On Wednesday I will be putting up my piece on the politics of China’s adjustment process, but before doing that I wanted to mention a few recent particles worthy of comment. First, Jamil Anderlinin has a long and interesting article in today’s Financial Times on China’s fast-speed railways. The most interesting part of the article, for me at least, was the last few paragraphs where he quotes Zhao Jian, a professor at Beijing Jiaotong University “who favours conventional rail rather than high-speed projects”:
Mr Zhao argues that few passenger trains will actually be taken off existing tracks, because they cannot run on the new high-speed lines and the government is not going to scrap all those old carriages.
The railway ministry accounts for as much as 10 per cent of all outstanding debt in the country, according to World Bank estimates. Chinese analysts say the proportion of railway construction funded by debt has increased from under 50 per cent in 2005 to more than 70 per cent last year.
“This is a real debt crisis building up for the government and it is going to break at some point,” Mr Zhao says. But Mr Scales is far more sanguine. “Even if the ministry can’t pay for all the new lines, the government will step in to cover the costs,” he says. “Governments subsidise their railways in most other countries as well.”
It is the sanguinity of John Scales, described as the World Bank’s transport coordinator in China, that worries me, especially since it is typical also of a distressingly large number of bankers. There is an assumption that losses on infrastructure projects somehow do not matter because of course the government can simply step in to cover them.
But governments do not cover losses. They channel money from households to cover losses. In other words if the Chinese railroad system turns out to be economically non-viable (i.e. the true economic cost of building it exceeds the economic benefits), households will be forced pay for the net reduction in national wealth. This of course reduces future household income and consumption – the surging of which is supposed to make all these infrastructure projects viable.
I am not suggesting that Mr. Scales is unaware of this, but it should be made clear by the World Bank advisors that these “costless” infrastructure projects are part of the mechanism that creates the domestic imbalances that so worries Premier Wen and many of China’s top leaders and economic advisors.
Second, I want to note that last Thursday’s Sydney Morning Herald had a rather overexcited article by Michael Pascoe assuring us that Chinese growth of the past two decades is nothing compared to what we are about to see:
Even if you think you know the “Chindia” story, odds are you don’t really know the Chindia story. And if you’re still caught up in China “housing bubble” and US-consumer-dependency yarns, you’re blinded by Western conceit and actually don’t have a clue. To put it simply in Bachman Turner Overdrive’s 1974 words, baby, you just ain’t seen nothin’ yet.
That first line has perhaps a little unintended irony, especially since the second line suggests that Mr. Pascoe doesn’t know much about the debate within China. For some reason the less a foreigner knows about China the more likely he is to insist that only (other) dumb foreigners with their unyielding biases could disagree with his views
In fact the debate taking place within China is much fiercer than that taking place outside China, and among the blinded so-called Westerners who worry about the China “housing bubble” and US-consumer-dependency yarns you would have to include Premier Wen, Standing Committee members Li Keqiang and Wang Qishan, and a small army of policymakers and advisors centered on the PBoC, the CBRC, the National Bureau of Statistics and the major universities and think tanks.
But that is not why I mention the article. The very next day in an also optimistic but perhaps more grounded article by David Stevenson in the Financial Times, Stevenson quotes a fund manager:
Much of the new investment money is going into consumer sectors, tempted by growing Asian demand for luxury goods. Chris Ruffle is a British fund manager who has worked in China for decades and manages successful funds for Martin Currie. As consumer credit levels start to rise, Ruffle reckons China is set for a consumer boom. “You ain’t seen nothing yet!” he tells me.
You ain’t seen nothing yet? That’s at least twice in two days, and I think I sense a pattern here. From time to time I like to formulate what I call Pettis’ Immutable Laws of Finance and Economics, so here goes:
Pettis Law #17: You have not entered into the final stages of a bubble until you hear repeated use of the phrase “You ain’t seen nothing yet!”
Professor Pettis,
Can you list all the Pettis’ Immutable Laws of Finance and Economics? Thanks.
ST, I was being a little flip. I scatter these around randomly but there is really no such thing, and certainly I haven’t kept a list.
An excellent article as usual. It is always refreshing to hear your take on these issues.
The segment here on infrastructure, for one, is an illuminating contrast to the recent squalor put forward by Tom Friedman et al about China’s alleged infrastructural dominance over countries like America. The quotes you point out about government covering losses, or investors having not seen anything yet, remind me of Edward Chancellor’s outstanding white paper from earlier this year (“China’s Red Flags”), about how China’s credit/real-estate boom squares perfectly with every classic bubble condition. Bubbles like the dot-com boom are so often punctuated by excitement over just how much better an already “good” thing is going to become. Investors look ahead and are staggered by the possibilities, such that they abandon any grip on reason.
I feel choppy waters ahead. Trade war with America seems inevitable, especially now that China is putting tariffs on U.S. poultry. Plus, I don’t think we’ve yet witnessed the last episode of Japan vs. China, either.
I guess some of Chinese rail producers may demand protectionist measures soon. Chinese government is happy to use it as a retaliation weapon. I have serious doubt on what a trade war will end like. Bad for China, but not necessarily good for US and EU. Not sure this is the best way to correct trade imbalance.
We need more coordinated action.
http://www.economist.com/node/17093549?story_id=17093549
http://prasad.aem.cornell.edu/doc/book_chapters/Prasad_Rountable.pdf
An interesting comment on the sterilization. I will advocate to shift the focus of the exchange rate to domestic distortion.
What scares me is a false economic theory that still today pretends there is no relationship between the economic system and our finite planet (and the environment), as if the economy could be bigger than the planet. What scares me is that we ignore that is the planet that give the rules, not us and we already caused the biggest life mass extinction of the last 65 millions of years. What scares me is our blindness about the impossibility of the BRICs reach the developed world stupid levels of per capita consumption of natural resources and ecological services. What scares me is that much before to try to reach such level, the planet will stop us in an unthinkable way. Chinese problem is repeating the same economic model of advanced economies, without no place to export its ecological collapse, in the same way developed world did and at a null cost through global commerce. This time is really different and our survivel is at stake.
Hugo Penteado
This simple smackdown of Australian journalists is much appreciated.
Agree with you on the government but a couple of points where I’d like to expand the debate as your stance seems too ‘American’ to me as it neglects factors Europeans would include. The amount of people jumping on the China bandwagon blindsightedly is frightening though, and made me more cautious.
Isn’t the European case that, yes, whilst high-speed rail is rarely economically viable it produces benefits for the country as a whole that go beyond the revenue stream? Spain’s case might be interesting here as it kniw the country closer together according to some voices.
Another problem is that infrastructure once built is difficult to upgrade, hence it may make sense to ‘build big’ as any further extension comes with extra cost and problems not evident yet. Infrastructure is difficult to scale to exactly needed size and demand. Airport extensions anywhere in Europe take several years at best.
Another idea specific to China may be that they have one or maybe two decades of really cheap labour left; so why not use it now and get things done?
BbbbbbBaby, you ain’t seen nothing yet …
I think this is a subliminal message to buy the loonie (and other commodity currencies [namely Sydney's readers' AUD]) … the behavioural economists will be all over this one, … baby!
It does have that end game feel to it? With Indonesian banks at 4.6x Price to Book and the kind of pressure building in FX and rates markets something has got to give. Nice to see the Brazilians calling a spade a spade: http://www.ft.com/cms/s/0/33ff9624-ca48-11df-a860-00144feab49a.html.
Pettis Law #17: You have not entered into the final stages of a bubble until you hear repeated use of the phrase “You ain’t seen nothing yet!”
too good sir too good. ha ha ha.
regards.
From what i take away from this:
Even the sometimes doubtful in their viability infrastructure projects will probably not lead to a banking / debt crises, since as everyone is keen to acknowledge, local govts / the central government will simple put future revenue into servicing the debts somehow. Apparently there is already portions of future budgets being set aside for this purpose. (and also current fiscal revenue is being set unallocated in some regions, just in order to service these debts)
This use of tomorrow’s fiscal revenue to pay for today’s stimulus infrastructure type projects is yet another drag on future comsumption, as the tax burden will be higher than it would be for the same non-debt servicing future govt spending.
So yet more bad news for the prospects of China’s consumption rate rising significantly in the near future.
Prof. Pettis, what i would like to ask you, in a “what if” kind of style, is how you think things will play out if indeed Chinese consumption remains seriously depressed. Presuming the government keep muddling through in the compromise “middle road” path, consumption stays very low…etc. Do you expect that growth will keep mainly coming from investment? How long could this go on for, and what will happen when it can’t go on any longer? I realise it is going to be a long way in the future, but how could it play out. Every increasing investment / drag on future consumption / infrastructure projects…and then what? When it reaches breaking point..how does it break?
Thanks, although i know i am asking quite a big question. I promise not to quote your answer back at you in five years time if things don’t go exactly how you predict (although i can’t speak for Jon Ross! – where is he by the way???)
Is this the new “It’s different this time.”
Yeah like the US heard/felt/saw/smelled that housing bubble come. The sky was the limit and unbridled growth is part of it. What do you call that? Irrational exuberance I believe.
“Mr Zhao argues that few passenger trains will actually be taken off existing tracks, because they cannot run on the new high-speed lines and the government is not going to scrap all those old carriages.”
The FT made a mistake in the above statement: China’s high-speed rail (HSR) and conventional rail are completely compatible. In China, conventional trains can travel on high-speed rails with raised speed, while high-speed trains can travel on conventional rails in reduced speed. In fact, few HSR routes in China is entirely high speed. Because of the compatibility, there is no need to convert the entire route. The efficiency of the entire route can be improved by converting only some segments of the conventional rails into high speed rails.
By 2025, 221 Chinese cities will have populations of 1 million or more, while today there are 46 cities with populations more than 1 million in Europe and U.S. combined.
By 2015, the projected annul passenger car sales exceeds 34 million in China, while the best year for U.S. saw sales of 17 million units. In 2009, the combined sales in U.S and Europe was approximately 24 million units.
If anything, there are not enough roads and railways built in China so far.
Michael Pascoe’s article for the SMH was based on a powerpoint presentation by strategist Michael Power of Investec. I saw Power deliver his presentation a few days ago (which is full of striking charts copied-and-pasted from other banks’ strategy presentations) and was lucky enough to answer a question. It turns out that Mr Power is of the Austrian school, and appears to think the US and other governments should drastically slash their social security programs in order to stay competitive. Despite his Austrian persuasion, the concept of “malinvestment” failed to make it into the presentation deck.
Maybe a bit off-topic, but considering infrastructure investments I have a great deal of interest in nuclear energy. I believe the rollout of nuclear power will be one of the most, if not the most important technological development of the century. China appears very likely at this point to lead the world in this development. There are currently 28 reactors under construction with hundreds planned. Westinghouse was required to transfer technology related to the building of 4 AP1000 reactors, which are currently under construction. The first of this advanced design to be completed will be Sanmen 1. Future construction may be strictly local, with a higher-power variant (1400 MWe versus 1100 MWe) prototype to begin construction in 2013. CNNC announced last week that they will spend $120 B by 2020 in reactor construction and the government announced an investment of $175 B to construct a ‘Nuclear City’ to concentrate suppliers, training, and design.
Electricity is essential to a high standard of living, not to mention the fact that nuclear generates no CO2 and not much else in the way of pollutants (spent fuel is not waste, it will supply energy for centuries in fast reactors). And, these plants are designed for 60 years and may actually last a century or more.
So, I’d like to offer this as an example of what seems to be a superb ‘infrastructure’ investment.
Wonder, if anyone has an opinion on this topic.
Just read the article in the FT. A main point of the article is the effect that China’s requirement for ‘technology transfer’ is having on the world-market for high-speed rail equipment. This is exactly what is going to happen with nuclear power. China is also having Areva, and Rosatom build plants, but because they did not agree to the extent that Westinghouse did on tech transfer that design is going to become the standard. The Chinese are also going to buy 2 BN800 fast reactors from Russia. In 10-20 years China will be competing all over the world for construction business in nuclear power. A preview is the likely agreement to build a 1000 MWe CP1000 (indigenous design based on French Technology) in Pakistan to go along with the smaller reactors they have already built.
Prof. Pettis,
Kaiser Kuo and his pals offered up a very interesting Sinica podcast this week on the subject of “China Bears.” The featured guest was Arthur Kroeber (a well-known “China Bull’) of Dragonomics, and your name was mentioned two or three times. Kaiser said something about inviting you to join them at some point. I certainly hope that you do.
The podcast can be found here:
http://popupchinese.com/lessons/sinica/attack-of-the-china-bears
Hi Professor Pettis, see below link to interview with Jim O’Neill, chairman Goldman Sachs Asset Management, with CNBC on 27 Sept 2010. He used the phrase “you ain’t seen nothing yet” as well!!!
Kind regards,
Kelvin Ng
http://www.cnbc.com/id/15840232?video=1601080355&play=1
If you don’t mind my shifting the topic a bit here, Michael, I was wondering if you have any comments on Wen’s speech in New York, reported in the South Morning Post, which had remarkably candid comments about the relationship of the RMB exchange rate and China employment. The article intermixes much of the standard party blah blah about how appreciating the RMB will not improve the trade imbalance. But such frank talk about the effects on Chinese employment is really the first time I recall seeing such a direct connection made by a senior Chinese official.
Here is one excerpt:
“Wen said he knew Obama was worried about unemployment in the US. But Obama did not have to find jobs for a labour force of 800 million people, including millions of new college graduates, army veterans returning to work and a large rural population living under the poverty line, he said. “I told him, `the pressure on my shoulders is a lot heavier than the pressure on yours’.”
At least this helps frame the argument. Jobs versus jobs. I really haven’t seen to date Chinese officials willing to overtly make this connection. Maybe I just haven’t followed things as closely as I should.
Professor, I’ ve also heard that “You ain’t seen nothing yet!” phrase re China in Bloomberg interview of “Mr. BRIC” Jim O’Neil
Moin from Germany,
almost feels like one bear ( Andy Xie ) is almost capitulating….
“As Chinese real-estate prices deflate slowly now, and faster in 2012, the economy will hold up. Exports, consumption and infrastructure should sustain a 7 percent to 8 percent growth rate for the next decade. That seems low compared with recent years, but it will be much better for lifting wages, household living standards and corporate profits.”
http://www.creditwritedowns.com/2010/09/andy-xie-is-much-less-bearish-on-chinese-housing-market.html
Ed Harisson nails it…..
“Am I wrong or does Xie almost sound like a China bull here?”
I assume the volatility will soon spike significantly…..
As far as you quote Mr Scales, he does not say “costless”. European countries development history teach us that governments subsidised their railways precisely to fight developmental imbalances. The economic cost of building is lesser by far than the social cost of non-building. Politics should drive economics, not the reverse. The current economic crisis remind us this law.
off topic, but maybe you can figure this out: according to the treasury tic table chinas treasury holdings have dropped in the last year or so from ~940bn to ~850bn. i’ve read several places that china buys >500mn of dollars a day to peg the yuan. presumably this is funded more or less by their ~200+bn annual trade surplus. ok that seems to make sense, but if they are buying 200bn or so dollars a year, where is the money going? not showing up on the tic table that’s for sure. so this doesn’t add up. are they holding 500bn in london in street name? love your stuff, just find this something of a head scratcher
Michael,
To step away from your bigger argument about a bubble, I find the particular example of railroads (and other investments in fixed transportation) interesting.
The ROI of railroads and highways seems to me difficult to measure, simply because a wide variety of benefits are generated that are nearly impossible to attribute to the highway itself. So while the people may have to pay for the railroad ministry’s debts, they are also likely receiving indirect benefits from a better transportation system. In addition to added trade, etc., the number of Chinese that are able to drive around and see/understand their own country is one of many intangible benefits.
In Japan, the investment in roads has clearly been overdone, and you can drive down quite a few roads in the countryside where one wonders how in the hell a politician ever justified a modern 4-lane highway to a village of about 3000.
But for China, they clearly need more roads or other ways of moving things around, even though I’m not sure a cost-return analysis will end up positive. I’d have similar doubts about the ROI of the US federal highway system. While you can certainly argue that the system has been vital for the U.S.’s economic development, I wonder if anyone has estimated cost versus return. While the government pays for the creation and maintenance of the highway system, the entire economy gains rewards that are difficult to directly attribute to the highways but are no doubt stimulated by them.
This argument (lots of indirect benefits) is no doubt used to support investment in all types of fixed infrastructure. For roads and railroads, though, I find it more convincing than for others, especially at China’s level of development.
Clipb:
To answer for Michael, I believe could be in London, or the Carribean, or elsewhere where there are large holders of shore if they are moving holdings to lessen the political fallout, shelter it, or perhaps they are slowing divesting, I believe this less than the other scenarios.
Nuclear – It is interesting how much nuclear is being talked about recently, investors, I would look to new supplies being brought online to meet the demand for uranium.
Infrastructure: If consumption had grown to great in some places, as it has fallen to low elsewhere, and if there is a lessor likelihood for a return to the status quo, always the choice in such circumstances, then much more talk of infrastructure, including that from the large institutional development bodies, the media, and political leaders globally may signal a global switch toward infrastructure at greater levels to propel global growth. If so, commodities will spike, anticipation of such will cause such. The question is can it be done in a fashion that enables it to occur, devoid of a bubble, can the resources be mustered at such a pace that it occurs devoid of bubble conditions, and can we all manage the foresight and long-term perspective to do it in such a fashion that it doesn’t come to comprise such a level of the global economy or global growth, that it leads all down the same path towards economic destruction as had others in the path. Those are Big IFs.
Premier Wen, need not only worry only about employment, but he and much of the rest of Asia need to worry about arable land, pollution and water safety/supplies where infrastructure spending will be as necessary as cleaner energy in the decades moving forward.
Although it is necessary and useful and proper to look at historical examples for clues as to what may eventuate, it is also useful to look over a longer view and how previous examples of globalization and technological advancement might have altered what was expected to happen by our forefathers looking at history for clues. IE How the present example of Globalization and Vast pace of technological advancement, might actually alter the utility of such things as cities, historical models of growth, what may occur in a beggar thy neighbor scenario, and the paces at which we return to higher levels of global growth, coupled to the traditional factors that individuals usually cite for such a return. Just some thoughts.
Seatrus:
You seem to know more about trains than me, but dont the fast ones levitate, or are propelled on a magnetic field, at least the highest speed trains? How could trains which use different modes of propulsion utilize tracks that only use one.
SteveK9:
175Billion Nuclear City
It is just such a perspective, to create champions in every industry, that will ensure the reverse of the global systemic structures, which when coupled to the financial repression system, have led to the rise in FOREX savings, if not essentially the increase in domestic Chinese savings through money growth, that would enable some of these plans to come to development.
CS
Blair
In the developed world, sanity will need to be brought to social safety nets, where the developing world will have the opportunity to utilize lessons learned in designing more flexible systems that react to such systemic factors such as dependency ratios, needing to respond adequately when you have youth bulges to human capital development needs, sufficiently to the needs of pensioners, while encouraging a culture of savings, and to both if one were burdened or blessed as it were. Of course, such issues, as with the global economic system in general, will require global coordination that is considerate of the needs of those in other regions, which requires the need for greater maturity in global affairs, ie no pandering to non-interference in others affairs as a strategy to maximize your interest under the radar while your interests might be at odds with other developing nations hoping to grow through similar methods (frankly dishonest that other could, while sucha large player skews the game) and further, no simple pandering to a notion of free markets when it simply implies something that doesn’t exist, ie all governments intervene in all markets to different degrees, while all acknowledge the primacy of entrepreneurship in this process, respecting that thoughts and ideas, even services, might be more valuable than the very tangible, but usually less valuable manufactured products that they (services and ideas) lead to, make better, or utilize more efficiently. IE The future economy will, and must be comprised of more than just manufactured things under a system of strong intellectual property rights to solve the problems will be confronted with in greater degrees as higher populations, with (if) higher standards, if not than we will limit our ability to meet the very great needs that will soon be on our door step. Regardless, more maturity and coordination and understanding that this is not a zero-sum game, while acknowledging the need for entrepreneurship, and yes even financial professionals (speculators/venture capital, PE, banking, stock markets, bond markets, etc), if at lessor degrees of importance psychologically, in a workable economic future.
China plans to sell high speed rail to the CA with money borrowed from China. Japan has a similar proposal. The much snickered about ‘fat’ American is still expected gorge himself on the world’s over capacity, until when ?
I guess it pains to be a China-skeptic these days.
Let me dissect this high-speed-rail-in-China-is-a-huge-misinvestment myth, once again.
First, Zhao Jian belongs to the anti-HSR camp and was quite popular with the Chinese media two years ago when there were fierce debates about HSR in China then. Because he is a professor with Beijing Jiaotong University – one of the top university in the field of railways, his opinions were highly sought after by the media and did catch some attention. His various anti-HSR arguments do not make sense at all and have been discredited even by the rail fans. Basically he doesn’t think China should build HSR at all. For FT quotes Zhao Jian seems to me to be quite old news now, considering he is rather quiet these days due to the new reality on the ground. I guess media need to quote certain people for certain opinions, similar to some media like to quote James Chano or Michael Pettis for “bearish” views about China’s economy.
Second, about the debt incurred by Ministry of Railways to build the country’s railways. Rest assured that the debt by the MOR is backed by the full faith and credit of the Chinese central government. MOR is just an execution body to implement the country’s railway build-out plan made at the highest level of government policy making. Please note that MOR, unlike airlines or other modes of transport, is not a public company. It is essentially a public service utility. That’s why it’s a separate ministry from the Ministry of Communications, which regulates but not runs all other modes of transportation.
Thirdly, the rapid development of high-speed rail in China in the last few years is astounding, which is a huge understatement; at this early stage its achievements and impact have been way beyond pretty much everyone’s expectation, including the government. The HSR network, once completed, will have profound impact on China’s social and economic developments and landscape, much like the interstate highway system on the post-war US. With the industries moving inland and urbanization continue, HSR has proved to be a huge boost even based on the few operational lines so far. We now have little-known middle size cities along the Wuhan-Guangzhou HSR line now getting record amount of investments moving out of Guangdong province and regular tourists and vacationers, for example. Invisible to the public, the HSR will release a lot of capacities for freight transport on the existing lines, which are in short supply and are much more profitable for MOR.
Fourthly, because of the nature of railway investments, which are usually characterized by large-scale upfront cost, long return time horizon, diffused benefits, and network effects, it is the kind of investments most appropriately undertaken by government. Indeed, it can be argued that not many developing countries (indeed many developed countries) have the favorable conditions to develop such a HSR network. To quote World Bank’s July 2010 report on high-speed rail:
“The combination of supportive features that exist on the eastern plains of China including very high population density, rapidly growing disposable incomes, and the prevalence of many large cities in reasonable proximity to one another (creating not just one city-pair but a string of such pairs) are not
found in most developing countries. Nor could all countries assemble the focused collective capacity building effort and the economies of scale in construction costs that arise when a government can commit the country, politically and economically, to a decades-long program over a vast land area.”
Finally, regarding the arguments on investment and consumption that Pettis has been keeping repeating in his blog posts. HSR is a perfect example of good infrastructure investment in China at this stage of the development, boosting the social and economic developments in the short-, medium- and long-term. For China, it goes beyond just put in a good piece of infrastructure that will last 50 to 100 years, but also enables China to leapfrog several decades and develop a complete and indigenous high value-added and high-tech industry, create high-paying jobs in China. The experience that China gains in building on such large scale will help China ultimately export the HSR projects and equipment. It is partly because of China’s very invisible examples in building HSR and railways in general that the developing world (heck, even the developed world) has caught on the enthusiasm. Witness the plans to build HSR in Brazil, South Africa, Saudi Arabia, Thailand, Turkey, Venezuela and, even Vietnam.
How do you increase consumption? Well, you don’t just give money to people for them to spend. You need create jobs, and better high-paying jobs. How do you create high-paying jobs? Well, you invest in high value-add industries, specially in a developing country like China. HSR is but one of many industries that China is targeting, a very successful one to be sure.
What we’re observing in China is not the near-end of the great China economic miracle of the last thirty years, but rather the beginning of the next, more exciting chapter/stage of the same story.
Indeed, to all those China-skeptics who believe the China story is a fraud, a mirage, a short-lived phenomenon or simply that the “best of China’s growth is behind us,” here is my answer:
You ain’t see nothing yet!
Dear Professor
What about gold in China ?
very low deposit interest rates even negative in real terms aren’t very bullish for gold ?
already ten years that we hear that “You ain’t seen nothing yet!” about the yellow metal ….
SteveK9,
You’re absolutely right about China’s nuclear power industry.
Like the railway industry, which has about half of the global railway equipment and rolling stock market, the nuclear power plants under construction in China consists of about 40% of the global market. The large scale development gives has attracted the world’s major nuclear power plant players and given China’s leverage to negotiate deals and technology transfers.
Much like the HSR industry, China is a later comer in nuclear energy development, but has been making progress rapidly. China’s goal is not just building tons of nuclear power generation capacities, but also develop a domestic and advanced nuclear energy industry. China had mastered the second generation nuclear power plant technology and indeed had exported the nuclear power plants to Pakistan. In third-generation nuclear power-pant, Westinghouse-Toshiba had agreed to transfer their technology to China and built several nuclear power-plants in China based on the technology (AP1000). China also obtained the right to develop in parallel its indigenous 3rd generation nuclear power-plant standard and technology (CAP1000) and is/will be building several plants based this standard/technology. (By the way, Westinghouse agreed to transfer the technology because they could not find any other customers for their new technology; China was willing to take the risk to be first customer for the untested technology and invest huge amounts of money to build several of these plants). Furthermore, China is leading the world in 4th generation nuclear power-plant technology, the so-called fast reactor. See the following Wall Street Journal report:
http://online.wsj.com/article/SB125683823531916471.html#articleTabs%3Darticle
Also pay attention to the comment by Rod Adams, Publisher, Atomic Insights Host and producer, The Atomic Show Podcast, in the article’s comment section.
When China masters/develops these newer technologies, it will create another high value-added industry with lots of high-paying jobs to serve the huge domestic demands for nuclear power and indeed, the coming global demands, particularly in the emerging/developing countries.
The nuclear power-plant industry is yet another excellent example of China’s investment in infrastructure and technology that will ultimately pay off by more jobs and consumption.
If we examine Pettis’ brand of China pessimism, his arguments just come down a few ones that he keeps repeating and recycling in different forms or shapes: consumption vs. investments, financial suppression (another way of saying the same consumption/investment imbalance), import/export/global imbalance (sometime ago I dubbed this as “US saves, China collapses” theory). These arguments all have their merits, to a certain degree.
The problem is, once he forms his theory, he starts to look for “evidence” all over the places. What amazes me is that he has been using auto industry and HSR industry as supporting examples, which are arguably two of the most successful industries to counter his arguments.
Greg,
Do any of your points address the question of whether or not high-speed rails are a good idea economically? It sounds like you’re insisting that they are good things because they’re really, really, fast and really, really cool. Maybe they are, but so what? In fact your whole argument seems to support Pettis. It sounds like you are saying that they are really cool and expensive toys so they must be good for the economy. But that is why Pettis says they are a mistake. If they cost more than they’re worth, whatever growth they will deliver will be less than the growth they subtract. I don’t see why this should be so hard to understand. I am not saying that I agree with Pettis about the trains, but I am saying that so far no one has refuted him or even begun to deal intelligently with his objections. I also don’t get why the fact that Pettis “recycles” his old arguments is a problem. If he is right, shouldn’t he stick with them? Changing his analysis just to add novelty is exactly what I hope he doesn’t do, and as a long time reader of Pettis I have to say that i am impressed that whereas a few years ago he was the only one “recycling” these arguments, now it seems that nearly everyone is.
JC (the other one)
“I guess it pains to be a China-skeptic these days.” What? A few years ago it was tough to be a China skeptic, but now? There aren’t too many intelligent people around who aren’t super worried about how unsustainable Chinese growth is. Do you even pay attention to what Chinese economic policymakers are saying, Greg, or are you so stuck into the cheerleader routine that you can’t see any of the evidence that doesn’t fit?
By the way, professor, did you see the Financial times article today: “Brazil in ‘currency war’ alert”? I know you have been “recycling” for two years your ideas of deteriorating trade and beggar-thy-neighbor policies, but it looks like you are going to be proven right on this one, whatever may happen about the high-speed rail. You can find it here:
http://www.ft.com/cms/s/0/33ff9624-ca48-11df-a860-00144feab49a.html
Greg: I agree with you on the enormous long-term productivity boosting aspects of HSR. Similar arguments can be found in Barry Naughton “China’s Distinctive system: can it be a model for others? in the J of Contemporary China June 2010. To paraphrase him:
Sure investment at 40+% of GDP is too high, “but it is hard to imagine a crash so devastating that it will wipe out the benefits of GDP growth above 10% for five years. Even a superficial familarity with China reveals the remarkable speed with which China has built infra-structure for a modern, middle-income economy….
A good way to look at the China experience is in contrast to India. “China consistently builds infra-structure out ahead of demand: India only builds in response to bottlenecks.
“OVERALL THE CHINESE APPROACH IS BETTER”. (He goes on to explain the financing and rates of return when one includes delays and bottlenecks, etc.)
The obvious importance of China’s investment effort has been one of the crucial facts leading to the collapse of the Washington Concensus and causing wider acceptance of stronger government acceptance. The Spence Report of the WB: concluded that “governments needed to take the lead in formulating a vision of future growth and mobilizing investment in support of the vision”.
So there appears to be many sides on this debate including the WB “mainstream views. regards james
Litz, yes we definitely need more coordinated action, and for the first time I am getting a little more optimistic (just a tiny little bit). The very strong statement by the Brazilian finance minister yesterday and the fiery call to arms by the FT’s Martin Wolf today suggests that it will be hard even for the most knuckleheaded not to see what is coming. Perhaps there is still a chance for the major trade partners to work to a less damaging solution than trade war.
Firat, you are absolutely correct. There are many non-economic reasons that may justify such things as high-speed railways, including tighter political unification, and of course it is no secret that this is an important part of the reason for the rail networks in China. But be careful. The overexcited cheerleading of the likes of Greg notwithstanding, I am not saying that it is a bad idea to build the railways, anymore than I would say that it is a bad idea to build a navy or a bad idea to create national parks. What I am saying is much more specific. If the economic value-added of a specific investment – including of course all the externalities – is less than the economic cost, the country will be poorer, not richer, and overall growth and wealth creation will be less, not more. In a poor country struggling with low consumption, forcing households to pay for non-viable infrastructure, however glorious and exciting and technologically advanced, will slow down the rebalancing and leave the country more vulnerable to the external and investment sectors. Your last point about cheap labor is interesting, but I suspect it would only be relevant if these projects were labor intensive. In fact they are incredibly capital intensive, and it is only their capital intensivity that allows them to be built.
Nemo, yes I was really interested to see the Brazil story. It is rare to see senior policymakers speak so clearly. The Japanese and the Koreans have been saying exactly the same things, but so circumspectly that if you didn’t already get it you would never have noticed.
Houhui, there are many ways this can pan out and that depends on political decisions as much as anything else, so predictions are tough (especially about the future, I am tempted to add), but I don’t expect anything so dramatic as a breaking point. My guess is that it will be a long, slow process of grinding away the excesses. Growth will slow significantly sometime after 2012, but how soon depends largely on how long it takes the new leadership to consolidate power and develop a consensus.
Seatrus, don’t confuse annual car sales with the number of cars on the road, and don’t assume large numbers justify infinite expansion, especially since most of the new cars out there are not speeding up and down China’s vast network of new highways but are, instead, mostly caught in a traffic jam on the highway in front of my office.
SteveK9, I don’t know very much about the nuclear reactor business, but it does seem to me that there are very strong economic reasons that justify them (please no hate-mail – I am just saying that they might be economically justified). This, by the way, is one of the few cases where high tech infrastructure is as justified in low wage countries as in high-wage countries, because the economic benefits (the savings in alternative cost of energy) are as valuable in rich as in poor countries.
Ma Bole, Arthur and I disagree on a lot of things – he is not nearly as skeptical as I am about the ruddy good health of the Chinese economy – but he is a very smart guy and I enjoy our disagreements. Kaiser and I have already discussed my joining his program, and I look forward to doing it.
Hua Qiao, you are absolutely right. It is jobs versus jobs and it is only recently that everyone is being so frank. That is at least part of the reason why I am not optimistic about an optimal resolution. Everyone wants the same thing.
http://www.chinahush.com/2010/09/24/china%E2%80%99s-bizarre-phenomena-buildings-die-unnaturally/
JMF, Andy Xie is another very smart guy, so whatever he says should be taken seriously, but he is certainly not a bull even if he expects a better outcome than I do. He is simply saying that contrary to his earlier expectations, the housing market won’t crash so much as slowly grind down. I have never believed there would be either a housing collapse or a banking collapse. For me the most likely outcome is precisely a decade-long grinding away of the excesses, but perhaps where I differ with Xie is that I think this implies slower, not faster, average growth.
Clipb, TIC data has huge problems because it only records direct holdings, and not bonds held in street names. This means that if a government wants to manipulate perceptions without changing reality, it is laughably easy to do so. There is anecdotal evidence that there has been a lot of this going on.
Chris, yes, the reason why the debate about infrastructure investments such as high-speed railways is so hard top resolve is largely because there are huge negative and positive externalities that are almost impossible to measure, and in the case of countries like China the capital costs are significantly understated, by perhaps as much as 30-50% thanks to the undervaluation of capital costs. In order to get around the hard-to-resolve bits I really think of it as a relative argument. In countries with wages and productivity levels that are five to ten times those of China, the use of high-speed railways is already very controversial. In France, for example, everyone loves the TGV except economists, who are much more divided about it. So if it is so hard to agree on whether these projects are economically viable in rich countries, where the economic value of the system (i.e. the hours and wages saved) is so much greater than in China, why should we be so certain that they are economically viable in China? Of course this doesn’t prove that they are non-viable in China, but anyone who doesn’t understand this point really does not understand the argument at all. By the way it is intriguing to me that while China was engaged in a massive infrastructure-building spree during the last decade (and with much lower levels of infrastructure, meaning there was more room than today to create value), consumption fell so dramatically, just as it should if these projects were already a problem.
Greg, like most infrastructure cheerleaders, you simply don’t understand the argument at all, and so you recycle statements that are totally irrelevant even when they are correct. Very briefly, because I have done this before:
1. To dismiss Zhao Jian’s criticisms because he belongs to the “anti-HSR camp” is as idiotic as dismissing you because you belong to th pro-HSR camp. By your logic the only person who can have a valid opinion is someone who doesn’t have an opinion.
2. Yes, you are right, and that it the point.
3. Yes it is astounding, and once again that is the point. By your logic, the more they spend, the more astounding it is, and the more astounding it is, the more they should spend. I am sure you see how silly that is.
4. Yes, but again not relevant. The fact that railroads are always expensive is not an argument that they are always economically viable.
5. Sorry, but this part is so confused that I am not sure it means anything.
6. You say: “How do you increase consumption? Well, you don’t just give money to people for them to spend. You need create jobs, and better high-paying jobs.” China has been rapidly creating jobs for the past decade while consumption has dramatically declined as a share of GDP. This fact alone should be enough to prompt you into seeing why you don’t understand your own argument.
7. You’re right, we ain’t seen nothing yet.
PekingMan, yes, it seems the skeptical camp is getting a little crowded, especially among Chinese analysts. Perhaps I should follow Greg’s advice and develop some bright new views.
JC, yes, a very interesting and possibly very important news item.
James, unfortunately the argument over China degenerates too quickly into a very silly tit for tat over whether everything China has done is right or whether everything China has done is wrong. I would suggest both sides of that particular argument are idiotic beyond words. A more interesting discussion might be whether the benefits from the growth model are sustainable, and under what conditions. After all people said the same things about the US in the late 1920s, about Brazil in the 1970s, about Japan in the late 1980s, and in so many other cases, as you are saying about China today. Just because a model has generate exceptionally high levels of growth for many years does not mean that it will continue to do so. In fact the historical precedents suggest a “lost decade” has occurred in every prior instance of this kind of growth (and, I might add, before the lost decades began we were many times assured that “you ain’t seen nothing yet”).
Ha ha Professor Pettis, I love it. You are so polite and good-natured but you never leave any doubt as to who is smarter.
On the last point made by Michael to James:”Just because a model has generate exceptionally high levels of growth for many years does not mean that it will continue to do so”, the ADB just released a report indicating that their baseline annual growth rate for China for the next 20 years is approx. 5.5% – given that the growth in capital stock has been the major source of growth in the past, and as the marginal productivity of capital declines, the contribution to GDP from the growth in capital stock to GDP declines also. Similalrly the contribution of TFP declines dramatically as well. While not sceptical, it seems that Wall St sell side remain the only raging bulls on China growth … oh and the politburo as well.
So Stuart how much you wanna bet that when growth slows to 5%, all the bulls will say that 5% growth is still damned good and anyway when they said China would keep growing by 10% they really meant 5% and when guys like Pettis said Chinese growth would slow to 5% they really meant 0%, so the bulls were right all along and the bears were wrong? To use one of Pettis’s favorite phrases, we’ve seen this movie before and we sort of know how it will end.
Michael, can I implore you to do a piece on the widely held misconception of the labour cost advantage being the driver China’s growth? Yes, it is the capital cost advantage that is the real driver. I cannot think of any one so able as you, to spell it out. You have mentioned it frequently but I don’t think it has ever been the main focus of one of your articles.
LOL pretty funny, Pigface, but it has already been happening. The bulls have appropriated little by little all the bear claims which they said would never happen, but are creating new stories to explain why they don’t matter. Five years ago they said not to worry about overinvestment because investment was going to decline as a share of GDP while consumption would rise. The opposite happend, and now they are saying that it doesn’t matter because increasing investment is a good thing. In five years when consumption is still below 40% and growth below 5% the bulls will claim that unexpected and unpredictable events caused growth to slow, and that their analysis was still right. They won’t see that all of it was already locked into the growth model. Yeah, I saw that movie in Japan.
Glenn, yes I have discussed it several times and plan to do so in my book, which i hope comes out next summer. To me the fact that 1)Chinese growth is so capital intensive when its comparative advantage should be cheap labor, 2)GDP growth rates of 10% have only stabilized unemployment rather than demolished it, and 3)Beijing can only generate rapid growth with an overwhelming credit push, should make it evident that growth is driven by cheap capital, and not cheap labor.
Michael,
I have a question about timing. From your recent comments, I take it you’ve come to the conclusion that while the current situation is unsustainable in the very long term, the powers-that-be can sustain it for much longer, two years or more, in spite of whatever market forces work against them, like a double-dip in the West.
Doesn’t this certainty imply that China has become, once again, a predominantly command economy? It makes me wonder at what point analyzing its economy as compared to more true market economies is pretty fruitless as everyone seems to agree that China need not be bound by market forces.
For instance, why is the idea of a short negative growth recession in China considered impossible? Not that it would happen this year, or next year, but the idea itself seems to be off the table.
Foblaze -
Is this really the lesson to be drawn from the history of European development? I suspect that most students of history will see the opposite: that for a thousand years “developmental imbalances” were the result of the politics of feudalism, and that only with the (pseudo-)liberalization of the economies did anything resembling balance emerge.
No argument, however, about the peculiarly European crusade against “social costs” that are almost as difficult to qualify as they are to quantify. Politicians have a knack for seeing giants rather than windmills… but then they, too, have something to sell. Finally, if it is not economics that drives politics, then it must be ideology; if Europeans wish to return to that state of affairs, then they must have short memories indeed.
Your #17 law is a truth no doubt. Is there a post of the other Pettis immutable laws ?
Enlightening discussion as always, Professor Pettis. As for the Bachmann-Turner-Overdrive tune, “You ain’t seen nothing yet”, I offer another sequel song (& subsequent meaning) to those that are overtly bullish on the China miracle, “Let it ride.” Something akin to betting on racetracks.
@Pigface – I’d take that bet
It is funny why such a debate is even alive today. look at Chinese stocks, both domestic and investable, that massively outperformed global benchmarks – if you are China bear of more than 3 -years old, you are already wrong. the market has already told you that. I was a bull, and I am a bull, but I am ready to change quickly. I am asking myself everyday what could go wrong? that’s why I come here for the intellectual depth for some bearish arguments. There may be new problems that will devastate China, but the bears first need to do a soul-searching about what has gone right and why. being positive on China is classified as a cheerleader for the chinese government, but this blog looks a lot like cheerleaders for the bears. being bearish makes one look sophisticated, but being sturbon does not pay. No offence, Michael, I like your stuff and I will come back often.
A Sam,
i wonder if you read the same articles I read on this site. Pettis has pretty consistently said China would keep growing rapidly for at least two more years and in March or April he predicted that the stock market would end the year a lot higher. I think he’s been pretty spot on, but easily misunderstood by people who only can understand two positions on China. 1)China is about to collapse in the the next two weeks. 2) China will grow by 10% every year for the next forty years.
It is funny too that by now most serious analysts seem to have moved either partly or all the way to Pettis’ views about the unsustainability of the economy.
I don’t mean to sound offensive either, but you’re a day trader, not an institutional or hedge fund trader, right?
I am glad you like my entries, A Sam, but it would be a lot more flattering if you actually read any of them. TZ is right. I argue that the Chinese growth model is unsustainable and will result in a very difficult adjustment, but will keep racing forward until at least 2012, and yes i did say several months ago that i expected the stock market to rise. I say the former on average at least 3 out of every 4 entries, so I am not sure how you were able to read my entries and not notice. I tend to agree with TZ that most people can only understand two very simple-minded stories about China, and unfortunately I am not really able to agree with either of them.
By the way, when i sold all my internet stocks in late 1998, for the next two years I got statements almost identical to yours — when will you allow reality (by which they always seemed to mean the day traders in the stock market) convince you that the internet market is not a bubble? Then those statements suddenly stopped.
Thanks for the reply Michael and TimZhang. Believe it or not, I am not a day trader – I am actually a strategist – but frankly being what does not matter, being right about the market is all that matters) and I did read a lot of the stuff you wrote, if not all of them. I did notice the call on Chinese stocks, which I happened to share, but for different reason. My reasoning was simply we would still see robust economic growth (and therefore strong profit growth) coupled with rather stimulative policies, and that’s a perfect combination for asset price inflation, and that’s what we as investors should care about.
It is not new to question China’s sustainability – even the Chinese premier claimed China is not sustainable and unbalanced. It is rather main stream. I’ve been following China for two decades, and the view that China is not sustainable has been as long as I’ve been following its economy. I like Michael’s articles because they make me stop and think twice, not like other people’s arguments that are simply bearish assertions and can be easily dismissed. It is easy to get bearish in today’s world for ALMOST EVERYTHING, and everyday I am wondering what could blow up. It is depressing indeed. But what I was also wondering, quite simply, is why, for so many years of doomsday prediction, China has been powering ahead. What has gone right? Is this changing? Is China turning into the wrong direction?
How sustainable China is, is of course debatable, but things happen for a reason.
• Money is cheap (where is money not cheap in the world now?), because there is plenty, due to China’s ultra high savings rate. I know you want to raise interest rates, and I know your argument (and the story of your student and her relatives of savings more due to a cut in interest rates– I did read your pieces), but how can higher interest rates reduce savings when households already hoard most of their wealth in bank savings account? Raising interest rates will reduce marginal savings is counterintuitive and most likely counterproductive. It may work for your student and her relatives, but not from macro perspective.
• Labor is cheap, because there is plenty. How can you artificially boost income without jeopardizing labor market flexibility? The government should and may cut taxes, but the labor contract law was terrible. How can we force companies to raise wages to boost household consumption?
• Capex is rampant, because there is plenty of savings, otherwise current account will go through the roof. Also China is at the prime stage of urbanization and industrialization. Return on capex is simply higher at this stage of development curve so consumption is pushed forward to the future. Isn’t capex a way to lift productivity? Isn’t China’s capital stock still terribly low compared with other countries? Why developing infrastructure has all of a sudden become a sin when China’s impressive success has been built on infrastructure? How can building high speed railway not be productivity enhancing?
• We all question the quality of Chinese data, but when China tells us its capex is about half of the GDP, we believe it immediately. Isn’t it possible that China actually massively underreported its household income and consumption, and that the economy looks a lot more “balanced” than people think?
Is China doomed because of all these conditions in two years? Isn’t the government trying all kinds of things to change the growth model? They may not take all the measures that you subscribed. I have no problem seeing it slow, but why China has to crash? You believe that all crisis stem from balance sheets (I don’t want to put words in your mouths Michael, correct me if I am wrong). I simply do not see the balance sheet problem that will devastate the country.
But again, I am going out now to check if the sky is falling, and I am not taking the elevator!!
and by the way, TimZhang, your comment that “It is funny too that by now most serious analysts seem to have moved either partly or all the way to Pettis’ views about the unsustainability of the economy” – this is not funny. it is exciting. it always, almost, pays to bet against “most serious analysts”.
ASam
The Shanghai stock market is down 20% for the year. How do you see that as a massive outperformance and a great case for the bulls? You must have had a terrible year this year.
and you say :”if you are China bear of more than 3 -years old, you are already wrong. the market has already told you that.”
The market has lost about 60% of its value in the last three years. My god I understand the confusion between you and Pettis. He thinks bull means up and bear means down, while you think bull means down and bear means up.
See Michael, you cheerleaders all jumping on me.
JXu, I meant to say Chinese stocks (both A and MSCI investable) outperformed global benchmarks in the past 10 years by about 300%. the market in 2007 was a stupid bubble not only in hindsight. By three years I meant there has been extreme negativism on the Chinese economy – “treadmill to hell”, “mother of all blackswans”, “the greatest bubble in history”, to name a few – but the economy still carries on.