China’s leaders make peace with its old economy

By Pete Sweeney

SHANGHAI (Reuters Breakingviews) - China’s leaders seem to have made peace with the old economic model. More lending, roaring exports and higher property prices helped push up output by 6.8 per cent in the third quarter. For all the talk of innovation, restructuring and deleveraging, the fundamentals driving the world's second-largest economy have not changed. China still depends on investment more than consumption, manufacturing over services, and cheaper products rather than stronger brands. For better or worse, Beijing looks okay with that.

In the three months to September, China’s bureaucracy mobilised to do what it does best: Produce a rosy backdrop to a big meeting. The statistical result of their efforts landed during the 19th Party Congress, the day after President Xi Jinping trotted out the usual platitudes about territorial integrity and market forces.

Those forces certainly have been cooperative. Housing investment, China's most critical single contributor to demand, remained healthy. Combined with infrastructure spending, it propped up state-owned cement producers, steelmakers and so on. This in turn drove demand for commodities, which pushed up producer prices, benefiting all sorts of other indicators - profitability in state-owned heavy industries, for example.

The private sector isn't complaining. Trade remains robust. Exports far outstripped imports, suggesting the government's de-facto import substitution initiative, also known as "Made in China 2025", is gaining traction. A rally in the yuan has deterred capital outflows without denting exports - another sign that Chinese firms are moving up the value chain.

Yet there is sparse evidence of a statistically significant move from manufacturing into services. And the country remains highly dependent on debt. It’s true the government has allowed some state-owned firms to default, and suppressed the more dangerous classes of shadow banking. But total credit creation has barely slowed, hitting $274 billion in September.

Sure, easy liquidity has stimulated sexy entrepreneurship, spawning startups that enable sharing of everything from bicycles to basketballs. But these are macroeconomic blips, and have yet to show that they can earn a return on venture capital.

It's politically expedient to present tweaks as revolutions. There are mounting challenges as distortions endure. But China’s old model, however unbalanced, is still easier for this crew to manage than a disruptive new one.