Chinese economic policies and motivations since 2008 not only emphasize growth and sustainability of state-owned enterprises but, a critical but much less well-appreciated dimension is the Chinese government’s emphasis on stability. No economic policy in China will ignore this, and the high value placed on stability pervades all the current trade talks with the United States.
To be clear, 2008 was a year of discontinuity in Chinese economic thinking and policy. Chinese officials clearly saw that the United States had 70% of its GDP driven by consumer activity. But, in China, it was about 30%. China was far too dependent on work for foreign companies serving foreign economies. Something had to be done to change this.
In February 2009 I was in Beijing, and the government officials I spoke with were pretty anxious. One turned to me and said, “we may have to deal with 150 million unemployed factory workers who have migrated to the cities and will soon have no work and nowhere to go.” He was borderline panicked. I saw Chinese policy change dramatically, I believe, sparked by that fear – and that is not going to change. Once you have stared into the abyss, you never want to do that again. I believe that guides Chinese policy today.
Essentially, the downside of an unstable economy is so great in their view, that Beijing will do anything to keep things stable. They overvalue economic stability quite highly. This is an area that Paul Kahneman and Amos Tversky described quite well when it comes to how people (and institutions) irrationally overvalue the prospect of a loss. Beijing is a great example of Kahneman and Tversky’s thinking. It’s human nature (we all act the same way), but when it’s applied to the world’s second-largest economy, it has a big global impact. This is not inconsistent with an uneven bargaining model. I’m not sure our current trade negotiators truly understand this.
One of the things that became apparent to me in my time in China, especially as growth was emerging in the late 1990s and early 2000s was the provincial rivalries. Of course, when Taiwan is labeled as “a rogue province” the government is really sending a message from Beijing to all the other provinces to behave, as well. This was especially magnified for me in the rivalry between Beijing and Shanghai. Shanghainese do not have kind things to say about the bureaucrats in Beijing. I believe that Beijing worried that Shanghai would exercise far too much independence as it grew wealthy and became a global financial center. Many of the policies I see today reflect that fear as much as anything.
There is a reason Beijing wants control, and there’s a lot of historical contexts and political basis for it, but it also comes down to trying to keep the provinces together and behaving – and feeding the Beijing economic beast. Beijing needs to share those economics with its state-owned enterprises to keep them afloat and to keep income distributed so the economy hums along. Local governments cannot come close to generating the revenue needed for their expenditures (as has been the case since 1995), so aggressive (and fundamentally unfair) land deals are a source of revenue for local governments. Meanwhile, Beijing is trying to intervene and control local economies, shadow debt markets, real estate prices, and spur domestic consumption. All this inefficiency wrapped around irrational exuberance in the real estate and equity markets is not a healthy cocktail.
It does strike me that the policies being implemented now are ones that were outlined to me 20 years ago. China does play the long game, and it still strikes me that in all of the dealings that the United States has with China, especially the current trade discussions, this historical context is simply ignored. If one understands, in any negotiation, the perspective and context of the other party, it’s the most effective way to form any agreement. It’s an essential element to any negotiation that a “context for understanding” is created. There seems to be no attempt to understand China’s political and historical context.
China has moral hazard regarding investments in general, but, especially real estate. It seems to me that the government has now created a sense of entitlement to all real estate investors (and investors in general) that there should be no sustained downside to any investment. This is how we get bubbles and they never end well. We are at the point of irrational exuberance, but, as you know, according to Galbraith, “the market can stay irrational longer than you can stay solvent.” I remember when Alan Greenspan identified irrational exuberance in 1996. We had almost 4 more years of heightened exuberance beyond that point. I just don’t know when the music stops.
The Chinese government has a massive incentive to intervene at the slightest indication of instability because their mere existence relies on providing for at least the basic necessities for the broader population. The music may not stop for quite a while. But then that makes the crash even louder.