The crux of China's big challenge, revisited

I had earlier posited the crux of China's big challenge as one of bringing debt levels down relative to GDP (both the growth gap and, over time, the absolute ratio).  Another article highlighting the urgency of the problem - showing the debt-to-GDP ratio at close to 350 percent as of April 2016 - lays out China's only way out: capital input growth (i.e. debt-fueled investment) must decelerate while productivity (effectively output per worker per unit of capital) must pick up the slack. Indeed, the flip side to any debt crisis is exactly that: a productivity crisis.

Total factor productivity (TFP) has been declining in China over a number of years, but apparently especially since the post-crisis stimulus, which isn't surprising: Beijing basically invested itself out of the global funk and created today's debt overhang. The overall "depth" of capital exploded relative to the actual utilization of it by the workforce from 2009 to 2015. With untold tens of thousands of factories operating at barely 60-70 percent capacity, China has without doubt suffered a dramatic flatlining (at best) of productivity in recent years.

On the bright side, as argued here, this makes the solution to its woes very simple in principle: it simply has to quit making so many unneeded investments and instead focus on getting the most out of legitimate ones. There's no rocket science to it at all.

In practice, of course, it isn't nearly so easy, primarily because Beijing still can't will its edicts into effect at the local government level. Even as the flow of cheap money to unproductive sectors is whittled down, funding could still be wasted on commercially unviable projects, the only saving grace being that the incentives for more aggressive ventures are naturally reduced by a tighter economic and fiscal environment. So long as the central government (especially the central bank) doesn't itself succumb to the temptation to ease and stimulate out of the growth conundrum, there's hope.

Critics, of course, are already jumping all over the latest credit boom engineered by the central bank as proof that Beijing's back to its old ways. Even if that's true, that doesn't necessarily mean the same old loss-making sectors are being supported just the same as before. In the coming months, China analysts must become increasingly specific about just where the new debt and output growth are actually happening: it's tempting for anyone to say that since debt is growing 15 percent overall, that Beijing's still spending money like a drunken sailor; but what if this aggregate figure includes 30 percent growth for robotics and automation equipment vice barely 5 percent for smokestack commodity steel?

As a final note, the biggest reason to be optimistic is that China's simply too big to fail: the entire global economy needs the difficult restructuring efforts being attempted by the Xi Jinping administration to succeed, and everyone must contribute to the financial and currency stability that would facilitate this transition. Of course, the risk is always there that if the going gets really rough, Xi and co. will truly retrench on reform; but that's quite different from clamoring that he's already failed, which, for some at least, is really a way of saying that he's an evil commie SOB and that red China should just go to hell already.