China’s economy has been slowing down. In fact, the Wall Street Journal reported that the GDP of China’s economy has dropped from 7.2% at the end of 2014 to 6.4% in June 2016. Despite China’s economic slow down, the Chinese economy is still doing fine. However, there are some problems in China’s economy, including the misallocation of capital and rising private debt. These problems are important to analyse because both could create larger economic problems for China that could lead to financial instability.
The Misallocation Capital
In an effort to increase economic activity in China, the Chinese government has increased the number of new project approvals. This has led to capital being over-allocated to the production of coal plants. For example, the New York Times has explained that several coal plants are being built-in China that could potentially operate at 5,500 hours per year. However, the amount of coal plants in China surpass demand by so much that these coal plants operated at an average of only 4,300 hours. Next year, these factories are expected to operate at an average of 3,600 hours. It is important to note that the Chinese government has been trying to fix this misallocation of capital. Beijing has published guidelines to stop the approval of new coal plants, however, the new guidelines do not apply to coal plants currently under construction.
Ghost cities are another result of the misallocation of capital in China. Ghost-cities are cities that have nearly zero inhabitants. In China, rapid development and the misallocation of capital has led to the development of many ghost cities. Other states going through rapid development, including Brazil and India, have also built ghost towns and cities, but not to the same degree as China. This is because in China municipal governments can easily and cheaply buy rural land to build cities. According to the Wall Street Journal, this leads to government officials building cities for prestige or to provide jobs to friends. Also, the ghost cities built-in China do not cater to the needs of the general population. For example, the cities do not have many necessities, such as schools or hospitals.
In order to ensure the growth of China’s economy, Beijing has continued to increase demand by increasing credit. In other words, the Chinese government has continued to encourage corporations, many of which are state-owned enterprises, to borrow more money so the corporations can spend more money. This may have increased the size of China’s economy, but it also increased Chinese debt. In fact, The Economist explains that at the end of 2015 private debt was about 240% of GDP. With this increase in debt, private companies are less able to invest in projects, due to the increase in interest payments that come along with an increase in debt. Additionally, many state-owned enterprises are not earning enough to service their debts.
Protection From Financial Instability
Just like any other state’s economy, China’s economy has its faults. China’s misallocation of capital promotes wasteful spending and increases debt. Additionally, growing debt in China could cause a decrease in aggregate demand. Both of these factors could lead to a recession or could cause other economic problems. However, China’s GDP is still high when compared with many other states. The Chinese government also has a surplus, a large amount of foreign exchange reserves, and China’s debt is mostly owned domestically. All of these factors protect China from financial instability. But financial instability in China is not implausible. It is important to look at the problems in China’s economy and research the best policies to address issues in China’s economy. If these problems continue to go unaddressed then there will be a higher likelihood of financial instability affecting China and the World in the future.
Image: The Economist, BIS