China's growth problem is an inequality problem
China's economic growth rate has been slowing down for the last decade. This Monday marked a new low, with news of just 6.2 percent year-over-year growth for the second quarter. Of course, if a major western nation like the United States posted 6.2 percent growth, champagne corks would be popping. But for China, that's a big come down from a peak of 12 percent in the late 2000s. President Trump was eager to take credit, crowing that "United States tariffs are having a major effect on companies wanting to leave China for non-tariffed countries."
If Trump's trade war were actually responsible for China's downshift, that would hardly be something to celebrate; along with the U.S. itself, China's growth is one of the few bright spots in an otherwise moribund global economy. But the main cause of China's struggles is arguably internal — the country's own spiraling inequality, and the government's lackluster response to it.
Despite liberalizing in a market-friendly direction in recent decades, China's economy is still quite different from ours, and still heavily influenced by its communist past. China's national government owns both a great deal of industry and a lot of the banks that lend to both state-owned companies and private companies alike. Directing newly created credit to finance big economic projects like infrastructure is the channel through which the government does much of its central-planning, and through which it pumps a lot of its stimulus into the economy. If the government wants a new high rise, it has its banks lend to the relevant construction company to fund the project, and it gets a new high rise.
This reliance on lending to fuel growth has led to a lot of handwringing from western observers about the massive build up of debt in China's economy. But China's government more or less explicitly backstops banks' lending with its ability to create limitless amounts of Chinese currency. It's possible that all this government-backed lending could overheat the economy — though national Chinese inflation remains pretty low, despite a spike in food prices — but the banks are never going to suffer a 2008-style collapse. Those kinds of financial crises are an outgrowth of America's more market-friendly setup, with its (ostensibly) formal divides between government finance and the entirely private banking sector.
The way China's economy can hit a real rough patch is if all that state-directed development winds up being ill-considered: highways and ports in the wrong places, cities that go unused, that sort of thing. This is, in fact, the classic capitalist objection to central planning, the suspicion that governments are poor planners. And in a way, this is what the growth slowdown points to, a weird hole in China's planned economic policy — which also happens to be the way it most resembles the U.S.
First, China suffers from America-esque levels of inequality. Its gini coefficient, a standard measure of a country's inequality, is actually higher than the U.S., while the top 20 percent of China's earners claim almost half of all the country's income. One effective way to combat inequality is to have big and generous social welfare programs, to slice money off the top while offering a lot more of it to the bottom. But again, like the U.S., China's welfare state is rather lackluster. None other than the International Monetary Fund observed that savings and income distributions in China point to "inadequate social transfers, a lack of progressivity in taxation, and a limited social safety net."
There are other ways to spread incomes to everyday people, like providing them with jobs through the kind of industrial policy that China does a lot of. But this can be an indirect route, especially in a country where huge swaths of the poorest citizens remain rural, and where industrial policy often has to filter down through multiple layers of corrupt regional elites who do double duty as both business leaders and political officials.
If China's big challenge is to navigate the shift from a rural to an urban society, and from a manufacturing-heavy economy to a services-heavy one, and to do all this while pushing up against the practical limits of its own state-planned policy model, then what China needs more of is bottom-up spending power for its own everyday consumers. That kind of aggregate demand is the raw fuel that can power smarter economic projects chosen by private banks and private investors — should China choose to liberalize further.
Ironically, that lack of sufficient bottom-up spending power is what both the Chinese and the American economy currently suffer from. And in both cases, a big part of the solution is the same: Greatly expand the scope and generosity of government redistribution.
Nor do the problems end there. If China's own consumers can't quite provide the demand their economy needs, China must look for demand from other countries to fill the gap. That's the basis for the country's export-focused trade policies that so aggravate President Trump. But that dependence on foreign demand also leaves China's own economy more vulnerable to slowdowns in other countries.
If economies across the globe tank, their demand for Chinese exports falls, and China's growth slows further. The European Union is still a bit of an economic basket case, and several major developing economies like Turkey are struggling as well. Just as much, and perhaps even more than, Trump's tariffs, those global economic troubles are dragging down trade as a source of growth for China's economy.
The Chinese government's latest stimulus efforts show promise. Some of the stimulus aims at increasing deficit-financed spending by local governments, and some aims to push through more lending to corporations. Even more positive was a cut in March to China's VAT (a form of sales tax), which should put a bit more money into the pockets of regular Chinese citizens.
If China really wants to balance out its economic growth going forward, however, it needs to move a lot more money down to the bottom of the income ladder.