Don’t Fear the Reaper, Adam Smith

As its economy rapidly emerged from the 2008 Financial Crisis, Beijing’s self-satisfied purring was enough to make the laissez-faire crowd believe they had developed tinnitus-like ringing in their ears. But don’t fear the reaper, Adam Smith – growing domestic challenges are forcing a reconsideration of the “Beijing Consensus” and the long-term viability of state-driven capitalism.Since gaige kaifang (reform and opening) in 1978, China’s economy has grown roughly 10 percent each year. Yet some of the Beijing Consensus’ development tenets (like currency controls and state-directed financial markets), which helped drive two decades of historic growth and mitigate the effects of the 2008 crisis, now serve to increase near-term inflationary risks and asset bubbles and portend a financial crisis and slower growth in coming years.Beijing’s currency and capital control policies have exacerbated inflationary pressures and asset bubbles. To maintain its dollar peg, China’s central bank extracts foreign currency and returns renminbi, the vast majority of which stays in China due to capital controls and savings behavior, potentially inflating the currency. March’s CPI reached a high of 5.4 percent year-on-year, a level unseen since 2008. Housing prices have also skyrocketed as Chinese investors, who are allowed few other legal investment options, plow their cash into what increasingly looks like a bubble market. Indeed, Xinhua, China’s state-run news outlet, recently reported the whistling sound of air escaping Beijing’s housing market, where purchase prices fell 26.7 percent in March.To counteract inflation, Beijing has raised interest rates and reserve requirements numerous times over the past six months but to no avail. Add rising interest rates and a potential housing bust to the misallocation of capital by state-owned banks, especially during China’s post-crisis stimulus, and the possibility of non-performing loans, bankruptcy, and an economic slowdown become more realistic. In which case, the capital and financial policies of the Beijing Consensus look more like a poison pill than the economic model of the future.Even if one ignores the distant sound of bubbles bursting in East Asia and maintains that China’s state-driven economy isn’t approaching a major setback, they still shouldn’t expect the Beijing Consensus to endure. After all, it’s not even Beijing’s. The world has seen similar systems before, albeit on smaller scales, in Japan, South Korea, Singapore, and Taiwan, all of which liberalized. For Singapore and South Korea, political reform followed per capita income (PPP) thresholds of roughly $6000 – a level China recently passed. Beijing has not discovered some magic economic formula. They have simply taken what worked previously in East Asia and adopted it to their own domestic conditions.And what are those domestic conditions? Low wage labor in often dangerous workplaces, rampant environmental degradation at the hands of the world’s leading producer of CO2, and dangerous consumer products like melamine-tainted milk and collapsing Sichuan houses built from sand. Not only does the “growth at all costs” China-model have heavy negative externalities, but recent evidence suggests other, more liberalized nations and regions are capable of catching up. In the fourth quarter of 2010, for the first time in decades, probably ever, both Brazilian and Latin American merchandise exports – a central component of a nation’s current account – grew faster than their Chinese and Asian competitors, portending a potential industrial shift and proving growth based on exporting goods is not the exclusive domain of current and former Asian autocracies. In the battle of developmental ideologies, the rise of a Brasilia-driven Latin American economic pole will prove important in refuting state-driven development, in favor of free-market developmental models.Assuredly, the world is exiting a period of economic turmoil that increased China’s share of the ideological and economic marketplaces. Yet, if Chinese domestic conditions and the experiences of other East Asian nations are any indication, then Chinese reform is as inevitable as Adam Smith's disappearance from the developmental canon was premature. This image is being used under Creative Commons licensing. The original source can be found here.