Sign Up

Should We Trust China?

Should China's recent economic growth and moves toward banking reform concern or reassure Westerners?

March 30, 2004

Should China's recent economic growth and moves toward banking reform concern or reassure Westerners?

In 1972, the Club of Rome gave long-term forecasting a bad name by declaring that we were on the brink of a global catastrophe. Soon, the world economy would hit a wall, as we were to run out of non-renewable resources.

Thirty years later, with prices of primary products still falling, few people pay much attention to such doomsday scenarios.

But the Club of Rome bequeathed us a striking metaphor that has proven more robust than those forecasts: If a water lily doubles in size every day, and we start paying attention to it when our pond is half covered, we have only one day to do something before the plant covers the entire pond.

In other words, if something is growing rapidly, there is very little time between its becoming large enough for us to notice, and its emergence as a behemoth.

China is like that. The country has been growing at nearly 10% per year for two decades, doubling in size roughly every eight years. But the Chinese economy was so small and impoverished in 1980 that only lately has it become large enough to attract our attention.

And has it ever! China has relentlessly climbed to become a major exporter and importer. In three or four decades, it may well be the largest economy on Earth. The country is already so large that its foreign exchange reserves are among the world's largest, as is its current account surplus.

Must we now act quickly to save our pond from the invasive lily of Chinese economic dominance? The answer depends more than anything else on how China will conduct itself — and that surely will be one of the key questions of the 21st century.

Reassuringly, the evidence of the last few years provides little reason for alarm. China's membership in the WTO, its constructive role in negotiations with North Korea and its generally benign international behavior have created a trade record.

It suggests that the country is either poising itself brilliantly to strike when the time is right, or that what we see is what we get — namely, a reasonably good world citizen.

China's recent efforts to deal with its banking problems reinforce this conclusion. In the international arena, China has become a powerful competitor and owner of substantial wealth. It now has foreign exchange reserves in excess of $400 billion.

Meanwhile, at home it has to contend with substantial financial problems. Many still important state-owned firms only survive with subsidies, some disguised as bank loans that will never be repaid. Other bank loans, too, are non-performing. Overall, something between a sixth and a third of Chinese bank assets are non-performing.

A banking system with rotten assets requires two interventions. First, the banking system as a whole must be made viable by injecting sufficient capital.

Second, any dysfunctional lending practices, which helped create the problem, must be corrected — so that bankruptcy and recapitalization will not become a recurrent cycle. Very likely, reform will include closing or merging some banks to improve management.

Political pressures to extend loans to commercially unviable enterprises must be curbed and property law must be enforced.

It is too early to say whether the sort of institutional and structural reforms required for a long-term fix will be implemented. But the Chinese have commenced with an orderly recapitalization, assigning $45 billion of China's foreign exchange assets to banks to bolster their balance sheets.

The central government has limited the banks' freedom to convert these assets into local currency in order to control the growth of the money supply.

Nevertheless, the transfer of assets seems to inject some badly needed concrete into the shaky foundation of the domestic banking system — at least for the time being.

Using the fruits of its success in foreign financial markets to undergird its weak local financial system looks like another sensible policy move by the Chinese.

Altogether, the relatively low-key, non-confrontational approach to policy embraced by the Chinese should reassure those in the West who worry that this big adolescent economy will soon have the strength to become another international bully.

So far, the outlook is bright. Our pond should do fine.

More on this topic