Everyone on Wall Street is talking about this dark new China report

Photo: Anthony Kwan/ Getty.

A new report by The Demand Institute — a collaboration between Nielsen and The Conference Board — has a dark prognostication for China.

And it has got all the China watchers on Wall Street talking.

“Many analysts once forecast a soft landing for the economy after more than 35 years of breakneck growth, but that landing point is still not in sight,” the report said.

“While we believe the government will pull enough policy levers to prevent full-blown economic crisis, the danger remains that China is facing a protracted crisis.”

The report predicts 4.5% gross domestic product growth on average between 2015 and 2020, and 3.6% on average from 2020 to 2015 if the government is able to stave off disaster through policy mechanisms.

Here is the killer line:

China’s productivity crisis — the result of both institutional deficiencies and a maturing economy — remains unaddressed. For these reasons, we believe China is facing a protracted period of declining growth that will be much longer and deeper than analysts may have predicted.

The party can’t

To successfully make the transition from an economy based on investment to one based on consumption, the Chinese Communist Party (CCP) has to execute a number of difficult tasks. The most challenging is reforming and restructuring debt-laden and unproductive state-owned enterprises (SOEs).

The party outlined some of its plans to do so in September, but they were thin on details — vague at best. One thing that they were clear on, though, was that the CCP would remain in control of the economy through its transition. This is an ideological must in the country.

But as The Demand Institute points out, it also runs in complete opposition to the idea and structure of an actual liberalized economy.

China is standing in its own way. “Instead” of liberalization, says the report, the government’s “focus appears to be on fixing the party, fixing politics, fixing society, and fixing the economy with a stick rather than a carrot.”

We saw this in action over the summer when the mainland’s stock indices started to nosedive. The government had encouraged people to invest in stocks, which prompted the indices’ year-plus 150% rally. When they started to fall, the government stopped IPOs and share offerings, went after “malicious actors” in the market, forbade short-selling and was generally heavy handed.

There was nothing free market about it.

Shanghai compositeYahoo Finance, Business InsiderThe Shanghai Composite

The new carrots look a lot like the old carrots too. The massive One Belt One Road initiative to build infrastructure to connect China to its neighbours seems a lot like the 1999 Going Out Policy, when China reached out to foreign nations to encourage investment.

China, the report says, can do this for a while by leveraging its Central Bank’s balance sheet to keep banks lending to local governments and debt laden SOEs.

But it can’t do this for long, and it certainly can’t spur a ton of growth while doing this, especially since China’s working-aged population is declining.

At a certain point, it’s going to have to come up with some new ideas.

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