Let’s start with the banks. Much ink has been spilled on the risks in China’s financial sector. Since November 2008, when then-Premier Wen Jiabao pressed the “go” button on the four-trillion-yuan stimulus, bank assets have more than quadrupled in size. Reviewing the history of credit bubbles, the IMF found none that had expanded so quickly, but plenty of more modest size that still imploded into crisis.
Worse, the problem of moral hazard—the assumption that a deep-pocketed government would backstop bad loans—was endemic. In 2019, cracks started to appear. Baoshang Bank Co., a city lender in Inner Mongolia, became the
Maybe tomorrow, but not today. Missing from the crisis thesis was a crucial point: Financial meltdowns don’t start because bad loans are too high; they happen because banks run out of funding. In the Asian Financial Crisis in 1997, Korea’s banks didn’t melt down because they had made too many loans to crony-capitalist chaebol. They melted down because the foreign funds they relied on to finance their operations dried up. In 2008, Lehman Brothers didn’t collapse because it had too many investments in dodgy mortgage- backed securities. It collapsed because the money markets that financed its activity decided to cut it off.
In China, the combination of a high savings rate and tight controls on moving capital out of the country means that a lack of funding is unlikely to be a problem. Its banks can count on a steady inflow of domestic savings to provide a stable, long-term basis to fund operations. While helter-skelter expansion in lending is a problem—as are a state-dominated banking system and zombie borrowers—as long as bank funding remains adequate, there’s no trigger for crisis.
Then there is the nature of business. Nowhere is the contrast between the U.S. free-market system and China’s state-centric approach as sharply drawn as in the relationship between government and corporations. In the U.S., a hands-off approach is a critical driver of economic dynamism. In China, the biggest banks, telecoms, airlines, and industrial companies are owned by the state. Even in private companies, the Communist Party exercises an influence that would be unthinkable in the U.S.
There are major costs to this approach. “We’re state-owned, so we don’t have to worry about profits,” says the manager of one massive power project on the outskirts of Beijing. Writ large, that cavalier attitude to the niceties of actually making money means a big chunk of the corporate sector is mired in low productivity. Return on assets for state companies is a fraction of the level in the private sector.
But there are also benefits. China’s direct control of state companies—and sway with the private sector—gives policymakers a powerful instrument to manage the ups and downs of the economic cycle. Rarely has that been more evident than in the response to the Covid-19 shock. State companies holding on to their employees prevented spiraling unemployment. Tech giants supported the public health response and the credit stimulus. In a crisis, government and business moving together can be a powerful force for resolution.
Behind it all are the benefits of China’s enormous size. As far back as 1776, Adam Smith—the grandfather of modern economics—recognized that the “vast multitude” of China’s population gave it a built-in advantage in the global economic race. If, Smith wrote, China could “learn for themselves the art of constructing all the different machines made use of in other countries,” they would be able to leapfrog ahead of smaller rivals. After Deng kicked open the door to the world in 1978, and even more after entry to the World Trade Organization in 2001, China had ample opportunity to “learn for themselves.” By directing the resources of the state to acquire new technologies, and then scaling them to China’s massive domestic market, industrial planners were able to give Chinese companies a competitive edge first in textiles, then metals, and now high-speed trains, solar panels, and nuclear power.
That story isn’t over. China’s GDP per capita is just a third of the level in the U.S. That means ample room for continued catch-up growth. As China focuses its attention on the technologies of the future—from electric vehicles to industrial robots and artificial intelligence—the annual pace of growth could stay close to 5% through 2025 and end the decade not much lower. With global businesses deeply invested in their China relationship, Trump’s trade war is unlikely to change the trajectory.
“There are lots of Baoshangs,” says one senior banker in Henan province, hinting that other banks could go the same way as the failed lender. Maybe. But as long as the market believes the government will underwrite their operations, they will stay in business. And as long as China continues to grow, the government’s ability to provide that backstop won’t come into question.
One day, a crisis will come along that’s too big even for Beijing to handle. When that happens, the price of allowing problems to fester in the dark will be a meltdown of monumental proportions. One day. But if a once-in-a-hundred-year pandemic doesn’t pop the bubble, the question is: What will? —With David Qu and Yinan Zhao