The hottest debate over the world economy is not on the fate of America; it's on the fate of China. Will it be the worst victim, or the most successful survivor, of the global crisis of 2009? So far the news all points to success, as the Asian giant defies the old assumption that an American recession would trigger a Chinese depression. Long dependent on exports to America, China continues to grow strongly despite a collapse of exports, down 26.4 percent in May alone. The reason is growth at home, with retail sales up 15.2 percent in May, and house and car sales taking off. To some, this is evidence that China has hit a new state of development, emerging as a consumer society wealthy enough to rival America as the world's best customer, and in some ways it has. The problem is that the consumer driving the boom is not the individual, because the Chinese shopper has been in retreat in recent years. The real big spender is the government.
China's economic recovery is real, but it's been bought by the state. No political party in the world can spend quite as freely right now as China's Communist Party, with its nearly $2 trillion in reserves and budget authority unchecked by rival parties or institutions. Beijing's stimulus plan amounts to 4 percent of GDP, double America's 2 percent, and China can deliver this booster shot without resorting to foreign borrowing. Government investment has driven the Chinese boom for a long time, and it is up 30 percent since the beginning of the year, with 75 percent of the money going into infrastructure; spending on rail lines and roads has more than doubled over the past 12 months. New community centers, convention halls, and sports facilities are springing up in major cities and provinces. Central and local governments are raising subsidies to support idle factories, retrain workers, and boost income aid in hard-hit areas. New government lending, as well as government orders to banks to raise lending, is helping to spur a surge in apartment sales. The state is even handing out spending vouchers directly to consumers, particularly in rural areas, good for cars, refrigerators, and other products, many with price restrictions that effectively limit the vouchers to inexpensive Chinese brands. As a top executive at one Chinese state-owned bank puts it, "This is all about the government propping things up."
The hidden hand of the state can obscure the degree to which China still depends on subsidized exports to America. Among the hardest-hit areas are those such as Guangdong province, a southern factory hub that represents an eighth of China's wealth and a quarter of its exports. There five-star hotels built in the boom times stand empty, while job centers for laid-off migrant workers are full. On a recent evening, the Pearl River itself seemed dimmer—many of the garish light displays that usually blaze from waterfront inns and restaurants had been turned off "to save electricity," says Su Caifang, deputy director general of the Guangdong Foreign Affairs Office, who notes that the province has suffered greatly in recent months because of the global downturn. "We're still very export-dependent, especially on America," says Su, who notes that 40 percent of the region's exports go to the U.S.
It's an honest admission that undercuts all the talk about an emerging middle-class Chinese consumer poised to take the place of Wal-Mart moms. Chinese incomes are about one tenth of those in America, and total consumer spending was about $1.7 trillion in 2007, compared with $12 trillion in the U.S. Local officials in the Pearl River Delta say they are now traveling inland to Hunan or Sichuan province to sell to their own countrymen the consumer electronics, jewelry, and shoes they once sent abroad. Yet local sales are a drop in the bucket compared with exports. There's a growing sense that the U.S. market will take years to rebound—while the Chinese market will take a long time to reach critical mass. "Even before the financial crisis, we knew we needed to move beyond the U.S. market," says Allan S.K. Lam, vice general manager of Hua Jian Group, a shoe manufacturer that makes much of what you see in stores like Nine West, Kenneth Cole, and Coach. "But it's going to take at least five years, perhaps even eight years, to develop the Chinese domestic market in an important way."
What's more, Chinese consumers have been playing a less important role in the economy in recent years. Private consumption has been steadily declining for some time, going from more than 60 percent of GDP in 1968 to 36 percent of GDP in 2008, a trend that defies the typical image of China's booming middle class. The biggest reason for this is increasing worry over the country's lack of a social safety net (pensions are rare; medical care means money down at the door). But freedom may play a role: a recent Carnegie Endowment study looking at political freedom and consumption found that countries that became less free over the last 20 years, like China, Iran, and Venezuela, had a significant drop in consumption.
The retreat of the Chinese shopper worries people like Stephen Roach, chairman of Morgan Stanley Asia, who says consumption needs to reach 50 percent of GDP for China to really move beyond the export model. "There's no paradigm shift," says Roach, adding that state investment could rise from 40 percent of GDP to 45 percent by the end of this year, levels "we've never seen." Even when Japan was rebuilding after World War II, its investments reached only 34 percent of GDP. And while Japan was generating double-digit growth with that cash, Chinese leaders admit they will be lucky to hit the 7 to 8 percent target this year. Locals in Guangdong say the view from the ground is less optimistic than the official projections. "I've talked to a number of factory owners in the area, and they tell me if they can't get more orders in six weeks they may go out of business," says Ding Li, director of the Center for Regional and Corporate Competitiveness Research at the Guangdong Academy of Social Sciences.
Of course, the government can always intervene. Just look what it's done in Shenzhen, a Pearl River Delta city that, if the market had run its course, might be in just as bad shape as neighboring Dongguan, where by some estimates one out of every 10 factories is now shuttered. Shenzhen, a mere 97 kilometers away, is a vision of how government support can remake a city. Thirty years ago it was a paddy field. Then Deng Xiaoping decided to turn it into a manufacturing base, which today has an economy nearly half the size of its older and more glamorous neighbor Hong Kong. Most recently the government decided to place China's version of the NASDAQ there, spurring more new development. Many of the bourgeois trappings found in Shenzhen today—hyper-air-conditioned shopping malls, mock-Disney weekend resorts and nonsmoking coffee bars—were built by OCT (Overseas China Town), one of the earliest central-government-owned real-estate operations. Since 1985 the company has developed $8.7 billion worth of real estate. Still, many public spaces are conspicuously empty. On one recent evening, a vast California-style shopping mall filled with Chinese versions of upscale Western brands (Aqua-scu-tum, Hugo Boss) attracted only a smattering of visitors.
Still, Beijing builds on. A new state-owned luxury condo development called Portofino works improbably to bring la dolce vita to south China, with cobbled streets, broad piazzas, and a terra-cotta clock tower that chimes on the hour. A government representative claims 80 percent occupancy, and says that the $30,000-to-$50,000 flats in the development are selling to upwardly mobile, well-educated Chinese, many of them returning expats who see better job opportunities here than in the West. Yet the fake piazzas are deserted, and the majority of the comments on the message board of the local French-pastry shop are in English. While officials won't comment, it seems likely that a number of the properties are owned by or leased to Westerners.
China's heavily centralized state has spent its way to recovery before—during the Asian financial crisis of 1997–98, and also after the bursting of the dotcom bubble in 2001. But in both hose cases, government money was a stopgap, meant to buy time while the global economy (and exports) recovered. This time is different. The U.S. and, to a lesser extent, Europe are on the road to recovery. Yet exports are not coming back, which means that jobs for the 20 million Chinese migrant workers already laid off may not come back either. In fact, UBS bank estimates that the ranks of the unemployed may grow by another 15 million this year, as the export dip plays itself out. This doesn't necessarily translate into seething social discontent, as is often written. The migrants will be going back to their villages with a lot more than they left with. But in the mid- to long term, it raises pressure on China to find a new model. "I just don't see it happening," says Roach. "That's why I'm worried about another dip in growth next year."
Optimists point to Beijing's power of the purse. "The Chinese Communist Party is now the world's most liquid financial institution; there are no fiscal constraints," says Andy Rothman, a respected China bull at CLSA in Shanghai, who predicts 7 to 9 percent growth next year. Most economists agree that autocracy has its advantages in the midst of a credit crunch, since there are no political or legal obstacles to spending. As an executive at one of China's largest state-owned banks puts it, "The government told us to lend—so we did!" Yet already there are concerns about where all the new capital is going. Moody's and other ratings agencies are worried about a future rise in bad loans in China, given the explosion in bank lending. And since much of the new lending has gone to business, rather than consumers, it may be recycled among enterprises without trickling down more broadly to the consumer level, where it's most needed. While consumer-spending growth figures look high, even bulls like Rothman say the numbers are inflated to more than double the true level because government purchases at retail shops are included in the figures.
China has begun to create a social safety net, which would give people more confidence to spend instead of save, if it were not so full of holes. A few months back Beijing passed a $127 billion national health-insurance plan, to be delivered over three years. That's less than 50 bucks a head in China—"just puny," says Roach. Meanwhile, China's social-security fund has only $82 billion under management, less than $100 per worker. Economists believe the numbers should be doubled immediately, and China could afford to do it. Yet Beijing has been talking about tightening social safety nets since 2006, with little action. Even Chinese are skeptical about Premier Wen Jiabao's boast to deliver universal health care by 2011.
Of course, increasing affluence would also help encourage consumer spending—the per capita GDP in China is still only $2,000. But that would necessitate moving up from cheap, polluting industries to global Chinese brands. Right now most Chinese exports are merely assembled in China, rather than designed and branded there, which means most of the profit, and the big salaries, goes to foreign partners. Throughout Guangdong, where many exporters are based, officials and factory bosses claim to be working toward designing and producing more sophisticated finished goods, but the statistics tell a different story. Some 60 percent of production in the region is still low-end component assembly. And until China becomes an advanced export power it will remain a backward consumer society, where any green shoots are pushed up by the state.