China's Economy May Outgrow Its Environment

China has achieved remarkable economic growth over the past 20 years. But now some economists worry that the Chinese government has engineered growth too fast and without needed reforms. The result, they say, could be ugly.

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SHEILAH KAST, host:

China's economy has grown at about 10 percent annually for more than 20 years. That's more than three times U.S. growth. So shouldn't you just invest all your money in China?

NPR's Adam Davidson reports that many U.S. investors are worried that China is growing too fast.

ADAM DAVIDSON reporting:

How can an economy grow too fast? Isn't that like telling your boss that too many raises are bad for you? Isn't economic growth good?

Mr. JASON KINDOPP (Analyst, Eurasia Group): Yes. Of course, it's good. I guess the question is at what point is the rate of growth considered bad?

DAVIDSON: Jason Kindopp, a Eurasia Group analyst, says China has plenty of the good kind of growth, the kind that comes from factories that make products people want, like cell phones and DVD players. The bad kind of growth, he says, comes from massive government expense in second and third tier cities, places even more remote than Chongging at the head of the Yangtze River.

Mr. KINDOPP: What I'm talking about are even smaller, more remote cities nestled deeper into the hinterland.

DAVIDSON: These remote cities, like everywhere in China, are run by Communist officials. And like people everywhere, these officials want to please their bosses and get promotions.

Mr. KINDOPP: And they have a list of criteria for career advancement, focused very heavily on the ability to deliver jobs to generate economic growth.

DAVIDSON: Communist officials in, say, Shanghia, are doing great. The economy is booming. But go to the inland provinces, places like Ching-hai or Shaanxi, and the economy isn't doing well. Which means the local officials aren't doing well. So lots of inland mayors and governors decide to help themselves out by opening big, inefficient steel and car plants, all funded by state owned banks. And that means...

Mr. DON HANNA (Citigroup Global Corporate and Investment Bank): Someone who is effectively bankrupt or is not earning a good return on capital can be in business for longer.

DAVIDSON: Don Hanna is chief emerging market economist for Citigroup. He says the Chinese government has tons of money to spend on the bad growth of these failed businesses, because U.S. consumers keep buying the products of the good growth Chinese factories. U.S. dollars are indirectly keeping that bad growth growing. Normally, this whole process is highly secretive. But recently we got a rare glimpse at how this system works, in the form of a prospectus issued by the Bank of China.

Jim Grant, editor of Grant's Interest Rate Observer, read it immediately.

Mr. JIM GRANT (Grant's Interest Rate Observer): I've been reading these things for 30 years, and I've never quite seen the likes of the Bank of China.

DAVIDSON: Part of the Bank of China decided to go public a few months ago. To meet international regulations, it had to publish that prospectus, complete with any negative information about the bank.

Mr. GRANT: From 1993 through 2001, three successive heads of the Kaiping subbranch of our Guangdong branch allegedly conspired to embezzle, or misappropriate, approximately $482 million from that sub branch.

DAVIDSON: Half a billion dollars stolen from one branch, and this was one paragraph in hundreds of pages of similarly shocking news. Even worse, the prospectus revealed that the Bank of China has barely any system to judge the merit of a loan project. Even if it wanted to stop throwing money at bad projects, the bank wouldn't know how to. Grant is strongly recommending that U.S. investors be very cautious about China. He thinks the Chinese banking and financial system is so unhealthy, it's headed for a big crash.

Citigroup's Hanna is more optimistic and says investors shouldn't necessarily fear China. The central government is fixing things, he says, just not quickly.

Mr. HANNA: They take small steps. Their attitude towards more or less any reform is to go slow.

DAVIDSON: The reform might be going slow, but the economy is anything but. For China to succeed, Grant and Hanna agree, the reform has got to speed up while the economy slows down.

Adam Davidson, NPR News.

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