China's focus on production over consumption and expanding supply rather than demand raises questions about what, or who, this supply is ultimately for. If domestic consumption remains sluggish, the only option is to export surplus supply. This is likely to provoke, if not already, a protectionist backlash from developed countries and similarly upset developing countries aiming for export-led industrialization to boost growth. Chinese authorities have been responding to this measure since the second half of last year. It slows down the economy in three main ways. The first was to lower borrowing costs, but China's problem today is not credit supply, but lack of credit demand. The second option is for the central government to borrow money and invest in infrastructure development, but the 1 trillion yuan (US$138 billion) bond issue approved in October does not appear to have provided much of a stimulus to the economy. The third one has recently become clear. The goal is to increase investment in “new, high-quality production capacity.” This is an abbreviation of China's industrial policy to increase the production capacity of advanced manufacturing industries and achieve self-sufficiency in future key technologies. This strategy is likely to result in overcapacity and create further deflationary pressures.The Japanese flag waves in the wind outside the Bank of Japan building in Tokyo. Despite very low and even negative interest rates, Japan's debt deflation continued for more than 20 years.Photo: Reuters
Chinese officials privately admit that domestic consumption is weak, but deny that the country has an oversupply problem. However, oversupply and insufficient demand are two sides of the same coin. Chinese policymakers also seem to believe that supply creates its own demand, when normally the opposite is true.
At its core, central planners often view market economies as machines or mechanical systems that can be precisely designed or predictably controlled. But economies are not mechanical; they are complex, adaptive systems.
First, market economies are complex because they consist of many interconnected parts that interact in ways that are not necessarily visible or obvious to policy makers. This means that because everything is interconnected, a small shock to one part of the system can have large and unexpected effects on another part. This is sometimes known as the “butterfly effect.” Additionally, making major changes may not produce the desired results.
The global financial crisis of 16 years ago clearly illustrated this. Although subprime mortgages were never a significant part of the U.S. mortgage market, problems with this obscure part of the mortgage market brought the global financial system to a standstill. Bad mortgages were distributed throughout the financial system through securitization. Conversely, Japan's lost decades from the mid-1990s to the early 2020s may not provide the desired consumer spending boost, even with very low and sometimes negative interest rates. It was showing. Investment and inflation when deflationary expectations become established.A high-rise apartment building under construction in Zhengzhou City, Henan Province, China. Even after the court order to liquidate Evergrande, China's real estate sector still faces myriad challenges. Photo: Reuters China's real estate sector is not only unusually large, accounting for about a quarter of annual output, but also strongly connected to other parts of the country's economy, particularly through lending to local governments. Chinese household wealth is also highly concentrated in real estate. Just as systemically important financial institutions had to be rescued to prevent financial collapse 16 years ago, China's big real estate developers may also be too interconnected to fail. The January decision by a Hong Kong court to liquidate Evergrande, the world's most indebted real estate company, is unlikely to signal the end of China's real estate debt crisis.
Second, the economy is adaptive in the sense that the businesses and households that make up the economy constantly anticipate and adapt to changing conditions. Their expectations and behaviors are adaptive rather than completely rational. They also react when they see others react. This imitation means that group psychology amplifies the errors of individual decisions rather than correcting them. Great Depression-era economist John Maynard Keynes coined the term “animal spirits” to describe how human emotions, rather than rational calculations, drive investment decisions during times of instability. I made.
China today faces a decline in animal spirits, and policymakers cannot afford to hesitate or send mixed signals when it comes to revitalizing the economy. Statements such as describing fiscal stimulus as creating a “welfarism trap” or hesitating to cut interest rates for fear of reigniting the real estate bubble (which would be understandable under normal circumstances), are statements that suppress the souls of animals. I'll just keep doing it. Similarly, the moral stance of not helping troubled real estate developers because they cause moral hazard is also unhelpful. The immediate danger facing China today is the risk of systemic infection.
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Third, the economy is a system due to the emergence of unpredictable patterns resulting from billions of interactions between economic agents. One such pattern is debt deflation. As was the case in China before the pandemic, in economies with very high debt levels, negative shocks such as zero-coronavirus policies and various regulatory crackdowns on technology companies can induce firms and households to deleverage and repay debt. Masu. Even if interest rates fall.
Personally, the rational decision to deleverage creates the overall macroeconomic impact of deflation. Deflation increases the future value of debt, causing further deleveraging and deflation. This self-reinforcing dynamic runs contrary to the self-correcting dynamics predicted by most rational choice economic models.
Once the dynamics of debt deflation have taken hold, it will take a great deal of effort to break out of it. Japan's debt deflation has continued for more than 20 years. If China does not heed the lessons from Japan's experience, it is not inconceivable that the current economic slowdown could be prolonged and its ambition to become a middle-developed economy by 2035 delayed.
Donald Low is a Senior Lecturer and Professor of Practice and Director of Leadership and Public Policy Executive Education at the Hong Kong University of Science and Technology.