Martin Wolf says that China’s economy could topple into depression.
By Gary Scarrabelotti
On March 19, in Australia fragilis, Scarra Blog argued that Australia’s future prospects rest uneasily upon a a Chinese property boom.
In an article in the Financial Times on 2 April, entitled “Beware: China’s economy could topple”, Martin Wolf explored the signs of a steep slow down in the Chinese economy and sets out the risks for China, and the rest of the world, as China attempts the transition from a high-investment, high-growth economy to a lower-investment, lower-growth economy.
The risk is that China will experience its own Japan moment and, instead of smoothly shifting economic gear, the change from one level of economic performance to another will be executed poorly and the country will slide into depression:
Here are the key passages from Wolf’s article:
“As the experience of Japan has shown, managing a shift from a high-investment, high-growth economy to a lower-investment, lower-growth economy is very tricky. I can envisage at least three risks.
“First, if expected growth falls from over 10 to, say, 6 per cent, the needed rate of investment in productive capital will collapse: under a constant incremental capital output ratio the fall would be from 50 per cent to, say, 30 per cent of GDP. If swift, such a decline would cause a depression, all on its own.
A decline in China’s growth is likely to mean a rise in bad debts.
“Second, a big jump in credit has gone together with reliance on real estate and other investments with falling marginal returns. Partly for this reason, the decline in growth is likely to mean a rise in bad debts, not least on the investments made on the assumption that past growth would continue. The fragility of the financial system could increase very sharply, not least in the rapidly expanding “shadow banking” sector.
“Third, since there is little reason to expect a decline in the household savings rate, sustaining the envisaged rise in consumption, relative to investment, demands a matching shift in incomes towards households and away from corporations, including state enterprises. This can happen: the growing labour shortage and a move towards higher interest rates might deliver it smoothly. But, even so, there is also a clear risk that the resulting decline in profits would accelerate a collapse in investment.”
Australia, be warned; Australia, get ready.