Why China Can’t Adjust

CLAREMONT, CALIFORNIA – China’s current economic slowdown has no shortage of causes: Europe’s financial turmoil, sputtering recovery in the United States, and weak domestic investment growth, to name the most commonly cited factors. Since exports and investment account, respectively, for 30% and 40% of China’s GDP growth, its economy is particularly vulnerable to weakening external demand and accumulation of non-performing loans caused by excessive and wasteful spending on fixed assets.

But China’s vulnerability to these factors, as serious as they are, is symptomatic of deeper institutional problems. Until these underlying constraints are addressed, talk of a new consumption-based growth model for China, reflected in the government’s recently approved 12th Five-Year Plan, can be no more than lip service.

After all, China’s major trading partners, international financial institutions such as the World Bank and the International Monetary Fund, and senior Chinese officials themselves have long recognized the structural vulnerabilities caused by excessive investment and low household consumption. And, for nearly a decade, China has been urged to undertake reforms to redress these economic patterns, which have undermined the welfare of ordinary Chinese and strained the global trading system.

The best-known feature of China’s macroeconomic imbalances is heavy dependence on exports for growth, which is typically attributed to weak domestic demand: as a middle-income country, China lacks the purchasing power to consume the goods that it produces. With nearly unlimited access to advanced-country markets, China can tap into global external demand and raise its GDP growth potential, as it has done for the past two decades.