Growth concerns aside, Beijing must grapple with an unwieldy shadow banking sector.
FORTUNE — The Chinese economy hasn’t fallen from the tightrope yet.
Markets in Asia rose Wednesday following the release of data showing that the growth of the Chinese economy slowed in the first quarter of 2014 to an annual rate of 7.4% from 7.7% the previous quarter. Though the first quarter saw the slowest growth for the Chinese economy in a year-and-a-half, markets were pleased with the way in which it was slowing — with increases in retail sales signaling growth in domestic consumption and a slight decline in the rate of fixed asset investment growth, which show the Chinese turning away from what China bears see as a dependence on debt-fueled infrastructure projects.
But these statistics don’t even begin to tell the story of how radically the Chinese economy continues to evolve. Millions of people per month continue to emigrate from China’s farms to urban areas in search of work in the country’s manufacturing sector, while the number of migrant workers in China is greater than the size of the entire American labor force. Maintaining an export sector that can supply jobs for all these people is priority No. 1 for China, lest a lack of economic progress leads to political instability.
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And while data released Wednesday suggest that China is growing quickly enough while managing to slowly rebalance its economy, there are still plenty of reasons for critics to doubt they can continue to pull it off. Here are three:
1. Economic history suggests a seamless ascent isn’t likely.
Be it the United States in the 1890s or Japan in the 1990s, it’s common for economies to experience some sort of financial crisis as they make a transition from emergent to developed. Exceptions to this rule include Singapore and South Korea — both of these “Asian Tigers” were able to ascend in status without lasting political or economic crises. Indeed, South Korea’s transition from authoritarianism to democracy is sometimes cited as a model for those hopeful that democratic reforms will come to China. But even these economies were hit hard by the Asian financial crisis of the 1990s, and neither country is anywhere near as large or diverse as China.
2. The Chinese central government isn’t all-powerful.
As former banker and author Satyajit Das pointed out recently, much of the case for expecting a so-called hard landing is centered around the way the central government interacts with powerful local governments in China. Writes Das,
An ancient Chinese proverb — shan gāo, huángdì yuǎn — states “The mountains are high and the emperor is far away.” The saying implies that Beijing’s control over its regions is historically weak, with local autonomy and little loyalty, meaning that central authorities have limited influence over local affairs.
Despite the central government’s efforts to curb shadow bank lending to support big, economically questionable, politically motivated local infrastructure projects, there’s plenty of evidence that these and other dodgy investments continue to be funded, threatening the stability of the system. A JPMorgan report from last year estimated that the size of the shadow banking sector doubled between 2010 and 2012 to $6 trillion. Even with recent efforts to rein in unregulated lending, much of the worst could already have been done.
3. Even without a bubble burst, wasteful spending could be a serious drag on growth.
In late January, a Chinese investment company was bailed out by the government after a coal company it was funding was forced to miss a debt payment. The bailout was arranged to calm fears that this particular fund company going belly up would spark panic in the rest of the shadow banking sector. The incident shows that the Chinese government is willing to go to great lengths to prevent a financial crisis, but Beijing can’t do anything to reverse bad decisions made by shadow banks. Even if China can avoid a bursting of a debt bubble, its economy will still have to struggle under the weight of economically unproductive projects.
