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more modest size that still imploded into crisis.
Worse, the problem of moral hazard—the assumption that
a deep-pocketed government would backstop bad loans—was
endemic. In 2019, cracks started to appear. Baoshang Bank
Co., a city lender in Inner Mongolia, became the first Chinese
bankin 20 yearstofail.Defaults,includingbystate-owned
companiesandlocalgovernments,rose.Evenaheadofthe
Covid-19 crisis, it seemed like sky-high debt, recklessly allo-
cated, might result in a day of reckoning.
Maybe tomorrow, but not today. Missing from the crisis
thesis was a crucial point: Financial meltdowns don’t start
because bad loans are too high; they happen because banks
run out of funding. In the Asian Financial Crisis in 1997,
Korea’s banks didn’t melt down because they had made too
many loans to crony-capitalist chaebol. They melted down
because the foreign funds they relied on to finance their oper-
ations dried up. In 2008, Lehman Brothers didn’t collapse
because it had too many investments in dodgy mortgage-
backed securities. It collapsed because the money markets
that financed its activity decided to cut it off.
In China, the combination of a high savings rate and tight
controls on moving capital out of the country means that
a lack of funding is unlikely to be a problem. Its banks can
count on a steady inflow of domestic savings to provide a sta-
ble, long-term basis to fund operations. While helter-skelter
expansion in lending is a problem—as are a state-dominated
banking system and zombie borrowers—as long as bank fund-
ing remains adequate, there’s no trigger for crisis.
Then there is the nature of business. Nowhere is the
contrast between the U.S. free-market system and China’s
state-centric approach as sharply drawn as in the relationship
between government and corporations. In the U.S., a hands-
off approach is a critical driver of economic dynamism. In
China, the biggest banks, telecoms, airlines, and industrial
companies are owned by the state. Even in private compa-
nies, the Communist Party exercises an influence that would
be unthinkable in the U.S.
There are major costs to this approach. “We’re state-
owned, so we don’t have to worry about profits,” says the
manager of one massive power project on the outskirts of
Beijing. Writ large, that cavalier attitude to the niceties of
actually making money means a big chunk of the corporate
sector is mired in low productivity. Return on assets for state
companies is a fraction of the level in the private sector.
But there are also benefits. China’s direct control of state
companies—and sway with the private sector—gives policy-
makers a powerful instrument to manage the ups and downs
of the economic cycle. Rarely has that been more evident
than in the response to the Covid-19 shock. State companies
holding on to their employees prevented spiraling unem-
ployment. Tech giants supported the public health response
and the credit stimulus. In a crisis, government and busi-
ness moving together can be a powerful force for resolution.
Behind it all are the benefits of China’s enormous size. As
far back as 1776, Adam Smith—the grandfather of modern

◼ REMARKS BloombergBusinessweek June 29, 2020

economics—recognizedthatthe“vastmultitude”ofChina’s
population gave it a built-in advantage in the global eco-
nomic race. If, Smith wrote, China could “learn for them-
selves the art of constructing all the different machines made
use of in other countries,” they would be able to leapfrog
ahead of smaller rivals. After Deng kicked open the door to
the world in 1978, and even more after entry to the World
Trade Organization in 2001, China had ample opportunity
to “learn for themselves.” By directing the resources of the
state to acquire new technologies, and then scaling them to
China’s massive domestic market, industrial planners were
able to give Chinese companies a competitive edge first in
textiles, then metals, and now high-speed trains, solar pan-
els, and nuclear power.
That story isn’t over. China’s GDP per capita is just a third
of the level in the U.S. That means ample room for contin-
ued catch-up growth. As China focuses its attention on the
technologies of the future—from electric vehicles to industrial
robots and artificial intelligence—the annual pace of growth
could stay close to 5% through 2025 and end the decade not
much lower. With global businesses deeply invested in their
China relationship, Trump’s trade war is unlikely to change
the trajectory.
“There are lots of Baoshangs,” says one senior banker in
Henan province, hinting that other banks could go the same
way as the failed lender. Maybe. But as long as the market
believes the government will underwrite their operations,
they will stay in business. And as long as China continues to
grow, the government’s ability to provide that backstop won’t
come into question.
One day, a crisis will come along that’s too big even for
Beijing to handle. When that happens, the price of allow-
ingproblemstofesterinthedarkwillbea meltdownof
monumentalproportions.Oneday.Butifa once-in-a-
hundred-year pandemic doesn’t pop the bubble,the
questionis:Whatwill? �With David Qu and Yinan Zhao

Adapted from China: The Bubble That Never Pops by Bloomberg
chief economist Tom Orlik. Published by Oxford University Press.

Aftera LongRisein Debt, a New Drop in Income
Chinaincomebysector,
year-over-yearchange
Governmenttax revenue
Household
Business profit

2/2019 5/

0%







Chinadebtasa share of GDP
bysector
Government
Household
Business

Q1’08 Q4’

100

0

200%

DATA: BANK FOR INTERNATIONAL SETTLEMENTS, NATIONAL BUREAU OF STATISTICS OF CHINA