ENERGY CONSUMPTION AND PRICES
One risk posed for China’s sustained high growth rate is the availability of oil and natural gas supplies at what might be sharply increased world energy prices. Price changes constitute the main risk, rather than China’s shift from being a net exporter of oil in the early 1990s to a situation in which nearly half of its oil and nearly a fifth of its natural gas consumption are derived from imports. To analyze this potential adversity, we consider several scenarios in which there is a drastic contraction in global oil supplies by about 25 percent lasting for a decade (2005–2015). The several scenarios consider a range of plausible demand elasticities, together with allowance for increased energy efficiency, resulting in a conservative estimate of increased global oil prices by as much as threefold. The resulting bottom-line effect on China’s annual growth rate stemming from a “moderately severe” scenario during the period 2005–2015 would be an average diminution between 1.2 and 1.4 percent.

FRAGILITY OF THE FINANCIAL SYSTEM AND STATEOWNED ENTERPRISES
One salient indicator of the fragility of China’s state-dominated financial institutions is the extraordinarily high rate of nonperforming loans (NPLs) on the balance sheets of the four major state banks. NPLs have risen and continue to rise as a result of accumulated “policy lending” from the state banks to loss-incurring state-owned enterprises. Estimates of total NPLs cover an enormous range, between 9 percent and 60 percent of China’s GDP: The correct figure is more likely to be at the upper end of this range. Under various plausible circumstances, China could experience a panic “run” of withdrawals from the state banks, large-scale capital
flight, a significant reduction in savings, and a sharp decline in capital formation. The ensuing financial crisis and credit squeeze could plausibly reduce total factor productivity by 0.3 percent, with an accompanying reduction in the annual rates of growth of capital stock and of employment that would collectively lower annual GDP growth by 0.5 to 1.0 percent.

POSSIBLE SHRINKAGE OF FOREIGN DIRECT INVESTMENT
Between 1985 and 2001, foreign direct investment (FDI) in China rose from an annual rate of about $2 billion to over $40 billion in 2001, in constant 1995 dollars. Analysts both within and outside China agree that FDI has been of considerable importance and has had leveraging effects for China’s high rates of real economic growth, although there is considerable disagreement about the mechanisms that account for these leveraging effects. High rates of FDI may well continue in the future, but there are also not implausible circumstances under which this FDI might severely contract. These adverse circumstances include both possible internal developments (such as tensions accompanying the leadership succession, the possibility of internal financial crisis, inconvertibility of the renminbi, and slow implementation of China’s WTO pledges), as well as possible external developments (such as improvements in the economic infrastructure and investment climate in other competing countries and regions in Eastern Europe, Russia, India, and elsewhere). To a greater extent than in the past, future FDI in China will depend critically on the comparative risk-adjusted, after-tax return on investment in China compared with that of other countries. Based on very rough assumptions and using three plausible but admittedly imprecise methods, our preliminary calculations suggest that a sustained reduction of $10 billion a year in FDI may be associated with an expected reduction in China’s annual GDP growth
between 0.6 and 1.6 percent.

TAIWAN AND OTHER POTENTIAL CONFLICTS
The status quo in the perennially troubled relationship between China and Taiwan entails major benefits for the People’s Republic of China (PRC), Taiwan, and the United States. However, there are also significant risks and tensions associated with the status quo. It is not inconceivable that these tensions might erupt into possible conflict between the PRC and Taiwan. We consider one scenario involving escalation from what Beijing might view as provocation by Taiwan, a blockade imposed by the PRC in response, tangible though limited coercive force to effectuate the blockade, and the resulting effects on China’s stock markets, exchange rates, and reallocations of resources to military spending, with ensuing reductions in the rate of growth of the civil capital stock and in total factor productivity. The bottom line of these adverse developments would be a decline in
China’s annual rate of economic growth, conservatively estimated at 1.0–1.3 percent. Table S.1 summarizes our rough estimates of the potential effects on China’s annual real economic growth that could ensue from each of the several adversities or fault lines, were they to occur separately on a one-at-a-time basis.