Economic failures are still within levels that are manageable

As an important China observer who lives in Beijing, Michael Pettis has focused on China's economic growth constraints for years. His new book, Avoiding the Fall: China's Economic Restructuring, is a timely and interesting insight on how China can successfully rebalance its economy.

Pettis has made an interesting observation in his book that China's growth could collapse in the next three years if it does not urgently reform its economic model.

He says that debt has reached unsustainable levels and China's investment-led model needs to be replaced by one in which consumption plays a bigger role. Though the government can consider further reforms, it would mean GDP growth of 4 to 5 percent for the next 10 years.

While I do agree with the general reasoning that China's economic growth model is unsustainable and consumption needs to play a bigger role, the detailed predictions are arguable.

When we talk about economic crisis and GDP growth in China we need to be careful as they have different connotations within the institutional framework.

Normally when we talk about economic crisis, we are often talking about economic crisis in the context of a free market. But when we consider China's strong government and the dominance of the state-owned economy, the concept may not be the same.

In a market-driven economy, when there are bubbles in asset prices, the market tends to correct itself through economic crises. However, in China the price anomalies can also be due to the government.

Bad debts due to inefficient investments can cause bankruptcies of banks in a market-driven economy, but in China the state-owned banks can put bad debt packages into state-owned asset management companies.

In such an institutional background, anyone who predicts an "economic crisis" in China should take a second look at the meaning of crisis. Pettis's "collapse within three years" can hardly be a real picture of China whether there are reforms or not.

In fact, there is not really any economic crisis or collapse in China especially if the crisis means sharp asset price drops, a large number of corporate bankruptcies, mass unemployment, bank failures and economic stagnation.

The truth is that instead of economic crises, there are only economic failures in China's institutional background since the government can control the seriousness of market crashes and stretch the pains of economic failures into the far future by increasing taxes, reducing social welfare, selling state assets and issuing more money.

Let's also look at the difference of GDP growth in China, a public ownership dominated country, and other private ownership dominated countries.

Pettis has predicted that even if China's government can turn its investment-led model to one in which consumption plays a bigger role, China's GDP growth will slow to 4 to 5 percent over the next 10 years.

While this prediction is in line with common perceptions that the GDP growth of a country cannot always be in double digits, I would argue that growth of 4 to 5 percent is too conservative.

China's GDP is not the same as private ownership dominated countries. Since privately-owned property is easily traded in the market, the economic activities that add value to it can easily be calculated for GDP growth. For a public ownership dominated country, the change of ownership from public to private or the entrance of public assets into the market can rapidly increase GDP.

Land is often regarded as the main wealth of a country. In China, the government owns most of the land. During the process of rapid urbanization, rural collective ownership of the land changes to city public ownership. As a result of this low land prices start appreciating considerably.

Since the increased value of land and the buildings on them will be included in GDP growth and China's urbanization process has only been half completed, the GDP growth of China cannot be very low.

China's per capita GDP is only a 10th of the US', its application of technology is not really wide, and there is still a long way before it becomes a free-market economy. Improvement of these factors can support faster growth of China's GDP.

Considering the above factors, though it is hard to forecast GDP growth, the prediction of 4 to 5 percent growth in the next 10 years may appear to be conservative.

The author is a lecturer at the Management School of Shanghai University and a research fellow at the China Europe International Business School Lujiazui International Finance Research Center.

(China Daily European Weekly 03/21/2014 page19)