In his new book, China’s Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle, Dinny McMahon, a former Wall Street Journal reporter, takes the reader on a grass-roots tour of the underworld of Chinese finance. Perhaps much more than the ascent of Xi Jinping, top-level power struggles, or conflict with the United States, this issue could determine whether China becomes a true superpower or grinds to a halt under the weight of bad debts.

Here, McMahon, who was born and raised in Sydney, answers questions from Richard McGregor, Senior Fellow for East Asia at the Lowy Institute, about what motivated him to write his book, and what message it contains about the Chinese economy.



One of the key messages from your book is that China’s economy has become addicted to debt. Or, to quote you directly, “The stimulus never stopped” after the 2008 financial crisis. Why is that?

In the popular imagination, China’s economy is primarily driven by exports, but that hasn’t actually been the case for about 15 years. China’s growth is actually driven by investment; specifically, investment in the construction of housing, public works, and the factories needed to supply the materials needed to support construction. Growth requires more construction, and construction is made possible by debt.

The reason debt has ballooned is because the need for fast growth is hard-baked into the political system. At the highest level of government, fast growth is necessary to realise Xi Jinping’s vision of national rejuvenation. At a local government level, the prospects of officials are intertwined with their ability to expand the economy. And officials at state firms are judged less for their ability to generate profit than to grow the size of the companies they’re responsible for.

Too many people have benefited from the fast growth of the past decade, and it’s been difficult to rein in the driver of that growth – debt – despite the accumulation of risk that’s gone along with it.



Much of the analysis about China is top-down, focused on the actions of top leaders and the big institutions, such the People’s Bank of China and the like. Your book is very much bottom-up, looking at the economic and financial incentives of lower-level officials. What is the value of your approach, and how do officials drive the way the Chinese economy works?

In my experience, the Chinese economy of the past decade hasn’t primarily been shaped by the vision and policies of Beijing, which have routinely been stonewalled or circumvented by lower levels of government. Over the past decade, the definitive characteristics of the economy – shadow banking, spiralling local government debt, and industrial overcapacity – have flourished as a result of local officials marching to their own tune.

On one level, the discretion that resides with lower-level officials has been part of the magic of China’s economic growth. It allowed creative solutions to local problems to emanate from the bottom up. But that creativity has been used to prevent the excess in the economy from being cleaned up, and to prevent the way the system works from changing.

The dynamic which best sums this up is the Chinese idiom shang you zhengce, xia you duice, which translates loosely as “above there is policy, but below we have ways of implementing policy”. My approach is to understand what drives officials at state firms and lower levels of government in order to piece together a picture of how the economy actually works, as distinct from how Beijing would like the economy to work.



You talk a lot about Chinese “exceptionalism”? How is that term misunderstood, and in what way is China genuinely exceptional?

China’s exceptionalism is based on the popular belief that the nation’s economic management resides in the hands of a technocratic elite that, undistracted by ideology, is able to make tough decisions in the pursuit of one overriding goal: growth. Although that might describe an earlier era, for the past decade the exceptionalism of China’s economic management has been the government’s willingness and ability to kick the can down the road. But – to extend the metaphor to breaking point – with each kick, the can gets bigger and doesn’t go as far.



Since the 19th Party Congress late last year and in recent weeks, Chinese leaders such as Li Keqiang have talked about the importance of quality of growth over quantity. In my experience, the leaders have complained about “GDPism”. Is this time different?

Not really. Beijing is still committed to fast economic growth. Sure, the 2018 GDP target of 6.5% is comfortably lower than 8%, which for years was the minimum level the central government would countenance. But Beijing is still insisting on a pace of growth that is significantly faster than the economy would likely generate if it was left to its own devices; that is, without the rapid build-up of debt employed in the interests of state-sponsored projects.

However, Beijing is unquestionably committed to the idea of a better quality of growth. “Quality” growth is an all-encompassing vision of an economy where rising prosperity is delivered without the pollution which has taken a severe toll on the quality of China’s air, soil, water, and people’s health. It’s an acknowledgement that China is no longer a cheap place to do business – the cost of land, energy, environmental compliance, and labour are all rising – and that it will have to improve the quality of the products it manufactures in order to compensate for them being more expensive. Quality growth speaks to the need for China to develop its own technologies – that is, to become more innovative – if it hopes to transition into the ranks of rich nations, including the US, Germany, and South Korea.

The challenge is to segue into this new and improved economy while still maintaining fast growth. But that will require continuing to lean on the old model of growth, which will exacerbate existing problems.



At his final press conference at the National People’s Congress in Beijing in March, the outgoing central bank governor, Zhou Xiaochuan, struck a positive note, saying China had clearly begun to stabilise its debt. Zhou, it must be said, is one of the great figures of Chinese financial reform. Do you think he was being overly optimistic?

The People’s Bank of China struck an unequivocal blow against financial risk last year. It managed to force a contraction in interbank lending which linked banks and other financial institutions in ways that, if the financial system experienced some sort of shock, might result in contagion. Moreover, the central bank’s colleagues at the banking regulator are trying clean up the financial system more aggressively that at any point in more than a decade.

But there are some things that the financial regulators have little control over. First, fast economic growth still relies on the even faster accumulation of debt, which means that the regulators can work to make the system less risky, but there are limits to just how much build-up of debt they can rein in. Second, if I’ve learnt anything from my time in China, it’s that financial institutions are incredibly skilled at designing workarounds to Beijing’s reforms – and it usually takes about a year to see just what those workarounds look like.

Of course, this time might be different, and from a distance the financial regulators certainly look as though they’re making headway. But I’ll reserve judgement for the time being.



Finally, what is your sense of Xi Jinping as an economic reformer – his strengths and weaknesses?

As yet, Xi Jinping doesn’t have much of a track record as an economic reformer. However, that might change with the recent changes to the constitution which allow him to remain president indefinitely. That’s because Xi’s most important economic reforms thus far haven’t been explicitly economic – they’re political. His efforts to imbue the party with greater authority, while at the same time imposing greater discipline and control over it, could give him the authority to break the ability of lower levels of government to stonewall and circumvent reform, as they have in the past. But while that might help Xi clean up excesses of the system, it’s less clear if it will help build the sort of high-quality, innovative, low-pollution, more equitable, and still fast-growing economy he wants to create.