China’s Economic Squeeze

China is in a squeeze. The domestic cause is the same familiar one that sparked the recent Asian crisis: government use of the credit system to give special privileges to certain firms (in China’s case, the state enterprises). Excessive credit has subsidized underproductive sectors of the economy and inflated a financial bubble. As in South Korea, the favored enterprises have used their access to excessive, low-cost funding to create vast empires of overcapacity and inefficiency. As in South Korea, the availability of funds regardless of profit supports a labor system that assures workers in favored sectors lifetime employment and a wide range of social benefits, even if their companies provide no useful output. And as in South Korea, the banks that underwrite this system now confront a daunting accumulation of bad loans that threaten the viability of the entire financial system and jeopardize decades of improvement in the standards of living.

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