With the U.S. economy in the doldrums and Europe's ongoing debt crisis continuing its downward spiral, analysts are left to wonder if China might be the savior of the global economy or, rather, whether the country is simply a multitrillion bubble about to burst. China's great leap forward in public infrastructure and urban construction had, until quite recently, attracted the breathless admiration — and even envy — of the world, but now its latest frenzy of debt-driven investment and sagging urban housing prices have observers guessing again.
In a recent research article titled "China's Infrastructure Investment Boom and Local Debt Crisis" published in the latest issue of Eurasian Geography and Economics, Professor Kai-yuan Tsui at Chinese University of Hong Kong analyzes the recent pattern of China's infrastructure investments and the country's serious local debt problems. He has observed a close and intricate relationship between China's land revenue-based local fiscal system, cadre evaluation system, banking system and investment in urban infrastructure and high-speed rails.
The state of this relationship suggests that without significant change in China's institutional environment, the recent investment boom and the resultant bubble will not simply be a one-time aberration triggered by the global financial crisis; instead, these events are closely related to China's unique institutional setting.
Chinese local officials are not immune to ramping up debt-financed infrastructure investments, given the opportunity. And the current state-controlled banking system is likely to be on standby to accommodate their wishes. As a result, China's economy is caught in a chronic cycle of sporadic surges in investment, financed at the first sign of easy credit, massive land requisitions, real-estate booms, piling up of local debt and ultimately bailouts (or, euphemistically, recapitalization), as banks and local governments assume too much debt. This systemic, cyclical and crisis-driven investment approach to development makes China's long-needed economic shift toward increased reliance on domestic consumption nearly impossible.
The latest episode analyzed by Tsui is an important reminder of the country's periodic waves of investment mania and the ensuing retrenchments over the last 60 years, with each wave inflicting vast amounts of damage. There would be at least one "great leap forward" in almost every decade.
The incentive system that fosters such behavior has hardly changed in nature either, as the cadre evaluation system remains very much top-down and based on short-term indicators, similar to the pre-1980s era. As such, the local bureaucracy is faced with almost no pressure from below, and thus has to worry little about public accountability. And while China's post-1990 banking system is not the same as in the past, as Tsui duly points out, it is at best only "half reformed." In this latest chapter, the half-marketized banking sector has also opened its doors to new practices unheard of in China before, namely, "incentivized risk taking" and "leveraged platforms," with greater potential to wreak havoc. If those tricks of finance sound reckless and familiar to observers of the 2008-9 global financial crisis, they probably are.
On a broader level, serious questions are also raised by Tsui about the viability of the China model — the so-called "Beijing Consensus" — and its transferability as a genuine alternative for other developing nations. These issues highlight the systemic nature of China's current economic problems, a fact that anyone who is serious about deciphering China's economy must come to recognize.
To purchase and view "China's Infrastructure Investment Boom and Local Debt Crisis" by Professor Kai-yuan Tsui, please click on the following link.
Kam Wing Chan is Professor of Geography at the University of Washington. He is also a co-editor of Eurasian Geography and Economics. An earlier version appeared in The Seattle Times on December 6, 2011.