China is confronting some serious economic problems, and how Beijing does — or does not — respond to them could bend the course of the global economy.
First, China’s real-estate bubble is deflating. However, its economy also seems to be suffering from what economists call excess capacity — an overinvestment in capital goods, whether in factories, retail stores or infrastructure.
So what now? The answer depends in part on your school of economic thinking.
Keynesian economics holds that aggregate demand — the sum of all consumption, investment, government spendingand net exports — drives stability, and that government can and should help in difficult times.
However, the Austrian perspective, developed by the Austrian economists Ludwig von Mises and Friedrich Hayek, and championed today by many libertarians and conservatives, emphasizes how government policy often makes things worse, not better.
Economists of all stripes agree that China may be in for a spill. British economist John Maynard Keynes emphasized back in the 1930s the dangers of speculative bubbles, and China certainly seems to have had one in its property market.
Keynesians would argue that Beijing has the tools to stoke aggregate demand. It could, for example, adjust interest rates and bank reserve requirements, instruct state-owned banks to maintain lending or deploy some of its US$3 trillion in foreign exchange reserves. The government also appears to have many shovel-ready construction and infrastructure projects that could help the economy glide to a soft landing and then bounce back.
The Austrian perspective introduces some scarier considerations. China has been investing 40 percent to 50 percent of its national income. However, it is hard to invest so much money wisely, particularly in an environment of economic favoritism. And this rate of investment is artificially high to begin with.
Beijing is often accused of manipulating the value of its currency, the renminbi, to subsidize its manufacturing. The government also funnels domestic savings into the national banking system and grants subsidies to politically favored businesses, and it seems obsessed with building infrastructure. All of this tips the economy in very particular directions.
The Austrian approach raises the possibility that there is no way for China to make good on enough of its oversubsidized investments. At first, they create lots of jobs and revenue, but as the business cycle proceeds, new marginal investments become less valuable and more prone to allocation by corruption. The giddy booms of earlier times wear off, and suddenly not every decision seems wise. The combination can lead to an economic crackup — not because aggregate demand is too low, but because the economy has been producing the wrong mix of goods and services.
To keep its investments in business, the Chinese government will almost certainly continue to use political means, like propping up ailing companies with credit from state-owned banks. However, whether or not those companies survive, the investments themselves have been wasteful and that will eventually damage the economy. In the Austrian perspective, the government has less ability to set things right than in Keynesian theories.
Furthermore, it is becoming harder to stimulate the Chinese economy effectively. The flow of funds out of China has accelerated recently, and the trend may continue as the government liberalizes capital markets and as Chinese businesses become more international and learn how to game the system. Again, reflecting a core theme of Austrian economics, market forces are overturning or refusing to validate the state-preferred pattern of investments.