Opinion & Commentary
Will the China boom last? – don’t bet your house on it
Ask anyone in Western Australia whether China presents an economic risk or opportunity and there will be few takers for the former - and with good reason. While other major economies such as America and Japan appear to be teetering, China keeps booming. The rate of development in China is equivalent to the construction of a Brisbane-sized city every month. This needs an enormous amount of raw materials. No wonder resource rich states like Western Australia are thriving.
The latest study by the Australian Bureau of Agricultural and Resource Economics (ABARE) study predicts record income for mineral and energy commodities in the year ahead, largely driven by a booming Chinese market. Although unit returns for some commodities are expected to fall compared to the previous year, export earnings are still expected to rise by 4 percent according to the study. The study comes on the back of the $45 billion gas deal struck between Woodside and PetroChina.
Profits do not lie: China has provided many resource companies, its employees, and shareholders with a once in a lifetime opportunity. Current house prices such as those in central and northern Perth is proof that much money has been made from the commodities boom. Across the board house prices in Perth rose a phenomenal 45 percent in 2006. But has it been on the back of a Chinese boom or Chinese bubble? And how long can it last?
Economists and forecasters have been asking this question for years. Up to now, the verdict has been optimistic. China’s boom, even if it slows down a little, has a lot more distance to run. For resource companies in WA, and those industries like construction and engineering that enjoy flow-on benefits, the challenge has been to find enough skilled workers to keep up with demand.
But the tide of optimism is turning and those in Perth betting their houses on a continued Chinese boom should reassess. As all good financial advisers keep telling us: past performance is no guarantee of future returns.
.
At the most recent National People’s Congress in March 2007 – the annual meeting of the state’s highest body – Chinese Premier Wen Jiabao warned “the biggest problem with China’s economy is that growth is unstable, unbalanced, uncoordinated and unsustainable.” This was an extraordinary public assessment by a leader of a country trading on the hype of success.
But it was not an off-the-cuff remark. Premier Wen made it during a televised address. He repeated it at the follow-up press conference, and has made similar remarks ever since. Strangely enough, few commentators in Australia have picked up on it. But that will soon change.
We need to understand the unique strategy that Chinese leaders have used to achieve their ‘economic miracle’.
It is all about state-directed money recycling. About three quarters of Chinese growth comes from capital investment. State-owned-banks offer cheap capital to mainly state-owned-enterprises who in turn pour money into investment projects.
What’s wrong with this approach? There is ample evidence that this state-directed forced-feeding strategy is unsustainable.
First, World Bank findings indicate that about one third of all recent investments are wasted, and it is rising. In the 1980s and 1990s it took $2-3 of new investment to produce $1 of additional growth. It now takes about $5 invested for $1 of additional growth. Incidentally, this is worse than even during the Mao period in which it took $3 of investment for $1 of growth.
Second, China is suffering the effects of massive and chronic ‘overinvestment’, over-capacity, and declining productivity. About nine out of ten manufactured goods are in over-supply and have been for almost a decade. Chinese companies keep pumping money into making goods, building roads and infrastructure, and erecting buildings that are not used or needed. No wonder achieving growth is becoming less efficient. The Chinese are clearly getting less and less bang for their buck.
When making foie gras, the French force-feed the geese to artificially enlarge the liver just prior to slaughter. In China, it is economic growth that is artificially fueled and force-fed. The Chinese know, better than anyone else, that this approach has almost run its course and are finally admitting as much.
The September ABARE study cautions against the possible consequences of the American subprime fallout but is sanguine about the prospects for continued Chinese growth. But the concern raised by the study about inflationary pressures in the Chinese economy is just the tip of the iceberg. The Chinese model is fundamentally unbalanced.
It is sensible to make hay while the sun shines. But it is time to reassess whether banking on continued growth in China is becoming more risky than good sense.
Dr John Lee is a Visiting Fellow at the Centre for Independent Studies. His book, Will China Fail?, will be released by CIS later this month.
