Robert J. Samuelson: China, Japan, made similar market mistakes

The questions that now face China are whether it can maintain its own internal stability and contribute to the vitality of the wider global economy. Like many economic juggernauts before it – Japan springs to mind – China seemed unstoppable. Its economy hummed along at the almost unimaginable annual growth rate of about 10 percent. No obstacle seemed beyond its power to surmount. After the 2008-09 financial crisis, it adopted a huge stimulus package equal to about 13 percent of its gross domestic product (GDP). Growth resumed, and China’s leaders were widely praised.

It now turns out that the Chinese – like the Japanese – are not infallible. Indeed, after allowing for differences in historic circumstances, China and Japan seem to have committed similar mistakes. Japan had relied on exports and business investment until an appreciating exchange rate in the mid-1980s undermined the price competitiveness of its exports. It then adopted an easy monetary policy, which led to bubbles in real estate and stock prices. Similarly, China depended on export-led growth and, when the financial crisis dampened trade, switched to a massive expansion of credit to finance infrastructure projects and more investment in heavy industry.

The trouble for both the Japanese and the Chinese was that these credit-driven booms were temporary. Japan’s bubbles burst (the stock market index is still below its 1989 peak). China’s bubbles left surplus production capacity in heavy industries and some sprawling residential developments that are largely empty. China’s leaders seem to have accepted the need for a new economic model – one that relies on consumer spending as the main engine of growth. But changing in theory and changing in practice are not the same.

China’s economy is clearly weakening, and its growth is probably below the government’s target of 7 percent – perhaps way below. In August, China’s manufacturing index fell to its lowest point in three years. Also worrisome are weakening electricity production and railroad freight shipments. But in a report, economists Donna Kwok and Tao Wang of UBS discount these developments. About 70 percent of electricity consumption comes from industry, which is being de-emphasized. As for rail traffic, much of it involves coal movements for power plants; with weak electricity use, that’s diminished.

China’s economy isn’t near collapse, write Kwok and Wang, although they acknowledge serious problems. The biggest is housing overinvestment, which has reduced construction and the demand for building materials (steel, cement). The stock market’s plunge has also left a bitter aftertaste. But good news gets overlooked, they say. In July, sales of retail goods were up 10.3 percent from a year earlier; smartphone sales rose 32 percent. The job market remains strong, and stocks represented, at their peak, only 12 percent of household wealth.

Economist Nicholas Lardy of the Peterson Institute, a China expert, agrees. “Wages and disposable income are still going up,” he says. “Consumption is rising.” But it’s being led by services, which represent nearly half of GDP, and not industrial goods, which account for slightly more than a third. “There’s been a lot of spending on health care, education, tourism and entertainment,” Lardy says. He cites one chain of movie theaters whose revenues were up 40 percent in the first half of 2015.

Regardless, China’s slowdown has already had global consequences. The country’s voracious appetite for raw materials (oil, grains, minerals) fueled a commodities bubble that has now burst. Prices soared and have now fallen sharply; there’s surplus mining capacity in many metals. Commodity producers from Australia to Brazil to Saudi Arabia have been hit hard. They (and almost everyone else) overestimated China’s long-term growth prospects. Their miscalculation represents a huge drag on the global economy.

More tricky is the connection between economics and politics. Will most Chinese adjust to the slower growth, still rapid by Western standards? Or will weaker growth discredit the Communist Party? Will China become more nationalistic and mercantilist abroad to distract from domestic disappointments? Lardy thinks the regime’s leaders feel safe as long as job creation remains strong – as it has been. In the first half of 2015, he reports, the number of nonfarm jobs grew by an impressive 7.2 million. The service sector is twice as labor intensive in its hiring as the industrial sector, he notes.

Still, there remains the troubling Japanese analogy. After the collapse of the export-led economic model, Japan never really found an adequate replacement. Its economy has stumbled along from one “reform” to another. In many years, growth averaged less than 1 percent. This was a radical break with the past. If China experiences something similar – even with growth exceeding 1 percent – it’s hard to imagine its leaders reacting with Japan’s passivity.