Last updated: 13:32 / Thursday, 2 May 2013
Walker vs. Mahbubani

Robeco, hosts the battle of the Titans for the future of China

Robeco, hosts the battle of the Titans for the future of China

China’s short-term prospects are bleak, with a recession ahead, Jim Walker told the Robeco World Investment Forum. But its longer-term rise, along with the wider Asian region, is unstoppable, countered Kishore Mahbubani.

China’s economy is faltering. First-quarter GDP growth disappointed, with a 7.7% year-on-year increase. That was lower than both the 7.9% reported for the final quarter of last year and the consensus expectation of 8%. Moreover, the government is warning that the country has entered an era of lower growth, as it presses on with rebalancing the economy from a focus on investment and exporting to domestic consumption.

What are the implications of this shift, both in the short term and in the long term? Where is the country heading in the next few years? And is China still on course to overtake the US as the world’s largest economy?

For Jim Walker, managing director at Asianomics, the independent economic research company, China is at a critical juncture. And the outlook is not good. “We think there’s a recession ahead for China,” he said. “Not just lower growth, but a recession.”

China saved the world but killed itself

Why? “China killed itself when it saved the world in 2009,” said Walker. That is because of the extraordinary credit expansion since the start of the financial crisis. In 2009, the Chinese injected new credit into the economy equivalent to 43% of Chinese GDP, or 16% of US GDP. They followed up by repeating the act in 2010, 2011 and 2012, when new credit was equivalent to 41%, 37% and 37% of Chinese GDP respectively.

At the same time, the growth rate is slowing. Walker argued that rather than the official 7.8% for GDP growth last year, digging into the supporting data suggests that 5% is a more realistic figure.

New credit increased further in Q1 2013

“This credit expansion cannot continue, can it?,” he asked. “Well, actually, in the first quarter of this year, it accelerated.”

The inevitable result of these floods of money is overcapacity across the economy. “When countries have overcapacity, they don’t make money in their corporate sector,” said Walker. And that is the case in China, he said, as the earnings reported by companies there “don’t actually exist”, thanks to accounting sleights of hand. Tellingly, operating cash flow as a percent of net profit was only 54% in China in 2011, against a typical figure in most counties of 100-120%.

“To improve that cash flow position, to improve the companies’ balance sheets, they’ve got to cut capital expenditure. And banks have got to stop lending to them,” he said. “When that happens, you get recession.”

New political leadership has its hands full

A further issue is China’s new leadership. Walker told the forum that his Beijing contacts are positive about the new leadership’s efforts in fighting corruption and moving the economy away from the state sector.

But he’s not so sure. For sure, they have been dealt a bad hand. “Corruption, corruption, corruption. China is ripe, rotten with corruption,” he said. “There is a clampdown on corruption. But is it enough?”.

The answer is: probably not. “They’ll take China forward to feather their own nests and to make sure that their pockets are full,” he said. “They know how to accumulate money like nobody else on the planet.” Moreover, the acceleration of credit growth in the first quarter of this year suggests to Walker that “more of the same” can be expected from the new leadership.

Still, Walker’s picture of China isn’t 100% gloom. “The Chinese take such crises on the chin,” he commented in his interview “Recession in China will come as a surprise”, before they bounce back.

Mahbubani: a major historical aberration is ending

According to Kishore Mahbubani, Professor in Public Policy at the National University of Singapore, China’s bounce-back is long overdue. Mahbubani’s stock in trade is not so much the rise of Asia but its return.

He argues that until 1820, the world’s two largest economies were China and India. And after two centuries of Western domination, the world is returning to the historical norm of the previous two millennia. In this longer-term perspective, the supremacy of the UK and the US should be viewed as “a major historical aberration”. “All aberrations come to a natural end,” he said.

For Mahbubani, “the big question” about Asia’s return to the center stage of world history “is why? And why now?”

Asians have learnt best practices from the West

His answer is that Asians have absorbed and understood Western best practices in many areas, from free-market economics to innovation in science and technology. “If you want to find the greatest psychological conviction about free market economics, it used to be in the West. Now, it resides in Asia,” he said. They have also instilled in many cases a belief in meritocracy and the rule of law, and developed what he referred to as a “culture of pragmatism”.

How meritocratic is China?

But just how meritocratic is China? The author of The Great Convergence: Asia, the West and the Logic of One World rejected the notion that nepotism offers an easy entry route into the country’s political elite, pointing to the intense struggles behind the scenes in the Chinese communist party.

“These guys fight their way up,” he said. And that, he said, has a positive effect, allowing only the cream to rise to the top: “The quality of the minds of the people at the top in China is probably among the best you’ll ever find.” That is quite a different interpretation of the Chinese leadership to Jim Walker’s.

Still, Mahbubani accepts there are risks for China, both internally and externally. At home, inequality is on the rise and the exploding middle classes are demanding more government accountability, creating some political uncertainty.

No avoiding Sino/US geopolitical competition

Abroad, there are geopolitical tensions within the Asian region, such as the squabble with Japan in the East China Sea over the Senkaku/Diaoyu islands, and with the US, whose number-one position in the global economy China is challenging. “Rising geopolitical competition between China and the US is inevitable,” said Mahbubani.

But he believes the Chinese government is too pragmatic to allow such tensions to have a long-term impact on economic relations. Moreover, he feels that the interdependence of the world economy, through trade and financial links, make the likelihood of war extremely unlikely. “There will be geopolitical rivalries. There will be no geopolitical wars,” he argued. “The US & China will actually work together in economic co-operation.”

Will China become the world’s #1 economy

So where does that leave China’s progress to economic top dog? For Mahbubani, it is just a matter of time—and not that much time either. He said that by 2017, China’s share of global GDP will have risen to 18.2% in purchasing power parity (PPP) terms, when the US’s share will have dropped to 17.6%.

Walker was more skeptical. “China will become the biggest economy in the world as long as it keeps printing numbers that don’t mean anything,” he noted.