China begins to suffer from growing pains as double-digit growth ebbs

As China’s high-octane economy shifts to a lower gear, virtually everyone agrees the double- digit, super-charged boom years are drawing to an end.

Speculation over the possibility of a hard landing for the country flourishes with each boom and bust cycle, only to die down as China’s growth revs up again. This time, however, external and internal factors — including global economic conditions, domestic politics, and financial trends — are reinforcing the downturn. Many experts warn that, without painful reform, there will be worse trouble to come.

Still, opinions about just how far China’s economy will fall range widely. Also, exactly what constitutes a hard landing for a country that has until now been viewed as an almost unstoppable economic powerhouse varies from analyst to analyst, although most point to China’s growth rate as a key defining factor.

“People give different definitions,” says Wharton finance professor Franklin Allen. “Mine would be growth below 5%.”

China’s growth slowed to 8.9% in the final quarter of last year after months of attempts by the government to cool inflation through curbs on bank lending, interest rate hikes and harsh increases in banks’ reserve requirements. The government has said all along that it expects growth to slow: In his address to China’s legislature on Mar 5, Premier Wen Jiabao set the annual growth target for 2012 at 7.5% — the first time the official benchmark has been set below the 8% level long viewed as the minimum needed to create enough jobs and ensure social stability. And in the current five-year plan, the government has set the annual growth rate at 7%.

China’s transition to an era of lower growth in some ways parallels Japan’s abrupt shift in the early 1990s. Both countries allowed excessively cheap, often politically influenced, use of credit to create a massive bubble in their property sectors.

But one key difference could lead to ugly consequences in the event of a hard landing, says Wharton management professor Marshall W. Meyer. “You still have a lot of poor people in China, many more than Japan in the 1990s. Japan was essentially middle class, with all [citizens] having medical insurance and social security. That is where the political trouble is,” Meyer says.

Dissatisfaction over lagging incomes and inadequate social services could spiral if the growth that has underpinned Communist Party rule were to stall: “Neither China nor the world would like to see turmoil [in China] like [what we saw last spring] in the Middle East.” Indeed, in mid-March, Wen noted that if the country doesn’t initiate key reforms, it could experience enough social unrest to precipitate another Cultural Revolution like the one that shook the country between 1966 and 1976.

Chief among the World Bank’s recommendations is a call for China to ensure that growth is more reliant on consumer demand than on the heavy investment in construction and capital equipment that has been the main source of dynamism in recent years.

In the view of Andy Xie, an independent Shanghai-based economist who travels extensively in China, the property bubble has already burst, though the results are less dramatic than in other major economies, partly because Chinese banks are constrained by political influences and generally do not foreclose on bad loans. “Instead, you see a lot of empty buildings. China has built too many buildings,” he says.

* This is an excerpt from a Time magazine article by Knowledge@Wharton, the online research and business analysis journal of the Wharton School of the University of Pennsylvania.