By John Garnaut
Professor Yu Yongding says he is ''one of 50 well-known Chinese economists in China''. Some respected market economists say he has a better grasp of China's macro-economy than anybody else, full stop. Either way, he has been one of the country's strongest advocates for a more liberal currency regime and other pro-market reforms, including when he sat on the monetary policy committee of the People's Bank of China in 2004 and 2005.
So when the first line of an email from Yu a fortnight ago began "John, I think your overcapacity story the other day is basically wrong" - it was time to rethink the China story.
I had argued on November 30 that the endless talk in China and abroad about the country's overcapacity problem was premature.
China would not have overcapacity in heavy industry (and therefore the Australian economy would remain underwritten by Beijing) for as long as it kept spraying highways and pushing up skyscrapers across the country, and that was going to be for a few years yet.
Yu, the recently retired director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, did not explicitly say I was barking mad. But his email continued: "When a country has an investment rate over 50 per cent [of] GDP and rising, you say this country is not suffering from overcapacity! … are you serious? ''To judge whether there is overcapacity you cannot just do a head account. With a 1.3 billion population and human greed, China's needs are unlimited, you can say that China will never suffer from overcapacity!"
The email noted that, on my logic, no developing country could ever suffer from overcapacity until it became rich and that the world should never have suffered a Great Depression in 1929.
Since that salutary critique, Yu has elaborated further on his views.
He believes China is trapped in a cycle where constantly rising growth in investment is constantly increasing China's supply, but consumption has conspicuously failed to grow fast enough to absorb it. And so China is forced to increase investment in order to provide enough demand to absorb the previous round of increased supply, thus creating ever-widening cycles of oversupply.
In this manner, the investment share of gross domestic product has increased from a quarter of GDP in 2001 to at least half.
"There is sort of a chase - demand chasing supply and then more demand is needed to chase more supply," he says. "This is of course an unsustainable process."
From 2005 China's overcapacity problem had been "concealed" by ever-increasing net exports - but that strategy was interrupted by the financial crisis. Then came last year's globally unprecedented stimulus-investment binge, which might not have been so worrying if it were delivering things that people needed.
But the Government's hand in resource allocation has grown heavier since the crisis without reforms to make officials more responsible for what they spend.
"As a result of the institutional arrangements in China, local governments have an insatiable appetite for grandiose investment projects and sub-optimal allocation of resources," as Yu previously said, in his Richard Snape lecture for the Productivity Commission in November.
So there are now airports without towns, highways and high-speed railways running parallel, and towns where peasants are building houses for no reason other than to tear them down again because they know that will earn them more compensation when the local government inevitably appropriates their land.
It's great for Australia in the short term, because we supply the materials, but it's unsustainable. One day China's overcapacity problem will become real. That will be the Wile E. Coyote moment: when the resource-exporting world falls off a cliff.
It turns out that Yu and I have less to disagree on than we thought. I had just watched more American cartoons than he had.
"I realised that our opinions were not really very different when I realised what the Wile E. Coyote moment meant," Yu says.
I have no idea how long China's unsustainable growth pattern can be sustained. Yu says "it cannot last for more than five years".
This year, he says net exports might again provide an escape valve for China's overcapacity, provided the US does not slip into recession.
"The swing in contributions of net exports to GDP growth from 2009 to 2010 could be as high as 6 percentage points, if the current momentum of exports can be maintained," Yu says. "The arrival of your Wile E. Coyote moment will be postponed once again."
And when the export engine fails again, China can again recapitalise its banks and reopen the fiscal and monetary floodgates.
Yu believes the cycles of ever-increasing exports and investment can be broken if the Government unleashes a new productivity boom by opening up the services sector. But this requires the Government making some very bold moves to loosen its grip, when all the signs are pointing the other way.
"If we do not reduce government monopolies in services to reduce policy distortions, then productivity in services cannot grow rapidly and might even stagnate," Yu says. "I'm not very optimistic about the services sector."
China will eventually make the transition when it has no other choice. ''China has defied predictions of economic demise repeatedly over the past three decades," Yu says.
"I am still basically optimistic about China's economic future. When China is pushed into the corner, adjustments will come. When a decision must be made, the decision will be made."