China’s economy is at a tipping point

China’s economy is at a tipping point

Shuaihua Wallace Cheng
China has narrowly escaped major financial crises for over two decades. But the good times may soon be over — and not because of the recent stock market crash.

The roller coaster of Chinese stock prices this summer has triggered debates about whether China now faces a serious economic crisis. The Telegraph compared China’s equity bubbles to the situation that led to the 1929 Great Depression. The New York Times and Fortune, on the other hand, have argued that the equity bubbles are merely false alarms, and fears about China are overblown.

In the short term, the latter argument is more convincing: China’s equity crisis has affected fewer than 15 percent of Chinese households. And the majority of these middle class investors have only lost money gained a few months earlier, when stock prices spiked. Even after the recent crash, the Shanghai Stock Exchange’s Composite Index still stands 1,000 points higher than it did in July 2014. And Chinese authorities still have the power and flexibility to mobilize economic growth. But while the Chinese economy is unlikely to crash anytime soon, China nonetheless faces a high probability of being the next major power to face an economic collapse.

One major reason is industrial overcapacity. Overcapacity is not new in China, but in sectors such as iron and steel, glass, cement, aluminum, solar panel, and power generation equipment. According to the China Iron and Steel Association, oversupply has depressed steel prices so much that the profit from producing one ton of steel cannot even pay for an ice cream cone. Industrial overcapacity has become a time bomb that threatens the Chinese economy because it has led companies to take on debt to repay loans. As of 2014, Chinese iron and steel companies collectively have $489 billion in debt. The publicly-listed solar panel manufacturing companies collectively have as much as $19 billion in debt. The combination of economic slowdown, excess production in manufacturing and rising debts at the macroeconomic level may cause a massive wave of firm closures and bad loans.

If this bomb detonates, the repercussions could be extraordinary. Because China does not have the mature social safety net of a country like Japan, and also lacks the political stability of the United States, it could face not only an economic blow-up but also serious social and political upheaval.

To avoid a crisis, Xi and his policymakers must focus on reining in China’s overcapacity problem.

First, Xi should set up strict rules for local governments that regulate tax concessions, and ensure that all government subsidies to private firms are transparent. Based on these rules, Xi could better guide the country’s economic transition towards an innovation and services sectors economy. Secondly, Xi and his administration should allow and even encourage bankruptcy liquidation of failed firms, in spite of opposition from local governments. 

Thirdly, Xi’s government needs to accelerate reforms of China’s financial markets. In the current financial system dominated by state-owned banks, firms focus on growing as big as possible rather than innovating, which is leading to overcapacity. China must encourage private equity, small and medium enterprises bonds, and equity crowd-funding, and it should allow the development of community and village banks that serve local firms. 

Finally, Xi should promote freedom of the press, which plays a crucial role in economic development, poverty reduction and the establishment of good governance. 
Xi should be confident, but not complacent.

Shuaihua Wallace Cheng is a Reuters columnist.