What exactly don't investors understand about the term "command economy"?
I've been pondering that question as I watch global financial markets retreat on worries that economic growth in China is going to slow precipitously.
I just don't think that kind of surprise is very likely, given the nature of China's economic system.
It's not that I think China's economic system -- or the people who run it -- is perfect. For example, China's leaders allowed a buildup of bad loans brokered by local governments that in another system would be big enough to bankrupt many of those local governments and a majority of the country's banks. In China's system, however, the government can bury that bad debt, as it did after the Asian currency crisis of 1997, and engineer the recapitalization of the country's banks. (For more on this debt problem and China's "solution" to it, see my June 1 column, "China's Ponzi-like banking policy.")
In fact, I'd argue that the Chinese economic system is generally bad at short-term economic decisions, because the Chinese economy doesn't provide either fast or accurate signals on pricing, supply or demand.
Trust China's sweet spot
But in a big swath of the middle term, China's economic system does a spectacular job at making sure that nothing goes terribly wrong. Over one, two or three years, China's unique combination of market and centralized command-style economics has the ability to make decisions far more quickly than most other economic/political systems. It also has the brute power to mobilize a high percentage of the country's resources behind the decisions. And that's exactly the time frame that includes current worries about China's economic growth.Right now, I've got big doubts about, say, short-term (a quarter or so) profits in China's auto industry. In the long term, I've got big doubts about China's ability to solve its terrible demographic problem over the next 20 years.
But China's ability to keep its economy humming at 8% to 10% a year for 2010 and 2011? Doesn't keep me up at night. Especially because China has successfully reloaded its stimulus pipelines with enough cash to overwhelm any slowdown in just the manner it did in November 2008.
In fact, I'd say that current problems operate on a time scale that's in the sweet spot for China's economic/political systems. These problems play to the strengths of China's economic system.
Let's take a look at China's Goldilocks worries, and at the short and long term, where China's system doesn't work nearly so well.
To understand the drawbacks of the Chinese economy in the short term, you don't need to look any further than China's auto industry. In 2009, subsidies and credits from Beijing boosted total auto sales in China by 45% from 2008 levels.
In the first half of 2010, sales growth dropped to a 30% annual rate.
And the rate looks like it is headed lower. Beginning in April, car sales have dropped every month from the month before. In June, for example, sales dropped 5%. That took the annual growth rate down to just 14% from June 2009.
Now that's volatility. And in a market with many features of a command-style economy, volatility gets magnified, because everyone jumps in the same direction on orders from the central government. And because there's very little pushback from market signals, the initial response to the volatility and the eventual response can get, well, out of control.
For example, in response to the 45% growth rate in 2009, the auto industry in China went on an expansion binge. The top 14 automakers in China, many of them foreign, launched plans to reach a combined production capacity of 23 million vehicles by 2012 -- even though demand in China is projected at only 20 million vehicles by then. And that measures only the big guys' plans. China now has more than 100 domestic car companies.
In other kinds of economic systems, banks would have pushed back against at least some of those expansion schemes. Financial markets might have pushed back against plans to raise all that capital. But in China in the short run, banks had been officially encouraged to make loans to car buyers with little or no effort to document incomes, and banks and the financial markets had been officially encouraged to provide financing to car companies. Only in recent weeks has the central government reversed course and started to push back against the trend that it set in motion. Beijing has not just announced an end to some of the subsidies for buying a car, it has also promised an investigation into why it was so easy to get financing to start or expand a car company. (Gee, you think they'll figure out who's to blame?)
This isn't an efficient economic system at work.
Continued: Unintended consequences, multiplied
