Most of this week’s newsletter was about the release last week of China’s fourth quarter GDP growth numbers by the National Bureau of Statistics (NBS). You can find the full NBS report on their website, but here is the key paragraph:
According to preliminary estimation, the gross domestic product (GDP) for the year 2010 was 39,798.3 billion yuan, up by 10.3 percent at comparable prices, or 1.1 percentage points higher than that in the previous year. In terms of growth by quarters, it was up 11.9 percent for the first quarter, 10.3 percent growth for the second quarter, 9.6 percent for the third quarter and 9.8 percent for the last quarter.
This places China’s official GDP for 2010 at a nice, round $6.0 trillion. There is of course a lot more interesting stuff in the NBS report. Those who are worried about excess investment will find it hard to see the data as anything other than worrying. Investment has gone up 23.8% from last year’s already sky-high numbers, and even the best consumption numbers merely reinforce the sense that there has been no rebalancing – three of the four consumption items that registered the most rapid growth were actually investment related.
All this investment-driven growth seems to have come as a surprise to many people and caused the markets in China and around the world to drop. I think the markets are right to be very nervous. The latest growth numbers are likely to cause real concern in policymaking circles and lead Beijing to do something to slow it down. Do what? Raise interest rates, I hope, and that is what I think the markets are most afraid of.
There were also rumors that the PBoC is going to cut the 2011 loan quota by 10% from the 2010 quota. I don’t believe it. Or rather I believe the PBoC will try to constrain monetary and credit growth, because they are genuinely worried about more misallocated investment and the threat to bank balance sheets, but this is really not something that the PBoC can decide. The growth in credit will be whatever it needs to be to achieve the GDP growth rates the State Council has decided upon.
To move on to another subject, one of the most entertaining parts of observing China’s economy is to watch the frantic race between various Wall Street houses (and a few other players) to predict the earliest date by which China’s economy will surpass that of the US to become the world’s largest. This of course is part of the standard Wall Street hype that accompanies any hot market. I think that so far the winner (I forget who) came in with a prediction of 2017.
But last week in a report a new entrant trumped everyone, although maybe by fudging a little. This new entrant claims that China’s GDP is already bigger than that of the US, according to PPP measures.
Perhaps that’s unfair because everyone else is using market exchange rates, and the poorer a country, the higher the PPP adjustment tends to be, but it certainly upped the ante. If any bank researcher wants to beat him, he is going to have to argue that China’s economy surpassed the US before 2010.
Here is what the author of the report, Arvind Subramanian at the Peterson Institute, says on the institute’s website:
Cross-country comparisons of economic size and standards of living of the average citizen rely on two approaches. The first uses market exchange rates to convert the economic value of goods and services produced around the world into a common currency, usually the dollar. According to the IMF’s latest estimates for 2010, the value of total US GDP was $14.6 trillion while that of China was $5.7 trillion.
…My calculations (explained in greater detail below) based on the most recent version, which is due in early February, show that the size of the Chinese economy in 2010 was about $14.8 trillion dollars—surpassing that of the United States.
So there you have it. China’s economy is already bigger than the US economy according to PPP. I am not disputing Subramanian’s numbers, but comparisons between two such disparate economies on a PPP basis of course have no meaningful content at all. The fact that it is much cheaper to get a haircut or massage in China (something the latter of which I am happy to exploit voraciously) tells us very little about the two countries that we wouldn’t have already known.
Still, it’s exciting, and guaranteed to generate headlines. Last year we had one “sorpasso”, that of China overtaking Japan according to market exchange rates, and this year we have another, that of China overtaking the US according to PPP rates.
But excitement aside, this whole exercise is pretty meaningless, and not only for the reason you might think – that economic growth is not a horse race between countries. It is meaningless for a far more fundamental reason, and this is because the comparable official GDP numbers for China (and PPP numbers start with the official numbers and then adjust for local prices) are wrong.
GDP may be higher
I am not just saying this because, according to Wikileaks, Li Keqiang doesn’t take the official GDP numbers too seriously. This was widely reported, but isn’t really news. None of us take the official GDP numbers too seriously, especially since it is almost impossible to produce good data in a large economy that is transforming itself so rapidly. I am saying that the GDP numbers are wrong for a more fundamental reason.
GDP is supposed to measure the total value of goods and services produced in China, but there are several problems with the official numbers. There are problems with all GDP numbers, but the biases, especially in the developed countries, are fairly consistent, which makes cross-country comparisons more or less meaningful. But in China there are additional problems, which make cross-country comparisons very complicated.
First of all we know that a lot of Chinese income – more than in most other major countries – is hidden, for whatever reasons, and this tends to pull down reported GDP numbers. One plausible recent estimate is that roughly 10% of total income is hidden beyond the NBS surveys, and so this suggests that GDP might really be substantially higher.
I wrote about this in my blog in my August 8 entry. I have no idea if this 10% number is correct or not – the NBS insists that their surveys are more accurate – but clearly there is room for a lot of fudging, and the amount of the fudge can be significant.
Second, when you compare the US and China (or any two countries), you have to think carefully about the exchange rate you’re using. The standard method is to use the current market exchange rate, not because it is the conceptually correct exchange rate, but rather because it is broadly meaningful when you think about international trade and, more than anything else, it is objective. At any point in time I can convert any Chinese GDP number into its incredibly precise dollar equivalent.
But what if you believe that the RMB is undervalued by 20% and held there only because of PBoC intervention? Doesn’t that mean that if the PBoC were to stop intervening China’s GDP would automatically be 20% larger relative to the US?
Yes, it should be larger, but not by 20%. The difference should be less than 20%, but how much less depends on how much of China’s GDP growth can be explained by the undervalued currency.
If part of the country’s high growth rate is a consequence of the undervalued exchange rate, and certainly Beijing seems to believe it is, than raising the value of the RMB would automatically cause a slowdown in Chinese growth. That is why analysts should consider the relationship between the two when they make projections, and by the way they are implicitly (if not very accurately) doing so when they calculate PPP numbers.
GDP may also be lower
But there is more. So far nearly all the adjustments and predictions about Chinese growth that we have seen in the press suggest that the “real” size of China’s economy requires upward revisions of official GDP numbers, but that might reflect China hype more than a judicious approach might justify. What if China’s GDP numbers seriously overstate the true value of China’s economy?
There are at least two very good reasons to believe that they might. The first is environmental degradation. To understand why, it is worth remembering that if an individual earns $100, but in so doing destroys $100 worth of his own assets, then a strict accounting would say that he earned nothing.
The same is true with the environment, which has a real economic value that can be adversely affected by certain kinds of economic activity. For example here is an article that came out four months ago on Bloomberg:
China, the world’s worst polluter, needs to spend at least 2 percent of gross domestic product a year — 680 billion yuan at 2009 figures — to clean up 30 years of industrial waste, said He Ping, chairman of the Washington-based International Fund for China’s Environment. Mun Sing Ho, a senior economist at Dale W. Jorgenson Associates and a visiting scholar at Harvard University in Cambridge, Massachusetts, put the range at 2 percent to 4 percent of GDP.
Failure to spend that much — equivalent to the annual GDP of Vietnam — may cost the Chinese economy half as much again in blighted crops, health costs and pollution-related expenses, He said: “The cleanup can’t catch up with the speed of pollution” if spending is less.
This article suggests that a significant portion of Chinese growth came with a destruction of value that should have been deducted from that growth. After all, if you create net $100 of chemicals, but in so doing you pollute a nearby river to the extent that future economic production associated with the river is reduced by $100 (there will be less fishing, perhaps, or less agricultural production, or less usable water, or more health care costs), then the net value you created is 0, not $100, although of course you as the polluter might earn $100 today while the rest of the country loses $100 over the future.
There is no objective way to figure out how much of Chinese GDP growth should be reversed because of environmental degradation (and in this China is simply an extreme case – most countries to a lesser extent have this problem), but there is no question that the number is big, and the result is that we overestimate China’s GDP growth today and will underestimate GDP growth tomorrow. In other words environmental degradation simply causes us to take future growth and count it today.
And it is not just environmental degradation that may require a downward adjustment in GDP. What about misallocated investment? Doesn’t that do the same thing?
Of course it does. If you invest $100 today to create only $80 dollars of value, you will show an increase in today’s GDP that is lower than the reduction in tomorrow’s GDP as you pay the capital cost of the investment. In that case if you really wanted GDP to account for changes in a country’s wealth, your investment should have shown up as an actual reduction in today’s GDP. This means, once again, that you would overstate growth today and understate it tomorrow.
Every country wastes investment, but China does it on a massive scale. I would argue that at least 1-2 percentage points of Chinese growth, perhaps even more, might consist of this kind of misallocated investment-driven growth.
When you add the impact of misallocated investment and environmental degradation, the necessary cumulative adjustment to Chinese GDP might be huge. For example, if the two adjustments combined range from 2 to 4 percentage points annually, over one decade China’s “true” GDP (whatever that means), would be below the official numbers by anywhere from 16-31%. Over twenty years official GDP would be overstated by 31-52%. That means that we are massively overstating GDP today and will experience very low apparent GDP growth for many years in the future as the official number returns to some reasonable approximation of the real number.
These are big adjustments, both above and below the official GDP numbers. This is why I find the whole horserace to predict the earliest date by which China’s economy will overtake the US to be so silly. What we are in effect doing is predicting the date by which an economy that is officially $6 trillion, but in reality anywhere from $3 trillion to $15 trillion in size, will overtake another economy that is roughly around $15 trillion in size.
And this is not the first time we have played this game. Look at Japan. Fifteen to twenty years ago Japan’s GDP was officially 17-18% of the world’s GDP and it was rapidly catching up to the US. Today it is 8%, and there seems to be no chance of it every catching up.
But can this really be true? Or is it possible that Japan’s official GDP growth was vastly inflated by misallocated investment before 1990, and vastly deflated by the repayment of that investment after 1990?
I think it’s the latter. If you look at the growth in Japan’s household consumption, you will find that household consumption grew much more slowly than GDP before 1990, and much more quickly after 1990. Household consumption might be at least as good an indictor of the real growth in wealth as production-side GDP numbers. So might it not be true that Japan’s official GDP was too high before 1990, and it has been slowly adjusting since then? And if this could have happened in Japan, whose investment growth was high but way below China’s, why can’t it happen here?
Under these conditions what’s the point of predicting when China’s economy will officially overtake the US? We simply have no idea, and we cannot draw any conclusions from the numbers. Can the horserace generate headlines? Yes. Can it generate understanding? Not much.
This is an abbreviated version of the newsletter that went out Monday. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at chinfinpettis@yahoo.com, stating your affiliation, please. Investors who are clients of Shenyin Wanguo Securities will already receive the newsletter. Investors who are not clients but who want to buy a subscription should write to me at that address.
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Has anyone yet written the story of that great “Green GDP” project a few years ago? I’m sure it’s all too sensitive to publish in China, but if an enterprising journalist were to get some good details, it would be an important story for all countries and policymakers, not just China.
Michael
Good points all. But since they apply to ALL GDP calculations, what you are saying is that we have no idea about how to measure GDP. You could argue for example that US GDP is also massively overstated becuase it ignores the cost of global warming, off balance sheet liabilities like pensions costs, nuclear clean up costs, coal clean up costs, as well as the costs of intensive agriculture, GM foods etc as well as overinvestment in capital goods etc. The point is surely that there may be too much investment in the world but whether this is an excess in China or the US is a moot point.
Another sorpasso – total value of Beijing real estate overtakes US GDP.
http://alturl.com/5os55
A major portion of the Chinese GDP is in investment in fixed asset formation. I suspect this number is the total input price of these fixed assets. And I suspect if the GDP is valued at the utility of these assets at completion rather than the input price, knowing that a lot of these assets stand vacant for extended period of time in China, the GDP entry for this item would be much lower.
In other economies, investors, private or public, would not invest in a money loosing asset. And therefore, the utility of these assets would be higher than the input price. Therefore, counting only input price would only produce a lower GDP, rather than higher.
This is somewhat tangential, but it is a question that has been bugging me for a long time, and I can’t think of a better person to ask. What do we really know about the Chinese government’s fiscal health? It seems like every time the government is said to be, for example, “flush with cash,” the reference point its “nearly 3 trillion dollars of foreign exchange reserves.” But, the way I understand it, forex reserves are not just a bank account from which a government may draw for general spending purposes. It’s not a budget surplus. Rather, these reserves are foreign currency that the central bank has purchased with its own currency and that can only be spent–rather than stored in some other form–in the real economy after it is bought back with other currency. And, in the case of China, they are paying more than they should, as a result of an undervalued RMB, for each dollar or euro or yen or whatever that the central bank purchases. Finally, in sterilizing the excess money supply–in part through selling bonds that yield more than many of the assets in which they store the reserves–they lose even more money. All of this, if I’m correct, tells me that China’s forex reserves actually generate more losses than gains in terms of the government’s actual fiscal health. Similarly, a current account surplus doesn’t necessarily mean that the government doesn’t spend more than it takes in in revenue. And–perhaps this is more relevant to your last post–but if a lot of state spending is actually disguised as bank “loans,” that would make it even more likely that something is amiss. My casual observer’s impression is that a government that spends far more than it should has managed to disguise itself as a government that spends far less than it actually earns. For the sake of argument, if Chinese GDP is actually around $6 trillion, how much of that accrues to the state annually in revenue, and how much does the state spend annually?
Prof Pettis
Don’t we have to account for debt when we talk about GDP?
What does it tell us when Countries such as Japan and the USA have debts growing faster than GDP?
Michael,
Wonderful post:
1. ” Or rather I believe the PBoC will try to constrain monetary and credit growth, because they are genuinely worried about more misallocated investment and the threat to bank balance sheets, but this is really not something that the PBoC can decide. The growth in credit will be whatever it needs to be to achieve the GDP growth rates the State Council has decided upon.” Absolutely right, at least in the short term. Then why not slow down a little to give the new boys a good start in 2012/13? It does not make enough sense. Maybe it is part of the plan to surprise everyone then, by squeezing a little more growth out of a tiring economy?
2. Consumption. First of all, I am glad that someone with an economics background realizes publicly that consumption growth (especially relative to investment) is an important indicator of economic success of a society (and up to a point of course, one can go too far, look at the US). And I do not mean that ironically..
It would be irrational for democracies (or any regime that cannot rely on hard political suppression, which includes basically all middle income countries (a few exceptions) to forever tolerate governments with policies that preference (industrial) investment over consumption, especially when the elite consumes conspicuously. The classical suppression dependent developmental state model of East Asia (Japan,Korea, Taiwan en to a certain extent Singapore (the exception in this group)) shows a certain “degradation” over time, where the nexus voter/worker/consumer starts to have influence to a greater extent than just allowing a dominant party or authoritarian gvt to rule with tacit consent, maybe out of fear of state/community violence aimed at the errant individual.Many have attributed this degradation to the end of the Cold War, but I believe that the economics of running dictatorships are just too unfavorable when you deal with the scarcety of talent, complex communication and control systems and a multitude of ways to escape supervision that accompany the entry into middle income land. And the responses of the various ruling elites in these countries (except Taiwan, where the politicians had a non-economic theme at their disposal) have been awkward.
China is not quite the same as these countries, it has a bit of all of them (as well as bits of Myanmar) and hence the rise of the consumer has been much more fragmented. Also and much more importantly, I think (based on highly flawed observation) that it takes much greater effort to keep the PRC citizens from consuming as much as they can within their budget constraints than those in some of the other countries. Normally I would not give too much for cultural explanations, but the Taiwanese, HKers and Singaporeans think that PRC people are “different”. Since consumerism can be as useful a political base for political oligopolies (I mean classless politics by a relatively stable incumbent group, such as the US has ) as developmentalism in electoral systems, the Chinese elite does not necessarily have to be afraid of it switching to a more electoral system. The hard part is the transition. In Russia it did not work smoothly, partially because Russia never produced a lot of consumer goods, but Russia’s elites have survived and adapted to a world where voters and popularity play a role. I do not believe that the Chinese leaders should consider the Russian example as a total failure, vindicating their more gradualist approach, but simply recognize that the situations were incomparable. Anyway China is capable of making consumers feel affluent very quickly, because it has a vast consumer-oriented production capacity. The main restriction is the budget constraint and perhaps the lack of physical space in houses and cities.All of that is pretty obvious, especially when your job is managing the PRC and there must have been good reasons why the situation is as it is. The chances are that for quite a while there has been real thinking (not ideologically constrained) about a switch but that the technical aspects have so far eluded the thinkers. Meanwhile, just trumpeting GDP growth (like the Singapore gvt) keeps people optimistic and confident that gvt is in good hands. That consumption lags behind (if the people notice at all) is something that will be corrected in the golden future. Since also this consumption repression has become more important during the past five years one may wonder that would have been behind the Party’s (I still guess that the Party hat trumps the State Council hat for the individuals involved) reasoning when following this path. Central weakness? Anecdotally much of this investment appears to be without much discipline, with very strong exceptions of course like infrastructure, power and deepening of the industrial base. But much of the urban construction does not look developmentalist at all. A temporary change in course in response to the GFC? Probably, eans especially when combined with the central weakness hypothesis. Maybe the fear is that abandoning the pro-producver stance of the CCP would create a vacuous situation, or worse, an unstable transition (there is quite a bit of unstable transition in Chinese history, they do not need the French revolution (also driven by frustrated would be consumers) as a scary example.. However, I suspect that without the GFC and stronger (I mean personally capable of occasional, functional violence as would have been some of their predecessors) personalities at the helm this would not have occurred. Maybe the incoming shift will be better.
As for the exchange rate, I have absolutely no trust on so-called McDonald Index. Economies are so complicated, not even a most powerful computer could figure out what is going on. How can people use a stupid McDonald Index to make comparison?
JJ
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GDP can be heavily manipulated by growth in credit. For instance, I could burn my uninsured farmhouse down today (which I own outright), take out a loan for the construction of a new home tomorrow, and GDP for the next period would only reflect the production of the new home. While our balance sheet looks worse (loss of assets, increase in debt), our GDP has increased.
As China and the US continue to borrow and print money (ie QE, where we directly monetize social liabilities), these comparisons become impossible to quantify with any consistency and/or accuracy.
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Interesting piece. Arguably this is not just the second time this vast misinterpretation of GDP due to misinvestment and the like has happened – at least the third time. The most significant case historically being the Soviet Union/Eastern Bloc countries’ development up until about the early or mid-80s. Remember, they were long seen as growing more quickly and having GDP comparable to most of the West – which immediately disappeared. I believe no-one is making this comparison now with China because (in retrospect) the lack of market prices allows everyone to say that clearly the underlying transaction values were all just wrong. I don’t see how this is fundamentally a different problem than with China or Japan, except perhaps by degree; the same issues to a large degree – overinvestment/underconsumption; financial restrictions biasing choices between the two; somewhat arbitrary currency policies; etc.
All GDP calculations, estimates and comparisons are wrong, some are useful; all GDP corrections (incl PPP, environmental, etc) are biased, but so is GDP itself (because it wilfully ignores obvious problems to favour ease of calculation).
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there was a great quote from a Chinese interior environmental official saying that if you include the cost of pollution, there has been effectively no GDP growth these last few years. Not surprising.
Source: http://goo.gl/7uoJ5
“As for the exchange rate, I have absolutely no trust on so-called McDonald Index. Economies are so complicated, not even a most powerful computer could figure out what is going on”
Are you high? You dont think the McDonalds corporation has… worked out the purchasing power in each market? It’s not that complicated.
But the objective situations are not invariable, the current objective situations effect what people will think, on the other hand, what people think now, will through their behavior to effect the objective situation, namely to change the current state. On one hand China can’t quite same with Japan, the other hand what i mean is that, with China’s development, many factories, which popullte the environment a lot, will move out of China, which at some degree will improve the future GDP.
What about the costs to control inflation?
I agree that these PPP numbers are close to meaningless. Same topic was the subject of Deaton’s AEA address and related work:
http://www.princeton.edu/~deaton/downloads/Reshaping_the_world_v2.pdf
http://www.princeton.edu/~deaton/downloads/deaton%20heston%20understanding%20ppps%20aej%20macro%202010.pdf
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I’m a bit curious.
If you made 100$ and the government paid someone else 100$ to fix your environmental mess, wouldn’t that made a 200$ GDP ?
Glen, these points apply to all GDP calculations, but not equally. Where they do, the numbers might be wronged, but without systematic biases, so they would still be comparable. I would argue that in some cases, such as China, the distortions are probably greater, which makes comparisons very problematic.
Anon, actually a few years ago when I started writing about real, as opposed to reported, debt levels it was pretty rare for anyone to discuss balance sheet vulnerabilities, but now I think there is a much wider acceptance that there are real fiscal constraints and lots of debt. And you are right about the reserves. I have written about this problem dozens of times over the years. The huge level of reserves is a weakness, not a strength.
RS, it tells us that aggregate demand is growing faster than GDP and that at some point in the future, as the debt is paid down, it will cause GDP to grow faster than demand – that can be good (high GDP growth) or bad (low demand growth).
Rene, thanks.
1. Now we are talking politics, something I don’t really want to talk about.
2. Yes, the purpose of producing more is to consumer more, and I think it is not a surprise that in countries with a more politically active population consumption levels tend to be higher.
GA, yes in my presentations I regularly point out the useful examples of the USSR in the 1950s and 1960s, Brazil in the 1960s and 1970s, and even the US in the 1920s (undervalued exchange rate, very low cost of capital)
Chris, yes it would, which is one of the standard problems with GDP measures, but perhaps not to the extent you might think. Remember that the money spent on fixing the environmental mess is money not spent on something else. But this isn’t really the aspect of environmental degradation that I meant. My point is that if you pollute a stream so that over the next few years nearby farmers produce $100 less of vegetables, that $100 will be deducted from future GDP, when a proper accounting would deduct it from current GDP.
If PPP GDP is useless, surely nominal GDP is even more useless. By nominal GDP, according to wikipedia, China already had the world’s largest economy in the early 1960s. Are we to believe that Mao Zedong was an economic genius now? When Deng Xiaoping came to power, he devalued the RMB from 1.5 to 8.3 within about 15 years. By nominal GDP, this devaluation resulted in an 82% decline in China’s GDP. In other words, during the 1980′s, Deng Xiaoping wiped out four-fifths of China’s economy, according to nominal GDP. Surely it does not take a Professor to see that this is insane.
As for Japan’s nominal GDP decline from 17-18% to 8%, the explanation may not need to delve into household consumption figures. More simplistically, Japan has suffered deflation since 1990 while the rest of the world has undergone inflation. For example, in the decade of the 2000′s, world real GDP increased by about 40%, but world nominal GDP nearly doubled. In Japan by contrast nominal GDP grew slower than real GDP by a substantial margin. Thus, this will heavily exaggerate the decline of Japan’s nominal GDP relative to its real GDP.
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thanks a lot for the article and the comments
i guess the question to ask is, what and where does it matter that especially these but also other GDP numbers are so… uncertain?
where are important decisions made, willfully, blindly, stupidly or ignorantly assuming the correctness of official and other economic growth numbers?
offtopic: michael, i didnt expect such an extensive article after your announcement about the new businessmodel.
that, more than a short entry, makes me actually want to look for the full version…
please replace correctness with accuracy in my above comment, though most shouldnt mind such an obvious mistake.
Hi Michael,
Again compliments and esteem (as well as admiration) from myself for the excellent work of analysis and critique you carry out – always absorbing, intelligent and informative.
I try whenever possible to bring your work to readers’ attention in the FT (especially at wolfexchange, Economists’ Forum and in comments to individual articles).
The problems you raise regarding “GDP measurement” highlight the “political-economic” nature of what orthodox economics views as hard-and-fast categories. It makes the work of analysis far harder, but less facile and irrelevant, as most “macroeconomic” analyses tend to be. It is far better to be broadly right than exactly mistaken. But the point is not so much one of “precision” as rather one of “relevance” and “accuracy”.
Given that the extension of the capitalist “world market” (known otherwise as “globalisation”) has resulted in “epochal” institutional, social and political transformations, it is all the more important that we have acute and astute observers to refresh and upgrade the often inapplicable old categories of mainstream economics. Keep up the good work. Regards.
Prof. Pettis –
We need a post from you blowing a hole through the notion that the real estate bubble in China is ‘safe’ (or that there is no bubble at all) because there is less leverage. Can you give us such a post?
I am convinced that a real estate bubble driven by buyers with a lot of savings (previously Japan, now China) is actually much more dangerous than a real-estate bubble like in the US that is driven by more leverage than savings. Why?
Case 1: The US Case
Real estate bubbles driven by borrowing end relatively quickly because mortgaged houses and leveraged commercial RE need to be covered by income and positive cash flow. As we have seen in the US, the market reacts fast and production is quickly stopped or slowed because of loan payments cannot be serviced on an ongoing basis. House prices in the US just three or four years after the bubble are back to their long-run average with respect to incomes.
In the US case, to talk like an Austrian, there are only 4 or 5 years of malinvestment before the bubble fails and perhaps a similar number of years are needed to absorb the excess. By needing investments to be cash-flow sustainable, the US is operating something a little like a just-in-time inventory system that responds fast when the numbers don’t add up.
Case 2: The Chinese (formerly Japanese) Case
Real estate bubbles supported by buyers with deep savings can run much longer and result in far greater malinvestment than anything that would be achievable with thinner personal balance sheets. Because buyers make such large down payments or buy their properties outright, the question of whether the purchases make economic sense is put off to another day. Even buyers who might themselves struggle may be surrounded by friends and family with deep savings.
Whereas in the US case the bubble quickly stumbles on financing problems, with a Chinese / Japanese style bubble, years and years of great past savings are available to pour into malinvestment. It is only when the incredible fortune of past savings runs dry that the bubble is choked off.
Finally after a Chinese / Japanese bubble born of deep savings peters out, there are several devastating consequences:
(a) Years of savings (generations of hoarded cash even) have been squandered and lost, poured into assets at prices greater than their worth.
(b) Because the bubble continued for so long, so much excess production occurred that there is left an enormous glut of assets, houses, buildings and factories alike. Income-generating potential of those assets collapses because of oversupply.
(c) National wealth collapses because it has been tied up in uneconomic assets.
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Glen,
Take a look at the intro to Shaik and Tonak’s
‘Measuring the Wealth of Nations’
http://homepage.newschool.edu/~AShaikh/wealth.pdf
‘…the issue concerns the nature of the
outcome; protection, distribution, and administration are really forms
of social consumption, not production.
At the heart of this discussion is a distinction between outcome and
output. Not all outcomes are outputs. This is evidently the case with personal
consumption, whose outcome is the maintenance of the individual,
not the production of new wealth.’
IOW, neoclassically based GDP accounting – pretty much all nations – severly distorts.
[...] blogged about this issue earlier in the year. He argues that China has probably been overstating its GDP for years because [...]