Should we be worried by economic warnings of a bear in the China shop?

It suits western policymakers to caution that China is darkening the global financial outlook - but the country is unlikely to go into imminent deep freeze

China is making headlines - but not for the best of reasons. It just recorded its lowest growth rate - 6.9% in 2015 - in more than 20 years, but even this is thought to be exaggerated. A lot of western policymakers, including Georage Osborne and Mark Carney, have warned that China, the world's second largest economy and biggeset export nation, is darkening the economic outlook. This is only partially true, not least because China isn't going into the deep freeze in the next several months. Yet it could well be heading for some sort of financial crisis in the next two to three years. So how worried should we be?

You can't separate economics from politics, especially not in China, and the most remarkable phenomenon in recent times has been the enormous centralization of power around President Xi Jinping, which is unprecedented since Mao Zedong, along with mounting signs of political and social repression. But the Chinese economy today is much larger and more complex, demanding a governance system that's anything but this form of political control.

A leading example is the president's anti-corruption campaign, designed partly to target Xi's opponents within the Communist party, but also to get party members to be more compliant, honest, and reject the pursuit of power and money for personal gain. Last year there was a fall in the number of investigations of officials in the party, army, local governments and stsate enterprises, but the number of people disciplined showed a sharp rise. The most famous "tiger" that have been brought down include Bo Xilai, a politiburo, member and former governor or Chongqing, and Zhou Yongkang, a member of the State Council and former head of internal security. Yet the campaign is having unintended consequences. It is stifling enterprise and initiative, and undoubtedly compromising economic activity, including for example the luxury goods sector, as companies such as Burberry and Prada can testify. The main shift going on in the economy is the wilting of the housing boom, which led the economy to rapid growth in 2000-2011. We are now seeing a relentless fall in housing investment, high levels of unsold properties and apartments in most of China's 660 cities, and generally weak sales activity. This decline is one of the main cause for China's slowdown going global, and is reflected in the current unwinding of a giant commodity and energy bubble.

Many Chinese industries, especially in the loss-making state sector, are characterized by high levels of unused capacity, which the government is loth to shut down for fear of aggravating the economic slowdown. The job losses announced recently by Tata Steel in Port Talbot, for example, can be traced to chronic overcapacity in the Chinese steel sector. China produces four times as much steel as any country has ever done, and has spare capacity of 400 million tonnes.

Steel, though, is just one example. Others include mining, shipbuilding, cement, power generation, real estate, and solar and clean energy. The capacity usage rate in the power, metals and mining sectors has fallen to around 70% or less and in the beleaguered shipbuilding industry, it is even lower, at about 60%. Up to three-quarters of China's coal mining companies are losing money, and painful as it will be, many mines will be closed, entailing the loss of hundreds of thousands of jobs.

The "China effect:" on the rest of the world is going to depend on how the government manages both the current slowdown, and the goal of economic transformation from a model dominated by traditional industries and investment to one led by consumption and modern industries. To be successful, the government will have to pursue extensive economic reforms, which its leaders acknowledge in principle. In an interview with the Wall Street Journal last September, President Xi promised: "Like an arrow shot that cannot be brought back, we will forge ahead against all odds to meet our goals of reform."

But we should beware. China is adept at articulating reforms but not so efficient at implementing them. And when leaders speak about making greater use of market mechanisms, they don't mean using prices to determine efficiency in the allocation and distribution of resources. They mean making the state sector profitable again and more competitive, and no less significant in the structure of the economy.

Incremental reforms have made headway in the financial sector, but not so much in the real economy. Doing one without the other, though, has contributed to speculative activity, excessive credit creation and financial instability. Since the start of this year, the stock market has fallen by 18% after an even sharper drop last summer. The yuan has fallen by about 5% since last summer, but even this is unusual and people worry now that China could allow the currency to fall much further, spurring others to follow in a so-called currency war. For now, though, the authorities have tried to calm such expectations. Credit has surged in recent years to 251% of GDP, about 2.5 times as high as it was in 2008. Since it is still growing two to three times as fast as GDP, the ratio is set to continue to rise.

If we take a step back, we can articulate China's challenge in two ways. First, technocratic change can no longer substitute for important institutional reforms, which are specifically off the political agenda, and deemed hostile to the primacy and authority of the Communist party. Second, the government's commitment to difficult economic reforms, including shutting down excess capacity, is faltering in the face of slower growth, and rising unemployment and labor unrest. In 2015, the number of labor protests doubled to 2,774, and many labor activists as well as lawyers and human rights advocates have been detained or punished.

It is not easy to predict what will happen next. The authorities appear to want to keep the yuan stable, and will probably ease monetary policy when appropriate, and provide one more fiscal boost in the form of more infrastructure spending, tax cuts, and faster development of the social security system.

But these programmes are no more likely to bring enduring stability than their predecessors. If the government continues to eschew institutional reforms, and allows the pace of credit creation to persist, a financial crisis is increasingly likely as the debt burden weighs down on the economy and the banking system. It won't look like the western crisis in 2008-9 because state banks won't fail, but will be a crisis nonetheless. This would then give rise to an extended period of very low growth, and probably a much weaker currency.

In short, it suits financial markets and western policymakers to blame China for the world economy's current problems. This seems an exaggerated reaction for now. But we have at least been warned that there is a bear in the China shop.