- - Wednesday, June 29, 2011


Everyone knows about China’s economic “miracle.” High economic growth rates and rising incomes have given many parts of the country all the trappings of a “nouveau riche” society — from luxury-car traffic jams to stylish tourists traveling the world.

Beyond doubt, China is an emerging economic giant. But a recent trip there left me doubting that its economic model is sustainable.

High-level economic officials were prickly and evasive. Any questioning of China’s growth or long-range plans sparked filibusters, changes of subject or attacks on the U.S. Though high-level political officials were welcoming and willing to engage over our nations’ many differences, the top economic policymaking body, the State Development and Reform Commission (SDRC), refused to meet our delegation. The logical conclusion was that the Chinese government had something to hide.

My Heritage Foundation colleague Derek Scissors suggests reasons why the Chinese are so sensitive. China’s epic-scale construction projects cost a bundle. Yes, the nation holds more than $3 trillion in currency reserves, but by Chinese law, it can’t spend foreign reserves on internal projects. Instead, it must find internal financial resources to build the roads, low-rent housing, technology parks and other large projects that dazzle American visitors.

The loans funding these projects have increased internal debt and inflationary pressure. Last week, Chinese Premier Wen Jiabao said it would be hard to meet this year’s initial inflation target. The announcement fueled speculation that inflation will remain elevated for some time.

Inflation makes Chinese officials nervous. They don’t have a good way of measuring it. They don’t know when it will crest. But they do know inflation is an Achilles’ heel in China’s economic boom. At worst, it could unleash the political unrest they most fear.

When pressed on the economy, officials to whom we spoke often fell back on blaming U.S. monetary policy — Fed Chairman Ben S. Bernanke’s so-called “quantitative easing.” Harping on this, rather than rising U.S. debt, suggests they are rehearsing future arguments to blame us for their economic woes.

China’s own numbers indicate its economic growth has slowed for four straight quarters. That trend is likely to continue. Two recent purchasing managers’ surveys say manufacturing has slowed again. Loans taken out by local governments to fund stimulus projects are failing. China’s huge stimulus spending, much like America’s, has run out of steam. Mounting debt, predictably, is starting to slow growth there just as it is here.

Another threat to Chinese growth is its imbalance. The Chinese economy relies more on investment than any economy other than communist failures such as North Korea. Beijing talks about reducing investment and raising consumption but may not be able to pull it off. That would require cutting subsidies to the state-owned enterprises that are driving investment. But not only do state-owned enterprises give the Communist Party a tool to control the economy, their officers are senior party cadres. It will be very difficult politically to curb state firms.

A precarious economy bodes ill for any leader, but in China, a failed plan is particularly dangerous. The Communist Party’s bargain with the Chinese people is that it — and only it — can deliver rising living standards via continuous growth. If that bargain is threatened, or even questioned, by the failure to reach planned goals, it makes the party look either dishonest or not in control.

Clearly, China needs to return to the market-oriented reforms presided over by Deng Xiaoping. Without Deng, the party has reverted to statism, receiving great global acclaim but also facing increasing economic and environmental stress. Slashing subsidies in China would have a similar effect to slashing federal spending here: eliminating gigantic amounts of waste, strengthening the financial system and making growth far more sustainable.

China is a growing economic powerhouse. Even if its economy falters, it is here to stay. But be leery of predictions about a Chinese juggernaut taking over the world. China has serious structural economic and even political problems its greatest fans tend to overlook.

Kim R. Holmes, a former assistant secretary of state, is a vice president at the Heritage Foundation (www.heritage.org). Follow him on Twitter @kimsmithholmes.

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