Stephen Cecchetti on China's Growth Prospects

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China's future in a few words: as you get richer you grow slower.

Cecchetti predicts that China — like any country on its way to growing richer — will be suffering from lower growth rates owing to an increase in the capital labour ratio, which causes the marginal product of capital and hence the growth rate of the economy to fall. This translates into an "iron law" of economic history that precludes a country from experiencing high levels of per capita income AND high growth rates.

The question is not whether China's growth rate will drop or not, the question is when and how fast.

In answering these questions it is instructive to look at the development of debt in China. Credit is growing quickly in China, with corporate debt dominating the category — quite in line with Pettis' complaint that the household sector is being crowded out by the government sector. 

At the same time, the level/size of debt is very/too/worringly high (relative to per capital GDP).

So: growth is on a downward path, debt is already high and growing fast, and, thus China is headed for a point beyond and lower than the optimal size of debt, as financial deepening and better and expanding credit/fiancial markets etc are a boon for a country up to a certain level of debt. At around 100% of GDP problems emerge that begin to overwhelm the picture with negative effect; the trajectory of improvement turns into one of decline, and debt is becoming a drag on growth:

" T[he size of your financial system alone becomes a drag on growth. Because you are starting to allocate credit to things that are lower growth rate things."

Even more importantly; the faster credit grows, the slower productivity grows. And again, it's an allocational issue:

"The faster credit grows in your economy, the more likely it is that you're allocating to low growth things."

There tends to be more expenditure going to pleadgeable, tangible asssts (like houses) which are provided by relativly low productivity industries.

"So, what you are seeing in China is three forces all at the same time that are becoming drags on growth": a lower marginal product of capital, a hugely sized debt, and debt that grows inordinately fast.

A final concern: China's banks do not have (yet) the incentives and the technical skills to take prudent lending decisions — routinely and systematically — like their counterparts in more developed countries. 

Hence credit/fiancial market liberalisation may well invite trouble as the capacity to allocate credit efficiently is not in place.