Is the Chinese bubble about to burst? There has been talk of China’s imminent financial crisis since the early part of this decade, but perhaps today the situation requires a little more attention.
We know how things look on the surface. Investments in Chinese tech startups have collapsed from $26.4bn in April-June 2018 to $2.2bn in the same period this year. High-profile wobbles have included the briefly ubiquitous bike-sharing apps and shopping website Pinduoduo, established in 2015 to break the Alibaba and Tencent duopoly, but more recently seeing its share price plummet 35% since March.
If this sounds dimly familiar, it should: as in the 2001 dot.com bubble, it’s been consumer-focused companies without a particularly obvious reason to exist that have felt the pressure. The bursting of the early noughties bubble, shortly before the 9/11 attacks, was contained by the US Federal Reserve slashing interest rates – thus helping fuel almost another decade of debt-driven, mortgage-led growth until the debacle of the 2007-8 crash.
This time round, the dynamics look different: the growth of Chinese internet giants has been real enough over the last decade, but, as in the West, they have depended on powerful ‘network effects’ (in which each additional user of the service adds additional use-value to other users) and access to deep data to succeed in establishing a dominant position in their marketplace. Put simply, Alibaba, Tencent and Baidu are amongst the largest companies in the world by value today.
China’s response to 2008.
For the smaller fry, lacking the network effects and near-monopoly market positions, the deliberate, government-mandated expansion of Chinese debt preceded the explosion of investment into new tech companies.
As the world reeled from the impact of the 2007-8 crisis, the Chinese government moved swiftly, instituting one of the largest economic stimulus programmes in human history: in November 2008, 4tn yuan (roughly $586bn) was earmarked for investment in infrastructure like high-speed rail and renewable energy, as well as housing and some social expenditure. The majority of this spending was funded through an exceptional expansion of bank lending, “predominantly to local governments and state-owned enterprises”. They had little choice but to act boldly: with world trade collapsing faster than even in the Great Depression of the late 1920s and 1930s, an economy as dependent on exports as China’s would have been massively exposed.
The impact, over the next decade, was the domestication of the Chinese economy. It remains the world’s largest exporter of manufactured goods, by volume, but growth became more domestically focused, with exports falling as a share of GDP from 36% in 2006 to about 19% in 2018 – a level below the average for major developed economies.
Inequality has fallen as growth has spread from the coastal regions inland, whilst sharp pay rises mean Chinese average hourly wages in manufacturing are now catching up with levels seen in Greece or Portugal. Rising pay, in turn, has sustained rising domestic consumption without the explosion in household debt familiar in the West over the last three decades. At 52% of GDP, China’s household debt is high for a developing economy, but comparable to Germany (53%) and well below heavily indebted developed economies like the US (76%) and the UK (87%). A new, affluent class of consumer has emerged: China today accounts for 32% of all luxury spending worldwide.
Corporate borrowing and shadow banking.
Borrowing in China has largely appeared elsewhere in the economy. China’s debt growth accounts for over 40% of the growth in global debt since 2007, but it has been corporate borrowing leading the way, with Chinese businesses now owing 160% of GDP – the comparable figure for the US is 74%.
As the post-crash stimulus worked its effects, helping drive 10% economic growth by early 2009, the government tightened bank lending. But this left a vast amount of borrowing still flowing through non-bank lenders, and through banks’ own off-balance sheet activities, forming the so-called ‘shadow banking system’. Successive efforts by the Chinese state to clamp down on this less-regulated lending has provoked economic jitters, and – as borrowing became notably harder from 2017 – pushed speculators into seemingly easy, high-returns wins in new tech investments, peaking last year. As the flow of cheap money has dried up, so too has this flow of speculative investment into tech. And as shadow bank lending has contracted for the first time in a decade, the number of corporate bankruptcies has begun to pick up.
The response from the government, in the context of slowing overall growth, has been to once again relax lending controls for local governments and promote further infrastructure development, with the stimulus amounting to perhaps 4.25% of GDP this year. Of course, the danger with looser lending standards is precisely that you end up lending to the higher risks, like smaller, struggling companies – staving off the immediate dangers today at the expense of a worse crash in the future.
The global economy has changed.
We should put this domestication of the Chinese economy – its big shift towards production and consumption for home, rather than for export – in the broader context of how the global economy has changed since 2008, since this gives us the biggest clues as to sources of future instability.
Three factors are important here. The first is the domination of new industries by a handful of giant firms, with the trio of Baidu, Alibaba and Tencent Holdings dominating “nearly every aspect of the Chinese internet” in the same way (and for the same reasons) that major platform companies do in the West.
The second is the reliance of those new industries on forms of competition not focused on price alone, or even necessarily a recognisable consumer market. As soon as the first advert appeared, capitalist competition has been about more than prices – they compete on alleged quality, branding, even emotions; today’s internet companies push this principle still further.
The third, directly related to the other two, is the growing, direct involvement of states in competition between different firms. This can be as crude as imposing new trade tariffs on steel, or it can be as sophisticated as contests over the regulation and control of the intellectual property needed to design an artificial intelligence microprocessor – and it’s the latter form of involvement that will ultimately prove more important.
Put all three together, and – as we’ve seen intermittently since 2008 – it’s not so much spontaneous financial market wobbles that threaten the system’s stability. It can’t be ruled out, but we’re not likely to see a direct repeat of 2008, in which financial institutions cheerfully spent a decade or so cheerfully building their own weapons of financial mass destruction before demanding a government rescue when they went off. Moreover, the most obvious ways in which financial contagion can be transmitted between economies – sudden switches in flows of capital across borders – look less of an issue when global cross-border financial flows have more than halved since 2007.
There are still very speculative movements of finance which could be destabilising, but they are unlikely (for developed economies, or those with major domestic financial markets) to be dramatic, although specific risks can be significant (such as British banks’ exposure to Chinese debt, the largest in the world outside of China). Instead, it’s the still-developing relationship between states, companies, and finance that poses the primary risk to global stability – whether the trade war between China and the US, the attempts by the Chinese state to prevent the wipeout of small businesses, or the sabre-rattling over tankers in the Gulf.
James Meadway is a columnist for Novara Media. He was formerly economics advisor to John McDonnell, the shadow chancellor.