How fast does consumption need to grow in China in order for a meaningful rebalancing to take place? Probably a lot more than you think. This is arithmetically the case because China is starting from such a low base.
At roughly $1.2 trillion in 2008, total Chinese private consumption is only a little more than that of France (around $1.0 trillion) and still less than that of Germany (about $1.3 trillion, not to mention the UK’s $1.4 trillion and Japan’s $3.2 trillion). This fact alone should cause us to be extremely skeptical of feverish claims about the role Chinese consumers can play in making up for any contraction in US consumption – which at roughly $9.4 trillion last year is nearly eight times the size of China’s – without even taking into account that Europe and Japan are likely to exacerbate, rather than help absorb, the contraction in US net demand.
Chinese private consumption has dropped dramatically as a share of GDP in the past two decades. McKinsey put out a much-discussed report on consumption in August, which like many McKinsey reports is thoughtful and thorough, and generally does a good job of summarizing the informed consensus – for example the claim that a major reason for high savings is the lack of a social safety net, for which I think there is much less than meets the eye.
Unfortunately, the report tends explain the sources of low consumption too often by referring to consequences of the underlying dynamics, rather than the underlying dynamics themselves, making its proposed solutions either impractical or irrelevant. For example, the report complains that “China’s investment- and industry-intensive model crowds out consumption.”
In fact the main reason for overinvestment, and the fact that much of it is misallocated, thus widening the future gap between production and consumption, is probably too-low interest rates and a distorted credit allocation system, so it is not a question of reorienting growth away from a capital-intensive model. It requires first of all a fundamental reform of interest rate management and banking governance.
One can also easily argue that the fact that “China’s consumers make limited use of credit”, as the report claims, reflects the underlying industrial strategy more than just a technical failure to develop consumer credit. A burgeoning consumer credit market – big enough to matter – will undermine the growth model by changing the direction of implicit subsidies. This is a pretty big reform.
But that is an aside. Like most McKinsey reports it has lots of great data. For example it shows that the Chinese were not always so reluctant to consume. According to the McKinsey (and the National Bureau of Statistics) data, in 1990 consumption represented just a little over 50% of GDP. Around the time of the inflationary crisis of 1993-94 it dropped to around 45% of GDP and stayed at that level until shortly after the 1997-98 Asian crisis, when it began a fairly steep decline, hitting 40% in 2003-04 and around 35% currently. Crises seem to drive the household consumption rate down, even though bull markets don’t seem to drive it back up. Is that because crises cause households to worry about risk (although if that were true they wouldn’t go permanently down, would they)? Or is it because the government responds to crises by increasing the amount of misallocated investment, the consequence of which is to reduce future consumption? Government consumption, by the way, has stayed pretty steady, at around 15% of GDP, during that period.
Compared to non-Asian countries Chinese consumption rates are astonishingly low. Consumption for most European countries lies in the 55-65% range. Consumption for other developing countries can easily fall in the 65-70% range – where much of Latin America falls. US consumption has been around 70-72% in recent years.
Even by Asian standards Chinese consumption is off the charts. South Korean and Malaysian consumption is around 50% of GDP (although during and after the Asian crisis Malaysian consumption did drop to around 45% of GDP, before recovering). Other major Asian economies, like India, Japan, Taiwan and Thailand, show consumption in the 55-60% of GDP range. Compared to those numbers China’s 35% is astonishing, even if, as some claim it may be somewhat understated (which by the way may be true of other developing countries).
The flip side of the decline in consumption has been the rise in household savings. After bouncing around erratically between 10% and 20% of disposable income in the 1980s, around 20 years ago Chinese household savings equaled 12-15% of disposable income. Around 1992 they began rising steadily until 1998, and then stabilized at around 24-25% until very recently, when they rose slightly to about 26% of disposable income. The report correctly notes that the real increase in national savings in recent years was caused by the sharp increase in corporate savings, although as I have often mentioned before, I think corporate savings are themselves caused by the transfer from household savings via low interest rates.
During that same period China ran small surpluses or deficits on the trade account until 1996, when it booked its last trade deficit, beginning a steady upward march of its trade surplus until 2003, when the trade surplus was around 5% of GDP, after which time it surged to over 10% of GDP in 2007-2008. Investment, too, rose steadily during this period as a share of GDP. In 1990 it was around 23% of GDP. It rose sharply in 1992-94 to around 31% of GDP, stabilized at that level, and then began climbing inexorably around 1997-98 to reach around 40% in 2008.
Rising investment and rising trade surpluses are inextricably linked in China’s case. Strategies that explicitly or implicitly boosted Asian savings rates and constrained consumption, I have argued many times before, were viable strategies as long as the resulting trade surpluses, which were an almost automatic account of these policies, could be absorbed by trade deficit countries. Of course the US has played this role for the past thirty years, but there is good reason to believe that it might not be able or willing to do so much longer.
These growth strategies basically forced households to subsidize investment and production, thus generating rapid economic and employment growth at the expense of household income growth, and as I have argued many times before it is the growth in household income that has primarily constrained household consumption growth.
This is borne out by the numbers. From 1990 to 2002, according to the McKinsey numbers, household income ranged from 64% of GDP to 72% of GDP. It peaked in 1992 and then began a slow, erratic descent to 66% in 2002, after which time it plunged to 55%. I suspect that if there were a way to measure changes in wealth – for example the value of the deteriorating social safety nets and the environment, the present value of savings as interest rates are changed for policy reasons, etc.—and household income were adjusted by these changes, the decline would have been greater.
The report goes on to discuss McKinsey’s projections and expectations for consumption growth over the next few years. I read it with interest but frankly I find these kinds of exercises not terribly useful because of the tremendous difficult in ascertaining the various feedback loops – of which there are many in China – which inevitably force reality far away from expectations. But I did try to do some quick arithmetic, in order to determine what kinds of numbers we are going to need to get anything resembling a rebalancing.
Rebalancing is the key word here. Many analysts think that what we need is for consumption in China to grow quickly, and this will resolve China’s (and the world’s) problem with contracting net demand in the US.
Actually, no. What we need is an expansion in Chinese net demand – rebalancing in other words – so that China can adjust to contracting net demand from the US in a way that doesn’t harm trade partners and competitors and rebounds on itself with escalating trade tensions. The way to rebalance is not for consumption to grow, but rather for consumption to grow as a share of GDP. Even if consumption declines, and GDP decline more quickly – a horrible outcome to be sure – rebalancing will occur. The best way of course is for GDP to grow quickly and for consumption to grow even more quickly.
But this is I think what most people miss. Just growth in Chinese consumption alone does not help if it grows in line with GDP, and less so if it grows slower than GDP. In that case the imbalances will get worse, and while the impact on the trade account can be temporarily disguised if investment continues to surge, ultimately it just postpones the needed adjustment (and increases the cost if the investment surge is misallocated).
What kind of consumption growth will we need for the country to rebalance? The numbers are a little worrying. If China grows by 8% a year, consumption would have to grow by a little over 11% to raise the consumption share of GDP from 35% to 36% in one year. It would have to grow by a little over 9 1/2% annually to do it in two years. Consumption, in other words, must grow substantially faster than GDP for the rebalancing even to begin to take place. This is arithmetically true because China begins the process with such a low consumption ratio.
Look at it over the longer term. Just to return consumption to 40% of GDP over the next five years (and even that level is widely considered to be way too low, and probably unprecedented in the world excluding recent Chinese history), 8% average annual growth rates in GDP would require a tad under 11% annual growth in consumption. Similarly, 7% average annual GDP growth rates would require that consumption grow annually over the next five years by nearly 10%. To bring Chinese consumption in 20 years up to 50% of GDP, which is the low end for other high saving Asian countries, and far lower than any other large economy in Asia (and remember that large economies are less able to rely on exports to fuel growth than small countries), 7% annual GDP growth would require average annual consumption growth of just under 9% for twenty years.
In other words while GDP growth slows significantly from its 12-13% rate of the past several years, consumption will nonetheless have to surge at rates far in excess of the 8-9% growth rates of recent years in order for even a small, partial rebalancing to take place. I don’t think I have ever seen a case in which consumption has grown at nearly that rate for any length of time. I believe if China pulled it off it would be unprecedented.
Of course this will not be easy, and I think too many commentators underestimate the magnitude of the problem. China’s rebalancing process will even in the most optimistic of cases take many years before it can even reach the lowest consumption levels reached by other Asian countries that pursued investment-driven policies accompanied by too-low interest rates and undervalued currencies. This will be a long haul, and if I am right – if we need to see a transfer of income back for the state sector to the household sector really to get it going – we should expect much lower GDP growth rates over the next decade than anyone is currently projecting.
Michael,
Isn’t China just the mirror image of a Latin American consumption boom? In such a boom, the continuing appreciation of a currency results in rising real wealth for consumers, and increases their propensity to spend on imported items. Production suffers, the trade deficit balloons, and the boom continues until the inherent instability drives away foreign financing, leading to a maxi-deval which depresses real wages and consumption. In the Chinese case, all of this is true, except its the opposite: China needs a a maxi-reval to raise consumption at the end of the cycle.
I understand a reval is hardly an original idea. What I’m trying to introduce is the concept that the solution to the Chinese problem is binary: either continue to export a huge production surplus; or dramatically raise the real wealth of consumers. Any “in-between”, or gradual, adjustment that does not result in a step-function increase in incomes is dooomed to insignificance.
The problem with binary choices is that they create inherent instabilities. Everyone assumes that it is in China’s interest to hold to the “Bretton Woods II” regime. True, as long as it continues to export production surpluses. So the most likely scenario is that China reacts to the global slowdown by moving EVEN MORE towards exporting surpluses (as its doing now by building yet more capacity and devaluing vs. non-US currencies). Eventually, it has a severe inventory cycle, and the recession makes it obvious that the model must change to consumption demand, leading to a shock maxi-reval.
Can’t happen? People think this because, implicitly, 90% of observers believe China can achieve export-led growth of 8-11% regardless of the condition of their customers. By virtue of its model, the driver of Chinese growth is exogenous, and we just don’t want to admit that, particularly because in 2009 the fact was obscured by China’s creation of yet more export capacity. Once it becomes clear, China will have no choice but to make growth endogenous, which it can easily accomplish through a reval, not because it wants to, but because it has to in response to an inventory-led recession. This inventory-led recession, in turn, would become evident once Chinese lending slows from the torrid pace of 2009 — something that has already occurred. In other words, we’ll find out soon whether the Chinese have been “pushing on an export-led string”, and have to resort to the other binary choice.
But you miss the point. China’s consumption is not simply what its consumers consume, but the total of that consumption plus its domestic fixed investment. Add that into the total and there’s an entirely different picture.
Let’s say US consumption falls by 5% or around $900bn, can China make up that shortfall? Actually yes pretty easily, it only amounts to a couple of years expansion, but more to the point, China’s growth has the effect of raising world raw materials prices and increasing consumption of the entire developing world, emerging markets or whatever you want to call them.
Paradoxically that reduction in US consumption will probably benefit the US too, the consumer glut debt ridden expansion of the last few years was mainly blown on imports.
From the Chinese government’s perspective, the key issue is what is the *optimal pace* of re-balance? The government must consider the short term trauma and pain to its society cause by change against the long term benefit that comes with that change.
China already knows the need to re-balance. China already knows that exchanging huge quantity of Chinese goods and services for trillions of dollar of a paper currency a very bad idea in the long run. China already knows having the stability and health of it’s society so dearly dependent upon the prudence of foreign consumers, foreign regulators and foreign governments is a very bad idea. China already knows it is a very good idea to have an economy that is strongly supported by domestic demand. China already knows it is a very good idea to enrich it’s average citizens so that they can enjoy the fruit of their labor.
To be honest, I think this latest blog post is really the first interesting post in a while. This blog has belabored why China needs to re-balance for a very long time with very long write ups. What we really need to figure out is what is the optimal pace of re-balance from China’s perspective? After all, this is the challenge and is what the Chinese government is striving for.
More analysis similar to the current post with more detail on the pace of re-balance is much appreciated.
edit question
“I have argued many times before, were viable strategies as long as the resulting trade surpluses, which were an almost automatic account of these policies, could be absorbed by trade deficit countries. Of course the US has played this role for the past thirty years, but there is good reason to believe that it might be able or willing to do so much longer.”
last sentence, do you mean “it might NOT be able or willing to do so much longer.” ?
Mr. Pettis – That last sentence in paragraph 12 is that what you meant to say? Or did you mean the US will not longer be able to be the trade deficit country for China any longer?
Paragraph 12
“Rising investment and rising trade surpluses are inextricably linked in China’s case. Strategies that explicitly or implicitly boosted Asian savings rates and constrained consumption, I have argued many times before, were viable strategies as long as the resulting trade surpluses, which were an almost automatic account of these policies, could be absorbed by trade deficit countries.* * *Of course the US has played this role for the past thirty years, but there is good reason to believe that it might be able or willing to do so much longer.***”
Sir
As aways a well reasoned and thought provoking article. While reading it I was struck by the thought that perhaps from the Chinese perspective nothing is amiss.
Looking at the current model from the perspective of the leadership one wonders what if anything necessitates change in their minds. Given the incredible success of the current model in both the political and economic realms, why is any change necessary?
Assuming that one of the Party’s prime goals is to maintain power, why promote consumption which operates on the whim of individuals? Why not maintain central control of the levers of growth (and power) through a continuance of the capital-intensive model via interest rate management and banking governance? Could this be one of the feedback loops that you mentioned?
As an aside, in your piece you stated:
“Of course the US has played this role for the past thirty years, but there is good reason to believe that it might be able or willing to do so much longer.”
Perhaps you meant to say:
Of course the US has played this role for the past thirty years, but there is good reason to believe that it might (not) be able or willing to do so much longer.
I’ve never understood how consumption can be such a small part of GDP in China. My guess is that residential construction is counted as investment snd buying apartments as saving and Chinese have upgraded their living standards tremendously by allocating income to new bigger apartments in recent years. Does this make sense?
David, I think there is a third option, and that is an agreement between the US, Europe and China in which the former two commit to maintaining open markets and try to slow their own adjustment while China commits gradually to relax the currency constraints and liberalize interest rates. This won’t be an especially easy process, but a rapid-adjustment for China would almost certainly cause a dangerous contraction in production and a surge in unemployment. I do agree with your concerns about inventory. Some of the optimists out there have claimed that as the contraction in trade stabilizes, the contraction in the trade surplus will be much less of a drag on Chinese growth than it was in 2009, and so it will take a much smaller investment push in 2010 and 2011 to maintain high growth levels. Aside from my skepticism that we have seen the end of the contraction in trade (on the contrary, I expect to see a rise in trade hostility), my guess is that the biggest drag on growth will shift from the trade account to inventory de-stocking. Creating all this inventory (which occurs not just on corporate balance sheets, but also in strategic reserves and among private investors) creates growth for the economy in the current period, but will act as a drag on growth in future periods.
Bill, I disagree. If China makes up for a shortfall in US consumption by an expansion in investment, that does not resolve the mismatch between production and consumption. It is implicitly a bet on a rapid recovery in US consumption to absorb the additional capacity. If that doesn’t happen, China is merely investing in inventory build-up, in which case we are back to the problem discussed on my response to David’s comments. Government consumption by the way doesn’t count if it is explicitly or implicitly funded by households. When governments borrow from households at extremely low interest rates to subsidize household consumption, they are not creating new consumption. They are merely changing the consumption pattern, at best by anticipating future consumption.
I am also not sure I agree with your math on the impact on commodity exporters. Although this increase in Chinese investment does translate into rising consumption by foreign commodity producers and exporters, if the resulting increase in production is not met by increased net consumption at home, it will also translates into rising future supply of finished goods. We are still stuck with the need to export excess capacity. I do agree that the reduction in US consumption will benefit the US, but only because the US itself must undergo its own difficult rebalancing process involving a switch from consumption to saving.
Silly things, I wouldn’t get too comfortable with the idea that China “already knows” these things. It also knew these things five and six years ago, and yet things continued to go in the wrong direction – for example five years ago there was widespread consensus that consumption, at 40% of GDP, was too low and needed to be raised. Instead it declined to 35%, and this during a global economic boom, when it would have been much easier to initiate the steps towards rebalancing. Like in the past, many of the current comments by policymakers suggest that whereas they might know in a superficial way the need to rebalance, the policy choices they make are actually contradictory. After all it is far easier to count the number of times policymakers have called for a stable currency (and in the case of Minister Chen and other Commerce Ministry officials, even calling for depreciation) than to see any real moves towards rebalancing the economy via the exchange rate. There has also been no change in interest rate policies, for all the talk or rebalancing. Much more obviously, the perceived need for China to rebalance is in contradiction with the massive stimulus package this year. Perhaps the idea that we need just to agree to rebalance, without spending time belaboring the causes of the imbalance, is the culprit. Weirdly enough, announcing that China needs to rebalance doesn’t automatically cause the economy to rebalance.
Lar and others, thanks for pointing out the typo. I have corrected it.
Nada, I think many parts of the leadership do recognize the risks and the need to change, but the bulk of the leadership at the provincial and municipal level, and in SOE management, seem to fail to see why investment strategies that worked before (when the US was growing quickly and its consumption even more quickly) won’t work any more.
David, I don’t think consumption is low as a share of GDP because of perverse behavior by households. In my opinion it is low because household income has grown so much more slowly than national income.
Michael,
Like many other commenters, I think this is a very good post because it highlight a persistent phenomenon that may be more of a problem in the eyes of people wiyh Western idea about good government and succesful economic policy. Without suggesting that current leadership are commited to socialist ideals (they probably are not), they happen to have an apparatus of government (that also runs a big part of what elsewhere would be the private sector) that shows all the signs of managerial pathology (entrenchment, lateral expansion, rivalry without competition, etc) that used to prevail in large western corporations prior to the ascent of “shareholder value” ideologies (not to say that those pathologies disappeared in the west, they became less legitimate) . But in political terms, the mebers of that, highly decentralized and fairly undisciplined apparatus are the leadership’s constituency. The interests of the rest of the population play more of a boundary role (a famine would be unacceptable, the things we observe are not).
What I would like to add to your description of the “symptom” (low consumption share) is the way this is mirrored in the “income” version of GDP: the employment share is extremely low (even for a country with a large rural population of self-employed peasants and equally self-employed labourers without urban residency) and has been declining. That income structure (given that the bulk of non-employment income is SOE or state-related) is maybe even returning to pre- 1990s patterns, but without the iron rice bowl. Widespread consumption share increases are basically impossible without an employment share that is not declining and especially without greater socialization of household risks such as injury, healt and unemployment. Exploited and insecure workers are unlikely to become enthusiastic consumers (and of course, consumption is not as virtuous as production in both the traditional and CPC value systems)
There are essentially two ways a constructive leadership could deal with low consumption caused by stagnant wages and high or increasing financial insecurity: (1) allow workers to organize themselves and bargain effectively (which may become more feasible economically given that the best cheap labor seems to be under cultivation already) or (2) introduce mandatory minimum wages, genuine social security, reintroduce health care and education provision that is of acceptable quality and affordable and finance that by extracting excess funds from the SOEs. In essence the set of solutions introduced by Bismarck in Imperial Germany.
A bargaining solution is incompatible with CPC rule, hence not possible. Minimum wages would be extremely impopular with
Continued. the leadership’s constituency but gradually one should become aware that the current situation is not only the source of trade complaints but also possibly the early stages of a process of “verelendung” that they used to teach at the Party school.
The problem is not just in encouraging consumption. The problem is that the income inequality between city folks and farmers is widening.
If those in the city spends on luxuries, those in the countryside will feel left out. I think it’s good that the government encourages, even subsidies the farmers, to buy computers, refrigerators, TV and others.
Once the households in countryside have the items that city folks have, the consumption in the country will increase at the same rate.
Michael,
So where does currency appreciation fall into your equation? China has already allowed its exchange rate to appreciate about 15% relative to the dollar in the last three years though this is obviously not enough to make the Yuan valued correctly based on Chinese capital flows, trade, etc. So, I believe it is safe to assume that we will see this gradual and controlled appreciation of the Yuan. This will increase the import purchasing power of Chinese consumers and will lead them to spend more on imports, which is part of consumption. Thus, a means for the consumption to adjust is through the exchange rate channel. Also, 7% growth over the next twenty years for China is quite unlikely. I am aware that the last thirty years of growth were unlikely, but 7% over the next twenty years is 1-2% higher than most projections I have seen.
Also, I am curious what you think about the comparison of China to Japan. Japan averaged 10.4% GDP growth in the 1960s after a decade of large growth in the 1950s, but GDP growth slowed to 5% in the 1970s and 4% in the 1980s and famously stagnated to 1.8% in the 1990s. In parallel, the Yen was fixed to the dollar (which was fixed to gold until 1971) until 1973. This allowed it to become very undervalued (familiar?) but US deficits and the oil crisis led Japan to choose to float the Yen, which led to its approximately 200% appreciation into the 1980s. I am unsure how Japanese consumption varied over this period and I acknowledge the differences (especially population) between Japan and China still I think the Japanese story is a similar one.
From this extrapolation, we must predict the rise of higher wage industries in China, which would allow consumption to increase. Also, the mounting pressure for improved education and government health programs will definitely decrease the need for such high savings rates (replaced by consumption most likely) within the next twenty years.
Rien Huzier raises some interesting points.
The CPC finds itself in a conundrum. In order to raise the level of personal consumption it must reduce the power of the various levels of government and the SOEs. Not doing so risks “verelendung” (thanks for the refresher on Marx, the term had faded from my memory).
That being said I would not be willing to wager that the CPC will put the welfare of peasants and workers above those of its functionaries and SOE management…riding the tiger indeed.
Pettis: “In fact the main reason for overinvestment, and the fact that much of it is misallocated, thus widening the future gap between production and consumption, is probably too-low interest rates and a distorted credit allocation system, so it is not a question of reorienting growth away from a capital-intensive model. It requires first of all a fundamental reform of interest rate management and banking governance.”
The interest rate and banking issues are important, but only part of the story. Business investment decisions typically consider probability the investment will make a profit and percieved risk compared to the expected profit, in addition to availability of financing/funding on favorable terms. The whole package of overlapping subsidies and constraints in China increases expected profit, reduce perceived risk and makes financing available on favorable terms. Important factors include the low controlled exchange rate, control of raw materials prices below market levels, tax rebates, policies that keep labor costs low (wages, benefits, and working conditions), and lax environmental and safety enforcement.
These factors increase investment within China, including projects that would not be profitable without the subsidies. For example, if a US based company is considering a manufacturing investment, with the expected profit larger, risk lower, and cheap financing available for a China location as compared to a US location then the decision is likely to locate in China (or other countries with similar practices). Because of these policies the US manufacturing base is rapidly declining. These same policies contribute to the large increase in corporate savings in China noted in the post. A significant fraction of the corporate savings is simply money that has been transferred from the government to the corporations via the various direct and implicit subsidies.
Michael – superb post. Thank you – something I’ve been looking for, for a while now, as you know. Several of the other commenters questions and challenges have been addressed in previous posts dissecting the underlying structural dynamics of forced savings. Among many other things the implications of previous much higher consumption tell us that such low consumption is not necessarily “natural” (there is btw a natural historical timepath of the proportions of Consumption; the US is far over it’s limited and was outside sensible ones at 67%. Look back at the 60s for the savings, investment, consumption and growth relationships to which we may, repeat may be returning).
The point about how China’s trade imbalances metastasized around 03 dovetails with my own findings and is the evil twin of excess debt and leverage in the developed economies. All of which is going away, one way or another. The problem will be will the different factions in the mandarinate coalesce around a new paradigm or are they so wedded to a particular viewpoint that serves their interest that they freeze up and collapse the state.
That’s the real heart of the implications here and you’ve implicitly set out some serious structural threats that could escalate dissent and disruptions over the next decade significantly. Just as one minor example of what might be the next line of inquiry (what’s the path forward) a substantive reform of the Financial system is in order (cf. Greg Chow’s magnificent discussion in his chapter in his book on China’s economic transformation for a detailed discussion). That would also put them in a position they are not now in to deal with revaluation challenges.
Lots more that spins off this but enough for now. Oh by the way you and your readers might want to take a look at this:
http://llinlithgow.com/PtW/2009/03/3of4_brics_governance_stabilit.html
Or for a bigger picture fitting China into a broader geo-political context this:
http://www.scribd.com/doc/18715606/Brave-New-World-Constructive-Engagement-and-US-Foreign-Policy
Another wonderful post Professor.
You said that the process of re balancing and raising consumption will take awhile. It seems to me at least that there are three ways to raise consumption, leverage up, consume more of what you are earning and/or drawing down savings to consume which I admit is similar to leveraging up. In both the first and last case, financial intermediation becomes an important part of raising consumption. The first could lead to a new round of NPLs like the previous attempts to give out credit cards and the third could lead to a diminishing of the banks capital base. I am fairly certain that none of the proposed consumption boosting measures would get the Chinese to draw down their savings but as the population begins to age, they will start having to consume more of their savings. So then it seems to me that those proposed social safety net measures become a way to protect the banks capital base. I know this will probably take place over a very long time horizon +15 years. But I was wondering if those were the only three options to raise consumption.
Revaluation of the Yuan also brings about other issues. First the issue of labour cost and productivity. These will face increasing pressure. BYD hand-making batteries vs. Sony’s or Sanyo’s highly automated factories. BYD has an advantage now, with labour so cheap. They will not at a certain wage price point.
On the other hand, the comparative value of infrastructure improvements will increase.
Professor Pettis: an excellent posting.
China clearly needs to engineer a big shift in primary incomes from the “corporate” to the household sector and a rising share of consumption. But, structural shifts since the 1990s may exaggerate the degree of the adjustment. Before the 1980s, private home ownership was unknown; rent was 1% of household spending.
In the 1990s, the government launched HOUSING PRIVATISATION supported by a Housing Provident Fund (jointly financed by employees and employers with low interest rates copying Singapore) and an Affordable Housing programme for lower and middle income classes.
By 2000, urban home ownership was an astonishing 77.1% and more recent figures are higher. That said, these policies need to be modified as sharply rising home prices have crowded out the middle class. Moreover, rising home prices accentuate and perpetuate rising income and wealth differentials.
As David Stern notes the treatment of housing in the National Accounts is abstruse. The purchase of a house is treated as gross fixed investment, while repairs and maintenance are intermediate and not final consumption.
How relevant is this? Housing investment as a share of Chinese GDP was virtually 0 in the 1980s; 2.4% in the 1990s and 4.6% in 2000. (For Japan and the USA the figures in the 1990s were 4.8 and 4.1% and 3.7 and 4.8% in 2000.)
First, the jump in Chinese home ownership and investment correlates with the drop in private consumption. Moreover, households’ target savings may be ratcheted up with home price inflation.
In short, your argument that liberalisation of interest rates, lower down payments (currently 50%?) and better availability of credit is spot on. This would be an effective way of boosting lower income households income and domestic consumption. These policies would also damp or reverse the explosive rise in income differentials.
best regards James
Rien- An interesting analysis. One see too many analysis of Chinese policies that view the country as simply the central government acting with the sole constraint of potential unemployment riots. As you point out, Chinese policies aren’t consistent with maximizing employment at all, and instead serve different constituencies.
It’s funny, but not ha-ha funny, how Western economists exhort the CCP to increase wages; even as they favor policies to drive down wages in the Western working class.
Professor, thanks for your illuminating post and responses to the comment. I agree with you that in the long run China needs to rebalance its economy to more consumption-oriented, but I was wondering if there would be an optimal short-term solution for the current imbalance without too drastical change in the economy of US and China, which is: (anyway we have to make sure the deliver
of adjustment without collapse from either side)Since China suffers from too much investment (low consumption) and US the opposite, why not the two countries reach an agreement to let China to use its foreign reserve to finance US investment? In this way China could actually create “external demand” for part of its overcapacity and help US create jobs at the same time. The painful adjustment that you mentioned will still have to take place, but I think for China, how to “create” external demand is also important as a way to alleviate the shock to export sector. I think China’s conditional loan (for purchasing Chinese goods) to some African countries is a good example to meet the demand of both sides (regardless of its political controversy).
Interesting ideas Rien. The debate about consumption is gradually focussing on consumers, not on what the government can do for consumption, which is a good thing. The government can do a lot, and quickly if it wants to, in China. Based on its record, and movement after movement backed only by unfunded slogans, it doesn’t really want to reform where reform is needed. The economic cycle is waning….the political cycle kicks in when the economic cycle slows down….based on the ways things look now in Beijing things will soon get ugly. Chongqing may just be the beginning. Consumers consume when they don’t worry about the future, and there are lots of reasons for them to worry – some defined above and ad nauseum elsewhere. My observation over recent years is that people lack a basic feeling of security that goes far beyond access to state-paid healthcare. Part of this is personal security (fear of “political” problems), and part of it is a basic lack of trust. Do you really know what is in the yoghurt you are buying, whether the little car you bought will withstand a collision with a bicycle, or whether your kid will be denied education to match his or her talents because you didn’t pay the right people? If you don’t worry about such things, you are probably more likely to spend more freely. When regulators and those in government are known to gloss over problems rather than deal with core causes, do you believe in consumer utopia?
James, interesting point. That (a statistical treatment that removes what would be considered a component of private consumption elsewhere) explains some of the consumption anomaly but none of the “income”. That could in fact point to an even tighter budgetary situation for consumer/employees! I would be extremely interested in learning more about this.
Purple: Western economists tend not to believe to believe believe that the income of the working class should be driven down. Most believe that labor markets should function properly, which means that there should be space for an efficient bargaining process. In some cases that could mean, eg, removing bargaining advantages of labor and in some cases the bargaining advantages of “capital”, in order to arrive at macroeconomic efficiency. The PRC would have several problems with this: incompatible with official ideology (but so was having a “property” section in the civil code) and unpopular with employers, who happen to control politics.
Purple,
To phrase it differently, if Marx would be alive today he would certainly see the PRC state as an instrument of the bourgeoisie. And one without the western camouflage of political pluralism, i e , naked. Non-marxists accept that governments rely on constituencies, ranging from a handful of oligarchs, chiefs or warlords, via an autonomous bureaucracy like the PRC up to groups within pluralist democracies.
Rien: as regards the big statistical hole in HOUSEHOLD INCOMES — nobody really knows what is going on. Chinese national accounts are a legacy of Soviet central planning.
In principle, GDP measured from the income, expenditure and output side should yield the same results. In practise, a rampant underground economy (30%+?), 100+ million migrant workers, dated sampling (the explosion of small private enterprise, self-employment) and unknown deflation techniques — mean the numbers never add up.
In OECD countries the National Income side of the accounts are regarded as the least reliable. For the PRC, I suspect the output data are the best of a bad lot. That said, a word of caution. Chinese quarterly GDP data are published before those of the USA and growth rates are always surprisingly “smooth” — typically in harmony with the policy rhetoric of the CPC. Thats why 8% growth in 2009 was always a slam dunk.
best regards James
Rien
As I recall, Marx theorized that an oppressed working class is a prerequisite for revolution. Perhaps the 1949 event in China was a bit premature, given the society was then agrarian.
Could current trends portend the rise of Communism in China rather than an increase in consumption? The irony would be delicious.
A colleague recently saw a Morgan Stanley presentation (equities) in which they are arguing that Chinese data simply does report things properly and, if properly reported, Chinese consumption would be >50% of GDP.
This is what we have to contend with.
I don’t buy any of it. The oligarchs in China impound import money and I don’t believe savings is that high for the typical Chinese middle class. The middle class in the US don’t have a safety net either. But, he has an income massively higher than China and cheap housing and relatively cheap food in comparison. Eating and having a roof over ones head in China should be enough to keep the average guy broke.
The biggest business in China is capital spending to build something right now that isn’t going to be used. The band has left and the dance is still going on. My view of China is one can only build so many steel mills that can’t be used, so many highways (all this is impounded domestic business and a cost to society, but counted as growth. Growth when the real pie is shrinking is known around the rest of the world as a bad investment. I watched in the early 1980′s as they started 20 million feet of office space in Dallas year after year. The beginning total at the start of the boom was 70 million feet and they finished with about 100 million additional and a glut that lasted to the present day). I believe China is the next Dubai, not all of China, but a good bit of it and the bust is going to roll backwards through the economy. I am starting to read things that show I am not alone in what I have been writing for some time.
http://www.pivotcapital.com/reports/Chinas_Investment_Boom_the_Great_Leap_into_the_Unknown.pdf
http://www.prudentbear.com/index.php/thebearslairview?art_id=10317
It is clear the US cannot go on expanding debt and at the same time have its wellbeing threatened by a large country that jawbones the dollar on a whim of trying to gain its own trade advantage by linking to the dollar then complaining about it. The growth in China is the growth in China and not the real growth in China. It is growth like the skyline of Dallas in 1984. Scarcely a building taller than 30 stories has been built since 1986 here, yet the population has grown by 2 million metro, though there has been what is called Uptown developed just north of the CBD. There are going to be Chinese cities that will be nothing but total losses as they have been constructed.
As always, I enjoy your posts. I saw an interesting report on China, and I thought I would send you the link. You would know whether they are right or not better than me.
http://www.pivotcapital.com/reports/Chinas_Investment_Boom_the_Great_Leap_into_the_Unknown.pdf
Thanks. Your writings have benefited me ever since “The Volatility Machine.”
“At roughly $1.2 trillion in 2008, total Chinese private consumption is only a little more than that of France (around $1.0 trillion) and still less than that of Germany (about $1.3 trillion, not to mention the UK’s $1.4 trillion and Japan’s $3.2 trillion). This fact alone should cause us to be extremely skeptical of feverish claims about the role Chinese consumers can play in making up for any contraction in US consumption – which at roughly $9.4 trillion last year is nearly eight times the size of China’s – without even taking into account that Europe and Japan are likely to exacerbate, rather than help absorb, the contraction in US net demand.”
Whenever you read these kinds of claim that Chinese consumption is equivalent to or less than those of France or UK (and is one-ninth of that of US), the first thing you do should be to question it with some common sense. Can anyone with some direct experiences in these countries seriously believe a country of 1.3 billion population consumes the same amount as or less than a country of 60 million even if the comparison is between a developing country and a developed one?
Lets’ start with some basic facts and numbers:
* In 2009, Chinese will have bought over 13 million automobiles while in France the auto sales will probably be just over 2 million
* In 2009, about 24 million LCD TVs will be sold in China, compared with 36 millions in the US
* In 2009, PC sales in China will be 47 million while US will be over 60 million
These are big ticket items in any country and I haven’t listed the figures for house and apartment sales. Are the numbers in France or UK even close to the above numbers in China? Or for that matter, Germany and Japan?
What about services? Consider the following:
* China has over 600 million cell phone users, larger than the combined population of US and Western Europe
* China has over 300 million internet users, more than the US population
* China has the world’s second largest aviation market, after the US
* China has the world second largest rail passenger traffic volume, after India
Are the corresponding statistics in France, UK, Germany or Japan even close to those numbers in China?
Make no mistake: China should increase the share of consumption in its economy; the share of personal income in the economic output should be increased. All of these I agree. Still, we should be careful with the numbers we use to make the point.
Some of the oft-cited numbers underlying the debates about Chinese economy need to be carefully scrutinized:
* Chinese investments at over 30% growth a year is way too high
China doesn’t have an investment figure equivalent to that of the west. The closest thing China has is the fixed-asset investment, which includes land purchase and does not include capital asset depreciation. The equivalent investment growth should be a lot lower than the headline numbers
* Chinese consumption at 35% of GDP is too low both in absolute terms and as a share of GDP
To put it simply, China’s GDP is underestimated and the main omission is in service. Therefore both the absolute consumption and consumption as share of economy are underestimated. Finally, the dollar equivalent value of China’s consumption is further estimated due to PPP.
The second point about is a very complex and highly technical subject. It takes a lot of pages to discuss in detail, but here are the main points
1. China did not adopt the western GDP concept until 1992. Historically, as a central planning economy, China measured its economic output using former Soviet Union’s method, which only counts material production (agriculture + industry) plus construction and transportation. The service sector does count in this calculation approach. Service sector in China, to this day, is still vastly underestimated due to historical and technical reasons
2. Even if China adopted the western GDP statistics in theory, the way China collects the economic data and the approach it calculated GDP are quite unique.
All western countries calculate GDP based on the expenditure approach; China uses a hybrid value-add (mostly agriculture & industry) and income (mostly services) approach to calculate its GDP due to historical and technical reasons. In theory, different approaches should give us the same GDP numbers, but in reality, they give very different numbers. Therefore the absolute GDP numbers, when compared with western countries, are not exactly apples to apples.
3. The biggest problem with China’s GDP calculation approach is the underestimating of service sectors.
The biggest omissions:
3a Housing – In the US, housing is counted as consumption and is over 10% of GDP (www.bea.gov). Housing consumption consists of owner-occupied services (75%) and tenant-occupied service (25%). In China, where most people live in their own apartments/houses and some rent from private owners, neither is counted as service or anywhere in GDP.
3b. Government expenditure – this is a very murky area in China where real statistics are lacking and way underestimated. Consider the government’s take share of the economic output, this is also a big omission in GDP
3c. Other service – A lot services China simply could not get reliable numbers, such as law, health care, education etc.
4c. Agriculture – This is not exactly service, but there is no statistics for the food and vegetable consumption for the 700 million peasants who harvest the crop from their own land. World Bank also questioned that China under-counted the farmland by anywhere from 1/10 to 1/3.
Finally, everybody understands that the service in a developing country is way undervalued compared to developed economies. Some personal experiences: a haircut in Xian costs 5 yuan, 15 yuan in Beijing, 12 dollars in Dallas, 20 dollars in New York. I was once involved in a car accident in China and got several stitches in my hands. Taking out the threads cost 4 yuan in China; for the same service in the US, I got a insurance company bill of 150 dollars!
It’s not difficult to see how off the base the claim that China’s consumption is smaller than France or UK is. By all accounts, China is the world’s second largest consumption market.
Corrections to my above post:
1. China did not adopt the western GDP concept until 1992. Historically, … The service sector does NOT count in this calculation approach. …
I missed NOT in the above paragraph.
James,
Fair enough, PRC statistics have their weaknesses. But it would be interesting if anyone had been able to do meaningful forensic work on those poor quality accounts. Who knows, the IMF may have something to say about this too, whenever they publish their country report. After the PIN in July, it should not have taken this long. Meanwhile, we might as well marvel at the face value of this stuff..
That Pivot report is a great read but why is it being plugged here?
Mr Pettis
Nice post. Hope it’s not too rude to say that was expecting this post particularly after Martin Wolf more or less directed everyone at one of his recent talk/conferences as the authority on Chinese imbalances – a very “discreet” reference to you as his friend whose opinion he agreed with.
Nada
Sorry to butt in in the conversation so late – have been saying for some time (not that anyone really pays attention to everyman ) that the new century might create the most conducive conditions for a mix of socialism shading (oddly enough) into communism just when the world hailed the end of communism in the 90s. And that’s not just amongst those nostalgic for the old commie bread lines. Not sure where you stand on that but that scares me!
Huizer
the post finally goaded you out of retirement huh? guessing from your response (correct me if it’s wrong)that you regard the central government as making that transition from communism by leaping head first into dirty capitalism with all the unsavoury power groupings that come with the system ? But is there really an alternative? Idealism aside the world is hardly a pretty picture most days.
Generally pretty surprised that there are still plenty cheering on the call to expand credit and consumption in China . Have misgivings about whether it really is such a good thing for a bemoth to go down the same garden path where one has already tripped. Putting aside the spectres of the credit meltdown (and the excesses that triggered the sequence) or even the mini scare of Dubai, if the consumption pattern of America poses such a burden on the world,(resources, environment etc) given the population size difference, does the world really want a China that eventually consumes at the rate that Americans have been consuming? Be careful what you wish for, Santa might just give it to you. Frankly, for all the complicated theories behind the non-consumption /high asian savings story,the real story might be as simple as a difference in experience – collective experience over the last century or perhaps more pertinently the last decade- would explain the urge to squirrel away money delayed gratification may just be good sense when there is no money helicopter dropping cash. Conspicuous consumption tends to bring with it shades of nouveau riche and therefore that silent disapproval – think Confucian shake of head if you wish.
Greg: there are two seperate questions here.
You are correct in saying that comparing consumption in US$ at market exchange rates is like comparing apples with oranges. That’s why cross country comparisons are made at PPP (purchasing power parity). China has not yet participated in the WB/OECD PPP programme (but I will check on that). If you compare World Bank estimates you can see China’s GDP at market exchange rates and at PPP. By memory, the latter is around four times the US$ figure — but subject to big revisions.
That said, Prof. Pettis is correct in using US$ based consumption data in his argument — because he is looking at global international imbalances measured in US$.
However, your point that Chinese GDP is way understated owing to bad measurement of the services and the private sector does imply that its current account surplus as a % of GDP is much smaller — and perhaps more manageable.
P.S. housing in the US is NOT counted as private consumption and it is not 10% of GDP. In the National Accounts, housing is treated as gross fixed investment. The bean counters then calculate “imputed rent” on the housing stock and enter this flow estimate as private consumption. How they do this is another can of worms, especially in China?
regards James
True, there is no way China can increase consumption as much as the consumption declined in Western countries on the short term.
But that is not so much a problem for China as it is for western countries, especially the UK and the US.
I have no doubt China’s success story will continue… What makes me optimistic is that there is a solid industrial basis in China, while the west is losing it’s economic basis… The US economy nowadays is just based on shuffling printed paper from one place to another, and they don’t even own the printed paper, it’s borrowed from China….
As greg indicated, the chinese economy as a whole is just massively undervalued, the prices just can’t be compared making any comparison on absoulute GDP basis absolutely useless…
I am very optimistic about the future development of China and Asia as a whole, just they should probably stop listening to what the West tells them… Rebalancing is what the western countries need, China can easliy live without it (at least for the next 20-50 years or so, until the west is totally f***** u*).
Thanks for that Greg, some very interesting points. One data point that supports your post is 40% upward revision to the size of Beijing’s services sector following the last economic census. There was another economic census done in 2008, and the results will probably result in a large upward adjustment to the size of China’s GDP. The full adjustment may not make it into the final report, because it would show just how bad the measurement (and managment) of the services sector and other areas has been. As long as it is indisputable that China is a bigger economy than lao ribenr, then that is OK.
Greg, James,
we all seem to agree that the numbers are wrong. First of all, consumption is probably understated for a vaiety of reasons, GDP as a whole may be overstated (easy to manipulate transactions within SOE conglomerates and with the formal public sector), the employment share may be unreliable, etc. My earlier point was that there is no evidence that the household sector’s budget constraints have grown in line with the reported growth of GDP. If consumption is understated, that (ceteris paribus) makes it even tighter. Or relies even more on dodgy accounting. But, one would argue, Chinese households are among the most fanatical voluntary savers in the world, and things like Greg mentions (cars, consumer electronics) sell in ever greater numbers. So we have people who are housed incomparably much better than only half a generation ago (where are those apartments with one kitchen and sanitary unit per floor that were still omnipresent in the mid-nineties), are achieving middle-income penetrations of cars and consumer durables, and save a lot. The answer must lie in (1) variation (2) relatively high (but hardly discretionary) prudential saving and (3) the informal economy. Not much to observe and analyze then!
Excellent article! Does anybody want to factor in what 83% of all new Chinese children are male for the last 25 years through their forced abortion policies of the State and the male being favored over the female through their cultural inheritance traditions. This lack of potential real families being created is going to be a huge destruction of consumption. You must have a growing population to expand the consumption side of the economy. This societal demise will undo the Chinese miracle for decades.
Hi Greg,
you are right Chinese service sector is undervalued, comparing to both other domestic goods and the foreign market through the exchange rate.
However this is not a statistical bias only.
If services sector were to appreciate both against domestic goods and against foreign goods, the export and investment sectors would immediately crash because of runaway human resource costs.
This is what one would call rebalancing.
Rien, thanks for your comments. The key is to increase household’s share of national income, and long with the political issues you mention there is also the problem of how to phase out the implicit subsidies without undermining the profitability of the productive sector. This is going to be a real tough issues to resolve, and impossible to resolve quickly.
Scheng, aside form the underconsumption problem is the problem you highlight – the distributional problem. I am not smart enough to address that problem, which is a very important one, but can only focus on the very difficult problem at the macro level.
Brandon, as you imply, I think the currency undervaluation is part of the consumption problem because of the way it implicitly transfers income from consumers to producers in the tradable goods sector, and yes, I think China is suffering an exaggerated version of what japan wne through. It is interesting that the mini-crisis in 1987, which signaled a period of declining US overconsumption, set off Japan’s fiscal and credit response and the subsequent lost decade(s). It is a worrying precedent.
G. Stegen and DBLWYO, yes, I think the banking system is at the heart of a series of related governance problems that encourage overinvestment. The necessary changes are more than just technical changes but also require a significant reform in governance that can as well be described as a kind of political reform.
Sean, I am very skeptical that we can expect much help from increased consumer financing in the short and medium term. It takes a long time to build a consumer credit system and earlier experiments have resulted in a surge in NPLs. Last week, by the way, the banks announced that credit card delinquencies are up more than 100% year on year (I think the reported number is 126%).
Pupple, it is also funny how commentators with very little knowledge use meaningless abstractions like “Western economists” to hide their lack of knowledge. Can you identify which “Western economists” have been exhorting the CCP to increase wages even while favoring policies to drive down wages in the Western working class, explain why that is necessarily inconsistent, and whether these inconsistent economists regularly comment on my blog?
Touer, in fact that is exactly what is happening. But although this may be a good solution to help resolve China’s employment problem, it is not clear why the US (and other countries) would be willing to tolerate the necessary increase in domestic unemployment. After all the US does not have a problem funding domestic investment, so it is not clear what it would gain from the agreement.
BCG8, even if the MS report were correct, 50% would still be extremely low for a large economy, especially during a period of contracting global demand. That would compare unfavorably with other high-savings Asian countries, even if we assume that Chinese numbers substantially understate consumption whereas other developing countries have no such data problems. At any rate the underconsumption problem is best measured by the trade data, which shows China with the highest rate surplus as a share of global GDP recorded in the past century (for an economy that is tiny compared to the next two highest surpluses). That indicates the extent of the problem.
Greg, since Chinese production and consumption is highly concentrated in the tradable goods sector, why would you point to automobile consumption as a useful proxy? Why not point to things on which France spends a disproportionate amount in order to prove the opposite, such as consumption of cheese, or movie tickets, or vacations on the beach? By the way India has just as many people as China. Are you arguing that common sense implies that Indians also consume more than anyone else? And since we are talking about China’s low consumption (and high investment) why do so many of your examples of high consumption involve investment items, like railways and airplanes? As James further points out, you are confusing PPP measures and real dollar measures. PPP-based adjustments cannot be used to resolve balance of payments imbalances.
Tom Jones, I am afraid I disagree completely. Since Chinese production relies heavily on foreign net consumption, China’s excess production very much matters to China unless you are assuming that the rest of the world has no problem with the unemployment consequences of leaking demand. If the rest of the world rebalances, China cannot avoid rebalancing. This is how the balance of payments works.
Oliver, Greg is measuring the wrong things. Whether China’s trade surplus is a little more or a little less as a share of GDP is not relevant. Even if China’s real GDP were revised to double its size, it is still far more reliant on external demand than any large country in modern history. To recap some of the numbers I have quoted before, the three largest trade surpluses in the past 100 years were those of the US in the late 1920s (0.4% of global GDP), Japan in the mid-1980s (0.5% of global GDP), and China in the past few years (0.6-7% of global GDP). The US in the relevant period was more than 30% of global GDP, Japan, if memory serves, was around 17% of global GDP, and China was around 7%.
The US and Japan suffered in the subsequent decades as they struggled to absorb their overcapacity in a period of declining global demand. It would take an off-the-charts revision of Chinese GDP to make the numbers even comparable, let alone manageable, and this assumes that the problems in estimating Chinese GDP could not possibly have existed in estimates of US and Japanese GDP. It also assumes that the only problems in estimating Chinese GDP imply upward revisions. In fact there have been many arguments that claim that such things as environmental degradation, the valuation of inventory buildup, infrastructure overcapacity, and so on overstate China’s true GDP. For example, if you spend $100 to build infrastructure whose value to the economy is actually $80, Chinese GDP numbers imply a $100 increase in GDP, whereas it should only be $80. Since nearly every Chinese analyst acknowledges the huge problem of overcapacity and overinvestment, it is a pretty safe bet that these should involve some pretty significant downward revisions in “true” GDP.
One interesting thought experiment is to assume that Chinese consumption is, as far as most national accounting seems ot be presented in China, rather accurate.
Then the next step is to assume that while China does have high savings, that they have “ordinary” levels of consumption.
Using simple artithmetic on the non-consumption national accounts – what does that suggest about the size of the Chinese GDP?
I have noticed in the past that national accounts usual adjust to consumption and in fact much of that adjustment turned out to be misstated investments and capacity and production, perhaps not maliciously so but often that a bubble was confused with growth. In other words it really never was there in the first place – while purchases of goods and services is almost always “real”. You can not fudge numbers telling you how much food or TVs or fridges folks buy – though China seems to have an interesting accounting for auto sales that reminds me of the US autos working with rental fleet sales in the 90s.
All this seemed to be especially true with countries that can “choose” and maintain a specific currency level and also are export trade centric.
Just a thought experiment.
Just on the point of the consumption of 1.3 billion Chinese versus the 60 million Frenchmen – I would note that according to World Bank data, as at end 2008 per capita income in France was $42,250 and in China $2,940. If the $1 trillion consumption level is correct thats approx. $16,500 per capita or approx. 40% of income. The $1.2 trillion in Chinese consumption equates to approx. $925 or 31% of income. On this basis the consumption figures detailed by Michael Pettis surely stand up to a common sense argument.
Judy Yeo
Better late than never. I too am frightened by the specter of a socialist/communist revival. The west has perhaps ended its experiment with command socialism and therefore assumes the “End of History”.
Developing countries are in many ways repeating the mistakes of the industrial revolution and as a result creating a proletariat that may resurrect Communism with Chinese Characteristics.
The irony is both fascinating and terrifying.
Michael,
you said…”the problem of how to phase out the implicit subsidies without undermining the profitability of the productive sector”
Q. if those profits exist only because of the implicit subsidies (as mentioned here before), can they be saved?
Greg,
The subject of overcapacity is an interesting one. Looking at the tremendous growth in auto sales this year in China, consider that the capacity must have already been in place to fulfill that demand. In hindsight the build up of capacity looks good.
Now take a way the stimulus, and consider that the pace of expanding capacity is not abating, and the potential for massive over capacity becomes real once again. The analysis below predicts a doubling of overcapacity.
http://www.bloomberg.com/apps/news?pid=20601089&sid=aUZybD9cOe9I
“China’s full-year auto sales may be about 13 million, compared with industrywide capacity to build 15 million vehicles, according to Booz & Co., which advises carmakers and investors in China. By 2015, output may reach 15 million, while capacity may be 20 million, according to Koji Endo, managing director of Advanced Research Japan in Tokyo”
Shipbuilding is another area where this looks to be of a concern. Look at the loans the Chinese shipbuilding industry has received (and the recent IPO). Contrast tha against an current over capacity in both active and planned ships. Yet the push to keep expanding is not stopped. The potential for NPL’s is extraordinary.
James: P.S. housing in the US is NOT counted as private consumption and it is not 10% of GDP. In the National Accounts, housing is treated as gross fixed investment. The bean counters then calculate “imputed rent” on the housing stock and enter this flow estimate as private consumption. How they do this is another can of worms, especially in China?
Greg: I was referring to housing service, not house construction. That is, if you rent an apartment, your expenditure is counted in US GDP (tenant-occupied service); if you live in your own house, you’re still contributing to the housing service part of the US GDP even if you’ve paid off all your mortgage (owner-occupied services). In the latter case, your contribution is converted into equivalent rent expenses even if you don’t pay anybody. There is no equivalent Chinese GDP statistic for housing service. Please check out the Line 16 of the US GDP table (http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=35&Freq=Qtr&FirstYear=2006&LastYear=2008)- it is 13% of US GDP.
James: That said, Prof. Pettis is correct in using US$ based consumption data in his argument — because he is looking at global international imbalances measured in US$.
Greg: That’s still not the appropriate comparison. US and other developed countries have become more of service-based economy. For example, 70% of US GDP is consumption (goods + service); out of the 70%, over 40% are service. Most of these services are just among people within the country servicing each other – you give me a haircut and I process your insurance claim etc. They’re not meaningful for cross-border comparison. The $ of these services are therefore vastly overvalued compared to a developing country.
James: However, your point that Chinese GDP is way understated owing to bad measurement of the services and the private sector does imply that its current account surplus as a % of GDP is much smaller — and perhaps more manageable.
Greg: My main points are that the main omission of China’s GDP statistics is service, therefore both the GDP and service’s share of GDP are understated. You’re also right that CA surplus as a % of GDP is much smaller. China is a continent-size economy and it’s still mainly driven by domestic demand even though the export is very important and a bit too high for such a big economy.
Pettis: Greg, since Chinese production and consumption is highly concentrated in the tradable goods sector, why would you point to automobile consumption as a useful proxy? Why not point to things on which France spends a disproportionate amount in order to prove the opposite, such as consumption of cheese, or movie tickets, or vacations on the beach?
Greg: That’s precisely one of the points I was trying to dispute. That is, service is vastly understated in China’s GDP figures due to errors and omissions. I’m giving consumption figures for some of the big-ticket consumption goods to show people if so many Chinese people can afford these expensive items, it is reasonable suspicion that Chinese’s overall consumption, including both goods and service, are not that small as your number seems to suggest. And I’ve laid out my arguments in my post to explain why service in China is substantially understated in China’s GDP. Please refer to that part.
As to your question why I don’t list some of the things that French spend “a disproportionate amount in order to prove the opposite”. Well, I think I indirectly answered that question in my post. The majority of the consumption in a developed economy like US or France is service. For example, 70% of US GDP is consumption and over 40% of that 70% is service. As I said, the $ value of service is vastly overstated due to PPP.
I list some of the tradable goods because they’re easier to compare cross countries. On the other hand, most services are not tradable and are pretty meaningless for cross-border comparison, as my haircut and healthcare bill exmaples show.
Your comparison of China’s consumption in $ to those of French or UK therefore is pretty meaningless and misleading. This is my whole point.
Pettis: By the way India has just as many people as China. Are you arguing that common sense implies that Indians also consume more than anyone else?
Greg: I fail to see where you draw that conclusion in my post. Since we’re talking about aggregate consumption of a country, both population size and standard of living count. India obviously is much poorer than China, therefore India is far behind China in total consumption even if the population is comparable.
I listed some population-related consumption, such as cell phone users, internet users. Even if Chinese’s average standard living is lower than French, the consumption in these areas in China simply outnumbers France due to population size (China’s cell phone users are ten times of French population and French is not going to buy 10 cell phone per person). Is this so difficult to understand?
Pettis: And since we are talking about China’s low consumption (and high investment) why do so many of your examples of high consumption involve investment items, like railways and airplanes?
Greg: Did I? I explicitly said “What about services? Consider the following:” before I talked about communication services (cell phone & internet users) and transportation services (airlines + railway). Nowhere did I mention railway investments.
Pettis: As James further points out, you are confusing PPP measures and real dollar measures. PPP-based adjustments cannot be used to resolve balance of payments imbalances.
Greg: Let me make the logic simpler to see why PPP is relevant here or not.
You claim that China’s consumption in 2008 of $1.2 trillion is about the same as those of France ($ 1.0 trillion) and UK ($1.4 trillion). Since consumption = goods + service and goods and service are priced in respective country’s currencies, you’re implicitly doing an exchange rate based conversion of the consumption to dollars for each country. While the goods’ prices are reasonably comparable cross countries, the services are usually non-tradable and vastly overstated in a developed economy relative to a developing economy.
My conclusion is therefore China’s consumption is understated when comparing on dollar basis using exchange rate. The comparison is even more skewed when you consider majority of the consumption in a developed country is service. This is where PPP comes in if you really want to compare the size of service sectors in different countries.
I hope I’ve made it clear enough.
Report on Chinese consumption in today’s New York Time:
Recession Elsewhere, but It’s Booming in China
GUANGZHOU, China — For the first time, Chinese will buy more cars this year than Americans. Demand is so high that drivers put their names on long waiting lists for the most popular models.
“I’m disappointed, but what can I do?” asked Zhang Ge Lu, a 28-year-old interior designer. He came recently with two friends to a row of dealerships here in southeastern China to buy a black Toyota RAV4, only to be told that he would have to wait two months for delivery.
And it is not just cars. For more and more consumer goods, China is surpassing the United States as the world’s biggest market — from cars to refrigerators to washing machines, even desktop computers.
The Chinese market is “on full tilt — booming is an understatement these days,” said John Bonnell, the director of Asia vehicle forecasting at J.D. Power & Associates.
China is pulling ahead at this particular moment partly because Americans, debt-laden and worried about their jobs, are pulling back. After decades of gorging on consumption, Americans are saving. And the Chinese, whom economists thought were addicted to saving, are spending more.
Among China’s 1.3 billion people, rising incomes are finally making large numbers of Chinese prosperous enough to make big-ticket purchases.
The question is: will they keep spending? The Beijing government is increasing consumption with rebates, subsidies and heavy bank lending. Whether China can turn the spending spree into the seeds of a true consumer society matters not just to China, but to the world.
…
The rest of the report can be read here: http://www.nytimes.com/2009/12/10/business/economy/10consume.html?partner=rss&emc=rss&pagewanted=all
Thank you Professor for your very valuable comments. I don’t think I agree with your suggestion that there could be room for GDP revisions based on the low utility of investment, and environmental costs, etc. These are just not things captured in flows like GDP. The effects are certainly evident in price trends, and I think you would agree that the overcapacity in China’s economy (thank you for the figures on the magnitude of the external dependence) will put significant downward pressure on non-food consumer prices and could potentially erode the income flows that corporates in China will need to pay back all of the debt they are taking on. But again, these are flows that don’t depend on whether or not there is too much of the related stocks in the short-term. This has to be the case if China is similar to (but still not the same as) Japan. I would agree that Greg is measuring the wrong things, to some extent, especially how to value and compare services consumption between countries. Anyway, I think that we should all start watching nominal variables more closely so that the implications for future growth and economic health are not missed in a deflationary environment. The corner solution for the scenario we have all be considering is the classic Fisher debt-deflation outcome, and this will be very real for China in the medium term, especially given the comparability of monetary policy in China today to Depression era monetary management elsewhere. I still agree that services are undercounted, mostly at the bottom of the income ladder, and this is where the real differential growth and contribution can and should come from. Urbanization is good for this: if you monetize the living expenses of tens or hundreds of millions of people that were previously essentially counted as production costs in the agricultural statistics, then you get some big numbers.
Greg: I agree with your main arguments concerning the huge under representation of the SERVICE sector in China.
But, services are not immune to globalisation; and are indeed growing twice as fast as trade in goods.
Many services are subject to international competition and outsourcing such as call centres, accounting services, travel, tourism, finance, etc. My architect outsources all his drawings to India from Paris in the evening and has the finished product nexst morning at a third of the cost. That’s why the exchange rate is so critical; it determines the “frontier” between tradeables and “non-tradeables” — although I agree that haircuts, jazz bars and massage parlours are harder to export. regards James
On the China’s growth is leading the world out of crisis front is an interesting article, in which Michael is quoted…
http://www.nytimes.com/2009/12/10/world/asia/10jakarta.html?_r=1&hp
“China 10 years ago is totally different with China now,” said Ansari Bukhari, who oversees metals, machinery and other crucial sectors for Indonesia’s Ministry of Industry. “They are stronger and bigger than other countries. Why do we have to give them preference?”
To varying degrees, others are voicing the same complaint. Take the 10 Southeast Asian nations in the Association of Southeast Asian Nations, known as Asean, a regional economic bloc representing about 600 million people. After a decade of trade surpluses with Asean nations that ran as high as $20 billion, the surplus through October totaled a bare $535 million, according to Chinese customs figures, and appears headed toward a 10-year low. That is prompting some rethinking of the conventional wisdom that China’s rise is a windfall for the whole neighborhood.”
——–
The friction between export development based economies is another dimension in this unfolding imbalance scenario. The 2009 TIC data is also instructive.
“That is prompting some rethinking of the conventional wisdom that China’s rise is a windfall for the whole neighborhood.”
I am not sure what conventional wisdom this is talking about, but I don’t know anyone who thought this.
An interest side point that these comments have raised. Demand for autos are up in China, but gasoline remains subdued.
(Courtesy of Clusterstock)
http://www.businessinsider.com/mystery-why-are-chinese-car-sales-booming-while-gasoline-use-remains-stable-2009-12
Now I’m sure the residents of China can speak more toward the restrictions on urban driving. But it does seem that there is a trend toward “conspicuous consumption” of owning car, but not the practical consumption of driving it around town.
Kevin Kim
Another school of thought is that innumerable vehicles of Chinese manufacturer are currently in vast car parks awaiting buyers. One wonders when Chinese auto companies book a sale, when the vehicle is purchased by the end user or when it is shipped to the sales outlet.
The difficult arithmetic of Chinese consumption…
Houhui,
In the mainstream western media the phrase “China is leading the world out of the global recession”, is repeated in various forms daily.
China, as a planned economy, could change faster than most economies it would be compared to. Think of the rapid transformation of Chile under Pinochet and the Chicago boys for example.
With the stroke of a pen, China could improve workers rights (e.g. to compensation), raise the minimum wage by 11% a year, compress tax brackets and spend the revenue on job training and upwards mobility, institute other social safety nets, etc, etc.
Some of the resistance to change may be, ironically enough for a “Communist” country, cultural. The Chinese seem to enjoy indebting their children to their parents, foreign nations to its exporters, its lower classes to its commercial banks, etc.
Additionally, like Japan, their current account surplus may be a matter of national pride and entrenched special interests.
So, for China’s sake and for the world’s, let’s keep the pressure on!
“Demand for autos are up in China, but gasoline remains subdued.”
The explanation for rising car sales and stable gasoline consumption is rather simple: there are approximately 168 million motor vehicles in China (I suspect most of these are not private passenger vehicles.) The total amount of gasoline consumed by these 168 million motor vehicles, including many heavy duty trucks and buses, are so vast, gasoline consumption will not increase that much if you add a couple of millions more new private passenger vehicles into the mix.
By the same token, changes in energy consumption are not a good indication of changes in production. The total energy assumption, both used for nonproductive and productive purposes, will be so huge that a couple of percentage production increase will not necessarily cause significant increase in energy consumption.
Part of the trouble with this debate is (1) that neither the US nor China have national accounts that follow UN guidelines (which by themselves are a bad compromise and, like Windows, produce occasional improvements that users adopt only with great reluctance. (2) China is unique. Its economic structure, artificial rural/urban divide, role of the state, huge informal sector create accounting problems that compound a legacy of national accounting as a central planning tool (and we all know central planning did not work in China, for reasons that are too complex to be discussed here, but still relevant for any formal or centralizing device facing people with local power) . A central planning tool that hails from the same era as our form of GDP accounting (and used initially to assist the Roosevelt administration in macroeconomic management. Unfortunately, GDP accounting and macroeconomic management, once introduced, tend to persist and are extraordinarily resistant to change (bar revolutions of the East-European type, or conquest). But comparing measurements requires a great deal of care and background knowledge.
As far as I know, there is no (at least not in the public domain) reliable and certainly not recent “US”, “Euro” or “UN” (old or new) presentation of Chinese GDP data. As a result, all we can do is speculate, look for areas that may well be “true” , genuine omissions and genuine untruths or implausibilities. That is why an updated IMF country report would be so useful..
@seatrus?
Your interpretation of the subdued gasoline sales makes more sense to me than the fanciful and creative ones that Kevin Kim and Nada Townie proposed.
The gasoline consumption has to do with both the composition and amount of vehicles out there. The big increase in the auto sales this year is mostly driven by small cars and light vehicles. When the economic prospect and activities were generally depressed earlier this year, usage of big commercial vehicles must have been down significantly.
Another example is electricity consumption. Both a decade ago after the Asian financial crisis and early this year, when China’s electricity consumption declined while economy was still growing (albeit at much slower rates), there had been wide-spread suspicions about China’s economic growth data. Of course, the calls were much louder a decade ago.
I think the similar explanation can also be applied to electricity consumption: During the economic downturn, the heavy industries or the industries that consume electricity much more heavily slowed down much more drastically, bringing down the total electricity consumption. The private consumption, meanwhile, still maintains growth.
The following are the breakdowns of the energy consumption in US and China by sectors (2005) from various sources:
Sector China US
Industry 71% 25%
Residential,Commercial and Agriculture 19% 43%
Transportation 10% 33%
The high % of transportation in the US reflects the fact that US has more cars and Americans drive much more than Chinese, not surprisingly.
Glen,
I must have been missing these articles. “Leading” suggests that China has the ability to pull the rest of the world out of recession, aside from some commodity producers, I can’t see any logic behind this. Unless leading means “is first” i suppose
On the contrary the FT, WSJ, Economist, SCMP regularly have columns / articles explaining why China can’t lead the world out of recession, or indeed, why China’s recovery might be prolonging the pain in other parts of the world
China has evidently found the key to solving the peak oil problem: build more vehicles.
“[Chinese] gasoline consumption will not increase that much if you add a couple of millions more new private passenger vehicles into the mix.”
We can obviously grow our way out of any resource shortage constraints, simply utilize Chinese statistics !
Dear Michael,
Could you explain the causal relation in the following sentence: “Or is it because the government responds to crises by increasing the amount of misallocated investment, the consequence of which is to reduce future consumption?”
Regards, Edward Amadeo (Gávea Investments, Rio de Janeiro, BRAZIL)
Could you tell me where the figures cited in the second paragraph are obtained [consumption in China, US. UK etc.]? I have been rooting around looking for referenced sources to back these but have had no luck so far.
Informative summary, bookmarked your site for hopes to read more information!