Paul Krugman is pessimistic about China’s growth path. Â He is certainly correct that China has focused on building up its export industries and has invested a fortune in urban infrastructure. Â Following a Keynesian model, it has invested in public works projects in hundreds of big and small cities as it anticipates the urbanization of 300 million more people over the next 30 years. Â China’s leaders must be aware that its exports are unlikely to grow by 8% per year. Â Instead, the future growth model must be based on the following; Â 1. Â improving the quality of Chinese products (food, goods, apartment buildings) so that producers can sell them for a higher price to domestic consumers. Â 2. selling stuff such as cars to their emerging middle class, 3. selling basic durables (fridge, AC) to the new urbanites from the countryside, 4. investing in their military. Â Â Krugman ignores the quality side of capitalism. Â As China grows richer, its urban middle class will seek to buy better stuff and this will create huge demand and growth opportunities. Â China’s domestic car industry is booming.
Dr. Krugman is correct that the local governments in China have made Zillions $ of loans in investments that may have a negative rate of return. Â But, this is “too big to fail” lurking again. Â I have asked my co-authors in China about implicit loan guarantees and they agree that the Central Government is highly likely to bail out cities for “bad loans”. Moral hazard always lurks and China will offer a nasty test of this hypothesis.