rather than innovate, often simply restrict output growth and jack up prices. Chinese pharmaceuticals are one example. Price liberalization in 2015 was meant to trigger an investment and research boom, aided by China’s vexing foreign drug-approval process. Investment did accelerate, but the main effect was spiraling price inflation, which hit nearly 7% in 2017 and drove listed firms’ returns sharply higher. A huge public outcry eventually forced Beijing to reverse course and start speeding foreign approvals again.

An independent judiciary enforcing tough antimonopoly laws can mitigate such problems. Instead, economic policy has moved in the opposite direction, promoting industrial consolidation in sectors from banking to steel. Antitrust enforcement has tended to target foreign companies. Of the more than 2,000 deals reviewed by regulators in the decade following China’s antimonopoly law’s passage in 2007, only two were officially rejected. Both involved foreign entities.

Tilting toward an import-substitution rather than export-led growth strategy has real costs. Capital Economics finds that countries sustaining rapid productivity growth above 3% unaccompanied by double-digit export growth are essentially unheard of. China could conceivably replace lost U.S. exports with a surge to the rest of the world. That risks a strong political pushback from those countries, though.

The implications for debt are also worrying. China has managed over the past two years to slow—if not entirely halt—its inexorably rising debt burden. But that limited victory was achieved with the help of export growth approaching 10% in 2018—the fastest pace since 2011. That also was the last time that Chinese indebtedness actually fell on the year. Stabilizing debt without the spur to productivity and growth from robust exports may prove impossible.

The U.S. too, has a problem with industry concentration and rising protectionism. But it also has strong courts and a more efficient financial system to help entrepreneurs—not to mention a free press to call out companies and local governments that collude to protect themselves.

In the absence of those things, China’s deep integration with global export markets has been a critical ingredient in its progress. If that goes into reverse, the nation’s economic miracle may too.

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