But this kind of productivity-enhancing technological innovation is far less likely to occur if capital is allocated according to political criteria rather than by investors and entrepreneurs in an open market. For years, Michael Pettis, a professor at Peking University’s Guanghua School of Management, has been arguing that the Chinese economy has been badly undermined by this kind of politicized capital misallocation. As he put it in his newsletter last year, “investment in high-prestige areas such as electric cars, solar panels, and so on for technologically backward countries with low worker productivity may be a little like investment in the space program or in the Olympics.” While these efforts might give a boost to national pride, “they reduce overall wealth and exacerbate domestic imbalances.” Pettis’s predictions are looking sound as the Chinese growth engine sputters.
Last year, the economists Barry Eichengreen, Donghyun Park, and Kwanho Shin published a fascinating survey of growth slowdowns. They found that fast-growing emerging economies tend to see a downshift in average annual growth rates around the time they reach a GDP per capita of $17,000, which China is expected to reach by 2015, and when 23 percent of the work force is in the manufacturing sector, a level China should reach around the same time. Other factors that are correlated with growth slowdowns are higher ratios of retirees to those of working age (a ratio that in China is expected to go from 11.6 percent in 2010 to 38.8 percent in 2050 — higher than the 37 percent the U.S. is expected to reach that same year), undervalued currencies (check), and volatile inflation rates (another problem looming on the horizon). Though Eichengreen, Park, and Shin are careful to note that there is nothing inevitable about growth slowdowns, experience strongly suggests that China is due for one in the very near future. Given that the Chinese Communist Party depends on high growth rates for its legitimacy, this is a profound challenge.
Even in the unlikely event that China does the right thing — if it addresses capital misallocation by placing more of the economy in private hands, if it allows Chinese households to retain more of the wealth they create — the country will still struggle with the bad debts it has accumulated over the last 20 years. Pettis anticipates that China will grow at an average annual rate of 3.5 percent, yet he argues that if China does not address the systematic misallocation of capital, growth could come to a halt. The real threat from China is not that it will grow so economically strong that it will bestride the world like a colossus. Rather, it is that it will become so weak and vulnerable as to collapse, or to lash out at its neighbors.
Consider what those who want America to mimic China are asking us to do. They want to place decisions in the hands of an enlightened elite that will invest heavily in electric cars, solar panels, and fast trains, and in infrastructure in politically favored regions. They want us to follow a course that is leading a great nation down a path of ruin and misery.