China's Dangerous Debt

Why the Economy Could Be Headed for Trouble

Priced out: construction in Changzhi, March 2012 Reuters / Stringer

In September 2008, when Chinese President Hu Jintao got word that Lehman Brothers, then the fourth-largest U.S. investment bank, was on the verge of bankruptcy, he was traveling by van along the bumpy roads of Shaanxi Province. Surrounded by policy advisers and members of the Politburo, Hu asked them how China should respond to the inevitable spillover. According to one participant in the discussion, the group reached a clear consensus by the trip’s end: China would need to launch a massive stimulus program. And it could trust only state-owned enterprises (SOEs), rather than private firms, to carry it out.

That November, as other governments were still debating what to do next, Beijing announced that it would distribute nearly $600 billion in stimulus funds to SOEs and other institutions, principally to fund ambitious infrastructure and industrial projects. Banks began lending generously, and local governments rushed to form shell SOEs that would allow them to borrow. Over the next six years, China’s nominal GDP roughly doubled, ballooning from around $4.5 trillion in 2008 to just over $9 trillion in 2014.

An employee counts Renminbi banknotes at a branch of Bank of China in Shanxi province, March 2009. Reuters / Stringer

China recovered from the 2008 financial crisis faster than any of its peers, and it drove unprecedented growth in the process, expanding its economy at rates its competitors had failed to match even before the financial crisis. The story was positive enough that some economists called on Western governments to adopt a similar approach, advocating increases in government spending and regulation. Yet China’s speedy response would have been impossible to replicate without the power and reach of its central government. The government owns, either directly or indirectly, almost all of China’s land and roughly two-thirds of its productive assets, enabling it to quickly allocate resources on an enormous scale.

This advantage carries a significant cost, however, and one that has already begun to surface. According to a recent report from the management consulting firm McKinsey & Company, China’

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