China’s unstable political economy – WSJ
The world is watching Chinese real estate giant Evergrande collapse, and some wonder if Beijing will soon have a moment like the Lehman Brothers collapse in America in 2008. Xi Jinping may be able to prevent the collapse of the housing bubble, but the Chinese economy is not moving towards more sustainable growth. The Evergrande woes are a reminder that China’s political economy under Xi has become even more volatile, even as Beijing grows impatient to supplant America as the dominant power. The time is not on China’s side.
The global financial crisis that began with the collapse of Lehman Brothers in September 2008 resulted in a severe liquidity shortage as financial institutions lost confidence in each other’s ability and business enterprises to repay their loans. The Chinese financial system doesn’t work that way. The loss of confidence in the business value of other entities is not fatal. Instead, banks and other financial institutions infallibly lend if the political masters tell them to.
This happened in 2008, when China’s state-owned banks injected around $ 15 trillion in new capital into the economy for fixed investment projects over the next six years, as export markets grew. North America and Europe were stagnating. It was about 1.5 times the size of the entire U.S. commercial banking system at the time. Politically motivated loans have been a hallmark of China’s political economy ever since.
There are other tools in the Chinese Communist Party’s kit. Loans and bond payment obligations are forcibly rolled over or deferred to ensure that non-performing loans and defaults do not burden the lender’s books. Public and even private companies are forced to buy bonds issued by moribund legal persons. In short, the determinants of liquidity in the Chinese system are political, not commercial – and the Chinese Communist Party has the tactical means to avoid Lehman Brothers for a while.
But don’t the woes of Evergrande prove that Beijing is seriously considering deflating a dangerous real estate bubble, reducing moral hazard in lending and breaking the economy’s dependence on debt, to avoid a terrifying calculation in the future ?
Xi promises to achieve all of this, but the reality is that local governments normally get around a third of the revenue from land sales and real estate transactions. In the 18 months of the pandemic, more than half of local government revenue came from real estate, while corporate and value-added tax revenue declined.
Beijing can’t turn a blind eye to this: Local governments are responsible for providing around three-quarters of all social and public goods such as hospitals and schools. Go beyond the Evergrande brand or companies like it, and their distress will increase fears that guaranteed capital appreciation for real estate assets is no longer a safe assumption.
This would lead to a rapid cooling of the real estate market and cause systemic failures. Purchases of existing and off-plan properties are widely used as collateral for further borrowing, and any rapid deflation in asset values could pose a serious risk to the economy as a whole.
Any permanent slowdown in credit and restrictive credit policies will mean that even more public companies and real estate developers will struggle to honor their debts, putting more companies in Evergrande’s predicament. At the same time, credit issuing institutions in formal and informal banking sectors would experience more defaults from borrowers, which would reduce their ability to issue new loans. This would undermine the only reliable means available to China to generate the growth demanded by policy.
This means that the political economy will remain largely unchanged even if Evergrande is allowed to fail. Evergrande’s “three ups and one down” model – high debt, high leverage, high revenue and low cost – will remain the Chinese modus operandi.
Xi’s pledge to reduce inequality by eliminating billionaires like Xu Jiayin from Evergrande is a smokescreen. The main cause of inequality in China is entrenched privileges for state-owned enterprises and well-connected people at the expense of the truly private economy. Until discrimination against them is reduced, wealth will not be better distributed and household incomes will not increase enough to stimulate and sustain the domestic consumption-led growth promised by Chinese leaders.
Xi is determined to tighten his grip on economic power, to the detriment of the country. He is also eager to challenge American preeminence. China’s material might is formidable and should not be underestimated, but Beijing is not starting from the position of strength it is eager to project.
Mr. Lee is a Principal Investigator at the Hudson Institute and the United States Studies Center in Sydney. He was Senior National Security Advisor to the Australian Foreign Minister from 2016 to 2018.
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