A tongue-in-cheek economic indicator with an uncanny track record of accuracy is that any country building the world’s tallest building will shortly thereafter enter recession. Malaysia completed the Petronas Towers in 1998, just in time for the Asian financial crisis. In 2000, the US took the top spot by adding an antenna to the Willis Tower. The global financial crisis was not far away; but more importantly, the building was originally completed (as the Sears Tower) in 1973, and the US entered recession a year later, in 1974. The commencement of construction on the building that is currently the world’s tallest, the Burj Khalifa in the UAE, was followed in short order by the bursting of that country’s real estate bubble and a deep recession.
There is a good reason the indicator works so well: the taller a building is, the more of its lower floors are lost to elevator space (because every elevator shaft needs to reach the ground). There are ways around this problem, most recently elevators that decide for themselves on which floors they will stop (in case you have not visited New York recently, you key in your desired floor on a keypad, and a display shows you which elevator car to take). Despite such advances, constructing tall buildings tends to be uneconomic, and so it only happens when a country is in the throes of an asset price bubble – usually, a bubble that is about to burst.
Of course, there are countries that have defied the fates. Specifically, there are two: Taiwan, which, despite the construction of Taipei 101 in 2003, has so far avoided a crash. And China.
The Shanghai World Financial Center, completed in 2008, held the title of “world’s tallest” only very briefly. And yet, according to this indicator, China does seem overdue for trouble. Schemes to construct the world’s tallest building have come thick and fast from China – most recently Sky City in Changsha, and now Phoenix Towers in Wuhan.
So, is China due for an economic meltdown? There are two reasons to think not. They are very good reasons, and until recently, I had been convinced that Chinese growth would remain stable.
The first reason is that, when it comes to stimulating the economy, China’s government has not yet begun to fight. The country’s fiscal position is, one could argue, the best fiscal position of any major world economy. The budget deficit will be only 2.3 percent of GDP this year, according to Oxford Economics (against 4.3 percent for India, 4.1 percent for Brazil, 5.9 percent for the US, and 7.7 percent for Japan). The ratio of government debt to the economic output is even more extraordinary: less than 17 percent, against about 60 percent for Brazil and India, 126 percent for the US, and 277 percent for Japan.
In terms of the soundness of government finances, China is a global outlier. If China needs to spend a fortune to stimulate its economy, it can. Of course, in the wake of the global financial crisis, we have learned to worry about contingent liabilities. Ireland in 2007 also had a very good fiscal position. But after an expensive bank bailout, Ireland went from an exemplary debt-to-GDP ratio of 29 percent to an unaffordable ratio of roughly 130 percent, almost overnight, and thus Ireland itself required a bailout, from the European Union.
Still, China’s fiscal position and external position are so good that even in a worst-case scenario, it is hard to imagine China ending up with this kind of problem. Ireland’s ratio of external debt (including bank debt) to GDP was more than 850 percent in 2007; hence the country’s troubles after the bailout. The equivalent statistic in China today is about nine percent. Even if China needs to bail out its banks, it is not going to face Ireland’s troubles.
The second reason not to worry about an economic crisis in China is that China’s economy should be slowing down. As result, China’s slower economic growth rate – from about 10 percent per year over the past few years to about 7.5 percent in 2014 – is not necessarily a sign of trouble.
China is becoming richer, which means a lot of the low-hanging fruit – efficiency gains that could be realized by shifting people from unskilled agricultural labor into unskilled manufacturing labor – is gone. China’s rise as the world’s workshop was stunningly rapid, not only in terms of the economic growth this produced but in terms of the resulting disruption to the world’s trade and production patterns. Manufacturing facilities around the world found themselves hopelessly out-competed by Chinese operations that only a few years before did not exist.
This process will continue, in higher value added industries like pharmaceuticals and aerospace. But becoming competitive in these industries will be much harder. China’s workers will need more time-consuming training; the business processes involved will be harder to replicate; China’s competitive advantage will be slimmer; companies in other countries will have more time to adjust; and China’s growth rate will be slower. Oxford Economics industry models still forecast China’s share of world output in sectors such as pharmaceuticals to rise inexorably. China still has a lot of catching up to do. But this will take time.
Thus there are good reasons to think that China can manage its current slowdown (and indeed, leading indicators are currently signalling a turnaround). Oxford Economics’ house view is that China’s growth will remain stable, slowing to a bit less than 7 percent over the medium term. And yet, one of the most popular economic scenarios Oxford Economics produces is a China crisis scenario. And lately, I have begun to worry.
While China’s growth slowdown is expected, it will be a delicate transition. In addition to moving into higher value added industries China must rebalance its growth away from investment and exports and towards domestic consumption. China’s economy is simply too large – by some measures, the world’s second-largest – for the country to be able to rely on foreign demand as the main engine of growth. Like the US, China needs to consume much of what it produces domestically. This process of rebalancing is, broadly speaking, embraced by China’s leadership.
That said, through no fault of China’s, this rebalancing is happening under intense pressure. The economic slowdown that accompanied the global financial crisis had the impact of accelerating the shifts in the economic environment that China faces. China expected, eventually, to rely on its own consumers to generate demand; but this shift came early as economies around the world contracted. China expected, eventually, to face intensified international competition as it moved into higher value-added industries; but this shift also came early as China’s competitiveness plummeted thanks to relative wage movements in the wake of the crisis (see graph).
An unready China responded to this pressure with an expansion first of bank credit, and more recently, with a rise in credit from the “shadow banking” sector (in China, this refers primarily to loans extended from one non-financial company to another). Rather than trying to rebalance at breakneck speed, China’s leaders appear to have attempted to keep the economy moving by propping up investment with easy credit.
It would be hard to begrudge China some stimulus. What is worrying is that in 2014, seven years after the crisis, even as Western economies recover, this stimulus is still going on. Indeed, it appears to be accelerating. Credit growth in China is now so rapid that over the past six months, China’s debt to GDP ratio has risen from 234 percent to 250 percent, an increase of 17 percentage points. The level of 250 percent is itself worrying. This is very close to the level in advanced economies such as the US and UK. Even more worrying is the fact that, seven years after the crisis, the direction is wrong. As the advanced economies recover, China should be able to turn off the stimulus taps.
In this context, recent news that China’s economy is bouncing back may be a bad sign. The more China carries on growing without rebalancing, the worse the eventual adjustment is going to be, probably involving a lot of sorting out of bad loans.
That said, China has learned a great deal from Taiwan, the other country that built the world’s tallest building and has (so far) avoided a crash. Taiwan has on hand a huge war chest of savings to battle any economic crisis. China’s war chest is even larger: nearly $4 trillion in foreign exchange reserves. Hopefully that will be enough to see the country through the messy adjustment ahead.