Will Lord Keynes cripple China's military?

By Peter Zhang
web posted November 1, 1999

In some ways economic thinking is so bad in China that I'm trying to think of something funny to say about it. While the British seem to have a happy knack of making fun out of even the grimmest of situations, no such tradition exists in China. That's sad because I think we're going to need one. However, American conservatives can look on the bright side — for the moment. While they are worrying about how to contain China's potential for creating military mischief Beijing is planning to implement economic policies that could cripple military expansion. Yep, life's full of ironies.

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. (Sorry folks, that's the best I can do for humour this week). 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 them.

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 has been a massive misdirection of production. Huge surpluses of goods have been produced at the expense of goods in greater demand. (Nothing is for nothing). Furthermore, a goodly 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. If the money supply figures are accurate then deflation is a myth. My guess is that bank reserves are accumulating while excessive stocks are forcing prices a down. In other words, a simple supply and demand situation.

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 this magazine continually points out, savings fuel growth and entrepreneurship drives it — but only within a free-market framework, even a badly hampered one such is the power of market processes. 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 be declining. 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 Reagan spent the Soviet Union into extinction to see what I'm getting at.

Before American conservatives jump with glee at the prospect Keynes' Chinese disciples eating their country's seed corn they should reflect on two very important points: (1) America is doing the very same thing and (2) a poorer China is not really in any nation's long run interests. Poverty always breeds resentment.

Reprinted with the kind permission of The New Australian.

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