Why China Faces a Difficult Road Ahead - A Conversation With Dr. Woody Brock

With China experiencing a major economic slowdown after decades of heavy investment-led growth, everyone wants to know, where is China headed and how bad could things get?

Dr. Woody Brock, a renowned economist and president of the economic research and consulting firm Strategic Economic Decisions, explained to Financial Sense listeners the historical pattern of growth and the necessary steps China must take to prevent a further collapse of their economy in a recent podcast interview.

To understand China's fate, “you have to go much deeper, I’m afraid, than the standard, conventional stories go,” Dr. Brock said. “You have to go deeper in understanding why China has done so brilliantly since 1980, and what may not be so brilliant in the future, and why.”

Brock first explains the monumental work of professor Walt Rostow at MIT in his book The Stages of Economic Growth, which posited that all emerging countries around the world follow a familiar pattern. They start off with low levels of investment, low productivity, and poor, agricultural economics. This is stage one, Dr. Brock said.

“To get out of that, and end up in stage five," as you see with advanced industrialized nations, “you have to go through a transformation,” he said.

“If you want to grow fast in stages one, two and three, there has to be somebody in charge,” Dr. Brock said. “China in the first 30 years since 1980 did an amazingly good job in growing very fast. … dictating what should be done, borrowing the necessary money. And the result was a huge, great new economic situation.”

However, China has exhausted this top-down state-led strategy we see in the early stages of a developing economy and now has to transition to a more diversified bottom-up model, Dr. Brock said.

“The problem is, when you want to get to (stages) four and five – and here is where incentive structure logic comes in – everything reverses,” he said. “(China) can’t become a decentralized, market-based, efficient consumer economy, unless the communist party on top lets go, which they’re not likely to do. You need bottom-up (growth) … you need you and me to start a business. And you need 10 million others to start businesses all the time.”

This is the main impediment China faces, in Dr. Brock’s opinion.

“China will have a very hard time, in my view, with this transition from top-down to bottom-up type of economic growth,” he said. “The communist party doesn’t want private property rights. … I do not believe China can cope with the challenges of becoming a full stage-five economy without radical political reforms, decent … infrastructure, taking power away from the communist party, and decentralizing the whole story.”

Ultimately, this means China is likely to grow at a slower pace, he said.

“I don’t believe the 7 percent they’ve been maintaining – and I think it’s much lower than (what) they claim right now from what I know – is sustainable in the longer run,” he said. “I’m more a 4 or 5 percent long-run growth guy, not 7 (percent), and the difference is huge when you compound that over 30 years.”

China’s sizeable debt obligations also worry investors, but Dr. Brock thinks the country has the resources to manage its debt.

“Those who are bearish today about China … look at the massive debt, and they see real problems for growth in China,” he said. “And there is an awful lot of debt, and it is a problem. I believe they can deal with this. The central bank has trillions of reserves. … It is a big problem for the short run. I think China can cope with it. … It’s going to hurt them and it will certainly (cost) them short-term growth, as it is now.”

Demographic hurdles may also impede Chinese growth, but Dr. Brock pointed out that there are several ways the Chinese can deal with it, including possible changes to the one-child policy and worker productivity.

“When you add it up, the notion that demography is destiny is wrong,” he said. “You can equally well say life expectancy is destiny.”

The end result is, China is unlikely to become a stage 5 political economy anytime soon, and Dr. Brock thinks that as a result GDP growth will slow.

Listen to this full interview with Dr. Woody Brock by logging in and clicking here. For a complete archive of our broadcasts and podcast interviews on finance, economics, and the market, visit our Newshour page here or iTunes page here. Subscribe to our weekly premium podcast by clicking here.

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