China: A New Economic Model?

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A few days ago on Curious Capitalist, I asked whether China was headed for trouble due to the potential damage done to its banking system by the government’s giant stimulus program. One of our readers, identified as tanboontee, was kind enough to write a very interesting comment. Here’s an excerpt:

Excessive debts in the west support lavish lifestyles, not necessarily so in China. Do not forget that capitalism is already malfunctioning. What’s wrong with introducing a new paradigm?

This has become a common view, not just out here in Asia, but around the world. Many observers believe China has developed a “new paradigm,” a superior economic model that challenges the dominance of Western ideas about economies. But I have a question for tanboontee, and for anyone else who wants to jump in on this discussion – what exactly is this “new paradigm?” From what I can tell, China is employing economic tools that many other countries have tried in the past, with both good and bad results.

First of all, China has generated its rapid growth using the same policies as the rest of Asia. The basic strategy looks something like this: Jumpstart growth by capitalizing on low-wage labor to produce cheap exports for consumers in the West. Take advantage of globalization – free trade, international flows of capital – to raise incomes at home. Tap into giant pools of domestic savings with pro-business policies to spur high levels of investment. Japan, South Korea, Taiwan, Singapore and others all did exactly the same thing (using somewhat different policy menus.) China, therefore, isn’t doing anything all that unique.

Trade. Investment, Exports. Private Enterprise. These are the basic building blocks of growth, in China and the rest of Asia. In a word: CAPITALISM. (Warning: Shameless self-promotion coming up: If you want to know more about how Asia became so rich, so fast, it’s the subject of my book, The Miracle: The Epic Story of Asia’s Quest for Wealth.)

What supposedly makes China “different” and gives its economy a special edge is the larger role of the government, in the form of state ownership of banks and companies, controls on capital flows, and other measures. But again, China is following in the footsteps of the rest of Asia. South Korea used capital controls and state-owned banks as part of its early development strategy. Japan’s bureaucrats employed all kinds of tools to direct bank lending to favored projects. Nor is China’s attempt to “mix” together state-dominated and free market-oriented sectors terribly unusual. That’s the basis of Singapore’s economic model. It was also tried in the “mixed” economies of Europe, and India under the License Raj.

But what we’ve learned from these examples from history is that the state-led aspects of “mixed” economies can create as much harm as good. Bureaucratic meddling was a key factor behind Japan’s Lost Decade(s) and the Asian financial crisis of 1997. The sickest part of the “mixed” economies in Europe and India was state-controlled industry. And you can make the case that the same is true in China today. The major troubles facing the Chinese economy right now – ballooning property prices and a looming bad loan problem – are a result of bureaucrats thinking they can turn on and off the banking sector like a desk lamp. A hefty portion of the loans made during last year’s credit explosion went to state companies and local governments – a sign that perhaps this lending was driven by government policy, not necessarily the actual needs of the economy.

It’s noteworthy as well that tanboontee mentions the risky consumer-credit practices that got the U.S. into trouble. It is true that banks in China tend to lend for investment, not consumption as in America. But from the standpoint of the bank, it doesn’t much matter who the end borrowers are – as long as they pay the loans back. Whether a Florida family who used a home equity loan to buy a flat-panel TV can’t meet its payments, or a Chinese company that invested in an unnecessary steel mill defaults, a hole in the bank’s balance sheet is created either way. The practices of Chinese banks aren’t a sign that China is following some kind of “new paradigm.” They could possibly be a repeat of the same mistakes that got the West into its financial crisis.

So how is it again that China is rewriting the rules of economics? Anybody? Anybody?

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