Crashed

by Adam Tooze

  II

  China’s growth rate was the envy of the world. But at home, given the huge social and environmental costs, reviews were more mixed. The aim of the Hu Jintao leadership when it took office in November 2002 had been to give new priority to consumption and the household standard of living. After a decade of superrapid growth, the Chinese had had enough of heavy industrial development.22 But investment-driven heavy industrial growth is a hard habit to break. Five years later, in March 2007, in a remarkably frank assessment delivered to the National People’s Congress, Premier Wen Jiabao warned that “the biggest problem with China’s economy” was still that growth was “unstable, unbalanced, uncoordinated, and unsustainable.”23 When announcing its stimulus response to the 2008 crisis, Beijing pushed high-tech railways and health care as hard as it did because it wanted to escape associations with clichés of heavy industrial growth. The government was determined to avoid “frivolous or speculative investments.” “There won’t be a penny spent on enlarging mass production, or highly polluting and resource intensive sectors,” Zhang Ping, director of the National Reform and Development Commission, stressed. All its efforts would be directed so as to “target spheres that would promote and consolidate the expansion of consumer credit.”24 In December 2008 the State Council followed the November stimulus announcement with an “Opinion on Stimulating Circulation and Expanding Consumption,” itemizing twenty measures to boost consumption. China’s 220 million rural households were offered state-funded discounts on the purchase of two large household appliances, such as televisions, air conditioners, washing machines and refrigerators.25 As the average rural household earned less than 16,000 renminbi (RMB—though used interchangeably with yuan, RMB refers to the Chinese currency as such, whereas yuan are the units in which sums are measured) in 2008, buying a computer or color TV for 7,000 RMB was a big step. But over a two- to three-year time horizon, the 140 billion RMB promised by Beijing was a powerful inducement.26

  The aims of China’s leadership were thus clear. And it is tempting to imagine these priorities being rolled out across the country by an all-powerful one-party state. But in practice, Chinese central government is stretched thinly across the giant bulk and complexity of the world’s most populous nation. Though responsibility for revenue collection falls heavily on central government, government expenditure directly controlled from Beijing has amounted to no more than 4 to 5 percent of GDP since the 1990s, a very small figure by comparison with its American or European counterparts. In China, 80 percent of government spending is done at the regional and local levels, where expenditure has surged between 1994 and 2008 from 8 to 18 percent of GDP, even as China’s national income quintupled.27 The regime thus operates through decentralization and indirect mechanisms, which amplify its power and extend its reach, but also distort and distend Beijing’s intentions.

  Of the 4 trillion yuan stimulus announced by the center in November 2008, only 1.18 trillion yuan would be delivered directly from central funds. The rest were to come from local government, a ratio of 1:3, corresponding roughly to the general balance between central and local expenditure. It was the decentralized nature of the state apparatus that made the mobilization of the Communist Party and its nationwide apparatus so vital. Central Document No. 18 energized the networks that linked the Communist Party, local government and business interests. It was precisely this nexus that over the last generation had combined to supercharge China’s spectacular economic growth. But it was that same combination that also went a long way to explaining the lopsided character of China’s growth. To meet a central target or quota, there was always some regional highway connection, housing complex, bridge or industrial park to be built and profits to be made doing so. When the stimulus was launched it was precisely this chain reaction that worried those who advocated a more balanced model of growth. The centrally ordained stimulus would unleash the bulldozers of the infrastructure machine. The results confirmed the critics’ worst fears. In Hubei province, with a population of 57 million and a regional GDP of $225 billion in 2009, there were projects under construction by 2010 notionally costed at $363 billion.28 A further $390 billion and $450 billion were planned for 2011 and 2012. Taken at face value, this meant that a single Chinese province with a population the size of the UK and a GDP the size of Greece was engaging in a program of investment larger than any stimulus ever attempted in the United States. Across China, within a month of the State Council’s November initiative, eighteen provinces had proposed projects with a total budget of 25 trillion RMB, six times greater than the original proposed stimulus, accounting for more than 80 percent of Chinese GDP.29 Not only was this proposed spending gargantuan, but within the corporate sector, it was the State Owned Enterprises (SOE) that took charge. Since the 1990s the thrust of central policy had been to shed labor and to streamline these vehicles of Communist economic development policy.30 Now, under the sign of the stimulus, the SOEs lurched once more to the forefront of Chinese growth.

  China’s Credit Stimulus, 2007-2013 (year-on-year growth rate)

  Source: Yukon Huang and Canyon Bosler, “China’s Debt Dilemma,” 2014, figure 1, http://carnegieendowment.org/2014/09/18/china-s-debt-dilemma-deleveraging-while-generating-growth-pub-56579. Data: UBS.

  Clearly the impetus for spending was massive. But from an economic point of view the vital question was how it was to be financed. This is the key question in any fiscal policy “stimulus.” If spending is paid for by tax increases, this negates any increase in purchasing power. Borrowing by issuing bonds will soak up private savings, which may divert the portfolios of private wealth holders away from other investments. Credit creation is the one surefire way to fund stimulus spending if the aim is immediately to revive an underemployed economy. Beijing’s stimulus was particularly effective precisely because it combined huge government spending with a spectacular loosening of monetary policy.

  In China, not only were many major industrial firms state controlled but the banking sector was under the direct influence of the central bank as well.31 When it wants to control credit, the People’s Bank of China (PBoC) not only sets the interest rates. It set quotas for credit issuance for each of the major banks. To further manipulate the credit flow it can use higher or lower reserve ratios and greater degrees of “sterilization” of its foreign exchange interventions. All of these mechanisms were once commonplace in the West as well, legacies of the World War II era. But from the 1970s onward, direct regulation of bank credit was progressively abandoned in the West. In facing the 2008 crisis these tools of banking control gave Beijing remarkable leverage. In September and November of 2008 the PBoC reversed its tightening of the spring by slashing its interest rate by almost 5 percent. Then it announced that for 2009 it was doubling the banks’ lending target from 4.7 trillion RMB to 10 trillion RMB. Reserve ratios were cut by up to 25 percent for smaller banks. It was, as the PBoC’s Monetary Policy Committee declared in April 2009, an “appropriately loose monetary policy” to sustain the priorities of the stimulus.32

  The banks responded. The Bank of China alone wrote 1 trillion yuan of loans in the first half of 2009, with the Agricultural Bank of China, China Construction Bank and the Industrial and Commercial Bank of China not far behind. Together in the first quarter of 2009 credit issuance came to 4.6 trillion yuan, with the top four being responsible for 3.433 trillion yuan. More new credit was issued in three months than the official fiscal stimulus would provide for the next two years. Meanwhile, provincial and city governments were enjoined to work with local banks. The main mechanism for financing their local spending were so-called city investment companies, or local government financing vehicles—the “shock troops of the stimulus.” These SPVs were endowed with parcels of municipal land against which they borrowed to fund development projects.33 Between 2008 and 2010 local government debt would rocket from 1 trillion RMB ($146 billion) to an estimated 10 trillion RMB ($1.7 trillion).34

  A
t the height of the stimulus drive, in the first half of 2009, 7.37 trillion RMB were issued in new loans. This was a 50 percent increase on the year before, which had also been a year of booming economic activity. By the end of the year the total volume of lending hit 9.6 trillion yuan.35 If we add the government deficit at all levels to the growth in bank credit beyond the 15 percent per annum expansion that had been the norm in China over the previous years, we get a measure of the true scale of China’s stimulus. In 2009 its dimensions were extraordinary—950 billion yuan in deficit, 467 billion in additional bond finance and 5 trillion in bank loans beyond the previous growth norm, for a total stimulus of 6,487 billion RMB, or 19.3 percent of GDP.36

  Big Bang: China’s Bank Lending and Fiscal Stimulus Programs, 2008–2010

  Stimulus (RMB billions)

  2008

  2009

  2010

  Fiscal deficit

  111

  950

  650

  Net new bank loans

  252

  5070

  1936

  Net new bond finance

  251

  467

  -232

  Total

  614

  6487

  2354

  Stimulus (% GDP)

  Fiscal deficit

  0.4%

  2.8%

  1.6%

  Net new bank loans

  0.8%

  15.1%

  4.9%

  Net new bond finance

  0.8%

  1.4%

  -0.6%

  Total

  2.0%

  19.3%

  5.9%

  Source: C. Wong, “The Fiscal Stimulus Program and Problems of Macroeconomic Management in China,” (2011), table 4, https://ora.ox.ac.uk/objects/uuid:4b8af91e-89c7-4a25-be7c-2394cd3c4e9b. Data: China Data Online.

  This huge additional growth boost was delivered through a variety of channels. But it was state directed from the top down and supplemental to China’s already enormous growth rate. When the entire complex is accounted for, this was an intervention comparable in scale to anything ever undertaken in the Mao era, or under Soviet communism. The Western capitalist economies had witnessed such huge mobilizations only in times of war. The rate of investment in the Chinese economy surged toward 50 percent of GDP, a level rarely, if ever, seen before. It was enough to offset even the worst shock to global trade.37 At 9.1 percent, China’s growth rate in 2009 was barely lower than it had been in 2008 and vastly higher than anywhere else in the world. And given the size to which the Chinese economy had expanded, this was decisive. In 2009, for the first time in the modern era, it was the movement of the Chinese economy that carried the entire world economy. Together with the huge liquidity stimulus delivered by the US Federal Reserve, China’s combined fiscal and financial stimulus was the main force counteracting the global crisis. Though they were not coordinated policies, they made real the vision of a G2: China and America leading the world.

  Drivers of World Growth (in percentage points)

  Source: S. Barnett, “China: Size Matters,” IMF (blog), https://blogs.imf.org/2014/03/26/china-size-matters/.

  III

  Given the geopolitical conclusions that are apt to be drawn from China’s “overtaking” of the United States, it is worth noting that the 2008 mobilization was not part of any master plan. It was a hyperactive response to an unforeseen emergency that struck China from the outside. The origin of that negative shock was in the West. It unleashed forces within China that took its economy in directions that the Beijing leadership had been struggling to counteract and that were widely unpopular in China. And the dramatic impact of the stimulus had consequences that were political and geopolitical as well as economic.

  The spectacular state action fit well within popular narratives of China’s rise. As the twenty-first century began Chinese audiences were hooked on a massive diet of TV and film offerings preoccupied with the question of the rise and fall of great powers.38 On the Internet there was a spectacular surge in public discussion of “Chinese greatness” and the “China model.”39 In the wider world, surveys conducted by the authoritative US polling center the Pew Charitable Trusts registered a dramatic shift in popular understanding of the global center of gravity. As the impact of the economic crisis sank in, the number of respondents identifying the United States as the dominant economy in the world began to decline sharply. By 2010 pluralities of respondents in both the United States and Europe would identify China as the “world’s leading economy.”40 In material terms it empowered the Communist Party and the growth coalitions built around it. Because of the decentralized nature of power, those coalitions came in different colorations, ranging from Shanghai’s hypermodernity to the neo-Maoism of Bo Xilai’s “Chongqing Model.” What was striking, however, was that these were overwhelmingly civilian coalitions. Unlike other historical examples of great growth spurts, China’s stimulus was not a military-industrial push.

  Unlike subordinate parts of America’s global network, like Japan or Germany, for instance, China had a conventional view of national power. It took for granted that national autonomy implied autonomy in security policy. Given China’s booming economy, spending on defense increased with spending on everything else. Already in 1999 the military-industrial complex had been restructured to increase competition. In 2005–2006 the Chinese military formulated a major technological modernization program.41 But this was merely a recognition of how far China lagged behind. The army was oversized and underpowered in technological terms. A society entering into mass affluence as rapidly as China was doing does not offer a congenial habitat for the underpaid profession of soldiering. Rather than raw recruits, the Chinese military needed technologists, but they were scarce and expensive. China’s military equipment and infrastructure were far behind those of Western militaries and behind the standard set by China’s booming business sector. And though it was increasing rapidly in absolute terms, as a share of GDP, China’s military spending remained flat at 2 percent throughout the crisis—half the level that the United States had sustained since 9/11. As the civilian-centered stimulus program hit in 2008–2009, the share of military expenditure in total public spending halved from 12 to 6 percent.42

  These facts were public knowledge, but Washington’s seismograph reacts sensitively to any challenge. When in March 2009 a flotilla of Chinese trawlers harassed an American naval reconnaissance vessel off Hainan island, the incident was promptly declared to be a sign of escalating confrontation.43 The Obama administration’s first encounters with the Chinese were frosty. Treasury Secretary Geithner provoked laughter from nationalist students at Peking University when he declared that American debt was “very safe.”44 As one American analyst remarked, “2009–2010 will be remembered as the years in which China became difficult for the world to deal with.”45 Whether this reflected geopolitical ambition was not yet clear. But as far as strategists in Washington, DC, were concerned, this was incidental.46 It was the economy itself that was decisive. Washington was convinced that China’s military potential would grow with ti
me, as would its ambition. What underpinned both was its spectacular economic growth, and what was decisive was Beijing’s ability to control it. In this sense the financial crisis marked a moment of transition, as much on the Western side as in China itself. Given Beijing’s response to the crisis of 2008, its emergence as a decisive force in world affairs was undeniable. As was the other realization taught by 2008: If China was not export dependent, it was massively interdependent with the West. It had a measure of control but not insulation. Since the early 2000s, Washington’s ambition had been to develop China as a “responsible stakeholder” in the world economy. Now the question was reversed. In the wake of the crisis what Beijing needed to know was what to expect from America. As Gao remarked to the interviewer at the Atlantic: “Why don’t we get together and think about this? If China has $2 trillion [in US assets], Japan has almost $2 trillion, and Russia has some, and all the others, then—let’s throw away the ideological differences and think about what’s good for everyone. We can get all the relevant people together and think up what people are calling a second Bretton Woods system, like the first Bretton Woods convention did.”47

  Chapter 11

  G20

  China’s stimulus benefited all its trading partners, from Australia to Brazil.1 Across the world the share of China trade increased.2 But, having recognized the scale and significance of the Chinese effort, it is important not to fall into the trap of allowing it to overshadow everything else. If we replace a narrowly Western view with a one-eyed focus on China, we fail to grasp the drama and complexity of the transition to a truly multipolar world. Ten years on from the emerging market debt crises of 1997–1998, what was impressive about 2008 was the policy response across the emerging economies. At the UN General Assembly meeting in New York in September 2008 it was the Latin Americans who were the most vociferous. But in responding to the crisis, it was “emerging Asia” that set the pace.