‘China’s Great Wall of Debt’ Review: The Chinese Growth Charade

The Wall Street Journal
By Mara Hvistendahl

Reporters in China often run up against Potemkin projects—gleaming science parks sitting half empty, new districts with eerily few residents, solar-powered cities where most of the panels are disconnected. These wasteful investments, designed to fulfill local-government ambitions to boost construction and drive short-term growth, can be a nuisance when researching stories about innovation or environmental foresight. But what if such projects are not a distraction but the story itself? What if China’s economy is, in fact, on the brink of a precipitous downturn? That is the question Dinny McMahon asks in “China’s Great Wall of Debt.”


Mr. McMahon, a former Beijing-based correspondent for this newspaper, suggests that China has powered ahead for as long as it has not because it is immune to crises but because its government has so far managed to intervene to stave them off. When China’s stock market plunged in 2015, the central government directed fund managers to buy instead of sell and pressured journalists to write only optimistic reports. One reporter who strayed from the official line was trotted out on state television to apologize.


Such intervention has created a false sense of confidence, Mr. McMahon argues, which in turn has led to a bad case of economic bloating. As of 2015, China’s firms had an accumulated debt equivalent to 163% the size of the national economy, compared with 105% in South Korea and 71% in the U.S. Many of the companies on a borrowing binge are large, state-owned enterprises deemed too big to fail.


Local government leaders are rewarded for contributing to this bloat. They are graded on growth figures; to keep those numbers high, they prioritize tax contributions and construction projects above management and long-term planning. Even zombie companies—those that do not earn enough to repay their debts—help generate taxes, reducing the incentive to shut them down. Mile upon mile of new housing and infrastructure may not fill any real need, but seizing land from rural residents and selling it to developers is an easy way for local governments to boost revenue.


When it comes to generating economic growth, Mr. McMahon notes, such strategies are low-hanging fruit. Land sales are a one-off gain; eventually, “there are no magic bullets left.” An explosion of wealth, meanwhile, has created bubbles far beyond the property sector. The proliferation of unregulated shadow-banking outlets has contributed to a ballooning finance sector. Financial services now account for a greater share of the gross domestic product in China than in the U.S.


China’s leaders are fully aware of the country’s debt problem. Writing in the official People’s Daily newspaper in 2013, the influential Chinese economist Ba Shusong warned that a cooling of the property market could lead to a financial crisis. In February, China’s regulators took control of Anbang Insurance Group Co., the conglomerate that had acquired New York’s Waldorf Astoria in 2014 for $1.95 billion; this following a series of moves meant to rein in the company’s lavish spending.


Predictions involving China don’t always age well. In his 2001 book, “The Coming Collapse of China,” Gordon Chang proposed that the Communist Party would be out of power within a decade. In 2010, hedge-fund manager Jim Chanos warned that China’s economy was on a “treadmill to hell.” Other Western fantasies include the notion that the internet would bring democracy to China and that Xi Jinping would prove to be a democratic reformer. Such analyses often say as much about Western anxieties and aspirations as they do about reality.


Here Mr. McMahon is not immune. His insights are grounded in the 2008 global financial crisis. China’s financial system, he notes, increasingly looks like America’s “prior to the Lehman Brothers bankruptcy.” Mr. Chanos, he says, is not wrong about where the treadmill is headed; it is just that Beijing has “an unparalleled capacity to kick the can down the road.” But because debt keeps growing, at some point the can “will go no farther.”


Unlike earlier doomsayers, however, Mr. McMahon wisely steers clear of broad strokes. He doesn’t give a timeline for a downfall; nor, despite his brash subtitle—“Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle”—does he delight in signs of malaise. His book will be an indispensable explainer in the event of a downturn and a useful guide to understanding China’s economy in the meantime.


Perhaps the book’s sole moment of overreach comes when Mr. McMahon turns to China’s capacity for innovation. Despite stunning successes in sectors such as tech, Mr. McMahon is skeptical that China will be able to innovate its way out of a downturn. Beijing’s plans for innovation are largely state-driven, he notes, and reliant on short-term tactics such as protectionism and industrial espionage. But illicit technology transfer has lately been joined by strategic acquisitions of overseas companies in sectors as diverse as artificial intelligence and seed science. It may be too soon to tell what effect such shifts will have on China’s long-term economic prospects.


Ultimately, Mr. McMahon notes, those most affected by China’s debt binge are the people of China—the rural residents who watch as their land is seized and yet the developments built on them sit empty, and the urban professionals whose savings take a hit in value as banks dole out nonperforming loans. Income inequality has risen dramatically in China since the 1980s, putting it on par with Brazil. China has so far managed to elude the instability that often follows such inequality, but only because in recent decades its people have known only growth. If the country hits a recession, that may well change.

Dinny McMahon