The signing of President Trump’s Phase One trade deal with China has rekindled speculations about the future of the world’s second-largest economy. Many analysts have cited trade frictions between the United States and China as a driving force behind the slowdown the Chinese economy has experienced in recent years. It is not a tariff crossfire, however, that explains the slowdown, argues Nicholas Lardy, a leading expert on the Chinese economy.
Lardy, the Anthony M. Solomon Senior Fellow at the Peterson Institute for International Economics, offered a different view on China’s slowing economy in a lecture presented at the China Program’s 2020 winter/spring colloquiaUsing data and trends from the last forty years of China’s economic growth, Lardy presented the case that the slowing trend in the Chinese economy is directly related to changes in how the government lends credit and to what he terms “resource misallocation.”
According to Lardy, the Chinese economy is slowing from the inside. The government’s recent campaign to deleverage the amount of credit coming out of the shadow banking system was arguably justified, but it has nonetheless reduced the amount of credit available to businesses, particularly private companies. As a result, the credit-to-GDP ratio has plateaued in the last several years and is growing in-pace with the economy instead of ahead of it.
Coupled with this is the observation that Xi Jinping’s government has actively sought to increase the size and scope of state-owned enterprises. Lardy’s research indicates that the assets of state-owned, non-financial companies in China are growing twice as fast as the overall GDP, a situation he feels is only possible if state companies are being allocated a disproportional share of credit and loans. Lardy shows that pre-2012, funding to private companies was at $3.6 trillion USD, but by 2016 it dropped to a mere $600 billion.
Taking these factors together, Lardy argues that the economic slowdown will continue if the Chinese government continues to aggressively emphasize party control and the importance of the state sector over private companies. While reporting on trade deals may dominate the media, “We will increasingly see friction not on tariffs, but on technology transfer and issues of technology,” he says. “The key thing to watch is whether or not Xi Jinping gets serious about reforming state-owned enterprises and having a financial system that allocates credit more efficiently.”