Is the Chinese economy overheating?

The overproduction in China is partly a result of the global recession that has caused demand for exports to be very much reduced. However, China will attempt to compensate to some degree for this by increasing domestic demand. The domestic market itself could be huge and no doubt there could be much greater demand within that market if credit is made available to Chinese consumers. However, Cowen could be correct that there still may be a bubble that will burst. However, I think that it is the US that needs to worry more about its economy than China at this stage and it is the US not China that needs to worry about debt!

The New York Times / November 29, 2009

Economic View
Dangers of an Overheated China

By TYLER COWEN

PRESIDENT OBAMA’S recent trip to China reflects a symbiotic
relationship at the heart of the global economy: China uses American
spending power to enlarge its private sector, while America uses
Chinese lending power to expand its public sector. Yet this
arrangement may unravel in a dangerous way, and if it does, the most
likely culprit will be Chinese economic overcapacity.

Several hundred million Chinese peasants have moved from the
countryside to the cities over the last 30 years, in one of the
largest, most rapid migrations in history.

To help make this work, the Chinese government has subsidized its
exporters by pegging the renminbi at an unnaturally low rate to the
dollar. This has supported relatively high-paying export jobs;
additional subsidies have included direct credit allocation and
preferential treatment for coastal enterprises.

These aren’t the recommended policies you would find in a basic
economics text, but it’s hard to argue with success. Most important,
it has given many more Chinese a stake in the future of their society.

Those same subsidies, however, have spurred excess capacity and
created a dangerous political dynamic in which these investments have
to be propped up at all cost.

China has been building factories and production capacity in virtually
every sector of its economy, but it’s not clear that the latest round
of investments will be profitable anytime soon. Automobiles, steel,
semiconductors, cement, aluminum and real estate all show signs of too
much capacity. In Shanghai, the central business district appears to
have high vacancy rates, yet building continues.

Chinese planners now talk of the need to restrict investment in
sectors that are overflowing with unsold products. The global market
is no longer strong, and domestic demand was never enough in the first
place.

Regional officials have an incentive to prop up local enterprises and
production statistics, even if that means supporting projects or
accounting practices that are not sustainable. For an individual
business, the standard way to get more capital resources is to put
forward a plan for growth. Because few sectors are mature, and growth
has been so widespread, everyone can promise to be profitable in the
future.

Over all, there is a lack of transparency. China’s statistics on its
gross domestic product are based more on recorded production activity
than on what is actually sold. Chinese fiscal and credit policies are
geared toward jobs and political stability [unlike, say, in the
U.S.?], and thus the authorities shy away from revealing which
projects are most troubled or should be canceled.

Put all of this together and there is a very real possibility of trouble.

China has had a 30-year run of stellar economic growth. But it’s only
human nature for such expansion to breed too much optimism,
overextending an entire economy. Americans have found this out the
hard way in their own financial crisis.

History has shown that no major economy has grown into maturity
without bubbles, crises and possibly even civil strife or civil wars
along the way. Is China exempt from this broader pattern?

The notions of excess capacity and malinvestment were common in
business-cycle theory of the 19th and early 20th centuries, when
growing Western economies had frequent crashes of this kind. Numerous
writers, from the Rev. Thomas Malthus to [Karl Marx to] the Austrian
economist Friedrich A. von Hayek, warned about the overextension of
unprofitable capital deployments and the pain from the inevitable
crashes. These writers may well end up being a guide for understanding
China today.

What will the consequences be for the United States if and when the
Chinese economic miracle encounters a major stumble? A lot of Chinese
business ventures will stop being profitable, and layoffs and unrest
will most likely rise. The Chinese government may crack down further
on dissent. The Chinese public may wonder whether its future lies with
capitalism after all, and foreign investors in China will become more
nervous.

In economic terms, the prices of Chinese exports will probably fall,
as overextended businesses compete to justify their capital
investments and recoup their losses. American businesses will find it
harder to compete with Chinese companies, and there will be
deflationary pressures in both countries. And even if the Chinese are
selling more at lower prices, they may be taking in less money over
all, so they may have less to lend to the United States government.

In any case, China may end up using more of its reserve funds to
address domestic problems or placate domestic interest groups. The
United States will face higher borrowing costs, and its fiscal
position may very quickly become unsustainable.

That’s not so much a prediction as a very possible contingency, and we
should be prepared for it. For now, we should avoid two big mistakes.
The first would be to assume that just because borrowing costs are now
low, we can postpone fiscal responsibility and keep running up the tab
— with the aid of Chinese lending, of course. The history of financial
crises shows that turning points can come swiftly and without much
warning. [I don't get this.]

The second mistake would be to demand too many concessions from the
Chinese. What we see in the numbers today are a growing China and a
somewhat ailing America. Yet there’s a real chance that, soon enough,
Chinese economic weakness will be a bigger problem than was Chinese
economic strength.

Tyler Cowen is a professor of economics at George Mason University.