Ning Leng

Another unexpected outcome of visibility projects is their effect on the private sector. To avoid blame or simply because they lack funds, government officials often ask firms—private and state-owned—to "sponsor" these projects in China. But when the visibility projects become too costly, or when too many pile up in one sector or locality, private firms often exit, voluntarily or not. Over time, state-owned enterprises expand in these spaces because their soft-budget constraints make them better able to absorb the costs of visibility projects. I don’t discuss this mechanism in the FA piece, but I develop it in my book and articles.

Ning Leng makes an important point here: "Over time, state-owned enterprises expand in these spaces because their soft-budget constraints make them better able to absorb the costs of visibility projects." In a 2012 Carnegie piece I warned that China was finding it increasingly difficult to identify enough productive investment projects (i.e. in which the value of the goods produced exceeded the value of the resources needed to produce them) to achieve the excessively high GDP growth rates Beijing was setting for the economy. If this continued, I argued, we would inevitably see a surge in the country's debt burden and a shift in the share of total Chinese production from private-sector producers to state and quasi-state producers. The reason was because the private sector mostly operates under hard budget constraints while the state and quasi-state sectors mostly doesn't. This means that private businesses in manufacturing sectors that have growing excess capacity (and over time more and more sectors will suffer from this problem) will find it increasingly difficult to get banks to fund growing losses and rising inventories, and so eventually they would have to cut production. Because high GDP growth targets required increasing production, rather than cutting it, and because state and quasi-state entities had much softer budget constraints, I argued that this would inevitably shift total production away from hard-budget constrained entities to soft-budget constrained entities, i.e. from the private sector to the state and quasi-state sectors. What many analysts saw as the result of a change in ideological preferences, in other words, is in fact the necessary outcome of the growth model, and this will continue either until Beijing allows GDP growth rates to drop sharply or until the system runs out of debt capacity. The point is that the regulators can insist all they want that businesses be more disciplined and that manufacturers and local governments behave more rationally, but it is precisely the hard-budget constraint that imposes discipline on investment. By insisting on excessively high GDP growth targets and all but eliminating hard budget constraints, there is simply no way to eliminate involution.

Very much looking forward to it!