China’s Big Spender

Of course, the government can always intervene. Just look what it's done in Shenzhen, a Pearl River Delta city that, if the market had run its course, might be in just as bad shape as neighboring Dongguan, where by some estimates one out of every 10 factories is now shuttered. Shenzhen, a mere 97 kilometers away, is a vision of how government support can remake a city. Thirty years ago it was a paddy field. Then Deng Xiaoping decided to turn it into a manufacturing base, which today has an economy nearly half the size of its older and more glamorous neighbor Hong Kong. Most recently the government decided to place China's version of the NASDAQ there, spurring more new development. Many of the bourgeois trappings found in Shenzhen today—hyper-air-conditioned shopping malls, mock-Disney weekend resorts and nonsmoking coffee bars—were built by OCT (Overseas China Town), one of the earliest central-government-owned real-estate operations. Since 1985 the company has developed $8.7 billion worth of real estate. Still, many public spaces are conspicuously empty. On one recent evening, a vast California-style shopping mall filled with Chinese versions of upscale Western brands (Aqua-scu-tum, Hugo Boss) attracted only a smattering of visitors.

Still, Beijing builds on. A new state-owned luxury condo development called Portofino works improbably to bring la dolce vita to south China, with cobbled streets, broad piazzas, and a terra-cotta clock tower that chimes on the hour. A government representative claims 80 percent occupancy, and says that the $30,000-to-$50,000 flats in the development are selling to upwardly mobile, well-educated Chinese, many of them returning expats who see better job opportunities here than in the West. Yet the fake piazzas are deserted, and the majority of the comments on the message board of the local French-pastry shop are in English. While officials won't comment, it seems likely that a number of the properties are owned by or leased to Westerners.

China's heavily centralized state has spent its way to recovery before—during the Asian financial crisis of 1997–98, and also after the bursting of the dotcom bubble in 2001. But in both hose cases, government money was a stopgap, meant to buy time while the global economy (and exports) recovered. This time is different. The U.S. and, to a lesser extent, Europe are on the road to recovery. Yet exports are not coming back, which means that jobs for the 20 million Chinese migrant workers already laid off may not come back either. In fact, UBS bank estimates that the ranks of the unemployed may grow by another 15 million this year, as the export dip plays itself out. This doesn't necessarily translate into seething social discontent, as is often written. The migrants will be going back to their villages with a lot more than they left with. But in the mid- to long term, it raises pressure on China to find a new model. "I just don't see it happening," says Roach. "That's why I'm worried about another dip in growth next year."

Optimists point to Beijing's power of the purse. "The Chinese Communist Party is now the world's most liquid financial institution; there are no fiscal constraints," says Andy Rothman, a respected China bull at CLSA in Shanghai, who predicts 7 to 9 percent growth next year. Most economists agree that autocracy has its advantages in the midst of a credit crunch, since there are no political or legal obstacles to spending. As an executive at one of China's largest state-owned banks puts it, "The government told us to lend—so we did!" Yet already there are concerns about where all the new capital is going. Moody's and other ratings agencies are worried about a future rise in bad loans in China, given the explosion in bank lending. And since much of the new lending has gone to business, rather than consumers, it may be recycled among enterprises without trickling down more broadly to the consumer level, where it's most needed. While consumer-spending growth figures look high, even bulls like Rothman say the numbers are inflated to more than double the true level because government purchases at retail shops are included in the figures.

China has begun to create a social safety net, which would give people more confidence to spend instead of save, if it were not so full of holes. A few months back Beijing passed a $127 billion national health-insurance plan, to be delivered over three years. That's less than 50 bucks a head in China—"just puny," says Roach. Meanwhile, China's social-security fund has only $82 billion under management, less than $100 per worker. Economists believe the numbers should be doubled immediately, and China could afford to do it. Yet Beijing has been talking about tightening social safety nets since 2006, with little action. Even Chinese are skeptical about Premier Wen Jiabao's boast to deliver universal health care by 2011.

Of course, increasing affluence would also help encourage consumer spending—the per capita GDP in China is still only $2,000. But that would necessitate moving up from cheap, polluting industries to global Chinese brands. Right now most Chinese exports are merely assembled in China, rather than designed and branded there, which means most of the profit, and the big salaries, goes to foreign partners. Throughout Guangdong, where many exporters are based, officials and factory bosses claim to be working toward designing and producing more sophisticated finished goods, but the statistics tell a different story. Some 60 percent of production in the region is still low-end component assembly. And until China becomes an advanced export power it will remain a backward consumer society, where any green shoots are pushed up by the state.

© 2009