There has been a lot of excited press commentary recently about China’s overtaking Japan as the world’s second largest economy. China’s GDP should be larger than Japan’s for the first time sometime this year, which in a similar context in 1987 the Italians called “il sorpasso”. For all the excited search for the deeper meaning of this event, however, I would argue that if we examine the change in relative position from the point of view of not just what happened to Chinese GDP in the past twenty years, but also what happened to Japanese GDP, there may be less cause for celebration than we might think.
Before getting into that, it’s worth noting an article that came out in Friday’s South China Morning Post. According to the article:
The head of China’s official carmakers’ association said full-year car sales will surpass 15 million units this year, a conservative forecast signalling a potential dramatic downturn in the coming months.
China Association of Automobile Manufacturers (CAAM) secretary general Dong Yang’s projection implies car sales in the world’s biggest car market will grow at least 10 per cent by volume this year. This is down sharply from 48 per cent growth in the first six months and last year’s 45 per cent rate.
More significantly, it signals a potential contraction of as much as 20 per cent in the second half of the year when compared with the strong, stimulus-fuelled sales volumes in the latter part of 2009.
Why does this matter? Because after growing 48% in the first half of 2010, and 45% last year, the sharp contraction in car sales in the second half of 2010 should intensify the debate over Chinese consumption growth.
As I have discussed before, in order to rebalance the economy China must sharply raise the consumption share of GDP. It has declined from 46% of GDP in 2000, which was already a very low number, although not quite unprecedented, to 41% in 2003, which is, I believe, an unprecedented number, at least for any large economy.
But that wasn’t the end of the story. Consumption declined further as a share of GDP to an astonishing 38% in 2006, finally to end under 36% in 2009. I don’t think we have ever seen anything close to this level before.
Policymakers are very aware of how urgent it is to reverse this decline, especially – rumor has it, and not surprisingly – the generation of leaders who will take control in 2012. Li Keqiang, widely believed to be the anointed premier after 2012, recently made just this point, according to an article Thursday in Bloomberg:
China’s past development has created an “irrational economic structure” and “uncoordinated and unsustainable development is increasingly apparent,” said Vice Premier Li Keqiang in a June article in the government-owned Qiu Shi magazine. Long-term dependence on investment and exports for growth “will grow the instability of the economy,” he said.
In order to reduce China’s excessive dependence on export surpluses and investment, it is vitally important that household consumption, which in China represents probably the lowest share of GDP ever recorded, rise significantly. To that end Beijing has implemented a number of policies aimed at boosting Chinese consumption. Are these policies working?
On the positive side, automobile sales surged last year. For most analysts, this was immensely good news and they argued that this increased demand signaled a major shift in the consuming and saving behavior of Chinese households.
Is consumption really rising?
But skeptics like me disagreed. We claimed that the surge in demand for automobiles was caused mainly by government subsidies, and that these were not sustainable. The same thing happened, by the way, to durable goods, which were also subsidized and which also saw a surge in retail sales. More importantly, we argued, any current increase in automobiles sales and durable goods would be reversed in the future as households absorbed the cost of the subsidies.
Remember that subsidies are not manna from heaven. They must be paid for, and ultimately it is the household sector that pays for them, usually in the form of higher taxes but sometimes, and certainly in the case of China, in the form of financial repression. The government, in other words, borrows from the household sector (via the banks) at artificially low interest rates, which implies continual government debt forgiveness paid for by the household sector. Either way, whether it is through taxes or debt forgiveness, as households pay for today’s subsidies out of tomorrow’s income, consumption will rise today and decline tomorrow.
Perhaps I am simply betraying my prejudices, but the recent news on automobile sales suggests that skeptics may have been right. If the growth in automobile and other consumption is indeed substantially weaker in the following months, as evidence seems to suggest, it should become increasingly clear that low consumption in China is not a discrete problem that can be resolved with administrative measures.
It suggests instead that the consumption problem is fundamental to China’s economic growth model and therefore cannot be resolved without a major change in the model. The same Bloomberg article, which quoted a number of skeptics, including me, on the ability of China to raise consumption levels, also included some objections from analysts who thought China would indeed see surging consumption. One true believer was much more confident than I am. According to the article:
Some economists argue that surging retail-sales figures and rising wages show China’s shift to greater consumer spending is on track. Dariusz Kowalczyk at Credit Agricole CIB in Hong Kong estimates consumption will account for 47 percent of GDP within 10 years.
I have seen lots of other people make similar claims about consumption at some point in the future being a much higher share of GDP, but I wonder on what basis these claims are made. Anyway whenever I see these numbers I am tempted to do the math. The latest official revisions have consumption representing 35.6% of GDP in 2009, so if consumption really does grow to 47% of GDP in ten years, we can easily calculate the average growth rate of consumption for any expected GDP growth rate.
The table below shows the necessary relationship between GDP growth and consumption growth that will get us to 47% in ten years:
|
Avg GDP growth |
Avg consumption growth |
|
0.00% |
2.82% |
|
2.00% |
4.87% |
|
4.00% |
6.93% |
|
6.00% |
8.99% |
|
8.00% |
11.04% |
|
10.00% |
13.10% |
OK, OK, ignore the spurious accuracy. There really was no need to go to two decimal places, but this kind of thing impresses people and anyway modern computing abilities make it very tempting to imply impossible levels of accuracy whenever you do the numbers.
But just look at what the table is implying. In order to get to 47% of GDP in ten years, consumption needs to do something it has never been able to do – grow faster than GDP by a huge margin – something like three full percentage points – every year for the next ten years.
The roots of lagging consumption growth
I don’t know what Mr. Kowalczyk’s GDP growth projections are for China, but it seems to me that the only way we can rebalance to anywhere near that extent is the way Japan did it: with a very sharp drop in GDP growth that is matched by a much slower drop in consumption growth. If China continues growing at 7-9% for the next decade, which is what many analysts seem to be projecting (very unlikely, I say), consumption must grow much faster than it ever has in post-reform Chinese history, even while China’s GDP grows more slowly than it ever has during that period.
It’s arithmetically possible, of course, but there are two schools of thought about how to do it. One school argues that relatively low consumption growth has to do with factors that can be changed without changing the fundamental growth model – perhaps demographics, or Confucian culture, or tax incentives, or lack of TV advertising, or the sex imbalance, or the lack of a social safety net, etc.
If they are right, then presumably Beijing can administratively address those issues while separately keeping GDP growth rates high. But if that’s what it takes, and since they have been determined since 2005-06 to drive up the consumption share of GDP, and during that time it has plummeted, you sort of wonder why they just don’t get on with it.
The other much smaller school (but growing rapidly, I think) argues that low consumption is a fundamental feature of the growth model because of the hidden taxes that channel household income into subsidizing growth. Growth is high, in other words, because consumption is low. This group has been arguing for the past five years that all the measures Beijing has taken to ensure more rapid consumption growth will fail because they do not address the underlying cause.
I guess we will just have to wait and see who is right, but I am confident enough to say that unless GDP growth plummets to below 5% annually on average, and probably even then, there is no way consumption will represent 47% of GDP in ten years. I say this with one caveat – if Beijing were to engineer a huge shift of state wealth to the household sector, say in a massive privatization program, it could boost household consumption significantly, but I suspect that this will be politically difficult to do.
So if Beijing really wants to increase consumption as a share of GDP, what must it do? The key, as I imply with my privatization comment above, is household income and wealth. Contrary to conventional thinking, the Chinese have no aversion to consuming. They are eager consumers, as even the most cursory visit to a Chinese shopping mall will indicate.
So why do they consume such a low share of national GDP – perhaps the lowest share ever recorded? The answer has to do with the level of household income as a share of GDP, also one of the lowest ever recorded.
Chinese households are happy to consume, but they own such a small share of total national income that their consumption is necessarily also a small share of national income. And just as the household share of national income has declined dramatically in the past decade, so has household consumption. This isn’t to say households are getting poorer. On the contrary, they are getting richer, but they are getting richer at a much slower speed than the country overall, which means their share of total income is declining.
The cost of over-investment
The point, then, is that if we want to increase the consumption share, we shouldn’t waste time and money trying to create additional incentives for consumption, to tinker with subsidies and taxes, to advertise more, or to change cultural habits. What is needed is a substantial increase in the share of national income that households take home. Give them more money, and they will spend it.
So how can their share rise? Here, the problem gets very difficult. The Chinese development model is mostly a souped-up version of the Asian development model, and shares fundamental features with Brazil during the “miracle” years of the 1960s and 1970. While it can generate tremendous growth early on, it also leads inexorably to deep imbalances.
At the heart of the model are subsidies for manufacturing and investment paid for by households. In some cases, as with Brazil in the 1960s and 1970s, the household costs are explicit – Brazil taxed household income heavily and invested the proceeds in manufacturing and infrastructure. The Asian variety relies on less explicit mechanisms to accomplish the same purpose. It channels wealth away from the household sector and uses it to subsidize growth by restraining wages, undervaluing the currency, and keeping the cost of capital extremely low.
This model, which some also refer to as the Japanese model, and which many countries have followed before China, has been extraordinarily successful in generating eye-popping rates of growth, but it always eventually runs into the same constraints: massive overinvestment and misallocated capital. And in every case I can think of it has been very difficult to change the growth model because too much of the economy depends on hidden subsidies to survive.
Unfortunately the longer we wait to make the transition, the more difficult the transition will be because the more debt there will be (and so, with more debt, the need to keep interest rates artificially low) and the more dependent growth will be on the subsidies. Ironically, since China is about to overtake Japan this year, Japan itself provides the most worrying example. It kept boosting investment to generate high growth well into the early 1990s, long after the true economic value of its investment had turned negative.
But for a long time the problem of misallocated investment, which was whispered about in Japan but not taken too seriously, didn’t seem to matter. After all, as nearly everyone knew, Japan’s leaders were extremely smart, with a deep knowledge of the very special circumstances that made Japan different from other countries and not subject to “western” economic laws, with real control over the economy, with a strong grasp of history and penchant for long-term thinking, and most of all with a clear understanding of what was needed to fix Japan’s problems.
And look what a great job they had already done: by the early 1990s Japan had generated so much investment-driven growth that it had grown from 7% of global GDP in 1970 to 10% in 1980, and then surged to nearly 18% at its peak in the early 1990s. In about twenty years Japan’s share of global GDP was two-and-a-half times its initial share. That is an extraordinary growth story and one that can only be explained as a function of a new kind of economic thinking, right?
But less than twenty years later, after a terribly long struggle to adjust to high debt levels and massive overinvestment, Japan is about to be overtaken by China with only 8% of global GDP. Japan, in other words, has given back in less than two decades almost the entire GDP share it had taken in the two astonishing decades that preceded it (while during the same period the US has maintained its share). What’s worse, it is hard to pick up a newspaper today and read about Japanese policymakers without getting the idea that they are a totally dysfunctional, narrowly ambitious, and not especially savvy lot, much like their US and European peers. As Mortimer Snerd used to say, who woulda thunk it?
So before we get too excited about China’s overtaking Japan, we should remember that this has as much to do with Japan’s astonishing decline as with China’s astonishing rise, and that there is at least some small chance that the policies responsible both for Japan’s breakneck rise and equally breakneck decline may be being replicated in China.
The sooner China begins the difficult transition, the less costly it will be, but in no circumstance is it likely to be easy. They key will be to get consumption to grow quickly relative to GDP, and China might simply not have the time to do it by reversing the household subsidies. I suspect that the only “easy” solution (economically, not politically) will be a massive transfer of wealth from the public sector to households, via, perhaps, privatization.
The latest economic data
Before finishing this already long entry I should mention two recent pieces of trade-related news and one piece of monetary news released this week. First, China’s July trade surplus was $28.7 billion. This is the kind of number we haven’t seen seen the halcyon days of world-record monthly trade surpluses. Here is what an article in yesterday’s People’s Daily says:
China’s exports rose 38.1 percent year on year to 145.52 billion U.S. dollars in July, but the growth rate was down from a 43.9-percent surge in June, the General Administration of Customs (GAC) said Tuesday. Imports increased 22.7 percent from a year earlier to 116.79 billion U.S. dollars. The pace of growth was slower than June’s 34.1-percent increase.
The Financial Times report was characteristically blunter:
China’s trade surplus jumped in July to its highest level in 18 months, raising new questions about whether the country’s currency remains undervalued despite government efforts to introduce a more flexible exchange rate. The trade surplus for July increased to $28.7bn, well ahead of the $20bn recorded the month before and significantly above analyst forecasts, according to data released on Tuesday.
The pace of increase in exports actually fell last month to 38.1 per cent, year-on-year, down from 43.9 per cent in June. However, import growth slowed even more, moving up 22.7 per cent against 34.1 per cent in June.
What does this suggest? Two things, to my mind. First, to return to my broken-record imitation, it is still meaningless to talk about a rebalancing of the Chinese economy away from exports and investment. It simply hasn’t happened yet – not even a little. Second, and speaking of mythical birds (my “halcyon” comment above, for those not keeping track) this is more evidence that consumption growth is anemic.
The second trade-related news has to do with Japan. Here is the Tuesday Financial Times article:
At first glance, the earnings results and forecasts delivered by Japanese companies over the past two weeks should have been great news for investors. Big names from Toyota to Sony outperformed in the quarter to June, and one in six listed groups raised its guidance. Yet Japanese stock prices have barely rebounded from their July lows – the Nikkei remains 15 per cent below its high for the year, set in April – and the mood among shareholders, policymakers and many executives is gloomy.
To see why, all it takes is a quick look at the yen. After surging during the financial crisis, the Japanese currency is on the rise again, trading close to last November’s 14-year high against the dollar of Y84.80.
…The yen’s strength compounded companies’ woes during the recent recession by making their exports less competitive just as foreign demand was shrinking rapidly.
The PBoC seems to be increasing its purchases of the yen, and that is causing the yen to rise. It is also causing very unwelcome weakness in the Japanese economy. Whenever people argue that the US wants and needs net Chinese investment in USG bonds, you should ask how that can possibly make sense when every country seems to be doing all it can to repel foreign capital inflows (or to increase their own net capital outflows, as in the case of China, Japan and Germany). The idea that the US or any other country “needs” foreign financing is total nonsense. Nearly every country in the world is trying to export capital and import demand. The world has no urgent need of capital. It needs consumption.
Away from trade, today the NBS released inflation statistics. CPI rose to 3.3% from 2.9% last month, and PPI declined from 4.8% from 6.4% (see the People’s Daily article). Other statistics released today suggest that the economy is slowing down further. Most China analysts seem to believe that the slowing is under control and that there won’t be a shift in policy soon. According to an article in today’s Financial Times, for example:
Most economists argue that China is witnessing a controlled slowing from the potential overheating of earlier in the year, rather than a new slump. “The key data point to a moderate slowdown rather than a sharp downturn,” said Brian Jackson at Royal Bank of Canada.
I am not so sure. My sense is that senior officials are already alarmed at the speed of the slowdown and we may be on the verge of panicking and switching policy back in the other direction. One piece of news that might contradict me is the rumor that the CBRC is demanding that banks put back on their balance sheets by the end of the year some of the stuff they tried to move off balance sheet in an attempt to evade loan quotas. Here is what Bloomberg says:
China’s banking regulator ordered banks to transfer off-balance-sheet loans onto their books and make provisions for those that may default, three people with knowledge of the situation said. The assets linked to wealth management products provided by trust companies must be shifted onto banks’ balance sheets by the end of 2011, the people said, declining to be identified as the matter isn’t public. Lenders should prepare provisions equal to 150 percent of potential losses, they said.
The CBRC is widely believed to be in favor of slowing growth and rebalancing, the economy — or at least that is effectively what it means to worry about deteriorating bank balance sheets. But will Beijing reverse course soon? The higher CPI inflation number complicates things, although perhaps this will be partially mitigated by the lower PPI inflation numbers. Higher CPI may prompt the PBoC to raise borrowing rates, but don’t overvalue what that might mean. Real interest rates have been declining, and the likelihood of even more wasted capital consequently rising. At this point an interest hike is not really contractionary. It simply reverses or reduces the expansionary impact of declining real interest rates.
My guess is that in spite of higher CPI, which is believed to be temporary, a lot of policymakers are very worried by the pace of the slowdown, and Beijing will loosen very soon. This probably won’t come about as a major change in announced policy so much as by stealth. They’ll simply stop putting pressure on the banks, and this will allow the combination of greed, cheap capital, and socialized credit risk to work its magic on loan growth.
Mr Pettis
Does this mean that the Yuan can be expected to rise against the US dollar? Is so will this be a rapid appreciation?
Thanks
The artcile is true or fault. It is so suprise to hear China‘s economy is so well.
I was thinking about something along the lines of the massive privatization you mention.
What if China created shares that represented most of the state ownership of firms, bundled them into an ETF like instrument, and handed that out to every person in China? And at the same time created a tax structure that favored dividends up to some threshold, so this ETF yielded 4-5%. They could make it expensive to trade so as to inhibit the accumulation by investors. It might be marginal income for well-to-do city dwellers, but it would probably boost the income of the rural poor significantly.
Instant consumer demand! Boy, that was easy…
As always, an interesting read.
It appears that large losses to banks from bad loans are inevitable in China. So far, no one seems concerned about the banking systems ability to absorb these losses (much like 2007 in the US at the beginning of the sub-prime debacle when wishful thinking about the “small size” of the subprime market, etc., etc. “proved” it was no threat to the banking system as a whole.). Do you think that there is an systemic threat of large and numerous Chinese bank failures looming? If so, any idea when the switch from a “no problemo” perception to a “the sky is falling” perception amoung investors may occur?
It is interesting that a system based on the “peoples” ownership of the means of production never actually gets around to giving the people title to their property. As we saw in Russia, it appears that privatization in China is code for “transferring control of the economy (and wealth) from government functionaries to private ownership by ex-government functionaries (or their families)” with only a little window dressing of including the average citizen in privatization. Are the Chinese people as easily fooled as the Russians were in the 1990′s about the transfer of the nation’s wealth from the Party (as a public institution) to Party insiders (as private individuals)? (Assuming you agree with me that this is what is on-going in China.) Thank you.
“China’s banking regulator ordered banks to transfer off-balance-sheet loans onto their books”
I’m sure it’s just my imagination running wild but I refer to this often: “Until people who speculate in currencies and commodities are punished, the international economy will continue to tether on the edge of collapse”
http://www.chinadaily.com.cn/cndy/2010-05/21/content_9875578.htm
Also read an interesting statement a few months back from a Chinese official responding to the US pressure to revalue. He said “do not lead, do not follow, say nothing, but do something big”
My tinfoil hat tells me China is in the process of soon shaking up the status quo, upsetting the apple cart
Nice article. There are a few points to quibble with though. Japan has done noticeably better than you imply if you accept these two facts
1) Its long term thinking and high level of investment was at least rational “enough” to allow for a future increase in consumption even with dramatically less labor utilization. It makes sense for Japan to be more capital intensive than the U.S. (five times GDP instead of 3 approx)
2) The resource intensiveness of the Japanese economy is dramatically lower than the U.S. (and not just because its an island). Some of the investment in Japan can be seen as a down payment on a future of greater resource scarcity for a country that has little natural resource endowment. As Im sure you know, this coordinated investment, especially in the transport sector, requires taking money from the household sector in one form or another.
Lastly, and its just a quibble, are you using market exchange rates to get GDP share or PPP? I can see an argument for both in this context but would probably settle on PPP to avoid big jumps in the future if economic regime were to change (for example a significant reval of RMB against dollar that would single handedly change the balance, in this case if there was little reval against other currencies like yen).
thx.
Michael:
How have the SOEs, if my memory is correct, seemed to have reversed their position regarding savings, and Chinese corporations in general, where the opposite seemed to be true several years ago regarding savings, operating on razor thin margins, where many were using loans to speculate in the stock market as overcapacity had led to the situation where it was more profitable to do such than engage in commerce within their respective industries (that last I suspect would be smaller companies not SOEs). Is this due to asset sales, perhaps land sales, or similar. Shares sales in the domestic, subsidairy sales externally.
What market share do SOEs hold in the domestic economy?
What percentage of SOEs are in companies that build Infrastructure? Engage in real estate development?
What percentage are in companies that produce consumables? White Goods?
I wonder the degree to which SOEs, their structure, and produce contribute to the skewing of their development model.
Michael:
Some more questions:
Nexus between Local Governments and Local SOEs, am sure that Local SOEs get revenue from taxes generated, are benefitting from the increased level of land prices under sale of local lands, and further that members of local governments work, at least the members pf their immediate families work in Local SOEs.
Have you looked into such a role in the misallocation of capital and its potential detriment on the development trajectory of China.
Are their statutory provisions against such, or is it commonplace for unpaid/lowly paid officials of local government to hold high positions in local SOEs.
I am really interested to learn more of your insight regarding the structure of the Chinese Investment community regarding the Roles of the PBOC and BOC, their relationships to the largest Banks in China, other Investment Bodies such as CIC and SAFE, and ultimately to their relationship to SOEs (their structure and position and focus in the domestic market) if not ultimately to their investment drive overseas.
If not able to answer, have at least provided some fodder to your research interests in the never ending quest to understand, the nature, function, and ultimate trajectory of the Chinese people.
To the global level, it is interesting, we have some interest in further fiscal expansion, we have greater interest in fiscal austerity, we have global aversion to further capital inflows (over the short to medium term I suspect), and universal interest in exporting as a way to get out of this global mess, with global, ultimately systemic origins (even if some continue to see this as having a genesis in a simple SubPrime fiasco).
I tend to think this goes deeper to the number, and size of new entrants in the market which does not denigrate the current model, its general success over the decades, and its contributions to lifting multiple countries out of poverty these last decades, but rather further tinkering, greater global responsibility sharing, and a renewed commitment to strengthen global norms across a wide variety of institutional structures. If not, even if in the medium term, I suspect a rise in further protectionist initiaitves, that will need to be overcome with greater sanoty in the development of the global development trajectory. Having the facts, understanding the true nature of the forces at play are a requirement to a better designed system able to address the needs of so many more participants. In opposition to this, there will an entrenchment in the system. Where some regions are so dependent upon exports, other regions so devoid of ability to consume, that could only be to the detriment of too large a percentage of the global population.
Another great article, and again, you do your best work when you also talk about economies outside of China. The Japan comparisons were very interesting, and offers a long view of the situation.
Everyone imagines that China will keep growing at this rate until the end of time, which of course means that its economy will eclipse that of the US. One can imagine that there may have been similar rumblings about Japan during it’s growth phase.
I have been reading many finance blogs for the past nearly three years, and I have to say that yours has been consistently the most consistent!
Very well written, in simple language without being simplistic, and very much the broken record – the only reason for that I assume, is the hope that someday (hopefully soon) the people who matter, will listen!
Kudos Prof / Dr. Pettis
I’d argue the auto/durable goods subsidisies aren’t so bad as you imply, though less welcome than asset distributions to the public or wage increases. My thinking is that Chinese policy has been vendor financing to the US for the last ten years, switching to vendor financing to Chinese households is a step forward. In that case, in so far as Chinese household financing crowds out US household financing, there is a net gain to Chinese households.
I certainly wouldn’t claim it ideal, but given the size of the imbalance and the number of Chinese employers that rely on a capital subsidy to survive I suspect these kinds of buying subsidies, whose economic incidence is split between producers and households, are likely to play some role.
On the other hand, it will be detrimental to efficiency in the market place, but it seems a bit late to get too sanctimonious on that score.
Michael, I thoroughly enjoy learning from this blog. You mention the composition of Chinese GDP growth over the years (between Cons/Investment). Is there a public website where you find all this data? I have had a lot of trouble finding this level of Data for China…many thanks for any guidance. Regards, Nick
Excellent
Michael,
I am sure you wrote it elsewhere–indeed, I remember reading it–but what finally happened in Japan that they couldn’t continue the former model, and what will ultimately make China’s current system and loan stop/starts cease to work? I guess a non-performing loan crisis?
Michael,
Very thorough and interesting article. Most of your articles have proved my long term view about Asia development. For quite awhile( a very long time), I am/was very intrinsically doubtful and skeptical on the long term success of the Asian Development model that you coined on your blog and its techniques. While it is no doubt good way to catch up with rich nations but probably/might not the best way to promote innovation . It seems the “success” of Asia (mainly SKorea, Japan, Taiwan, Singapore, Hong Kong etc) was built on the over reliance/overuse of subsidies( be it what ever form ) or foreigner’s consumption.
I’m wondering How exactly do you get a net consumption to go up or build a c economy based on consumption (no blueprint for this one?)? Lately, there was has been a lot of talk in the US to raise the consumption tax on almost everything over the coming years . ( Forcing Americans to save rather than slapping tariffs on imported tradeable goods in order to rebalance the economy) This would bring surely bring the deficit down. Would this be a good way to rebalance ’cause this means Asia would have to bear the majority of the pain/ cost of America’s rebalancing (no one to buy) .
Oh One more question , in regards to japan, how do you see japan getting out of the financial mess they are in? They have a shrinking population with a high debt load from previous misallocation of capital, and with current export markets unable to absorb their excess capacity ? I presume monetary inflation.
Thanks.
“What is needed is a substantial increase in the share of national income that households take home. Give them more money, and they will spend it.”
Prof: would increasing wages do it?
This is a very thought-provoking post, but I think there are a couple of issues with it. One is that I think the use of market-rate GDP comparisons to infer that Japan’s share of global GDP is declining while the US’s is stable. PPP is a better basis for comparing national outputs like this, and the PPP figures suggest a pretty different story, in which all developed countries are losing share. See:
http://earlywarn.blogspot.com/2010/08/global-market-shares.html
for graphs and more detail.
Further, I would argue that Japan’s rapid growth essentially ran out of steam when it’s levels of labor productivity and labor costs reached ballpark equilibrium with the rest of the world. The bubble was essentially an overshoot at the end of that fundamental trend. At least looking at China’s labor costs, it’s nowhere near that kind of parity, suggesting the comparison to Japan may not be relevant for quite a while to come.
Interesting article. And great site. You have a fascinating perspective.
I just have three questions/points. First, surely not all government investment is “misallocated?” Doesn’t it make sense to invest in public transportation given the numerous positive externalities? (Lower energy costs/dependence, cleaner air, etc.) And basic research beyond that provided by the private sector often provides dividends? Like the NIH in the US? (Obviously, not all of China’s investment falls into the useful category. But some of it does.)
Second, as far as export led growth–I always thought much of the point was technology transfer. Which, obviously, stops at some point. But it does have permanent implications for GDP? And relative GDP? Isn’t Japan is better off for having transformed into an industrial economy through the Asian development model than they would have been if they had remained an agricultural economy? Regardless of “share of world GDP?”
Finally, as far as US share of world GDP–isn’t much of that about a)understating CPI, and b)the inflated value of the dollar?
What I find interesting is that Michael, rightly so, points out that the household sector in China implicitly subsidises industry. In much the same way, the same has happened in the West. Western society has given up employment opportunities so as to allow companies to offshore production and services. The true impact has been obscured by reporting on average incomes while ignoring the increasing stratification.
Like all complex systems though, mechanisms of homeostasis will prevail. In ecosystems, big trees eventually choke out the smaller plants that recycle nutrients into the soil. Sealing there own fate. Animal populations boom and crash after exhausting their food supplies. So to will the imbalances be corrected not only in China but in the West.
Michael,
Great post and especially your final remarks are plausible.
I have long argued that the employment share is the key variable, not the exchange rate and not even private consumption and it is good to see a similar argument here. Of course consumtion is not entirely dependent on household income (job security, free healthcare and education, and old age pensions all would stimulate consumption spending for a given level of private household income)
Although I agree with your position that Chinese development has similarities with other Asian fast growers (export led, wage- and financial repression, priority for industrial upgrading and expansion in allocating the natio’s resources, in which the market plays a distinctive, but not decisive role). However, I do not believe that the paralel as it manifests itself today is entirely as sustainable as it was in Japan and Korea.
Japan has hit a plateau – and a very comfortable one at that- for a variety of reasons, most of which may be demographic or related to the fact that Japanese non-service, non-construction firms (the ones that were the engines of growth) now employ at least as many people directly and indirectly overseas. This (often eulogized by Japanese scholars as the Flying Geese model) played to a Japanese gvt strength for the simple reason that Japanese firms and the Japanese development model were the pioneers of exploiting in situ labor (rather than allow labor immigration or increased finished product imports). That was in Manchukuo. Manchukuo was also the laboratory that gave the post-war planners the expertise that led to Japan’s own productivity explosion in the 50s and 60s. In fact, one can see the period from roughly 1948 to 1975 as an aberration, in that Japanese firms used Japanesel labor and subcontracters in the role of the locals of Manchukuo (and to a lesser extent, Korea). Once that was getting too constraining (and given important trade friction combined with a floating USD) they moved again production (but rarely development and key component and tool manufacturing) to either output markets (like the US and EU for cars) or reservoirs of socialzed labor in countries with low levels of local productivity, especially in countries where the US (Japan’s main “export” market) could only apply trade and currency measures at a high political cost, especially during the Cold War. If the Japanese authorities had not condoned and supported this “virtual Japan” in East Asia and the US (Japanese firms were still dependent on bank finance and with that, administrative guidance), its firms would not have been able to retain global positions as they have so far.
China faces a very different situation. It has large reserves of socialized labor residing in low productivity areas, which facilitates an “in-house flying geese (?)) process. It benefits from established import patterns in, a.o. the US. But on the negative side,(1) China is already showing signs of running into trade friction, at aggregate industrialization levels where Japan was when its GDP level/cap was still far below OECD levels for a similar human capital endowment. That connects with (2): China’s “social contract” is very different from what Japan’s was in the 1960s (the correct comparison period, I believe). Too long to explain here, but China’s recent social history makes it more costly for the government to maintain high levels of repression (Japan had famously wild “stop-go” effects that would be unthinkable in Urban China) (3) China’s politics are seemingly more unified than Japan’s were during the 1960s, with violent manifestations of class-based politics. However, the Japanese bureacracy was far more disciplined than China’s appears to be with visible authority deficits where economic policy is concerned. And bueaucracy is the key in this process, at this level of development.
China’s handicaps (it has strenghts as well) in following the Japanese model will imo no doubt start to create problems at much lower levels of GDP than Japan did ultimately achieve (even after correcting for the large section of the country that will remain underdeveloped for at least 15 years).
That is probably very well known to the policymakers (who may have a different scorecard than we here assume, one that uses power as currency) and in that respect it is remarkable that they allow the employment share to be so low and still declining. Maybe the persistance of this phenomenon is an indication that the central policymakers are embedded in a structure that makes it impossible to conduct he sort of policies necessary for a soft landing of their unsustainable socio-econonic system. One doe not have to be a path-dependency freak to give some credit to this notion. Should this situation of capture be true (and irreversible in the medium term), the only way to avoid a nation wide atmosphere of dissatisfaction (a phenomenon well known in Chinese history and folklore (and virtually unknown in Japan) would be to slow down GDP overall (as you said) (which would ruin quite a few local potentates) whilst introducing a coordinated programme of party discipline, buying off the more important potentates, and promising a shift in the social-democratic direction. But that seems to be beyond the capacity of current gvt and party leadership, who seem to be far less surefooted than their predecessors. A few difficult years ahead..
Prof Pettis
care to elaborate on the “massive privatization” that will shift wealth from state to household? could it backfire and increase the gini coefficient without fulfilling its aim and increasing social dissatisfaction?
this pettis guy is anti-chinese, all he does is bash china.
he must be deported.
he is working for the US government or CIA.
only the US consumption is subsidized by aid given by china to the US.
US consumption is all based on debt, borrowed money from china.
china is the largest consumer in absolute numbers in many things, who cares about % of gdp.
china’s GROWTH is coming from domestic consumption.
overall 36% of gdp is consumption, but that it the gdp from past decades.
NEW chinese gdp GROWTH is coming from domestic consumption. in 2007 consmuption was the biggest driver of gdp growth.
pettis, take ur keynesian anti-chinese views back to america.
dont like china, then get the F out of china.
china is the largest car consumer.
china is the largest car producer.
china is the largest General Motors car consumer.
china is the largest Volkswagen car consumer.
china is the largest energy consumer.
china is the largest primary-energy consumer.
china is the largest carbon dioxide emitter.
china is the largest renewable energy producer.
china is the largest renewable electricity producer.
china has the largest installed hydropower capacity.
china is the largest hydroelectricity producer.
china has the largest installed hydro-electric capacity.
china has the largest installed solar thermal power(solar hot water) capacity.
china has the largest hydroelectric power station (Three Gorges Dam).
china is the largest wind turbine producer.
china is the largest solar panel producer.
china is the largest Lithium-ion battery producer.
china is the largest Lithium-ion battery consumer.
china spends the largest in clean energy investment.
china is the largest exporter.
china has the largest mobile users.
china has the largest internet users.
china has the largest broadband users.
china has the largest current account surplus.
china has the largest foreign exchange reserves.
china has the largest bank by market value (ICBC).
china has the largest bank by deposits (ICBC).
china has the largest bank by profit (ICBC).
china has the largest bank by number of branches (Agricultural Bank).
china is the largest raw materials consumer.
china is the largest meat producer.
china is the largest cement producer.
china is the largest cement consumer.
china is the largest coal producer.
china is the largest coal consumer.
china is the largest gold consumer.
china is the largest gold producer.
china is the largest platinum consumer.
china is the largest palladium consumer.
china is the largest copper consumer.
china is the largest steel producer.
china is the largest steel consumer.
china is the largest stainless steel producer.
china is the largest iron ore producer.
china is the largest iron ore consumer.
china is the largest zinc producer.
china is the largest zinc consumer.
china is the largest aluminium producer.
china is the largest aluminium consumer.
china is the largest nickel consumer.
china has the largest tin reserves.
china is the largest tin producer.
china is the largest tin consumer.
china is the largest lead consumer.
china is the largest antimony producer.
china is the largest arsenic producer.
china is the largest bismuth producer.
china is the largest fluorite producer.
china is the largest manganese producer.
china is the largest cotton consumer.
china is the largest silk consumer.
china is the largest paper consumer.
china is the largest natural rubber consumer.
china is the largest pork producer.
china is the largest pork consumer.
china is the largest grain consumer.
china is the largest rice producer.
china is the largest rice consumer.
china is the largest soybean consumer.
china is the largest wheat producer.
china is the largest tomato producer.
china is the largest apple producer.
china is the largest garlic producer.
china is the largest tangerine producer.
china is the largest peanut producer.
china is the largest eggplant producer.
china is the largest potato producer.
china is the largest cabbage producer.
china is the largest cauliflowers and broccoli producer.
china is the largest fish producer.
china is the largest silk producer.
china is the largest rapeseed producer.
china is the largest tea producer.
china is the largest tobacco producer.
china is the largest tobacco consumer.
china has the largest livestock of domestic sheep.
china has the largest livestock of domestic pigs.
china has the largest police force.
china is the largest consumer of Japan exports.
china is the largest consumer of South Korea exports.
china is the largest consumer of Taiwan exports.
china is the largest consumer of North Korea exports.
china is the largest consumer of Mongolia exports.
china is the largest consumer of Iran exports.
china is the largest consumer of Yemen exports.
china is the largest consumer of Kazakhstan exports.
china is the largest consumer of Oman exports.
china has the largest shopping mall (New South China Mall).
china has the largest city square (Tiananmen Square).
china has the longest building (Great Wall of China).
china has the tallest statue (Spring Temple Buddha).
china has the longest bridge (Weihe Grand Bridge).
china has the longest metro system (Shanghai Metro).
china has the largest highspeed rail network.
china has the fastest train in the world.
china has the largest population.
china has the largest labor force.
china has the largest company by market value (Petrochina).
china has the largest insurance company by market capitalization (China Life Insurance).
china is the largest online gaming market.
china is the largest construction market.
china was ranked number 1 in gold medals won at the 2008 olympics.
china has the largest mobile network (China Mobile).
china has the largest home appliance manufactuer (Haier).
china is the largest home appliances market.
china is the largest refrigerator market.
china has the largest army.
china has the largest golf facility (Mission Hills Golf Club).
china is the largest power equipment market.
china is the largest metal consumer.
china has the largest reserves of rare earth metals
china is the largest producer of rare earth metals.
china is the largest emerald consumer.
china is the largest jade consumer.
china is the largest pearl consumer.
china has the largest microwave manufacturing company (Galanz).
china has the largest air conditioner manufacturing company (Gree Electric Appliances Inc).
china is the largest beer producer.
china is the largest beer consumer.
china has the largest air carrier by market capitalization (Air China).
china had the most expensive olympic games ever (2008 beijing olympics).
china is the largest holder of US government debt.
china has the largest bridge (Donghai Bridge).
china has the largest total waterways length.
china has the largest high-speed railway network size length.
asia-pacific is the largest aviation passenger market.
china is the largest smartphone market.
china is the largest computer producer.
china is the largest desktop computer consumer.
china is the largest RFID market.
china has the largest number of International trademark applications by Chinese residents in 2007 (604,952).
china has the largest number of International trademark registrations by Chinese residents in 2007 (215,161).
china has the largest number of International industrial design applications by Chinese residents in 2007 (253,439).
china has the largest number of International industrial design registrations by Chinese residents in 2007 (122,288).
china has the largest Primary sector ($515 billion as of 2009).
china is the 2nd largest economy.
china has the 2nd largest stock market by market capitalization.
china is the 2nd largest importer.
china has the 2nd largest Secondary sector ($2.30 trillion as of 2009).
china is the 2nd largest luxury goods consumer.
china is the 2nd largest oil consumer.
china is the 2nd largest manufacturer.
china is the 2nd largest spender on R&D.
china has the 2nd largest installed windpower capacity.
china is the 2nd largest Audi car consumer.
china is the 2nd largest Lamborghini car consumer.
china is the 2nd largest Maybach car consumer.
china is the 2nd largest Lexus car consumer.
china has the 2nd largest Renewable energy capacity.
china is the 2nd largest destination for tourists.
china has the 2nd largest bank by market value (China Construction Bank).
china has the 2nd largest bank by profit (China Construction Bank).
china is the 2nd largest military spender.
china has the 2nd most billionaires.
china is the 2nd largest advertising market.
china is the 2nd largest computer consumer.
china is the 2nd largest global search market.
china has the 2nd largest total expressway network length.
china has the 2nd largest road network size.
china has the 2nd largest total rapid transit system.
china is the 2nd largest diamond consumer.
china is the 2nd largest electricity producer.
china is the 2nd largest electricity consumer.
china has the 2nd largest academic research papers.
china has the 2nd largest scientific reserach papers.
china has the 2nd largest sovereign wealth fund by total assets.
china has the 2nd largest number of brands in the world’s top 500 brands. (79 brands)
china is the 2nd largest lottery market.
china is the 2nd largest grocery consumer.
china was the 2nd largest receiver of foreign direct investment.
china is the 2nd largest country by land area.
china is the 2nd largest corn consumer.
china is the 2nd largest energy producer.
china is the 2nd largest energy consumer.
china has the 2nd largest Lithium reserves.
china is the 2nd largest linseed(flax) producer.
china is the 2nd largest aluminium oxide producer.
china is the 2nd largest bauxite producer.
china is the 2nd largest salt producer.
china is the 2nd largest bentonite producer.
china is the 2nd largest poultry producer.
china is the 2nd largest poultry consumer.
china is the 2nd largest sugar consumer.
china has the 2nd largest airport terminal (Beijing Capital International Airport).
china is the 2nd largest consumer of Malaysian exports.
china has the 2nd fastest supercomputer (Nebulae).
china has the 2nd most number of supercomputers in the TOP500 fastest supercomputers list (24 supercomputers).
china is the 2nd largest commercial aircraft market.
china is the 2nd largest flat-panel TV consumer.
china is the 2nd largest LCD TV consumer.
china is the 3rd largest Ethanol producer.
china is the 3rd largest Ethanol consumer.
china is the 3rd largest wood consumer.
china is the 3rd largest cosmetic consumer market.
china is the 3rd largest paper consumer.
china has the 3rd largest railway network size.
china is the 3rd largest titanium consumer.
china is the 3rd largest BMW car consumer.
china is the 3rd largest Porsche car consumer.
china is the 3rd largest Rolls Royce car consumer.
china is the 3rd largest Bentley car consumer.
china has the 3rd largest stock market by daily average turnover (trading value).
china has the 3rd largest number of world heritage sites (38).
china has the 3rd largest tidal power station (Jiangxia Tidal Power Station).
china is the 3rd largest Lithium producer.
china has the 3rd largest Lithium reserve base.
china is the 3rd largest sugarcane producer.
china is the 3rd largest dry bean producer.
china is the 3rd largest wool producer.
china is the 3rd largest hop producer.
china is the 3rd largest green bean producer.
china has the 3rd largest coal reserves.
china has the 3rd most number of global 500 companies in Fortune Magazine (46 companies).
china has the 3rd busiest airport by passenger traffic (Beijing Capital International Airport).
china has the 4th largest Tertiary sector ($2.15 trillion as of 2009).
china has the 4th largest number of millionaires.
china has the 4th largest installed biomass capacity.
china is the 4th largest Mercedes-Benz car consumer.
china is the 4th largest Jaguar car consumer.
china has the 4th largest number of International patents granted to Chinese residents in 2007 (31,945).
china is the 4th most visited country by international tourist arrivals.
china is the 4th largest copper producer.
china has the 4th largest total pipeline length.
china is the 5th largest consumer market.
china is the 5th largest fast food consumer market.
china has the 5th largest International patent applications in 2009 (7,946).
china has the 5th largest gold reserve holdings.
china has the 5th most international tourism receipts (earner).
china is the 6th largest pharmaceutical market.
china has the 7th largest number of International patents in force by Chinese residents in 2007 (100,097).
china is the 8th largest wine consumer.
Mr Pettis,
I will be in Beijing next week and was hoping to meet at some point. I write for a few different financial websites and am traveling around China for 2.5 months visiting publicly traded companies.
Zack Buckley
RS, I think the RMB will rise against the USD but this will be a very political process, driven by trade relations. Whatever happens to the RMB, however, doesn’t matter as much as what happens to real interest rates.
Bob in MA, there are many ways they can pass assets on to the household sector, but I suspect none of them are likely to be easy or without tremendous controversy. If nothing else, transferring ownership is not just about giving ownership to someone. It is also about taking ownership away from someone.
Mark G, I read the China daily article after you posted it and found it profoundly silly and incoherent. Speculation doesn’t create bad outcomes. Rather it is policy inconsistency that creates both speculation and bad outcomes. At any rate most of those speculators are local businessmen trying to protect their wealth, and historically speculation exists because government promises are too often betrayed for “speculators” not to hedge or bet against them. The desire to punish speculators is a complete waste of time and should not be a key determinant in policy making.
Tyler, all investment is postponed consumption, by definition, but that doesn’t mean all investment is economically viable. I have no problem with investment that creates more value than it costs, but when it creates less, it is an economic form of cocaine – it creates pleasure today at the greater expense of tomorrow. As for your second point, I am using market exchange rates. The point is not the precision of the numbers but rather the huge relative reversal.
CStevens, SOEs are a big part of the problem. Their savings rate has surged, their productivity has fallen, and they grab an increasing share of total resources, away from the much more efficient SMEs.
OGT, you are right to say that the subsidies can be seen as a kind of vendor financing, but for me the problem is that the financing is repaid by effectively forcing debt forgiveness onto the household sector. It seems to me just a very inefficient way of redistributing income.
Nick, the Chinese National Bureau of Statistics website has much of the best economic information. The PBoC website has most of the financial and monetary information.
Hoang, I am not enough of an expert on Japan to try to answer your question, but my model suggests that once they are no longer able to use financial repression to get implicit debt forgiveness – i.e. once they have to turn to other sources besides Japanese households (directly and indirectly), they may have real trouble.
Bigbadbank, increasing wages, raising interest rates, revaluing the currency, privatizing – all of these work. Unfortunately all of them also have significant problems associated with them.
Stuart, thanks. Very interesting post of yours. I am a little uncomfortable with PPP measures because there are so many hidden and unsubstantiated assumptions and they seem to have long-term biases. I also worry that they fail to capture very important things, like environmental deterioration, misallocated investment. It is not that market exchange rate measures don’t have these and other problems, but I worry that the PPP methodology has big systematic biases that make the measures at least as questionable.
Lurker, no, not all government investment is wasted. I don’t think I or anyone else would ever say that. The question is whether the economic value of investment in the aggregate, including externalities, exceeds the economic cost, where all inputs including capital are adjusted to reflect their true cost to the economy.
Rien, thanks as usual for your comments. The argument as to whether China can have a problem similar to Japan when wages and productivity are so much lower is fiercely debated. To me this debate may miss the point. First, if the problems in both countries was an imbalance between domestic production and consumption, then the ability of the rest of the world to absorb that imbalance is the key issue, and clearly the Chinese form of the imbalance was much greater than the Japanese form by any measure. Second, if investment driven by cheap capital, socialized risks, and financial repression is the other important driver of growth. Inevitably capital misallocation becomes a problem, and although it is true China has less investment per capita than Japan, it is also true that China should have less investment per capita than Japan. It is very possible for Chinese investment to be lower than Japan’s and still excessive (leaving altogether aside the question as to whether Japan has not itself misallocated investment).
Judy, that is one of the many problems with privatization. Well-connected individuals can do extraordinarily well out of them.
P-i-a-C, sigh. I‘ve been accused often enough of being a CIA agent as well as an agent of the CPC, so I guess I must be incredibly well-informed. Why am I am pretty sure you are not a PKU student? How can you argue that China is a huge consumer when your own data show that it consumes way below its economic and demographic weight? About one-fifth of what you say is relevant, but wrong. The rest is irrelevant.
Michael, how would you respond to the argument that the consumption share of GDP is higher than the official figures reflect, because the official methods of data collection and analysis miss a large part of consumption? Some equity analysts have argued that if you proxy consumption based on revenues of Chinese consumer products companies, for example, this suggests a much larger consumption share – already on the order of 40-50%. There are probably many ways to criticize that methodology, but the idea that official stats are distorted by methodologies developed during and for a more centrally-planned, less services- and consumption-driven economy has a nagging plausibility to me. Is it conclusive to say if consumption were really that high China would not export so much?
Michael, I hope you’ve learned your lesson now: “Everything is OK”. Always was, always will be.
Seriously though, it’s nice to finally see some comedy come to your website.
I momentarily pondered the listing of the achievements of my home country, Australia, but, seeing as that includes being #1 in car thefts, I thought better of it and went for a lie-down instead.
You see David Malpass is running for Senate from NY? Any comments?
It seems to me that so much more needs to be done, that people get lost in perspectives, safe, comfortable vantage points from which to review these very complicated, oft contradictory issues. While much of the discussion in the developed world is about stagnation of middle class conditions, much hope in the developing world is placed upon a hope for a similar development for the peoples and nations more widely dispersed upon the globe on similar conditions, if not principles, or strategy as what is coming to be seen as the Chinese Development model. Much hope is proferred by these movements if there is great misunderstanding to nature and construction of GDP, while all seem to highlight the benefits, under the bigger is better assumption frame, the more is beneficial, quicker even more admirable mindset, few seem to acknowledge the potential side effects where entrenched interests work to cultivate the, those people, want us to fail, or worse yet, are actively seeking to undermine us so as to deprive us from our rightful place as we have the “special stuff” that all secretly want perspective. These arguments, perspectives and foci are not simply specious, but truly distracting from the greater issues confronting our collective global, human, future as so much needs to be done to ensure a more equitable, sustainable, and mutually beneficial human existence under conditions of increasing population growth, depleting energy resource base and a shrinking world where truly no man, nor even a country is an island unto itself. What is distracting in this whole affair is how these very complex issues, these trillions of moving parts are reduced to few strongly defended positions as people seek to reduce the uncertainty and complexity of these very complicated and multifaceted issues to a few, able to be defended tenants. This process, is both natural and able to be understood, its roots able to be found in cultural, historical, biological, even spiritual, substructures which are transitory even evolutionary in disposition. Unfortunately, the character of discussions, dialogue, argumentation, and debate too often devolves into a range and level of discourse that fails to account for, rarely if ever acknowledges, the broader interplay of issues that need be more profitably addressed as zero-sum game perspectives prevail. Unfortunately, in the truest sense of the word, and directly due to the nature of such dialogue, a zero-sum game in the absolute may eventuate. The Freest Market Dogmateers on the one hand, the Radical Anti-System Institution Enthusiast cum Environmentalists on the other, the man in the street deserving and desirous of more, the women watching things slip away, the liberal minded person wiping a tear from their eye, the Ultra-Conservative attempting to erect sandbags against the flood, the Illiterati with the luxury not to care, the common man just living his life with little concern for such thoughts, the entrenched interests seeking further gain, the person in a mud hut with no thought for these all share a common destiny. The question is how, and under what circumstances, over what timeframe are we to get there.
These are very large issues, if we are mostly discussing the examples of what is evolving in China. To wholeheartedly adopt any of the above positions, is mostly a disservice to yourself and all others who, do ultimately, and will eventually end up in the same place. I think one of the gravest problems confronting humanity, regardless as to whether one lives in relative abundance or under conditions of deprivation, is that all (things in our environment) has sped up so quickly, even for the person in the mud hut. This factor, especially for we who have access to this communication medium, the internet, placing us as relatively advantaged members of the human family, the time factor coupled to the information factor largely enables/encourages/requires us, especially those who have retreated into one of the camps above, to undermine the level of discussion required to truly get a grasp on the issues and challenges facing our collective human family. Our assumptions become truths, are quickly forgotten, as the power of recent data, often that which we choose to review, as privileged members of a new tribe of information hunters and gatherers, furthering complicating the matter, and devolving the quality and level of discourse required to get to more fundamental and universal principles required to address the underlying obstacles to optimizing the human condition in ever more optimal ways. Not that there will ever be a lasting, universally applicable silver bullet toward solving most or even all the problems confronting the human condition, which shouldn’t keep us from searching or experimenting for it, nonetheless, even if it dispirits us, in the case of those with the luxury not to care.
Truly, great inequality currently exists, in fact it is a growing trend where large new entrants skew the inequality between nations as income converges, even while there is growing divergence within nations. With that said, my eyes are dry, as time does move quickly, but shouldn’t move too quickly or quite the opposite of what we might hope to eventuate would be more likely to occur. It should be clear at this point, that GDP can be engineered, great questions remain if it should, and further, it should be understood that it couldn’t, on a broader scale toward solving the grave problems confronting the human race due to the wide variety of issues at hand:
from population to the environment, from legal structures to political innovations, from the social to cultural unto the technological we have a myriad of sub-set challenges to our national, regional and global development.
In this discussion it might be worthwhile to state our assumptions:
Mine is that change comes best more slowly than quickly ( a challenge in our time constrained information overloaded world, which often only serves to further delude us into our perspectives, as we try to make sense of this crazy world)
There significantly more participants in this system than their were previously existent but a few decades ago ( due to expanding population and expectations)
There are expanding constraints on the system, especially under current pricing levels (reinforcing the need for some form of monetary incentive to most efficiently extract the required resources toward the goal of universal development)
The USD as the International Reserve Currency is a detriment to the US people and Currency if it does have some utility to the International Trading System. A utility that few countries under more serious thought would want to undertake, I daresay.
A more productive, and ultimately equitable evolution to global production and consumption trading system between nations would be a more comprehensive push to refocus the Global Economy on principles of Resource and Productive efficiency coupled to endeavors to enhance the very tangible intangible of human capacity development. More efficient everything. More productive everything. More efficient use of Energy, More efficient production of Food, More Efficient Use (and Re0use) of Water. A greater understanding , and coming to value, the value of our Natural Capital. The introduction, and greater utilization of closed looped manufacturing systems, squeezing the last bit of utility from each and every waste stream. From the capture and use f waste heat off off inefficient coal power plants, to the creation or upgrading of waste sewage treatments systems to use human manure in the creation of energy to the segregation and re-use of phosphates, fertilizers and chemicals flowing through the system. For the sake of enabling this, the system needs be incentive, for neither the good will of man, nor even understanding the better that this will provide each of us, will lead to such a destination even under the obvious limitations of a fiat monetary system where all paper is fiat and as there is, and never will be enough shiny gold to ever make a difference. Truly, even were more resources are economically feasible to be exploited at ever higher price points, it should be understood we need to squeeze the absolute utility out of each and every resource more efficiently as the global population has exploded from 1.6 billion and will likely exceed 10 Billion by 2050, a trend that grows exponentially as time passes, the ultimate saturation point who knows. Acknowledging that where we have a responsibility to our human brothers and sisters everywhere, this is a reciprocal relationship with a reciprocal response, hard to rationalize to a subsistence level individual requiring multiple children to ensure care taking in their older ages.
One final point, while the vast, and quick development of China is admirable it is very unlikely to be be modeled and created elsewhere due to the very great cost and resource utilization. Truly, much more resource efficiency will be required moving forward, with advances in technology, especially those that squeeze, in ever increasing fashion the last bit of utility from new and re-used resources. It is easily understood why the path has developed as such, what eventuates from it, the benefits and the detriments over the longer term are yet to be determined. And, yes, there are always, benefits and detriments, sacrifices and trade-offs in every of the systems under which man finds himself.
So, while we continue to look at the nature and function, the development, the trials and tribulations of such a large change upon not simply the Chinese people, and the benefits and detriments that that causes for them, all should understand that this occurrence resides within a greater system of human interaction and offers opportunities and costs. When Global political leaders speak of having compassion and understanding for Chinese leaders, I believe all understand what is at stake for not simply the Chinese people, but for all other inhabitants of our collective home the earth. While I hesitate to wipe my eyes for our collective natural habitat, you will not see me turning over any cars at an IMF meeting, or attacking any Japanese Whaling fleet, but, rather, patiently and consistently calling for more need to find restoration, replentishment, and essentially, further construction of GDP in not simply making the best use of somewhat, or vastly, deplenishing resources, but further engaging dialogue to enhance such things as we continue to populate the world. This is truly a long-term endeavor my friends, and better had need be unless we intend to eventuate in the Sci-Fi thriller of some over-imaginative Hollywood screenwriter.
Those are my assumptions for what they are worth, I generally appreciate the more mature, clear headed, policy dialogue to be found on Michael’s site rather than so many others out in the blogosphere of considerably lessor value.
Hello,
I was listening to a lecture in an MBA course that a large problem with the labour force in China is that it is quite mobile in the sense that many workers go into an area to earn a certain amount of money and then they often go home (or somewhere else, immediately leaving the factory). I was wondering if the reason China was subsidizing durable goods was to make the labour force less mobile and want to settle down more (since they have all this nice new furniture or whatever for their living spaces). That, in turn, would possibly raise consumption to GDP levels would it not? Working at a regular job with (an ideally) regular amount of income.
Thank You,
Rob S
Michael:
Is the surge in savings partly due to the Chinese Stimulus and how this was geared toward the produce of SOEs, as was suggested by Chinese Box?
Were there policies in effect, previously, that supported the produce of SOEs by export rebates, import tariffs, and similar forms of incentive that predominately supported that produce. Are they recent innovations that thus support the earnings potential of SOEs. Is this a movement toward the creation of Korean Chaebol or Japanese Keiretsu? If so, the numbers are substantially larger, much more than the 8 Chaebol in Korea? I wonder the viability of such a path, and if such measures wouldn’t increase, rather than lessen the protectionist drumbeat. Chinese Box argues that there will be much ability for technology from China to Africa, other argue similarly of India, that many of the technologies are more suited to the level of development, also due to their success in Small Plot Ag Tech. There seems to be some corollary there to the transfer of Tech to the Chinese, ie contract manufacturing eventually creates a competitor ie HCT….and similar. Reminds me of how so many companies weere clamoring to get into the market previously, and where such deals were cut to get in, the technology transfer deals were so high in regard. Further the recent deal with Westinghouse for the construction of a few Nuclear power plants, with transfer of technology for the production of a couple dozen more. Most likely leading to whichever Chinese SOE receives the technology will likely be developing more overseas eventually. I wonder where the BOP situation is of concern, Current Account Surpluses and Deficits, Trade Surpluses and Deficits, where of such a concern, then why continue to insist on technology transfer rather than trade, if balance in the situation were desired. I understand that 40 Billion of Cleantech Investment was positioned in China last year, and the argumentation toward affordability, do to the great growth in energy usage and CO2 emissions, but again, in so far of the network effects, and if more balanced trade were desired, then again. With that said, I still see Energy, Food, and Water efficiency or Security as the best driver of Future global growth, but am often confused about the dialogue coming from all sides of this issue regarding trade balances, inability of the US to produce (when it is the worlds largest manufacturer to date) and similar absurd discussions; especially where tech transfer, and I know its value toward moving China to a medium tech producer, but am confused as to how this situation couldn’t be rectified, and might be in the worst possible ways, if we do not move these overall discussions to a more mature level of discourse.
Professor Pettis:
Great post as usual. But I don’t understand your trashing of SOEs performance. According to Barry Naughton’s numbers (Journal of Contemporary China June 2010) the SOEs under the purview of the SASAC have been recording rip roaring profits and vastly improved rates of return on equity since 2002. He describes how SASAC has totally rehabilitated management practises by introducing performance based pay for managers based on 1 and 3 year profit targets, sectoral comparisons and returns on equity. The OECD Survey of China 2010, says the same thing and underscores a big improvement in TFP since 2002, albeit lagging the private sector.
Granted, a lot of this improvement reflects booming growth and better TFP reflects the SASAC’s ability to control entry and preserve big oligopoly profits.
Even so, today’s SOEs don’t appear to be the deadbeat group of losers a decade ago.
I found the Caixin article that unrecorded income in China was 10 trillion Yuan or 30% of GDP (63% going to the top decile) fascinating. It may explain why the property market remains so buoyant and how 25% or more of flats are paid for in cash. It also suggests that consumption is also seriously underestimated. Do you have any views on the author’s approach based on the Englel curve and spending on food?
best regards and many thanks for your terrific insights, James
Pettis replied to my comment: “Speculation doesn’t create bad outcomes”
Huh? What? None the less, China is in an unique and interesting position regarding their bloated holdings of US debt and dollars. A “crisis” would increase the value of their US holdings as the safe haven trade returns. Allowing a divesting of their US holdings into euros, EU debt, coal, copper whatever.
At the same time, by not reinvesting into US holdings, a crippling blow to US style capitalism would be delivered. Not w/o pain to the chinese but a command economy mixed with some George Bush style jingoism should go a long way to tamping down some ill effects
Michael,
regarding consumption figures, isn’t it also true that the measure used in China differs from what is used in other countries? Here in China, domestic consumption does not include the purchase of a family home/apartment. This is included in urban fixed asset investment, whereas in the USA and elsewhere, it is included in domestic consumption.
Assuming I am right, and I do not know for sure, then domestic consumption is actually much higher. Indeed, if you add purchases of homes to domestic consumption, then it shows much stronger growth over the last 5 years (that I have looked at.)
Cheers,
Paul Adkins
Beijing.
BCG81, I am very skeptical about those claims, which generally seemed proffered by cheerleading research analysts intent on uncovering reasons why we shouldn’t worry. There are at least four arguments against them:
1. Although there may be uncounted consumption because of the grey economy, it has always seemed silly to me to say that this lowers the gap between China’s consumption rate and that of other high-saving Asian countries. Why should we assume that China has an uncounted grey economy but Malaysia and Indonesia don’t? All countries do, and so all comparative statistics, and not just China’s, must be adjusted. In that case there is no reason to believe that adjustments would reduce the gap. They might actually increase it.
2. Speaking about the grey economy, the latest revisions by Credit Suisse show that Chinese have more income than recorded and that it is more unevenly distributed than the official numbers show. Since the rich save more than the poor, it also suggests that reincorporating the grey economy actually causes a huge increase in the savings rate and a reduction in the consumption rate. It turns out the whole grey economy argument got the conclusion exactly backwards – the grey and unreported economy increases China’s savings rate by 4 or 5 percentage points.
3. Of course there are discrepancies between official numbers for consumption and real consumption, but why assume that all the discrepancies lower the official numbers? Monopolistic or oligopolistic pricing, currency undervaluation, and internal trade barriers, all of which exist extensively in China, create hidden taxes on consumption, but these taxes are not recorded as taxes but as actual consumption. They aren’t. I would argue that all of the prices increases caused by these factors should be removed from the official consumption numbers.
4. But the main argument is just to consider why this matters. China has the highest investment rate perhaps ever recorded. Simple b-o-p accounting identities (CAS = savings – investment) tells us that a country with the highest investment rate should run a large current account deficit, but China has one of the largest current account surpluses ever recorded. How is this possible? Only if savings are immense, right? So they must be immense.
James, SOE profitability has certainly increased, but profitability can include subsidies. The HK Institute for Monetary Reform did a study last March that argued that if you eliminated the 100 bp subsidy caused by the implicit government guarantee, 100% of the aggregate profitability of the SOE sector would disappear. Clearly if you raised rates by the at least 400-500 bps needed to eliminate the interest rate subsidy, they would all go bankrupt. They are profitable but more then 100% of their profitability comes from subsidies. As for the Caixin article, as I discuss above in my response to BCG81, the study is creating some confusion I think. It does not say that the consumption share of GDP was understated. It says that both were understated, and consumption by less than GDP. In fact the net impact is that savings is a substantially higher as a share of GDP than originally thought – I think they say 4 to 5 percentage points higher.
John, I didn’t know that about David Malpass. We are probably on opposite sides of the US political spectrum, and disagree on many things, but also agree on many others. Overall I think he is a clear thinker and a smart guy, and he has always been willing to listen very seriously to arguments that run totally counter to his own.
Rob S, I don’t think we need to go that far. I suspect that Beijing subsidized certain goods for the reason it said – because it wants to increase both domestic employment and the consumption share of GDP.
Mark G, just because criticizing speculators has always been policymakers’ favorite response to crises (along with criticizing foreigners) doesn’t mean that speculators caused the crises. Speculators take advantage of bad policies by forcing adjustment, often brutally, but they do not cause the underlying imbalances. As for the rest of your point, China cannot easily refuse to invest in US securities, and to the extent that it didn’t, and invested elsewhere, either this would be intermediated back into the US markets or the US trade deficit would contract. Neither represents in any way a “crippling blow” to the US economy, nor anything close. This seems to be a very hard point for people to understand, and I am not sure why.
bcg81
I would agree China’s consumption is higher. But, at the same time I would argue China’s GDP is grossly understated. A recent Bloomberg article claims more than $1 trillion worth of GDP has escaped the government bean counters.
I admire Prof Pettis’s views and analysis and am in awe of his work as it is bold in the face really fuzzy stuff coming out of China’s propaganda/statistics department. Pettis is on the ground and has a good feel for some of the Oz like facade that has/is been/being created in China.
Prof Pettis,
I had to giggle when I read this:
“After all, as nearly everyone knew, Japan’s leaders were extremely smart, with a deep knowledge of the very special circumstances that made Japan different from other countries and not subject to “western” economic laws, with real control over the economy, with a strong grasp of history and penchant for long-term thinking, and most of all with a clear understanding of what was needed to fix Japan’s problems.”
To use a Yogi-ism “It’s déjà vu all over again.” Just substitute “China” for “Japan” to see what I mean.
For more than 25 years, I have been looking at China stats and have watched anomalies disappear, information is suppressed then reappears, when the new stats conform to expectations. You can expect consumption in China to improve simply because it is perceived, outside of China, as a problem.
Good stuff and good insight. You are amongst the few who get what China is about.
Have you seen this article ” Is Chinese Annual Household Income Understated By Almost 10 Trillion RMB?” which also mentions your article. Wish you can give us some thoughts about the grey income in China.
http://www.businessinsider.com/is-chinese-annual-household-income-understated-by-almost-10-trillion-rmb-2010-8
It seems ‘Il Sorpasso’ as hit the NYT, expect many more links to your article and essay requests.
I agree that durable subsidies as vendor financing are not a particularly good or efficient policy, just better than vendor financing to the US or Europe. Call it ‘Theory of the Second Worst.’
Hi Michael,
Although I agree with you that the recent subsidies on appliances and cars are not helpful from a consumption perspective, I am not convinced that (despite their claims) this is the purpose the government truly intended them to serve. When one considers them instead as obscured environmental policies, designed to increase efficiency and reduce emissions through substituting more up-to-date products for old ones, they may have a very positive role to play. Having just spent a few days speaking to clients producing goods affected by these policies that certainly seems to have been the actual outcome.
On a separate note, I see you do not put much weight on the chance of the market pushing up the share of national income earned by households. Given the recent rash of strikes and early signs of very strong wage growth in 2011, I wonder if this isn’t more likely an outcome than mass privatisation…
http://blogs.wsj.com/chinarealtime/2010/08/16/ignoring-chinas-bad-debt-or-business-as-usual/?mod=rss_WSJBlog
Any comment on the rolling over of AMC bonds, as described in the link above? The article itself has links to the announcements. Key passage:
“On Friday, the Industrial & Commercial Bank of China Ltd. issued a statement saying that a series of 10-year, nontransferable bonds it bought from China Huarong Asset Management Corp. worth 313 billion yuan ($46 billion) had their life extended by a further 10 years by the Ministry of Finance.
“It follows a similar move in June when the ministry extended by 10 years China Orient Asset Management Corp.’s 10-year, 160-billion yuan bond to Bank of China Ltd.
“In both cases MoF said it would “provide support for the payment of the principal and interest” of the bonds without specifying the nature or conditions of that support.
“Late last year China Construction Bank Corp. had the 10-year, 247-billion yuan bond it bought from China Cinda Asset Management Corp. in 1999 rolled over for another 10 years. Since then, Cinda and MoF have set up a jointly owned fund to repay the bond, giving MoF a more explicit role in ensuring the debt’s repayment.”
It’s a great way to keep the Ponzi going and explains some of the mechanics of the financial repression you describe. I believe there were 10 AMC’s created in 1999-2000; the bonds rolled over by the three above amount to RMB 720. The AMC’s issued bonds – to the banks – to buy NPL’s – from the banks – at FACE VALUE. Meanwhile, the AMC’s swap debt for equity with the insolvent borrowers, and likely continue to support the companies of which they likely became majority holders. (Within thirty months after acquisition, one of the largest AMC’s claimed to have recovered assets equivalent to 31% of the original NPL’s, but only 4% of that was cash. Public data releases in English ended thereafter.) Unable to pay off the bonds? No problem. Just roll over and play alive…
This is another, partial description of the issue: http://seekingalpha.com/article/125105-really-bad-banks-chinas-asset-management-companies
james: I found the Caixin article that unrecorded income in China was 10 trillion Yuan or 30% of GDP (63% going to the top decile) fascinating. It may explain why the property market remains so buoyant and how 25% or more of flats are paid for in cash. It also suggests that consumption is also seriously underestimated.
This finding is not surprising at all, to long-term observer of Chinese economy.
Overall, the size of the Chinese economy is understated, particularly the service sector, as I commented in this blog some time ago. This is not mainly due to the grey economy although China does have a large grey economy sector, as other developing economies do.
“Why should we assume that China has an uncounted grey economy but Malaysia and Indonesia don’t? All countries do, and so all comparative statistics, and not just China’s, must be adjusted. ” Well, the large gap in reported Chinese economy is due to the Soviet accounting method of national economy that China had used until 1992. The Soviet method basically ignored the service sector and only counted the material production. When China switched to the western system of GDP, it actually relied on the old method of data collection and surveys with some modifications and conversion. As such, there have been large omissions and errors, even to this day. I have commented in this blog before the areas that tend to be ignored or understated, with one glaring example being that the housing sector.
Another evidence of understated Chinese economy is the tax revenue growth. Year in and year out, China’s tax revenue grows by 20-30% annually, much higher than the reported GDP growth. I’m not going into the details of how tax is collected in China, but suffice it to say that it follows a very different approach to track the economic activities.
The Chinese consumption is much larger than what is reported, and has much greater potential. By all accounts, China has the world’s second largest consumer market and is growing the fastest.
Pettis is just rehashing his old claims in this post, nothing really new and much is exaggerated and one-sided as is usually the case.
Professor Pettis,
Could you give a brief summary of why low household consumption is eventually bad???
Demand is weak in the US but still running at around 70% of GDP from what I can tell…
I am in favor of demand-side economics now in the US and it looks relevant for China too… I want to change trickle-down economics into rain-down economics… Do you really see it is time for that type of change, at least in China?
Edward Lambert
Oahu, Hawaii
Greg: “Pettis is just rehashing his old claims in this post, nothing really new and much is exaggerated and one-sided as is usually the case.”
If you read the report, rather than just read someone else’s version, you would see that Pettis was right to rehash his old claims, and professor, please keep doing so until the old China hands like Greg finally stop repeating all the standard cheerleading stuff The report doesn’t just say that total consumption may be higher than reported. It said that the consumption share of GDP is much lower than previously estimated and the savings rate much higher. As far as I can see, the report proves that Pettis has been resoundingly right, and that consumption a bigger problem than ever.
Greg, Pettis has repeated this many times but let me try. The problem is not low consumption. It is LOW CONSUMPTION AS A SHARE OF GDP. That is what causes the imbalance between production and consumption and what the government is worried about and pledged to resolve. You guys just never get it. The Credit Suisse report indicates it is WORSE, not better, than we thought.
Professor, it must have been very frustrating having to deal all these years with the amazing blindness of all the cheerleaders, who are not only blind, but also so sure that they alone can see what’s really going on (in which case why do they all say exactly the same things?) but little by little it seems that all those who think they are experts because they hang out an an expat bar in Shanghai are being dragged, kicking and screaming, into your camp.
Crispus, that is exactly the point. Both consumption and GDP seem to be higher – something that most people believed anyway – but it turns out that the estimated difference in consumption is substantially less that the estimated difference in GDP. As John Calhoun below implies, it is going to take a long time for most people to understand that this means the problem is worse than the pessimists had been saying.
Duncan, rising wages are certainly a necessary part of the rebalancing, and if this happens more I think it is certainly a good thing. Remember however that the key is to raise the household income share of GDP, and for that to happen, we need wages to rise faster than productivity. We also need to raise interest rates and the currency. Rising wages, if they are sustained, is a start.
John, yes the AMCS are rolling over their obligations and are expected to do so indefinitely. Remember that they bought most of their assets in two great tranches, exchanging them for bonds at 100% of face and 50% of face. Since they have only been able to collect at roughly 20% of face, and even this is barely enough to cover operating coasts and interest, they clearly cannot ever repay. Most estimates of the true level of government debt add back the AMC bonds since they are effectively guaranteed by the MoF.
Greg, as JohnCalhoun suggests, perhaps you don’t have a very clear understanding of what the rebalancing problem is about.
Edward, in the US household consumption has probably been too high and almost certain to decline. In China it is too low, by which I mean that China relies too heavily on unstable foreign net demand to resolve the difference between production and domestic use.
JohnCalhoun, no it isn’t frustrating. On the contrary, I suspect that the a-historic misunderstandings of people like Greg, which have dominated conventional foreign opinion about China for so long, is what has allowed me to add value. By the way if you pay attention to the internal debate within China, you can see that this is mostly a problem of foreign misperception. Within China we don’t see quite the same level of incomprehension. In Japan in the late 1980s it was the same. A few foreign and many Japanese economists were very worried about the imbalances and how they would be resolved. Most foreign “experts”, however, totally failed to see the problems. I have theories about what that so often seems to be the case.
I buy completely into the structure and concept that Prof is putting forward. However, I have asked this question earlier as well, why can’t the adjustment be gradual? What does it need to be sharp or sudden?
Afterall, the US budget deficits are not coming down in a hurry. Japanese or Greek debt is not coming down in a hurry. Why does the Chinese readjustment need to be sudden?
From the table showing consumer spending and GDP growth, the Yuan could rise anemically contributing to an increase in GDP in dollar terms much higher than what the rise will be in RMB. The consumption growth would need a fundamental shift, but it could happen.
Secondly, why does a massive privatisation drive need to happen to make it work? The government could just sell (say) 25% stake in SOEs and that should do it…. while the exports are still growing, the PBOE is having to release more RMB into the economy, to buy the incoming USD- thereby increasing its reserves. Can’t the government mop up part of this money through a sale of shares in SOEs? They can price them attractively, so that the people make money, thereby effecting a massive transfer of wealth. The control of the companies is still with the government. Why is this so difficult to do, eocnomically or politically? Actually, it would actually be both politically and economically good – sort of a win-win! And it can happen over 3 or 4 years.
Professor Pettis,
I need some clarification… You say that household consumption in the US should decline. But wouldn´t that exacerbate the slump?
I can see that you might want balance in the trade surplus of China… that you may feel China depends too much on foreign demand so it would be good for China if the US was to buy less from China… Is this what you are implying?
but then wages would never rise in China to the extent that they would surpass productivity if foreign demand was falling…
Ronnie:
If I might add some points that perhaps Michael will respond to, disagree with, or follow-up upon:
1.) Of late, a large percentage of savings are in the hands of SOEs, I wonder if this doesn’t have to do with recent subsidies, ongoing subsidies, and forced loans (the last dangerous in an era of contracting demand)
2.) Selling off more of the companies is possibly possible if it is a policy goal, it would be interesting to look at the nature of Parent and Subsidiary companies, and whether the long term trend would be to spin off the subsidiaries, as often they seem to be the ones to generate the largest amount of income relative to the parent companies, an interesting structure, where many subsidiaries are already sold on Nasdeq and similar, where parents are SOEs, who can guess how that works, is strange nonetheless. Especially with such savings in the hands of SOEs, perhaps even forced loans, in need of repayment seeking increased demand.
3.) Simply transferring wealth to people is only one aspect of increasing demand, the goods and services, relative to the different demographics in the economy must exist in addition to a stable social safety net to transfer such increased wealth into consumption, especially for the bulk of those who have less benefited from recent development.
Just a few thoughts.
Edward:
Michael is saying that this is a shift, a longer term process, and that Consumption need grow faster than the economy, and all other segments of the economy that comprise GDP. Again a slow and gradual process, whereby domestic consumption will outstrip the the gorwth that currently drives the system. In the end, US imports could eventually exceed those of recent years, and even Chinese Imports of US goods and Services, as well as other regions of the world could increase, balancing trade. This would allow dewvelopment to be more widely dispersed, benefiting developed and developing trade partners, in addition to the Chinese people themselves. I think, a problem with the vast increase in global communications and technologies, is that people have a remote control mentality, due to their ability to satisfy many of their wants, whether intellectual or material, at the push of the button. Ronnie mentioned, a sudden revaluation of the RMB, and move to more domestic concumption, this could have been more easily accomplished during the previous era of global gropwth, rather than the resent era of global demand contraction, thus extending the process. I would argue. Perhaps, Michael disagrees, or others.
Amazing post. Thanks.
Ronnie. China should adjust gradually, but the pace of the adjustment will not be set just by China. it will be set globally since China’s trade suplus will be constrained by the deficits of other countries. The problem is that the rest of the world is adjusting already, while China needs at least 8-10 years. As for your second question, a sale of 25% of state assets would be pretty massive, I think. the key point is not how much to sell. I would argue that in order to get a good price, any sale would have to involve significant governance reform.
Edward, yes a nominal decline in US consumption would exacerbate the slump, although a relative decline might not. it depends on how it happens — for example a sharp decline in the US dollar would slow consumption while it increases production and employment — just as is happening in Germany. But I wouldn’t want to be too optimistic. Both China and the US need to rebalance, albeit in opposite ways, and neither wants to do so because it almost certainly involves short term pain.
CSTEVENS, yes, much of the increase in Chinese savings is occurring at the state and business level. Remember however that more than 100% of SOE profits are created by the interest rate transfer from household savers, so ultimately it is all directly or indirectly driven by households.
Thanks for the explaination Prof. Yes, the pace of the change is not just set by China. And I suspect the G20 keeps meeting again and again to manage this pace of change (hope?). I hope there are enough smart people in positions of power that have figured this out already, and what we hear in public are only oft repeated positions to maintain business as usual. If this is not the case- then a disaster of epic proportions awaits us.
A double dip in the US will force a sharp sudden painful readjustment (that was avoided last time round). Simply put, there is excess capacity that cannot be absorbed anywhere without creating more imbalance. Creating more imbalance will mean that the global economy will reach a point, at which the consequences of loose monetary policy will mean- debased currencies.
Real change is too difficult or impossible to achieve, the world simply does not have the men to do it. We seem to be just kicking the can down the road, and hope to drop out of the frame once the can stops moving… as someone said- in the long run, we are all dead!
Michael,
Can you recommend a good work on Japan, particularly one that focuses on the period since the post-80s peak?
I know you’ve mentioned some works before, but I can’t seem to locate them in your archived posts.
Thx
Robert, I’ve been impressed with books by Richard Koo and Christopher Wood. Krugman has a short piece on Koo: http://krugman.blogs.nytimes.com/2010/08/17/notes-on-koo-wonkish/
http://www.zerohedge.com/sites/default/files/FarosSpecialReport081910.pdf
Interesting report from Faros Trading claiming that China is buying emerging
market government securities in local currency exchanging US dollars to do so.
The emerging market Central Banks have bought the dollars in order to maintain export competitiveness: but the FX losses and the carrying cost of holding dollar investments – not to mention the effect on local CPI – are becoming burdensome.
Faros suggest it will probably be more cost effective to let FX appreciate and simply incentivize exporters!
It’s always surprised me that countries with currencies likely IMHO to appreciate against the dollar, euro and yen pay such handsome returns in local currency on government securities. Is there really a (nearly) free lunch here?
Chinese Purchase of Emreging Market Bonds
This could be a way to staqrt recycling the too high dolar surpluses but will not last long. It might create a way to raise, dollar holdings of some countries, thus to increase import cover in some nations, but I would guess, without looking, the ones least in need. The Japanese are probably getting more uneasy with their bond, and currency purchases, do to FX impacts. Likely, emerging markets will as well, unless this is a coordinated effort in countries with weak dollar holdings. Each nation, has a unique set of circumstances, where excessive purchases of their bonds, over too short of a period, could create more detriment than benefit. Least not, a rise in their FX rates against the dollar, something that seems unfair considering Chinas reluctance/inability to meaningfully address its own, or great volatility in the emerging market, if done too quickly. Emerging Markets, and Frontier markets with the least cash, deficits, in need of import cover, via dollar holders, might be the least able to handle, large infusions of cash. Perhaps, the larger countries with infrastructural plans, but even then too soon, too quick, and great difficulty. Might be easier, too address their own currency, and address the reserves over time. After all, the reserves, have accumulated from a process that has built bridges, has employed millions of people during a fragile period of time in their ongoing development and similar. The most important part of reserves being in import and trade cover. Where these things grow too quickly, there is something amiss. Had they only addressed the currency issue during the high growth period of the 2000′s, and the US had started to deflate the housing bubble, a few years before it burst. But hey, many things were produced and sold that went into the vast overcapicity of productive development and houses in many parts of the world, further, the great stimulus that that had entailed for high end European and Japanese machinery manufacturers, Commodity producers globally, producers and assemblers of electronic goods, producers and assemblers of textile goods, and so many other types of traded products. What all nations need to understand is, at the present moment, different countries and regions are facing different issues, and need to act differently than the previous status quo to get through this thing, taking the steps to alter from what had become the norm yesterday. IE What worked might not work in the coming era of lessor global demand among traditional demand contributors to the global economy, and that traditional supply contributors to the global economy need to take action, not too quick (but definitely not too slow, or to reverse course) becuase this will lead to occurences that will most likely be to the detriment of supply contributors (the trade dependent, export dependent countries). FX reserves are particularly useful as a tool to ensure import cover, their original intention, I daresay, or perhaps to spend in the old age of an economy (as was seemingly intended and discussed), which is fast approaching for some surplus takers, even for others, if we do tend to get confused as to time in a remote control global society. Most importantly reserves are necessary to cover reserves at least a few months out, where excesses would be cycled out to other parts of the global economy, rather than piled up, if they have been during the last decade or so. In the timeframe of an economy, in the path toward the development of the global economy, that is like to quick shifting of gears by some Formula One racer as he reaches the straightaway after rounding a corner if not pictorially reminiscent of the blinders placed upon the head of a horse in the Kentucky Derby of Global Development. I suspect these occurences, were they to get too profound will cycle the global economy nowhere good, not that I am for further surplus taking, but more perhaps for trade.
Professor Pettis,
I have enjoyed your posts over the past several months as I have tried to understand the macro issues involving the US/China trade imbalance If I could return to Duncan’s question on the 16th, it seems to me that the “easy” way for China to rebalance is for wages to rise substantially, much like what happened in the US in the early 1900s when Henry Ford raised his wage to $5 a day. This was institutionalized later on by the labor unions as they pushed for higher wages (ultimately overshooting the wage market and shooting themselves in the foot and taken advantage of by the Japanese manufacturers).
It seems now that all the wealth is being concentrated in the hands of a few who are investing in real estate and the stock market, but not really recycling the wealth through the economy. I have never been a labor advocate, but it seems to me that this might be the only plausible way for consumption to increase as a share of GDP, at the same time benefitting US multi-nationals and the S&P 500?
Prof Pettis
Saw your piece on potential trade war (via Yves Smith). Yes, things do look headed that direction. But there is a question: as deficit nations try to reduce household debt and therefore curb or reduce the trade deficit, it will impact import (through the egs of import quota and tariffs you raised), however are we looking at impact mostly felt through higher end goods rather than basic stuff (for lack of a better eg, shoes, and not the ferragamo types but those you see most of us sporting) that one surplus country in particular has been flooding much of the world with? If we are talking about stuff that isn’t produced in the US or EU (because the manufacturers have moved up the income chain), the stuff has to be imported. The irony is much of the stuff in this category comes from companies who shifted manufacturing overseas(to said surplus country) to lower costs and if tariffs and quotas are “country specific”, will merely shift them to countries offering even lower cost manufacturing, it’s merely a case of musical chairs that in effect just shifts the surplus but not effectively “eradicates” it. What do you think?
sorry detected a problem:
but does NOT effectively “eradicate” it.
http://www.ibtimes.com/articles/44283/20100819/china-to-eventually-cause-exodus-out-of-dollar-assets.htm
Good amplification here of Faros Trading report of August 19th
“What Happens When China Stops Playing the Music?”
Must keep your exchange rate artificially low to stimulate economy….implies an ungodly and increasing quantity of US Dollar reserves……get killed on FX and brutal carrying costs on dollar investments versus what you pay on your own bonds in local currency. Plus local CPI will tend to increase.
Does your economy grow fast enough to compensate?
Aren’t you better off letting your currency appreciate and incentivize exporters? Are you listening Argentina?
Yes, but…
Normalize to GDP means nothing. Normalize this consumption to population instead. It’s the product of per-capita consumption x population that really matters and the recent % US consumption drop can be easily offset by a much smaller % rise by China. If you are going to insist on boundary conditions and continuity it must be on this total. Comparing % consumption of total GDP is apple-to-oranges.
The population ratio between the US and China gives China stronger leverage with respect to declining US imports of Chinese goods.
JG
You are correct about consumption to population. However, the reality in China is not what GDP or consumption numbers seem to tell us.
While aggregates suggest a huge nation of consumers, the reality of China is that most Chinese live only a little above subsistence levels. My guess that this includes, easily, 800 million Chinese.
I reckon most GDP, income, consumption and significant economic activity occurs in 300-400 million urban, educated folk. The other 150 million, or so, are hard to classify and could be the migrant workers.
One of my former students, graduated 2009 is so happy she is making $560USD a month. Happy because she has a job and is making twice what her classmates are making.
Thanks Dr. Pettis, for yet another great article spelling it out so clearly.
Could you please consider speaking to the following topics in your future wirtings?
1. This news of internationalization of the RMB, where global banks are encouraging settlement in RMB. What are the motivations, effects, and ultimate destiny of this trend?
2. Could you speak a little about what could be the most likely scenarios for the coming re-balancing of trade? How do you expect the U.S. to force the issue and how will China respond?
3. What will be the ultimate outcome of re-balancing at the economic and political levels?
Thanks again,
-Dave G
“Is consumption really rising?
But skeptics like me disagreed. We claimed that the surge in demand for automobiles was caused mainly by government subsidies, and that these were not sustainable. The same thing happened, by the way, to durable goods, which were also subsidized and which also saw a surge in retail sales. More importantly, we argued, any current increase in automobiles sales and durable goods would be reversed in the future as households absorbed the cost of the subsidies.”
Prof. Pettis, I would like to debate with you the above two assertions you made in this blog. The government did stimulate the auto market to get it to 15M units last year, but they did it with a clever ploy exploiting Chinese penchant for optimizing on small expenses. The government spread the rumor at the beginning of 2009 that sales taxes (business tax?) waiver for small-engine (1.6L or below) vehicles would be repealed at the end of 2009. That drove a lot of people to buy in 2009. At least in Beijing that was the case. And to continue this reverse stimulus through this year, they extended the waiver for another year. I know they did announce some subsidy (13%?) for rural buyers of small trucks but I think these were pilot programs and the percentage impact small since those truck models were the cheapest.
In 2009 they had gone nationwide with the “Home Appliance to the Villages” subsidy program. Again about 13% rebate of the purchase price reimbursed to the consumer. Just last week I realized that it was a gambit to boost the manufacturers’ profits. I happen to check on the JiaDianXiaXiang list for Hai’er refrigerators (the most popular brand accounting for 70% of the program). I discovered that the JDXX models are about 250rmb higher than regular models you can buy in the store, so the “xiao kang” farmer who is buying his first white goods pays about the same and the manufacturer gets to collect some extra revenue.
I reckon most GDP, income, consumption and significant economic [url=http://www.vornline.com]activity[url] occurs in 300-400 million urban, educated folk. The other 150 million, or so, are hard to classify and could be the migrant workers
Late last year china Construction Bank Corp. had the 10-year, 247-billion yuan bond it bought from China Cinda Asset Management Corp. in 1999 rolled over for another 10 years
Howdy just wanted to give you a quick heads up. The words in your article seem to be running off the screen in Firefox. I’m not sure if this is a format issue or something to do with browser compatibility but I thought I’d post to let you know. The layout look great though! Hope you get the problem solved soon. Thanks