Markets have been crazy this month, but rather than try to wade through all the news, much of which doesn’t seem to have much informational content, I thought I would duck out altogether and instead make a list of things I expect will happen over the next several years. We are so caught up in noise and market volatility – as the market swings first in one direction and then, as regulators react, in the other direction – that it is easy to lose sight of the bigger picture.
My basic sense is that we are at the end of one of the six or so major globalization cycles that have occurred in the past two centuries. If I am right, this means that there still is a pretty significant set of major adjustments globally that have to take place before we will have reversed the most important of the many global debt and payments imbalances that have been created during the last two decades. These will be driven overall by a contraction in global liquidity, a sharply rising risk premium, substantial deleveraging, and a sharp contraction in international trade and capital imbalances.
To summarize, my predictions are:
- BRICS and other developing countries have not decoupled in any meaningful sense, and once the current liquidity-driven investment boom subsides the developing world will be hit hard by the global crisis.
- Over the next two years Chinese household consumption will continue declining as a share of GDP.
- Chinese debt levels will continue to rise quickly over the rest of this year and next.
- Chinese growth will begin to slow sharply by 2013-14 and will hit an average of 3% well before the end of the decade.
- Any decline in GDP growth will disproportionately affect investment and so the demand for non-food commodities.
- If the PBoC resists interest rate cuts as inflation declines, China may even begin slowing in 2012.
- Much slower growth in China will not lead to social unrest if China meaningfully rebalances.
- Within three years Beijing will be seriously examining large-scale privatization as part of its adjustment policy.
- European politics will continue to deteriorate rapidly and the major political parties will either become increasingly radicalized or marginalized.
- Spain and several countries, perhaps even Italy (but probably not France) will be forced to leave the euro and restructure their debt with significant debt forgiveness.
- Germany will stubbornly (and foolishly) refuse to bear its share of the burden of the European adjustment, and the subsequent retaliation by the deficit countries will cause German growth to drop to zero or negative for many years.
- Trade protection sentiment in the US will rise inexorably and unemployment stays high for a few more years.
There is nothing really new in these predictions for regular readers. These are more or less the same predictions – based largely on historical precedent and the logic of the global balance of payments mechanisms – that I have been making for the past five or six years (the past eleven year, when it comes to the breakup of the euro), but I thought it would be helpful, at least for me, to list them.
Note that although at first glance some of these predictions seem unrelated to others, in fact they all flow from the same basic balance of payments and balance sheet frameworks. To explain each in greater detail:
- There has been no decoupling of developing economies, or more narrowly the BRICs, from the developed world. All that has happened is that the transmission from one to the other has been delayed.
Since most global consumption comes from the US, Europe and Japan, the collapse in their demand will ultimately be very painful for the BRICs and the rest of the developing world. The latter have postponed the impact of contracting consumption by increasing domestic investment, in some cases very sharply, but the purpose of higher current investment is to serve higher future consumption. In many countries, most notably China, the higher investment will itself limit future consumption growth, and so with weak consumption growth in the developed world, and no relief from the developing world, today’s higher investment will actually exacerbate the impact of the current contraction in consumption.
This delayed transmission, by the way, is not new. It also happened in the mid-1970s with the petrodollar recycling. Economic contraction in the US and Europe in the early and mid 1970s did not lead immediately to economic contraction in what were then known as LDCs, largely because the massive recycling of petrodollar surpluses into the developing world fueled an investment boom (and also fueled talk about how for the first time in history the LDCs were immune from rich-country recessions). When the investment boom ran out in 1980-81, driven by the debt fatigue that seems to end all major investment booms, LDCs suffered the “Lost Decade” of the 1980s, especially those who suffered least in the 1970s by running up the most debt.
This time around a huge recycling of liquidity, combined with out-of-control Chinese fiscal expansion (through the banking system), has caused a surge in asset and commodity prices that will have temporarily masked the impact of global demand contraction for BRICs. But it won’t last. By the middle of this decade the whole concept of BRIC decoupling will seem faintly ridiculous.
- By 2013 Chinese household consumption will still not have exceeded the 35% of Chinese GDP reached in 2009. In fact it will probably be lower.
For much of the past decade there has been a growing recognition that Chinese growth has been seriously unbalanced, as Premier Wen put it, and that at the heart of the imbalance has been the very low consumption share of GDP. In 2005, when consumption hit the then-astonishing level of 40% of GDP, there was a widespread conviction in policy-making circles that this was an unacceptably low level and that it left Chinese growth much too dependent on the trade surplus and on increases in domestic investment. At the time the former seemed a more dangerous risk than the latter – although even then massive overinvestment was China’s true vulnerability – but I think by now there is a rapidly developing consensus that investment, and the unsustainable concomitant increase in debt, is China’s biggest problem.
That is why Premier Wen listed the need to raise the consumption share of GDP second in his speech last March before the unveiling of the new Five-Year Plan. This time, the message seems to be, they are serious about doing it.
But I remain very, very skeptical. Low consumption levels are not an accidental coincidence. They are fundamental to the growth model, and the suppression of consumption is a consequence of the very policies – low wage growth relative to productivity growth, an undervalued currency and, above all, artificially low interest rates – that have generated the furious GDP growth. You cannot change the former without giving up the latter. Until Beijing acknowledges that it must dramatically transform the growth model, which it doesn’t yet seemed to have acknowledged, consumption will continue to be suppressed.
- In the rest of 2011 and during all of 2012 Chinese debt levels will continue to rise very quickly, in spite of attempts to slow the growth in debt.
The attempts to rein in debt growth will fail because they address specific areas of debt and not the overall tendency of the system to generate debt. So although there may be more pressure to rein in local government borrowing, for example, this will probably fail, and if it succeeds it will only be because other entities, most probably locally-controlled SOEs, are enlisted to fill in the gap. My guess is that next year the general alarm among investors will have switched from local government debt to SOE debt, not because the former will have become manageable, but rather because the latter will surge, albeit in not-always-transparent ways.
With consumption growth constrained and the external environment unsound, increasing investment is the only way to keep GDP growth rates high. China funds almost all of its major investments with bank debt, and it long ago ran out of obvious investments that are economically viable – at least investments that are likely to be generated by what is a distorted system with very skewed incentives – so increases in investment must be matched by increases in debt.
To the extent that investments are not economically viable, this means that the value of debt correctly calculated must rise faster than the value of assets. By definition this results in an unsustainable rise in debt.
- By 2013-14 Chinese GDP growth will slow sharply, and by 2015-16 predictions of a sustained period of growth rates at 3% or lower will no longer seem outlandish.
I don’t expect a significant growth slow-down until after the new leadership takes power in late 2012, but my guess (and hope) is that by 2013 the stubborn refusal of consumption to rise as share of GDP, and the continuing surge in debt, will have convinced all but the most recalcitrant that China needs a dramatic change of policy. The longer we wait, the more debt there will be and the more pressure there will be on Beijing to use household wealth transfers to service the debt.
Why do I say we will be talking about 3% growth soon? Two reasons. First, I am impressed by the bleakness of historical precedents. Every single case in history that I have been able to find of countries undergoing a decade or more of “miracle” levels of growth driven by investment (and there are many) has ended with long periods of extremely low or even negative growth – often referred to as “lost decades” – which turned out to be far worse than even the most pessimistic forecasts of the few skeptics that existed during the boom period. I see no reason why China, having pursued the most extreme version of this growth model, would somehow find itself immune from the consequences that have afflicted every other case.
Second, I just use a very simple calculus. Remember that rebalancing is not an option for China. It will happen one way or the other, and the sooner the less disruptive. And for China to rebalance in a meaningful way, consumption growth is going to have to outpace GDP growth by at least 3-4 full percentage points (and even then, at that rate, it will take China over five years to return to the 40% that was not long ago considered astonishingly low).
During the boom of the last decade consumption has grown at a very sharp 7-8% annually. If consumption growth remains at that level, China can slowly rebalance with GDP growth of 4-5%. But historical precedent (along perhaps with common sense) suggests that if GDP growth drops so sharply, from 10-11% to 4-5%, it will be incredibly difficult for household income and household consumption growth to be maintained. In that case a 2-3% drop in household consumption growth may be a fairly conservative estimate, and as the growth rate declines, GDP growth will also decline with it. I discuss this more in a WSJ OpEd piece last week.
- The decline in Chinese growth will fall disproportionately on investment and, because of this, it will severely impact the price of non-food commodities.
In the past, as the consumption share of GDP declined sharply, the investment share rose. By definition as China rebalances, this process must reverse. This must mean that consumption growth will speed up (relatively, at least) and investment growth decline even if overall GDP growth remains unchanged. Of course if GDP growth drops, as it absolutely must, investment growth must drop even more.
The implications are inescapable, although I think many people, especially in the commodities sector, have missed them. If GDP growth drops by X%, investment growth must drop by substantially more than X%. This is what rebalancing means.
What happens to real interest rates will determine when the process of Chinese adjustment begins. In fact there is a chance that we may see growth in China slow significantly in 2012, perhaps even to 7%, although I suspect that it will probably be in the 8-9% region.
This is a bit of wild speculation on my part, but depending on what the PBoC is allowed to do with interest rates, we may see the beginnings of an adjustment as early as next year. In the past year the PBoC has raised interest rates by roughly 125 basis points. Obviously, as I have argued many times, this has not been nearly enough given the much higher increase in inflation and it is part of the reason why the domestic imbalances have seemed to have gotten worse in the past year, not better.
But I expect that inflation will begin to decline soon, and it may even drop quite sharply. In that case what will the PBoC do to interest rates? If they can refrain from lowering them, the higher interest rates will reduce overinvestment while putting more wealth into the pockets of household deposits. This will both slow growth and speed up rebalancing.
Will it happen? I have no idea. What the PBoC does to interest rates is likely to be the outcome of a struggle in the State Council between policymakers that are worried about growth and those that are worried about imbalances. If the PBoC can hold off the former, and especially if wages continue rising, we might begin to see Chinese rebalancing taking place a little earlier than expected. Of course this must, and will, come with much slower GDP growth.
- Growth rates of 3% will not necessarily lead to social and political instability. Most analysts argue that China needs annual growth rates of at least 8% to maintain current levels of unemployment. Anything substantially lower will cause unemployment to surge, they argue, and this would lead to social chaos and political instability.
I disagree. The employment effect of lower growth depends crucially on the kind of growth we get. The problem is that China’s current growth model encourages a heavily capital-intensive type of growth – wholly inappropriate, in my opinion, for such a poor country.
But since rebalancing in China requires less emphasis on heavy investment and more on consumption, and since rebalancing also means a sharp reduction in free credit provided to SOEs and local governments and cheaper and more available credit for efficient but marginal SMEs, a rebalancing China would presumably see much more rapid growth in the service sector and in the SME sector, both of which are relatively labor intensive. Much lower growth, in that case, could easily come with minimal changes in overall employment.
That is why Japan is a useful reminder of what can happen. After 1990 GDP growth collapsed from two decades of around 9% on average to two decades of less than 1% on average, but there was no social discontent, and unemployment didn’t surge. Some analysts credited Japanese lifetime employment or invoked the natural docility of Japanese people (a bizarre argument at best) to explain the lack of social upheaval, but for me it was because Japan genuinely rebalanced in the past two decades.
Before 1990 GDP growth sharply outpaced consumption growth, whereas after 1990 their positions were reversed – consumption growth sharply outpaced GDP growth. In that time the Japanese savings rate declined sharply, the household income share of GDP rose sharply, and Japan became less dominated by the industrial giants that were almost synonymous with Japan of the 1980s.
So as I see it the Japanese didn’t react to Japan’s “collapse” with outrage or horror largely because Japan didn’t really collapse in any meaningful sense. Japanese standards of living on average continued to rise after 1990, and on a real per capita basis probably only a little slower than they had before 1990. It was the state sector that bore most of the brunt of the slower growth, and this shows up as the explosion in government debt. Households were fine because although the GDP pie was growing at a much slower rate after 1990 than before, their share of the pie was growing after 1990, whereas it shrank before 1990.
I think the same might happen, or at least could happen, in China. It depends in part on how resistant the elites are to the process of rebalancing, which almost by definition means eliminating the distortions that had benefitted them for so long. As Jeffrey Frieden pointsout in his brilliant Debt, Development and Democracy (1992), the elites that benefit from economic distortions are traditionally the ones most likely to prevent necessary adjustments, and if they actually run the whole show, adjustment can be incredibly painful and disruptive.
If I am right, and China begins to rebalance (and it has no choice but to rebalance unless it has infinite borrowing capacity and the world has infinite appetite for Chinese surpluses), then the debate must shift from economics to politics. We need to understand how and under what conditions China’s elite will permit an elimination of the distortions that benefitted them. For example, under what conditions will the export sector and its defenders allow the RMB to rise, or will SOEs and provincial governments tolerate an increase in interest rates, and so on?
- Because of its rapidly rising debt burden, the only way for China to manage a smooth social transition will be through wealth transfers from the state sector to the household sector. In the past, Chinese households received a diminishing share of a rapidly growing pie. In the future they must receive a growing share. This will probably be accomplished through formal or informal privatization.
The right way to engineer the transition to a system in which household wealth isn’t used to subsidize growth is to raise wages, raise the value of the currency, eliminate SOE monopoly pricing, and raise interest rates. The problem is that all of these have to adjust so far that to do so quickly would lead to massive financial distress. It would also lead to rising unemployment and, with it, declining consumption, so that the rebalancing would occur through low consumption growth and perhaps negative GDP growth. No one wants this outcome.
Doing so slowly, however, so as not to cause financial distress and a surge in unemployment will result in worsening imbalances over the medium term. It will also lead to a continued building up of debt – and I think we only have four or five more years of this kind of debt build-up before we hit the debt crisis that every other investment-driven growth miracle country has faced.
So what can Beijing do? They’re damned if they go slowly and they’re damned if they go quickly. There is however an alternative solution that is relatively easy (easy economically, not politically). It is to increase household wealth through a one-off transfer from the state sector. The state can privatize assets and use the proceeds either to increase household wealth directly (gifts of shares, improvement in the social safety net, etc.) or indirectly (clean up the banking system and pay down debt).
Right now it is hard to find anybody who really thinks Beijing will engage in a massive privatization program, but this is the only logical alternative I can come up with, and it is the least painful. So my guess is that in two or three years privatization will become a very popular topic of policy discussion.
- European politics will become much more difficult and disruptive. The historical precedents are clear. During a debt crisis the political system becomes fragmented and contentious. If the major parties don’t become radicalized, smaller radical parties will take away their votes.
Remember that the process of adjustment is a political one. We all know someone has to pay for the massive adjustment countries like Spain must make. The only interesting question is about who will be forced to take the brunt of the payment – workers in the form of unemployment, the middle classes in the form of confiscated savings, small businesses in the form of taxes, large businesses in the form of taxes and nationalization, foreigners, or creditors.
Deciding who pays is a political process, and because the stakes are so high it will be a very bitter process. This means, among other things, that politics will degenerate quickly, and of course if Europe doesn’t arrive at fiscal union in the next year or two, it probably never will. This conclusion is also the reason for my next prediction.
- Spain will leave the euro and will be forced to restructure its debt within three or four years. So will Greece, Portugal, Ireland and possibly even Italy and Belgium.
Once the market determines that debt levels are too high, then debt levels become too high, and without a deus ex machina the results are predictable. All the major economic agents begin to behave in ways that worsen the debt crisis until finally the country slides into default. Businesses will disinvest, creditors will demand shorter and riskier maturities, workers will strike, politicians will shorten their time horizons, and banks won’t lend.
In that case, with incentives lines up so that all the major economic agents worsen the debt problem, debt must rise faster than both GDP and the country’s debt-servicing ability. The worse the debt level gets, the faster debt rises relative to GDP. What’s more, the only strategies by which Spain can regain competitiveness are either to deflate and force down wages, which will hurt workers and small businesses, or to leave the euro and devalue. Given the large share of vote workers have, the former strategy will not last long. But of course once Spain leaves the euro and devalues, its external debt will soar. Debt restructuring and forgiveness is almost inevitable.
- Unless Germany moves quickly to reverse its current account surplus – which is very unlikely – the European crisis will force a sharp balance-of-trade adjustment onto Germany, which will cause its economy to slow sharply and even to contract. By 2015-16 German economic performance will be much worse than that of France and the UK.
If Germany does not take radical steps to push its current account surplus into deficit, the brunt of the European adjustment will fall on the deficit countries with a sharp decrease in domestic demand. This is what the world means when it insists that these countries “tighten their belts”.
If the deficit countries of Europe do not intervene in trade, they will bear the full employment impact of that drop in demand – i.e. unemployment will continue to rise. If they do intervene, they will force the brunt of the adjustment onto Germany and Germany will suffer the employment consequences.
For one or two years the deficit countries will try to bear the full brunt of the adjustment while Germany scolds and cajoles from the side. Eventually they will be unable politically to accept the necessary high unemployment and they will intervene in trade – almost certainly by abandoning the euro and devaluing. In that case they automatically push the brunt of the adjustment onto the surplus countries, i.e. Germany, and German unemployment will rise. I don’t know how soon this will happen, but remember that in global demand contractions it is the surplus countries who always suffer the most. I don’t see why this time will be any different.
About a week after I set down these “predictions”, and two days after I finished this point, I saw in the Financial Times that German growth has already hit a wall. Expect to see a lot more articles like this over the next few years.
- As the US fights over the fiscal deficit and whether or not it is the right way to expand domestic demand, more and more politicians will focus on the expansionary impact of trade protection. There will be an increasing tendency to intervene in trade – in fact I think of quantitative easing as a policy aimed at trade and currency imbalances as much as one aimed at domestic monetary management.
As unemployment persists, and as the political pressure to address unemployment rises, the US will, like Britain in 1930-31, lose its ideological commitment to free trade and become increasingly protectionist. Also like Britain in 1930-31, once it does so the US economy will begin growing more rapidly – thus putting the burden of adjustment on China, Germany (which will already be suffering from the European adjustment) and Japan.
Trade policy in the next few years will be about deciding who will bear the brunt of the global contraction in demand growth. The surplus countries, because they are so reliant on surpluses, will be very reluctant to eliminate their trade intervention policies. Because they are making the same mistake the US made in the late 1920s and Japan in the late 1980s – thinking they are in a strong enough position to dictate terms – they will refuse to take the necessary steps to adjust.
But in fact in this fight over global demand it is the deficit countries that have all the best cards. They control demand, which is the world’s scarcest and most valuable commodity. Once they begin intervening in trade and regaining the full use of their domestic demand, they will push the adjustment onto the surplus countries. Unemployment in deficit countries will drop, while it will rise in surplus countries.
This is an abbreviated version of the newsletter that went out two weeks ago. 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 want to buy a subscription should write to me, also at that address.
Wow, thanks for the great post. Your best yet. Regarding your concern about SOE debt, i can see it baking right now. While people have been focused on LGFP debt, the SOE sector has been quietly building massive capacity over the last 3 years and using debt to do it. This is about to explode in an orgy of problems. Look at the shipping industry, for example. Bulk rates are greatly depressed not because volume decreased but because capacity (new ships) have come on line and will continue to come on line over the next 18 months.
In the US, a major expansion of capacity is 25% or more. Chinese companies frequently engage in projects that will double or triple capacity. Banks lend willingly and the projections used to justify these financings are so sophomoric that a first year MBA at any 2nd rate US school would have a field day poking holes in them. The Chinese investment analysis is, to be kind, strategic. (Strategic is a word that we in the financial world use laughingly when the subject project does not pencil.) The Chinese investment approach mixes a nebulous notion of econmies of scale with an absolute obsessive desire for volume. Market share is everything regardless of whether you make money.
In another example, you are beginning to see articles about SOEs getting into logistics businesses, specifically warehousing and storage. I submit this is because they need storage for all the inventory they are producing and cannot sell.
Companies have had to maintain employment and therefore, to avoid expensing labor costs, the have capitalised those labor expenses in an accounting gimmick by including them in the cost of construction projects and in inventory. However, this cannot continue as they leverage their balance sheets. Interest expenses can only be capitalized for so long. Book losses will begin to show up and even dumb Chinese bankers will realize they have a problem loan. Watch out when this starts happening.
Your analysis on the Chinese and world economy is superb. I particularly agree with your theory of global imbalance and systematic problem in China’s economic system. I’m sure your view will be vindicated as events unfold. Keep up the good work!
Not sure what happened to the RSS feed for this article, but there were numerous references to ‘Medication Levitra’ in the headline and inserted throughout the article text. Some (new) type of annoying Spam?
For a few moments I thought that was referring to an economic term in Latin that I was not familiar with…but a web search proved otherwise.
Anyway, just bringing this to your attention.
Prof Pettis,
Thank you for your analysis.
I would like to ask if you feel that the US has experienced its worst unemployment already?
When you talk about inflated asset prices worldwide would you also include US stocks/bonds and real estate?
Thanks
Prof Pettis,
Thank you for your thoughtful analysis. I however, have not heard any mention of trade protection muttered by any US politician as of yet. I feel that we a quite a ways from US closing its ports.
In your opinion has the US already seen its worst unemployment for this cycle?
Also would you include US stocks and real estate in the category of assets that are inflated by the recycling of global surplus dollars?
The “easy way” for China sounds awfully like “shock therapy”, which caused millions of premature deaths in the former Soviet Union. A much better way is to invest more in social welfare, such as unemployment and retirement benefits, and to establish affordable health care and education by nationalizing most health care facilities and schools, and making most health care workers, primary and secondary school teachers civil servants. Increase subsidizing for farmers and affordable housings.
Only after these, privatization can be considered. Besides land, nature resources, health care, and education (primary, secondary and some colleges), everything else can be privatized slowly, if necessary.
Some really good predictions.
I still think that the idea of a united Europe is so strong in Germany and France, that they will choose to create a stronger union -not destroy it. Even the public would approve of this in the end.
I wonder if the fact that liquidity, investments and transactions are now moved faster then ever before would help deficit countries rebalance over a short period of time. As the wages go down a lot in real terms over the next two to three years, there will come a point where it is cheaper to produce in the Sourthern Europe countries then anywhere outside of the EU. This could mean that a lot of jobs could be comming home or at least not leaving Europe anymore. If so then the burden of unemployement would be put on China / BRICs and not on Germany / Scandinavian countries.
The argument for producing in China is quickly giving way to the argument for selling in China.
Dan: I saw the same thing. It seems to be a regular occurrence – I’ve complained about spam issues in the RSS feed before (Google Reader). Still don’t know what that is about.
—
I like the specificity of the predictions here. I make & track predictions as a hobby, so here’s the ones I’ve stolen:
2013: Chinese household consumption <=35% of Chinese GDP
1 January 2013
"Over the next two years Chinese household consumption will continue declining as a share of GDP…By 2013 Chinese household consumption will still not have exceeded the 35% of Chinese GDP reached in 2009. In fact it will probably be lower."
http://predictionbook.com/predictions/3190
"Chinese debt levels will continue to rise quickly over the rest of this year and next."
1 January 2013
http://predictionbook.com/predictions/3191
2014: Chinese GDP growth French or British GDP growth
1 January 2017
“…the subsequent retaliation by the deficit countries will cause German growth to drop to zero or negative for many years….By 2015-16 German economic performance will be much worse than that of France and the UK”
http://predictionbook.com/predictions/3196
Hi Professor Pettis, I just wanted to let you know your blog seems to have been hacked by erectile-dysfunction peddling websites. Your RSS feed is loaded with this garbage and there is pages on the site dedicated to it. I suggest you contact your webmaster, upgrade your copy of the blogging software you are using and try to weed out the embedded spam. this link illustrates one of the many instances, as seen in an rss reader (through iGoogle’s Reader widget)
whoops, forgot to add link, http://twitpic.com/6ctsbg
Michael,
Why do you think inflation will abate? With negative interest rates, with are seeing disintermediation from bank deposits into other vehicles such as trusts where investors can earn much higher returns. Seems to me the pboc could lose control of the money supply. China’s price system is horribly messed up with government induced price constraints wreaking havoc with resource allocation. The upshot is you have run away food and staple inflation with simultaneous overcapacity in the industrial sector.
Thank you for elaborating on the balance between supply-side and demand-side economics. You have integrated the two and found deep understanding.
“…demand … is the world’s scarcest and most valuable commodity”
Bingo! Unless and until TPTB realize, “It’s the demand, stupid,” the world is going to be floundering in consequences of the neoliberal nonsense that completely misses the key point. One can call the view that demand is key “Keynesian” if one wishes, but the obvious has no name attached to it.
Hi Michael,
1st, Obligatory great post comment.
2nd, Is the 70s-80s petrodollar boom-bust cycle really a valid comparison to today? Oil prices skyrocketed and then collapsed in the learly 80s Its hard to imagine the same happening today to the same extent in the energy market at least(oil would have to drop down to around 40, maybe 35 dollars per barrel). So at least some states will still have plenty of petro dollars sloshing around.
I have the same “levitra medication” text in RSS hearline and text, very annoying to see this already for several months.
Excellent article as always.
Your analysis makes a lot of sense to me (scientist, not economist) for what that is worth.
It is not a pretty picture but, reading you, I understand that these are processes that have affected societies in the past and this is not the end of the world. The end of our current world perhaps, but life will go on and principles you discuss will shape the structure of the what comes after the current globalized economy.
Thank you for your clear exposition of what is driving current events and what may happen in the future.
I wish policy makers would read your blog (I bet many do) and pay heed to your analysis (I fear they do not).
Dr. Pettis, I just wanted to thank you for sharing your superbly thought-out analysis & predictions for the decade. I certainly hope that China does remain peaceful through the coming difficult transition to a more balanced country.
To find harmony you must first find balance. Let’s hope China finds both, as you have.
Keep up the excellent work. I look forward to your future postings.
-A Big Fan
Dear Professor,
I have been reading your book, The Volatility Machine. You mentioned that the “capital structure framework is applicable to all the so-called emerging markets”. As China’s financial system was more relatively closed than and different from other less developed economies, problems of China’s financial sector mostly came from internal conflicts and weaknesses, other than external shocks. Do you think the framework you established in the book is also applicable to China? Thank you.
Kind regards,
Michelle
Dear Professor,
Some researchers pointed out that actually risks of local government loans and/or SOE loans are more controllable than risks of off-balance-sheet liabilities and assets in Chinese banking sector, especially in the medium and small scale banks. That part of business has been relatively lacking of close attention from observers and regulators. I would like to have your opinion regarding the total risk of shadow and underground banking in China, and if they are much more volatile and dangerous than the government background loans. Thank you.
Fantastic post. Thank you for taking the time to write it. You are no doubt quite brave in writing it like that black on white, considering there is no man on earth who can predict the future
It’s a fun game nonetheless!
I have one request if I may: we are predicting doom and gloom for our Chinese friends, well, I do have some Chinese friends in China which I care about. I wish to them and their families the best.
So to the request: may we have one article or a comment which gives some advice to local Chinese how to protect their wealth? What are their options considering the limitation on their currency and transaction of currency abroad?
There are so many articles about the economic situation in China, I’m yet to see one which puts this theory to practice and tries to at least help the common people with some practical comments.
Thanks again! Awesome post.
Prof Pettis
In your opinion has US unemployment peaked for this cycle?
Thanks
Professor Pettis,
I’m interested in your perspective on Yukon Huang’s recent article for WSJ titled “Misinterpreting China’s Economy”. Essentially he argues that there is no crisis in China, with debt, consumption, or otherwise, because statistics gathering in China is so deeply flawed. He believes that consumption as a share of GDP is actually dramatically undervalued.
Personally I think having bad statistics might be an even larger problem all together, but how much can you really rely on Chinese statistics when most numbers coming out of China have to be taken with a boulder of salt?
Great post.
re:Your discussion of Japan, their fiscal policy and debt explosion as a model for China rebalancing …
It seems when this happens there are two paths China can take:
- the forced government rebalancing can only be done through more repression and favoring of SOEs, meaning China will regress back to 1990, or …
- quasi-democracy and reduced state control (or maybe the government-sponsored role, like Japan Inc, Singapore etc.), where it will be tested by the rest of Asia to see if it can really become the next Japan and Korea. Can the Party make this transition?
Sounds like China is entering Everest’s deathzone, where success and failure hang in the balance.
Hi Professor Pettis,
as always, a very impressive and interesting post, I wish we would have something of similar quality covering the issue from a German perspective.
I fully agree that ongoing trade surplusses are not sustainable, but I do see some differences between China and Germany, most notably that the German standard of living is high, that our social security is outstanding and that most of us Germans should be quite happy with their wage level.
Only a couple of years ago, Germany was adressed as the problem case in Europe: uncompetetive wages vs. productivity, high unemployment, weak GDP growth. The measures implemented then (both governmental and within the industry) led to the strong, maybe too strong productivity boost compared to smallish wage increases.
Telling the Germans that the best case is to go back to the initial situation will politically be a tough sell (also to me!), but since the conservatives are loosing ground rapidly, we might get the prescribed policy by chance.
If you are aware of a German source that discusses your topics in meaningfull depth, I would be very happy to get to know it.
Best regards,
Jan
Great piece, and I think I agree with it wholly except that I think your time frames may prove wrong in that they underestimate the speed and reactiveness of markets and economies at points in time to moving to the ‘new paradigm’. Often it is right to be patient and wait for things to play out but when a certain unhealthy criticality is crossed the move to something new can happen quickly.My guess is that that that switch is in play now and will develop faster than the 2-3 years you talk about. Si I think what you say is right but we are now in fast forward on it (driven by US and Europe) and by 2-3 years we will be well in it.
As an aside (and I am not an economist so readily admit to misunderstandings and maybe framing what comes below badly) I think that the parallel with Japan is appropriate and interesting. The last 20 years in Japan are not nearly as bad as portrayed and in many ways they are very successful in that the gains from investment and export driven growth have been maintained and transferred into the economy decently well. At a high level Japan shows it has escaped a Malthusian sort of trap whereby growth way limited (and perhaps could only be taken if given willingly by the successful non Malthusian economies). This shows a society with broad based innovative capabilities and real knowledge capital. The interesting question is does China have the mysterious fabric that allows this happen too? I do not know the answer.
Trade protection in the US might come in the form of a VAT and/or a cut in the corporate tax rate (and a regional system). Both of these would neutralize the tax advantage of setting up shop in China and would incentivize US companies to repatriate cash back to the US (currently over $1 trillion is locked up overseas). The SF Fed recently did a study on the trade balance with China, suggesting that the trade deficit is due to US companies importing their own products from China (Apple alone accounts for a $2 billion trade deficit with China). Synthesizing this with other sources of information, the implication is that US companies are not repatriating their cash for tax reasons. Domestic US politics has been delaying these changes in the tax system for years, but the fiscal deficit debates and the unemployment rate might force the hands of Congress.
Michael
Only Krugman, when he stops being the political attack dog and returns to being an economist, is your match in understanding the “circle of life” globalization has brought to world macro economics. Brilliant stuff. Your analysis is the best there is currently.
However I disagree in two very important thesis you propose. I think you are overly optimistic in China. I think it is going to blood and hard landing is assured unless they make radical commitment to liberal democratic market driven economics. Since I dont think that will happen I think they will finish their move to Confucian authoritarian governance and then bunker in an “Blame America”. many of their folks will not buy that. Still there is a chance that many of their now highly educated leadership will understand Confucianism is a bust and make a go of it like Yeltsin did in Russia.
The second tenet I disagree with you is where I think you are too pessimistic. I firmly believe the kaibatsu like structure in Germany and commercial interest, just as it was required for the backing of the Nazis for them to have a go at it, now they will back a Hegelian constitutional forming of Europe. The rest of Europe will remind Germany will remind them that the reason Europe is in this mess is to answer German belligerency (the historical timeline is very clear on this factor for all the treaties) and that a bill is still to be paid. The combination of this very real security need and the commercial interests of every large German entity will force Union. The final conclusion of the grand experiment in Europe will lead to Europa, the “dialectic” opposition to the USA and a bi-polar power structure formed. USA will grant Europa a Monroe Doctrine like sphere of interest and Europa will re-arm with USA leaving the area. The massive commercial and power gains on that move will trump (and I think it is trumping now with Europe’s Hamiltonian Trichet forcing new constitutional laws to be written to accommodate his all Europe bond purchases) any regional reluctance to subsume into Europe and give up power. Those like UK and Finland will have to join in or seek a “special relationship” with the USA. The USA will allow this Europa forming as the whole structure via allowing Monnet to manage the Marshal Plan is a US device anyway, and it is now time for the USA to set up Europa as an immediate equal as it will eliminate much of the huge trade imbalances and neatly contain China (and lesser BRIC actors).
To allow Germany to simply leave Europe onvce it does not serve immediate financial gains is to let Germany “get away” with a 60 MM souls blood debt and to allow Germany to throw the world into such imbalance likely general war will emerge.
We take for granted the pax Americana “peace” such that many now even say “soft power” is where it is at and all those troops and weapons the US (and others have) really dont matter at all. Hard power is so, well, passe and of no consequences. Hard power is still the alpha and omega of any long term economic forecasting success.
Germany will soon be the most Romantic supporter of the Europa and the constitution for Europa is already starting to be drafted with Trichet’s brilliant moves.
So while I find your ability to show how all is connected now, which also makes it such a vital and critical historical time, and how rare an analysis you provide as so few realize this – I hope you are wrong as I think that such an outcome will smash any Metternich like balance and the US will have to demonstrate the hegemon nature ( a role, by the way, the US does not want and will share/shed as soon as responsible others are found) of the hard power aggregated ina way that will make the 20th C seem tame. As you do counterfactual exercises you find what i am saying here is credible enough to at least persuade policy such that Germany will not only stay in Europe but will become the “keystone state”.
Dr. P,
Of the BRICs you mention the C but no mention of BRI. Any view there? Brazil for instance, though they benefit from higer commodity prices, trade is only about 10% of GDP and of that only 15% is directly to China. Also India is more a domestic demand economy and is generally hurt by higher commodity prices so it also should be a net beneficiary of the unwinding of global imbalances.
I generally agree with your conclusions but in my scenario analysis I put a much lower probability regarding the potential for an unwind of the Euro as well as the US putting up trade barriers. But certainly agree that it is within the realm of possibility.
Fantastic post, thanks.
Many commentators have fretted about US protectionism but I see this as impossible, because American democracy does not express the will of the people. Campaigns are funded in large part by MNC’s who make profits from offshoring, most often to China, precisely because it is a low wage, low reg environment. Look at Geithner – he has failed to even label China a currency manipulator. He is probably the only one left in the world (non-Chinese) who does not see this. Or perhaps it is more enlightening to interpret this as testimony to how complete the dominance of MNC preferences is in the American political spectrum.
The pundits across the spectrum do not highlight currency issues, trade barriers and the like, specifically with China. The penetration of Chinese interests into the American economy is simply too deep for protectionism to be an option. I think this is one of those political factors which cannot be fit into economy analysis and often upsets economic predictions. If I am right, how would that change your analysis?
I’m very interested to hear your thoughts on Adam’s question about the reliability of China’s statistics. The validity of numbers for investment and consumption as a percent of GDP is crucial to this discussion.
I think social disruptions are already surfacing and thats before the economy slows down. The chance of a bumpy ride is more likely than not.
There are two ways to eliminate a persistant current account surplus:
1. Reduce exports until they balance with imports.
2. Spend the export earnings.
Option 1 increases unemployment and kills the economy, while option 2 stimulates the economy and reduces unemployment. Why don’t the surplus countries get it? They seem to think they need a big trade surplus to maintain their employment and economy, while if they just spent their excess trade surplus revenues it would build their economies and reduce or eliminate the slow motion train wreck that professor Pettis has outlined.
As others have said before me, really great post! Thanks
Two questions arise in my mind:
Ref Chinese re-balancing: empowering consumers relative to local govts / SOEs inevitably leads to political empowerment. It may start with traditional demands for consumer protection – say legal redress for health damage from tainted milk or compensation for lives lost in a hi-speed rail accident – but these require an impartial judiciary and soon an irresistible demand grows for accountability throughout the political system. China is the ultimate family business – how will the 100 families who control the Party, and hence the country, react? Historical precedents are bleak. I see great turbulence to put it mildly. Privatisation would bring the same dangers, but faster and in spades.
Multinational Actors: what of the role of MNCs and especially banks, that straddle and to some considerable extent escape national economies? We have seen an astounding increase in the power of TBTF financial institutions relative to the “rest of us”… does your de-leveraging prognosis include imposing discipline on currently out-of-control actors such as major banks? How would it be done?
Michael, excellent analysis.
George, a deserving analysis. However, I cannot agree to it. While creating a real Union in Europe would be the right move for the average European, it would be better for some Europeans than for others. In fact, for some Europeans it would be almost a catastrophe.
The only way to ensure a fair share for each European (not only between different nations, but also *inside* each nation) would be to have a system in place that prevents banking and export bubbles and softens the economic cycle. As of today, that means returning to national currencies.
There is no way the Spanish young or the German consumption sector will thrive with the current system in place. Only German exporters and once-and-again-rescued banks would.
In other words, your argument about European concers on a militarily powerful Germany could have been used in 1913 or 1938 to argue that Europe would unite and prevent war. History teaches us that powerful lobbies and distorted self-images lead Europeans to collectively take the wrong decision every 2 generations.
Prof. P,
I strongly suspect that if what you predict (~3% growth by 2016) comes to pass, the Chinese government will cook the books so that GDP growth is still reported as 7%+, otherwise I’d be willing to lay a bet 100 USD that GDP growth in the PRC doesn’t go below 4% before the end of the decade. I’ve just seen too many predictions of gloom-and-doom for China to believe any particular prediction.
Michael,
One question.
Your second reason to expect China’s growth to slow to 3-4% a year is that GDP growth must slow if consumption is to outpace it and hence allow rebalancing. But why must this be the case? Why can’t consumption growth at 15% a year? I’m not saying this is likely, but it doesn’t seem to be impossible, and so there’s no logical reason for the second explanation to be true…
Thanks
Matthew
OK, I have now read the WSJ piece and see it answers that question.
How does the global demographic changes influence demand?
Europe and in particular the Mediterranean states (Spain, Italy) will experience a strong decline in population over the next 40 years. A scarce resource will become even more scarce.
Jan (comment 24):
The problem with Germany is not high productivity or efficiency. The problem is too much saving. Since 2005 the German current accout surplus has totaled the equivalent of more than 1.2 trillion US dollars. As Prof. Pettis has pointed out the current accout suplus is numerically equal to the excess cash savings, i.e. total all the cash savings in the country and subtract the total cash loan demand and investment demand within the country (individuals, business, plus government). As the excess cash has no home within Germany it is essentially forced into other countries, primarily as debt. As long as this situation continues there is no way for the deficit countries to pay their debt. The obvious answer (to me at least) is for Germany to start spending its export earnings rather than contine to pile them up. However, the response from Merkel is the opposite-Austerity!! There may be a time when German needs to invoke austerity and reduce its budget deficit; however, if there is to be any hope to aviod the disaster Prof. Pettis forecasts, this is not that time! If Germany contiues to refuse to spend the money they will most likely loose much of it since the deficit coutries will simply be unable to pay it back. An appropriate response by Germany could be a temporary cut in the VAT of 75 to 100 billion Euro per year coupled with a 75 to 100 billon Euro increase in government spending (yes increase). This would stay in place with adjustments until the crisis has passed and other more structural changes have time to take effect. The goverment should annunce to the people that these harsh measures will remain in place until they start spending their excess cash savings.
The logic of the German goverment in moving towards austerity at this time is hard to understand. Perhaps they think it is leading by example, i.e. showing the deficit countries what good responsible government looks like. However, it is really one of the more irresponsible things they could do at the present time.
One more related item. The idea of a uniform limit of 3% on goverment deficits in the EU is a bad idea, bad economics, and bad philosophy. It might make sense for the trade deficit countries, but there should be no limit on government deficits of the persistent trade surplus countries. In the trade suplus countries, the goverment deficits are simply soaking up some of the excess cash savings of the people and businesses, i.e. Germans (the goverment) using the excess savings of Germans to spend for the benefit of Germans.
@FOARP 45
Such a false-advertising approach has already been tried in the USSR, during the 1960s. Soviet authorities reported clockwork annual growth of 6-8%, but outside economists (and the CIA) correctly surmised that growth had already slowed sharply. More importantly, these inflated numbers do not do much to change the tangible experience of households and enterprises as the lending environment changes.
I do not think Professor Pettis is advocating “gloom-and-doom,” really: he is not predicting the collapse of the Chinese state or the society that supports it, only that China’s trajectory will fall into line with every other “miracle” economic story from the past.
Excellent analysis
What I like is that you succeed in a rather brief post to mention the core issues and leave out the irrelevant stuff. And this while it covers a lot of ground.
After a first read two questions emerge
First why the timeframe 2012 or 2013-14 for a slow down of the Chinese economy? An educated guess?
The Japanese consumer did benefit from the rebalancing of the economy in the nineties. But this rebalancing has shifted to the other side and a rebalancing of the rebalancing might be close. And what worries me more is that not the big companies have taken the burden but the government (or the citizens as a whole). But maybe you already answered this musing when you mentioned that the surplus countries will suffer the most in the future.
Dear Prof. Pettis,
“Every single case in history that I have been able to find of countries undergoing a decade or more of “miracle” levels of growth driven by investment (and there are many) has ended with long periods of extremely low or even negative growth…”
I just checked the GDP growth numbers for South Korea. Except for three short-term dents around 1980, 1997 and 2009, South Korea seems to have avoided the above prediction.
Jason
Michael,
I’d be curious how you square your views here vs. your colleagues at CEIP; specifically Yukon Huang’s recent piece about consumption actually being meaningfully higher than official numbers and Albert Keidel’s meaningfully more optimistic views (the word apologist comes ot mind).
Re: the dodgy links infesting the prof’s blog: i found that if you type mpettis.com into the address field it’s kosher, but clicking links to the website from google can provide a suboptimal reading experience.
Dan (and many others), yes my site has been hacked, hence the sex ads. I am trying to get it fixed but my computer guy has been so busy that it is taking a long time. Please bear with me.
RS, yes I think I would include US assets among those whose values have been inflated. In fundamental terms I think we should be generally pricing in very slow demand growth over the next 5-10 years, but I think excess liquidity has created a distorted picture of growth.
Seatrus, we have to be careful about not throwing out the baby with the bathwater. Just because shock treatment almost always involves privatization, we shouldn’t then assume that privatization equals shock treatment.
Andelli, I am not sure wages are going down a lot in real terms. For that to happen we would need a lot more inflation in countries like Germany, or a lot more unemployment in countries like Spain.
Hua Qiao, a decline in Chinese inflation is one of the least confident predictions I am making. I think inflation will decline because I think repressed financial systems, by reducing both real income (and so consumption) and real borrowing costs for producers in times of inflation, are good at converting CPI inflation into asset price inflation. However if we see a significant increase in velocity as depositors take devaluing money out of the bank and use it to buy stuff, then my prediction on declining inflation in China will be wrong. My other Chinese predictions may be accelerated in that case.
Tom, I spent two days last week in Brazil with the eminent Keynesian Robert Skidelsky and I had a great chance to t4st some of these ideas on him. I think he agrees strongly with your sentiment that “it’s the demand, stupid”.
Dennis, I would say not to focus just on oil but on commodities generally. Anyway the point of the comparison is that a surge in liquidity drove EM economies and, with them, over-excited talk of decoupling.
Michelle, it doesn’t matter whether or not a financial system is open or closed for the structure of the balance sheet to matter. The relative openness is simply part of the structure. I think the capital structure framework is especially applicable to China today. As for the informal banking system, it is very important, a big potential source of instability, and something that we really need to understand better, but it has been created in part to get around regulations so it is hard to understand.
Julia, sorry but I have enough trouble just analyzing stuff without explaining how to invest.
RS, I don’t know if US unemployment has peaked but I suspect not. At any rate I expect it will persist at these levels for quite a long time.
Adam, I think Yukong misinterpreted the data suggesting that there is hidden income in China. In fact most of that income accrues to the wealthiest households, who consume a much lower share of their income than do the poor or middle classes. In that case we would assume that hidden income implies that consumption is even lower as a share of GDP than the number suggest, and that is exactly the conclusion of the economists who made the claim.
But in the end we don’t need their numbers. We know from the balance of payments identities that the excess of investment over savings is equal to the current account deficit. When a country has an “average” level of investment and an “average” level of savings, its current account deficit will be zero. When a country has the highest level of investment ever recorded (like China), it should have a large current account deficit if it has an average level of savings. If it has a zero current account deficit, it must by definition have an extremely high level of savings. Of course China actually has one of the highest current account surpluses ever recorded. The math is inescapable. To make the accounting identities work China must have an extraordinarily high level of savings, which is the same as an extraordinarily low level of consumption. Every other argument is irrelevant.
Jan, one of the problems I see with Germany is that in the past decade German productivity did not improve and all the economic growth seems to have been generated by the trade surplus, which to me is another way of saying that German labor became more “competitive” by a relative decline in wages. Healthy growth for Germany should involve rising productivity and more rapidly rising wages. We have seen the opposite.
Mojo, getting the timing is always the hardest part. Things always happen much slower than you think possible, and then suddenly happen at a dizzying pace beyond your wildest expectations. That is why predictions should never come with dates.
Thanks George. You may be right about your first claim, but for obvious reasons I am not willing to explore that possibility. Suffice to say that it is very hard to predict the path of resolution when imbalances and distortions become too great. As for your second, even if Europe finds its Hamilton, remember that the Hamilton story was hugely improbable and the creation of a federalist USA a great miracle. Every time I reread the story of Hamilton and the assumption of debts I am always convinced, even though I know how the story ends, that he cannot possibly succeed. Europe needs both Hamilton and his highly improbable success.
Asiequana, I do discuss the rest of the BRICs on occasion. My basic view is that Brazil is a big bet on China and that Russia has serious structural problems and may also be too dependent on high Chinese-driven commodity prices. I am no expect on India, but my very superficial view is that it is in a relatively good position to grow since its demand is generated internally and it has a lot of room (once it eliminates some of its political idiocies) for a massive expansion in infrastructure. In fact in that sense it has some of the same positive conditions that the US has (not to mention that these are the only two with stable or good demographics).
G. Stegen, good question. I guess because the steps needed to change the trade balance would initially hurt those constituencies that benefitted from the earlier distortions, and whether or not it benefits the economy generally, they are too powerful to permit it. This is Jeffrey Frieden’s argument.
Diego, I think I agree with you. It is hard to make the necessary changes in a smooth way, and positions will only harden over time.
FOARP, the argument that all the gloomy predictions were proven wrong is the kind of argument that some of the less sophisticated banks used to make, but it is of course wrong. There have been very difficult periods of low or negative growth, and these were only resolved by terrible worsening of domestic imbalances and rising debt. This only goes on so far. It is like a man who makes huge gambling losses every year who is able to cover them and maintain a good life by selling off his inherited wealth. He can say that the doomsayers were wrong, and that he is living as well as ever, but they weren’t wrong.
GV, the time frame has to do with the political cycle.
Jason, you are right and I have been sloppy because I have repeated this so much. One possibility is a lost decade, but there is also the possibility of a Korean-style very brutal but short period of adjustment, with sharply negative growth. In that case growth over the medium term is very low because of the one or two years of very negative growth. Notice that countries that take the short-sharp-contraction route tend to have higher growth over the longer term. This might be because by liquidating debts they return more quickly to a period of efficient capital allocation. By the way, and as an aside, I am always worried about drawing too many lessons from Korea and Taiwan. Both were smallish countries whose economic success was vital to US political needs during the Cold War.
Mr Pettis
Thank you for answering my questions. I realize that you have very little free time.
I’m often presented the argument that countries which export a meaningful amount of primary inputs, mostly Brazil, Australia and Indonesia, will not necessarily be hurt by a slow down in China because the marginal increase in exports resulting from higher commodity volumes and prices is very small in relation to the overall national economy.
Yet I get the feeling that something is missing from the analysis. I would side with you that a slow down in Chinese commodity demand would have a more meaningful impact on said countries. What I find lacking however is any credable historical examples or research. I suspect you could draw some conclusions from a spill over effect from rising consumer confidence and a resulting rise in debt levels or by tracking the chain of money as it flows to other parts of the economy such as investment or household income.
Prof. Pettis,
Yes thank you for taking the time to reply. I know you usually don’t do second questions, but maybe some of the other readers can help.
When you talk about demand it seems to me like you see demand as a singular unite that can be traded away. Now we know that there are different kinds of demand a.k.a price elasticity of demand. Price elasticity is based on needs. The diabetic needs insulin like non-diabetis need water. So I have trouble with the statement below.
“But in fact in this fight over global demand it is the deficit countries that have all the best cards. They control demand, which is the world’s scarcest and most valuable commodity
The deficit countries don’t have “bargin power” or control over this “national” demand because their populations will always choose to buy foreign products because they need them and there are no domestic alternatives. The Southern European countries have trade deficits because most of their products are elastic. German products are inelastic and thus Germany, Holland and the Scandinavian Countries have a trade surplus.
This is one of the things China has done so well It has been able to find / create domestic substitutions for foreign inelastic products while being very competitive on elastic products due to low wages. Thus China has a surplus
In that sense Spain just has to find domestic substitutions (or make even more competitive alternatives) for German products in order to rebalance.
Jason and Mike,
I believe the answer to your question regarding Korea (and Taiwan) is that their growth is largely based on export rather than investment or credit boom. As long as somebody is buying their exports, they can keep the growth. Go check their GDP and economy data during the 2008-2009 crisis and look inside, you will know what I am talking about. This could be an oversimplified version of answer but by and large it tells the story.
As for Brazil, I think one should clarify the inherent difference between its recent boom and the Chinese economic miracle. Brazil’s growth has been moderate and regular since 2004, with no real “miracle”, and another difference is that its economy lays very much on domestic consumption.
Being a sort of anti-China, Brazil’s growth needs much more investment and savings than now, so the prediction considering the unsustainability of the Chinese model of investment-led growth wouldn’t apply well to Brazil, which actually invests little (only 17-18% of GDP).
As for trade, it’s very important to the Brazilian economy but corresponds only to 10-15% of GDP, and unlike other countries (like US-dependent Mexico) Brazil doesn’t depend absolurely on one country to maintain its exports (about 15% go to China, another 10% or so go to the US, 7% to Argentina and so on). As for domestic consumption, it’s grown steadily higher than overall GDP and keeps growing this year and sustaining a moderate growth of 3.5%-4% with record low unemployment. Inflation has been a problem, but it’d certainly lower with less global demand.
I’d like to know if your predictions on the BRICS take into account the differences between the Chinese and the Brazilian “models”, especially if we consider that the same phenomenon may have entirely different consequences in China and in Brazil.
Professor,
Thanks for the succinct and excellent response, much appreciated.
MIchael,
Great read, this post. Obviously we will have to wait and see and maybe your predictions are the opposite of self-fulfilling. Wrt your comments on the European situation, I think you are too pessimistic (or optimistic). There are several avenues for improvement that can be tried. It is more a matter of political will and realism on both sides. No one has yet to face complete disaster (except Greece). Quite a few countries are largely EURized whilst retaining their own currency for domestic use. The good response of these economies to the financial crisis is probably due to the fact that they could avpid the problems of sticky wages better than, eg Spain can. It is up to the gvt of Spain to bargain hard within the EU for better conditions, and once Greece is out of the way that should be possible.
However, I am more interested in your China predictions. We probably agree that the employment share is unacceptably low, and with it the household consumption share. However, I am not sure that the rest of the story is too simplistic (maybe due to the format). One way to rebalance would be to let the relative share of “the working class” rise with a relatively static gdp. That could happen as labor shortages and declining productivity growth (an inevitable consequence of all that wild capex) combine into lower profit growth and higher wage growth. But it could also happen as a result of a more selective labor market approach where consumption grows fastest in what are now the poorest segments of the population, and with a fair dose of inflation plus cost of living compensation. In other words, an incomes policy that would fit the CCP’s historic roots well and signal a level of societal maturity commensurate with the new skylines, highways and car ownership, to name a few. Foreign investment in China may suffer a bit, but the development model (this is not Korea, more like Taiwan) aims at making the transition from an undeveloped country into a middle income one, and in the large ciities that is not too far off. They know about the middle income trap and would try to avoid it. I agree that the political model is not as sensitive to GDP growth as it is to standards of living, but an incoming government with an apparently strong powerbase should be able to make the transition to a higher share employment share at a lower cost to GDP than you predict.
But once again, a very good read.
Welcome back Professor. I admire your courage. But be careful. Nice commentary.
China has committed to raising the minimum wage 15% every year for the next 5 years. It’s in the plans as a concrete measure to boost consumption. At the same time the labour force is shrinkage, so the tide does look like it is turning to the lower classes favour. This is very positive for consumption as they spend almost all their income locally and do not move their assets off shore. We could see many enterprises in china focus inwards to capitalize on this income
Growth as it creates large new markets for them.