Can the Earth support Chinese growth? The coming boom-bust cycle

International Economy, The, Fall, 2004 by Tadashi Nakamae

In the hope of stimulating a lively debate, let us consider four scenarios for the economic performance through 2015-20 of China and Japan, relative to each other, and relative to appropriate growth paths for a developing and an industrialized economy--say 7 percent for China and 3 percent for Japan. The four scenarios to the left are followed by questions for discussion below.

Question: Which scenario would most seriously undermine the security status quo in Asia?

Answer: Scenario One.

Question: Which scenario would be worst from the viewpoint of global economic growth?

Answer: Scenario Two.

Question: Which scenario, by concentrating the world's resources in Asia, would most seriously threaten the U.S. position as the world's sole super power?

Answer: Scenario Four.

Question: Which scenario, therefore, might the United States see as the most desirable of the four?

Answer: Scenario Three.

Question: Which scenario is associated with the greatest country risk for China?

Answer: Scenario Three.

Question: Which scenario runs most contrary to the general prevailing mood of optimism on China and of pessimism on Japan?

Answer: Scenario Three.

Scenario Three thus emerges as perhaps the most intriguing--if not necessarily the most likely--of the four scenarios.

I have long argued that the first part of Scenario Three--sustained Japanese recovery is not an impossibility. It is becoming more difficult as Japan's population ages and shrinks. Nevertheless, given deregulation and higher interest rates, Japan can still turn things around.

In support of the second part of Scenario Three, I would like--in the role of devil's advocate--to focus on two major downside risks for China; namely

* The risk that the Earth is simply not big enough to sustain rapid Chinese growth;

* The risk that, in the absence of a properly functioning market mechanism, investment-led growth will lead China into one boom-bust cycle after another, with each boom less sustainable than the previous one.

CAN THE EARTH SUPPORT CHINESE GROWTH?

The Chinese economy today is reminiscent of the Japanese economy in 1973, when the first oil crisis drove down Japan's long-term growth rate from 10 percent to 4 percent. But Japan then was a small fish in a big pond. China now is a much bigger fish in a more overcrowded pond.

China's total population is 1.3 billion (ten times that of Japan), of which around 900 million Chinese may be assumed to be of working age. If we assume a labor participation rate of 65 percent, then given that an industrializing economy normally requires around 20 percent of the working population to be employed in manufacturing, this raises the prospect of manufacturing employment in China amounting to 120 million workers--a staggering total when seen against the 80 million for all OECD countries combined.

An early warning sign of the "big fish in a small pond" problem was briefly seen during 2003 when, at the peak of the boom in Chinese infrastructure investment, the world did not seem to have enough resources of iron ore, copper, nickel, and other raw materials for China to gobble up.

Even at the peak of its post-war expansion, Japan never came near to creating such a global shortage of resources.

Chinese growth is liable to be constrained not only by such global shortages of industrial commodities, but also by the limits of its own natural and human resources.

Water is one great problem. The Yellow River is already dry for more than half the year. Water contamination, especially around Beijing, is becoming dire.

Agricultural land is another great problem. Farmers working in the city send money home to build houses on what used to be farmland, in the suburbs of big cities, local governments create new industrial developments on what used to be farmland. While the stock of land available for food production is thus reduced, Chinese people are eating more meat, which, as a means of obtaining nutrition from the land, is many times less efficient than eating rice, grain, and vegetables.

The aging and shrinking of the population is yet another great problem for China--perhaps even more serious for China than for Japan, as the effects of the one-child policy begin to be felt.

CAN CHINA GO BEYOND BOOM AND BUST?

The Chinese way of economic development so far has been massive investment in infrastructure culminating in two or three years of boom, followed by six to eight years of relative bust, followed by another boom.

Thus, during the boom from 1991 to 1993, surging investment in infrastructure was accompanied by rapid inflation. This necessitated tightening measures, as a consequence of which year-on-year growth of fixed capital investment fell from over 50 percent in 1993 to less than 30 percent in 1994 and from there to just under 8 percent in 1997 (see table).

At the peak of the latest boom, in 2003, an influx of foreign capital and a corollary surge in money supply, compounded by speculative anticipation of a rise in value of the Chinese renminbi, caused year-on-year growth of fixed capital investment to climb to 23 percent.