Five Reasons For Optimism About China

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A new report from McKinsey&Company reminds us that things are almost never as bad as they may seem, and that maxim certainly applies to the economy of China. McKinsey analyst Jonathan Woetzel makes a strong case that things are not nearly as bad in China today as many would have you believe, and while the Middle Kingdom is indeed suffering through an economic slump and has some notable structural issues to deal with, these kind of hiccups are to be expected when such a giant economic engine is changing gears.

Woetzel notes: “China’s slowdown is both real and important for the global economy. But news events like this year’s stock-market plunge and the yuan’s devaluation versus the dollar reinforce the refrain, among a chorus of China watchers, that the country’s long flirtation with disaster has finally ended, as predicted, in tears. Meanwhile, Chinese officials, worried about political blowback, are said to ignore advice from outside experts on heading off further turmoil and to be paranoid about criticism.

My experience working and living in China for the past three decades suggests that this one-dimensional view is far from reality.”

In his report, Woetzel deflates five myths about the Chinese economy.

China is “faking” economic growth

One argument for the China hard landing thesis is that it is not structurally capable of developing a sustainable economy. Critics say it does not have a competitive private-enterprise structure and has already captured almost all of the possible value from cheap labor and heavy foreign investment.

Woetzel argues this is an inaccurate perception. Noted academic Nicholas Lardy recently highlighted that the private sector in China is vibrant and tracing an upward trend line. Moreover, the total share of state-owned enterprises in industrial output continues to decline (from 78% in 1978 to 26 percent in 2011).

He also emphasizes that China’s development model mirrors that of other industrializing economies in Asia and elsewhere across the globe. Wotzel says: “The high savings rate, initial investments in heavy industries and manufacturing, and efforts to guide and stabilize a rapidly industrializing and urbanizing economy, for example, resemble the policies that Japan, South Korea, and Taiwan followed at a similar stage of their development.”

China is only capable of minimal innovation

Another argument is that Chinese companies are not innovators, and that they copy instead of invent. Critics also often make the claim the educational system “stomps out” creativity or innovative thought.

Woetzel claims this is another misperception. He points to a McKinsey Global Institute study focusing on areas of Chinese innovation. Woetzel mentions that “process innovations are propelling competitive advantage and growth for many manufacturers.”

He also argues that adapting to fast-changing consumer needs is a form of innovation, and that new leaders like Alibaba and Xiaomi are emerging as top dogs in China and global contenders. Also keep in mind that China ranks second in global R&D spending, and over a million science and engineering graduates join the workforce every year.

China has destroyed its environment

There is no question that the last few decades have led to a huge increase in pollution in China, and that the environment is in big danger if immediate steps are not taken.

Woetzel claims that a great deal is being done about pollution in China. He points to the highly popular documentary on China’s serious air-pollution problems titled Under the Dome (by Chai Jing, a former journalist at China Central Television, the biggest state-owned network) was seen more than 150 million times in just three days in March 2015. The 140-minute video strongly criticizes regulators, state-owned energy companies, and steel and coal producers. The video was taken down after three days, but the People’s Daily newspaper ran an interview Chai Jing, and she was praised by a senior Chinese environmental minister.

The Chinese government is also heavily involved in trying to control pollution. The Airborne Pollution Prevention and Control Action Plan that requires reductions in coal use and emissions is also spending $277 billion to help in the areas with the heaviest pollution.

China has unmanageable debt

Chinese debt is huge and growing, but so is their economy. Woetzel says the misperception here is a failure to appreciate the economy of scale involved. Critics like to point to the fact that in 2013, China consumed 25 times more cement than the US economy did, on average, from 1985 to 2010 as a sign that building was out of control. However, when  adjusted for per-capita consumption and construction cycles, it turns out China’s cement consumption is not much more than that of South Korea and Taiwan during their booms a few decades ago.

Woetzel agrees that China’s debt is large and growing, but says it is still manageable: “China has seen its total debt quadruple, to $28.2 trillion last year, a recent MGI study found. Nearly half of the debt is directly or indirectly related to real estate (prices have risen by 60 percent since 2008). Local governments too have borrowed heavily in their rush to finance major infrastructure projects.

While the borrowing does border on recklessness, China’s government has plenty of financial capacity to weather a crisis.”

Growing social inequalities threaten society as a whole

The rapid rise of a wealthy class and the resulting social inequalities are a major issue in China, but as Woetzel points out, this a big problem all across the globe (even in developed economies). He also admits that “while economic growth has benefited the vast majority of the population, the gap between the countryside and the cities is increasing as urban wealth accelerates,” but continues to say that “urban inequality and a lack of access to education and healthcare are not problems unique to China.”

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