Overhauling China

LONDON – Pessimism about China has become pervasive in recent months, with fear of a “China meltdown” sending shock waves through stock markets worldwide since the beginning of the year. And practically everyone, it seems, is going short on the country.

There is certainly plenty of reason for concern. GDP growth has slowed sharply; corporate-debt ratios are unprecedentedly high; the currency is sliding; equity markets are exceptionally volatile; and capital is flowing out of the country at an alarming pace. The question is why this is happening, and whether China’s authorities can fix it, before it is too late.

The popular – and official – view is that China is undergoing a transition to a “new normal” of slower GDP growth, underpinned by domestic consumption, rather than exports. And, as usual, a handful of economic studies have been found to justify the concept. But this interpretation, while convenient, can provide only false comfort.

China’s problem is not that it is “in transition.” It is that the state sector is choking the private sector. Cheap land, cheap capital, and preferential treatment for state-owned enterprises weakens the competitiveness of private firms, which face high borrowing costs and often must rely on family and friends for financing. As a result, many private firms have turned away from their core business to speculate in the equities and property markets.