Peter Zhang
BrookesNews.Com
Friday 19 September 2003

While the British seem to have a happy knack of making fun out of even the grimmest situation, no such tradition exists in China. That's sad because I think we're going to need it. However, American conservatives can look on the bright side. While they are worrying about how to contain China's potential for creating military mischief Beijing has implemented monetary policies that could cripple military expansion.

While having clever young Chinese train in the West as engineers and scientists was a smart move, having some trained as economists was definitely dumb. So dumb in fact that I suspect a CIA plot. Smart as our students are, they still tend to do everything by rote. This means that having learnt Keynesian economics at British and American universities they will inevitably apply it in a mechanical way.

The likely consequences for the Chinese economy is not something most Chinese would care to dwell on, that is if they understood the economics.

It was the State Development Planning Commission that forced me to consider the extent to which Lord Keynes' poisonous economic brew had become Beijing's economic panacea. The commission calculated that if each of the 85 million peasants who are to be moved off the land were to each spend 30,000 yuan this would expand the demand for residential housing by 2550 billion yuan. In addition, further spending of 400 billion yuan on consumer items like fridges, televisions, etc, would stimulate the economy and help absorb a glut of consumer goods.

The fallacy here is the very old one of thinking that savings are a drain on an economy while consumption drives it. There is no general glut in China but there is a massive misdirection of production. Huge surpluses of state-produced goods have been manufactured at the expense of goods in greater demand. (Nothing is for nothing). Furthermore, a significant proportion of these goods are of such inferior quality they shouldn't even be classified as stock.

The problem here is that over the years massive amounts of savings have been malinvested. But under the present system these malinvestments have been kept in operation with cheap loans and outright subsidies, meaning they have continued to produce goods in excess of demand.

The piling up of huge surpluses and the emergence of 'excess' capacity as many malinvestments find it increasingly difficult to maintain output combined with an apparent fall in consumer prices have persuaded some that China is deflating. But money supply is rapidly expanding, thanks to Keynesian thinking. The massive residential and office-building boom is striking evidence of a very loose monetary policy.

So why should the commission's spending calculations be bad for China's military? Because they will damage investment and that in turn will hamper the military. As +Brookes continually points out, savings fuel growth and entrepreneurship drives it.

Massive consumption spending, and that includes housing, at the expense of savings will reduce the size of China's already small capital structure. Should this occur the effect will be to raise the opportunity costs of military spending because living standards will decline. Because, for example, America is vastly richer than China, dollar for dollar America's opportunity costs of military spending are lower than China's.

One only has to think of how easily President Reagan spent the Soviet Union into extinction and how quickly President Bush crushed the Taliban and Saddam's regime to realise that America's power resides in its economy and not its military. This is something Beijing fully understands.

However, before American conservatives jump with glee at the prospect of Keynes' Chinese disciples eating their country's seed corn they should reflect on the fact that a poorer China is not really in any nation's long term interests. Poverty always breeds resentment.