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Some analysts disagree. Pivot, for instance, argues that China¡¯s infrastructure has already reached an advanced level. It has six of the world¡¯s ten longest bridges and it boasts the world¡¯s fastest train; there is little room for further productive investment. That is nonsense. A country in which two-fifths of villages lack a paved road to the nearest market town still has plenty of scope for building roads. The same goes for railways. Again, a comparison of China today with the America of a century ago is pertinent. China has roughly the same land area as America, but 13 times more people than the United States did then. Yet on current plans it will have only 110,000km of railway by 2012, compared with more than 400,000km in America in 1916. Unlike Japan, which built ¡°bridges to nowhere¡± to prop up its economy, China needs better infrastructure.
 

It is true that in the short term, the revenue from some infrastructure projects may not be enough to service debts, so the government will have to cover losses. But in the long term such projects should lift productivity across the economy. During Britain¡¯s railway mania in the mid-19th century, few railways made a decent financial return, but they brought huge long-term economic benefits.

The biggest cause for worry about China is the third point of similarity to Japan: the recent tidal wave of bank lending. Total credit jumped by more than 30% last year. Even assuming that this slows to less than 20% this year, as the government has hinted, total credit outstanding could hit 135% of GDP by December. The authorities are perturbed. This week they increased banks¡¯ reserve requirement ratio by half a percentage point. They have also raised the yield on central-bank bills.

However, too many commentators talk as if Chinese banks have been on a lending binge for years. Instead, the spurt in 2009, which was engineered by the government to revive the economy, followed several years in which credit grew more slowly than GDP (see chart 3). Michael Buchanan, of Goldman Sachs, estimates that since 2004 China¡¯s excess credit (the gap between the growth rates of credit and nominal GDP) has risen by less than in most developed economies.

Even so, recent lending has been excessive; combined with overcapacity in some industries, it is likely to cause an increase in banks¡¯ non-performing loans. Ms Wang calculates that if 20% of all new lending last year and another 10% of this year¡¯s lending turned bad, this would create new bad loans equivalent to 5.5% of GDP by 2012, on top of 2% now. That is far from trivial, but well below the 40% of GDP that bad loans amounted to in the late 1990s.

Much of the past year¡¯s bank lending should really be viewed as a form of fiscal stimulus. Infrastructure projects that have little hope of repaying loans will end up back on the government¡¯s books. It would have been much better if such projects had been financed more transparently through the government¡¯s budget, but the important question is whether the state can afford to cover the losses.

Official gross government debt is less than 20% of GDP, but China bears argue that this is an understatement, because it excludes local-government debt and the bonds issued by the asset-management companies that took over banks¡¯ previous non-performing loans. Total government debt could be 50% of GDP. But that is well below the average ratio in rich countries, of around 90%. Moreover, the Chinese government owns lots of assets, for example shares of listed companies which are worth 35% of GDP.

Ying and yang

Even if, as argued above, concerns about a financial crash in China are premature, the risks of a dangerous bubble and excessive investment will clearly increase if credit continues to expand at its recent pace. The stitching on the Chinese economy could fray and burst. Would that imply the end of China¡¯s era of rapid growth?

Predictions that China is heading for a prolonged Japanese-style slump ignore big differences between China today and Japan in the late 1980s. Japan was already a mature, developed economy, with a GDP per person close to that of America. China is still a poor, developing country, whose GDP per person is less than one-tenth of America¡¯s or Japan¡¯s. It has ample room to play catch-up with rich economies by adding to its capital stock, importing foreign technology and boosting productivity by shifting labour from farms to factories. This would make it easier for China to recover from the bursting of a bubble.

Chart 4 examines the relationship between growth rates and income per head for six Asian economies. Each plot shows a country¡¯s growth rate and GDP per person relative to America¡¯s for successive ten-year periods, starting when their rapid growth took off. It illustrates how growth rates slow as economies catch up with America, the technological leader. The fact that China¡¯s GDP per head is much lower than Japan¡¯s in the 1980s suggests that its growth potential over the next decade is much higher. Even though China¡¯s labour force will start shrinking after 2016, rapid productivity gains mean that its trend GDP growth rate is still around 8%, down from 10% in the past decade.

Japan¡¯s stockmarket and land-price bubbles in the early 1960s offer a better (and more cheerful) analogy to China than the 1980s bubble era does. Japan¡¯s economy was poorer then, although relative to America its GDP per person was more than double China¡¯s today, and its trend rate of growth was around 9%. According to HSBC, after the bubble burst in 1962-65, Japan¡¯s annual growth rate dipped to just under 6%, but then quickly rebounded to 10% for much of the next decade.

South Korea and Taiwan, which experienced big stockmarket bubbles in the 1980s, are also worth examining. In the five years to 1990, Taipei¡¯s stockmarket surged by 1,600% (in dollar terms) and Seoul¡¯s by 700%, easily beating Tokyo¡¯s 450% gain in the same period. After share prices slumped, annual growth in both South Korea and Taiwan slowed to around 6%, but soon regained its previous pace of 7-8%.

The higher a country¡¯s potential growth rate, the easier it is for the economy to recover after a bubble bursts, so long as its fiscal and external finances are in reasonable shape. Rapid growth in nominal GDP means that asset prices do not need to fall so far to regain fair value, bad loans are easier to work off and excess capacity can be more quickly absorbed by rising demand. The experience of Japan in the 1960s suggests that if China¡¯s bubble bursts, it will hurt growth temporarily but not lead to prolonged stagnation.

However, it is Japan¡¯s experience after the 1980s that most influences the thinking of policymakers in Beijing. Many blame Japan¡¯s deflation and its lost decades of growth on the fact that its government caved in to American demands for an appreciation of the yen. In 1985 central banks in the big rich economies agreed, in the Plaza Accord, to intervene to push down the dollar. By 1988 the yen had risen by more than 100% against the greenback. One reason why policymakers in Beijing have resisted a big rise in the yuan is that they fear it could send their economy, like Japan¡¯s, into a deflationary slump.

The wrong lesson

Illustration by Derek BaconYet Japan¡¯s real mistake was not that it allowed the yen to rise, but that it had previously resisted an appreciation for too long, so that when it did happen the yen soared. A second error was that Japan tried to offset the adverse economic effects of a strong yen with over-lax monetary policy. If policy had been tighter, the financial bubble would have been smaller and its aftermath less painful.

This offers two important lessons to China. First, it is better to let the exchange rate rise sooner and more gradually than to risk a much sharper appreciation later. Second, monetary policy should not be too slack. Raising reserve requirements is a small step in the right direction. Despite the bears¡¯ growling, China¡¯s economic collapse is neither imminent nor inevitable. But if it continues to draw the wrong lesson from the tale of Japan, then one day its economy may look just as tatty.

Correction: We quoted some figures from a UBS report, that ¡°China¡¯s steel capacity of almost 0.5kg per person is slightly lower than America¡¯s output in 1920 (0.6kg) and far below Japan¡¯s peak of 1.1kg in 1973.¡± All those figures should have been tonnes, not kilograms. This was corrected on January 18th 2010.
 

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