• In this note, we attempt to make a judgement as to the sustainability of the Chinese growth model. We question whether China’s investment boom continue, or face the risk of a financial meltdown as we saw in Japan in 1990 and East Asia in 1997-1998? We also scrutinise whether China will be able to move further up the value chain, which is essential to maintain high productivity growth.

  • We argue that on a 10-20 year horizon corporate investment growth is likely to slow as the industry intensity of China’s economy falls. Moreover, household savings will fall in the long term due to: 1) a build-up of the social safety net; 2) financial liberalisation, and 3) the ageing of the Chinese population. But again this may be more of a 10-20 year story rather than something which will happen over the next decade.

  • The weak link in the Chinese economic model is the state’s interference in the lending decisions of the state controlled banks, and the lack of effective corporate governance - which implies that state owned corporations, may be investing inefficiently. The inefficient financial model is not a problem at the moment as the banking sector and the state-owned firms are effectively guaranteed by the state. But as the state loosens its grip on the banking sector, a crash cannot be ruled out.

  • What is ultimately driving the sustainability of China’s investment boom is whether China’s productivity growth will continue. China is still such a backward country in many ways, implying that if the reform process remains on track then the productivity catch-up is likely to continue for many years. One big risk is more severe backlash on protectionism. If the protectionist steps from the EU and the US broadens in scale it may slow down FDI. This could have a significant effect on China’s productivity growth.