By DAVID KELLAND

How can an authoritarian government control a country of 1.3 billion people in 2015? The answer is simple: Real GDP grows at more than 6% for 34 out of the past 37 years. 

We're obviously talking about China, and the Communist Party's responsibility for this growth is only partial.  The best recipe for economic growth in East Asia in the 20th century (and perhaps of all time) has been to start from a level of gross underdevelopment.  Japan, Taiwan, South Korea, Malaysia, and others have grown at torrid rates by using the export-driven growth model. 

The export-driven growth model is simple. You use domestic financial repression (limit the available investment options for the household savings of your citizens) to mobilize capital at sub-market interest rates for investment in export-oriented industries. This gives your industry a comparative advantage versus other producers and the end result is that those exporting industries employ lots of people and bring prosperity to your citizens. This strategy has an advantage over resource extraction, which conversely tends to employ relatively few people, and the profitability of which is also subject to volatile commodity prices. Natural resource wealth also encourages political instability because would-be dictators see great financial opportunities from a successful coup d'etat. The Niger River Delta is one of the more prominent examples of the resource curse. In any case, the natural resource endowment of East Asia was insufficient to make commodity exporting a viable growth strategy.

China pursued export-driven growth with great success for years as its economy moved from pre-industrial to modern.  In 2009, however, the leadership launched a $586 billion stimulus program in response to the global financial crisis as the crisis sapped demand for China's export.  To put that into context, the United States implemented a $787 billion stimulus program around the same time with an economy that was thrice the size of China's.

Much of China's program was spent on infrastructure in an economy that didn't need it, and most analysts believe that the funds were allocated inefficiently, which was inevitable given the program's size relative to the Chinese economy.  The bad loans (non-performing loans) will impair China's banking sector until the problem is cleaned up with write-downs of those non-performing loans and the banks are recapitalized (given more money).

China also experienced a property bubble in the late 2000s. At the time, savers in China had few attractive investment options available to them. They were unable to directly invest abroad and the local interest rates on deposits were below inflation (remember, domestic financial repression). Negative interest rates can always be relied upon to set off a property market boom, and this time was no different. Furthermore, local governments used land sales to private developers as a significant source of revenue (property taxes are politically difficult in China). Once the property boom ended, however, developers no longer want to buy land and local governments were strapped for cash. Also, millions of property owners (individual and corporate) are now underwater on real estate holdings. 

Moving forward to 2015, the Chinese government engineered a boom in the stock market. Margin trading (buying stock on borrowed money) has only been legal in China since 2010, and combined with low rates available to Chinese depositors (again, domestic financial repression), these factors sent stocks soaring in the first six months of this year. High share prices allowed companies to raise money by issuing new shares and then they used the proceeds to pay down debt.  Every piece of evidence, both quantitative (median price/earnings ratios on Chinese stocks ventured into the 80s) and anecdotal (taxi drivers became respected market analysts) suggests that this will end badly. In the month to July 7th, the Shanghai Composite lost 29% of its value and over $2 trillion of wealth was destroyed.

So we have three major problems: an impaired banking sector, a popped property bubble, and maybe a burst stock bubble, none of which are supportive of economic growth. That combination led Japan to two lost decades in the 90's and 00's after the Heisei Bubble (which included stocks and real estate) popped in 1989. Flat-lining incomes — not to mention wiped out personal savings from gambling in stocks — do not make happy citizens. Of course, the Chinese government, although not actually elected, regularly functions as if there is a party waiting in the wings to seize power. The anti-corruption drive begun by Chinese President Xi Jinping in 2012 shows that the government does respond to the concerns of its citizens, sometimes more decisively than in democracies. But still, this is 2015 and humility from an under-performing government only goes so far. 

While democratic elections may not work any better for China than its current political system (and may pose serious diplomatic problems to the international community on climate change), people like to make their own mistakes. As for the current government, many of its members have already looted the economy through corruption and secured their children's financial futures. Anyway, when economic growth is slowing, why not let somebody else take responsibility for it?

07.07.15