The Free Exchange blog at The Economist has accepted my bet, and very cleverly (the bastards!) they have added a second one. For two years I have been arguing that a Chinese rebalancing will require much slower GDP growth rates than we currently think possible and, working backwards from annual consumption growth rates of 7-8%, I have argued that this implies that China’s real GDP growth rate will average not much more than 3% annually over the rest of the decade.
The key is how the transition takes place. If there is a massive privatization program in which large amounts of wealth are transferred to the household sector, it will be possible for household consumption to grow much more quickly and so pull GDP growth behind it at higher rates than I assume. But such a program of wealth transfer is, of course, not politically easy, and perhaps in recent events we have seen just how hard the debate over reform has become. That is why I am not optimistic.
When I first proposed that annual average growth rates would probably not exceed 3%, the consensus for Chinese growth among local academic economists over this period was 8-9%. Since then the consensus seems to have dropped to 5-7%, and especially in the past few months I regularly hear private comments from Chinese academics expressing concern even about this growth range. Yesterday for example I received a very worried email from a professor at Zhejiang University who I had not met before. In the email he told me that he was especially concerned that the inability of the reformers to combat what in China are referred to as the “vested interests” might result in two years of rapid but strained growth and burgeoning debt followed by a crisis. I am not as knowledgeable about the politics of the transition as he is likely to be, but his focus on the debt is, I think, spot on.
But of course in spite of the growing group of worriers and extreme skeptics my “barely 3%” growth prediction is still very much an outlier. This worries me a little, of course, because one always assumes that conventional opinion must have some value, but I do remember that even the greatest skeptics about earlier investment-driven growth miracles seriously underestimated how difficult the adjustment was going to be, and that gave me some comfort.
Even after the skeptics became concerned about Brazil’s growth miracle in 1980-81, for example, no one, as far as I know, predicted negative growth for rest of the decade. And to take another example in Paul Krugman’s famous 1994 Foreign Affairs article, “The Myth of the Asian Miracle”, he warned – against all the hype of Japan‘s being the world’s largest economy before the end of the century – that Japan’s annual growth rate was unlikely to exceed 3% for any long period of time and that even by 2047 Japan would “probably” not overtake the US.
Probably? In retrospect Krugman’s “probably” seems almost perverse given two decades of near-zero growth, but it does contain an important warning. If even the very skeptical Paul Krugman wasn’t able to come close to predicting how bad things would get, why should we assume that we are a whole lot better today at understanding how difficult the adjustment process can be?
So of course as far as predictions go I am an outlier, with some trepidation, but in the end I suspect that if I am wildly wrong I am as likely to be wildly wrong in one direction as in the other. As Rudiger Dornbush once said, “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.”
So here are the two bets.
- The Economist says that at the then current dollar/RMB exchange rate China will be the world’s largest economy in 2018. I disagree.
- I say that in real RMB China’s average annual growth rate for the rest of the decade will average 3.5% or less. The Economist disagrees. There is some question as to how to define “real”, but I think we will be able to agree on an acceptable GDP deflator.
What are we betting? I was hoping I could get them to help promote some of the amazing young musicians coming out of Beijing if I won, but reasonably enough they can’t commit to the logistics, and propose instead a bottle of whisky or baiju. I accept.
Having said all that, let me note how pleased I am by their knowledgeable reference to Birdstriking, Offset: Spectacles, and most of all to a band known almost exclusively among the cognoscenti, and one of my favorite bands in the world, the otherworldly, Ourself Besides Me, comprised of three talented women led by that painfully shy genius, Yang Fan. This has nothing substantial to do with our bet, of course, but I am delighted that such smart and knowledgeable people at The Economist can refer so confidently to such brilliant musicians. At the very least it shows that the quality of Beijing music is no longer a secret.
P.S. The purpose of these bets is largely symbolic. I am not trying to earn additional income by making book on growth prospects, so please my dear readers do not offer to make additional bets with me. I simply don’t have the ability or interest to track multiple bets and there are much easier ways of making or losing money. If you want to bet among yourselves, of course, please do so.
To be fair professor even if average growth rates this decade are 4-5% you still deserve the moral victory. You were the only one as far as I know who was able to explain why growth rates had to drop substantially, back when everyone, including the Economist, was proclaiming and planning for 8-10% growth rates for the rest of the decade. Your contribution has not just been being the first to say that Chinese growth had to slow dramatically, but rather being the first (and so far only) to explain why growing debt was fundamental to Chinese growth and why it would eventually derail growth. Many now see the debt issue, and some are even incorporating it into their own scenarios, but they see it as an unexpected event that will justify their growth revisions next year and the year after, but you were the first to make it clear that the growth in debt was no accident.
Anyway just as you predicted would happen back in 2009, the growth rate consensus has been moving down pretty quickly, so that when the Economist and the rest of the world are finally predicting 4-5% growth rates, which I guess they all will be by the end of 2013 or 2014, they will turn out to be right or nearly right only because their predictions will have adjusted to the “new reality.” They will say that the “unexpected” growth in debt is why they can revise their numbers without admitting that their whole analysis was wrong.
I think you should have included a gapping clause in your bet with the Economist. Your point has been that they can get all the growth they want as long as they keep jacking up debt, but in principle that means that they could get another five or six years of 7-8% growth followed by twenty years of 0% growth, in which case you will have lost the bet but definitely won the argument. You assume that they wouldn’t do anything so foolish, but why not? They might, and that would make your analysis completely right even if your narrower prediction was wrong.
Is this the Krugman article? http://web.archive.org/web/20090129222011/http://web.mit.edu/krugman/www/myth.html
The reason why you’re going to win both of these bets is quite simple.
There is no easy way to go from 30-40% consumption to 60% consumption.
It’s taken Japan two decades of massive debt spending and deflation to just go from 50% to 60%.
And we’re supposed to believe that China can undergo a much more difficult transition from 30-40% to 60% without a gigantic restructuring of their economy? That’s simply not logical. They’re also aging as fast as Japan is. That’s going to start impacting their growth prospects within the next decade or two, and it’s going to prevent them from just spending their savings willy nilly (especially without a safety net).
Prof,
Read a book Global Minotaur by Yanis Varoufakus. I am not sure you have had a chance to read or even care to read but his premise is that the global surplus recycling mechanism is broken. This is thrusting the global economy into chaos and it will take nothing short of a miracle of global planning and cooperation to fix it otherwise we will see a decade or more of stagnation. Is your outlook as negative?
zeek,
30% of WHAT? You are assuming that current GDP numbers and growth are, how to put it… a reasonable reflection of reality or represent any real growth…
30% of a 100 becomes 60% when that 100 is reduced to 50…
Consumption as percentage of whatever can in fact increase while he still wins the bet.
If you win, you’re going to buy all of us who have been championing you all these years a beer in your new bar, right? And finally explain to the drunken dolts among us why the Chinese can’t use their foreign currency reserves to bail out their banks (only kidding).
Well, relaxing the one-child policy will be one of the biggest economic stimulus for China in the next 10 years or so. Increased investment in healthcare and education, as well as infrastructure and continuing urbanization, can probably keep China growing relatively fast for at least one more decade. Cleaning up the environment also adds to GDP.
Luddy, which group of people who have been championing him? Five years ago all of us who know Pettis was right could probably fit into my living room. Now, I think it would take a large hotel to fit us all in, and a large hotel chain to fit in all the people who have absorbed the Pettis analyses into their own without realizing or acknowledging it. On the other hand in two years all the people who don’t see China and the world the Pettis way might all be able to fit into my living room.
I still don´t get how a bet can be made without a good solid inflation number? I quote The Economist “inflation–as measured by the GDP deflator–of 4% in China” I take it that the GDP deflator is the one used by the World Bank ? If China´s has had an average inflation growth of 4 % (or even 6 %) within the last 4 year or will have within the next 4 year. I promise that pigs will fly….
In that sense Prof. Pettis will win the bet if we use real inflation numbers, and the The Economist will win if we use the official inflation numbers. A strange kind of win/win if you ask me. I just told the old couple next door that prices only rose 5-6 % on average the last 4 years and that they will only rise 4% over the next 4 years. The reply I got is not suitable for a public place like this.
This is a very smart comment board. I have some questions and I would accept answers from anyone who has them.
First, to what extent are the big banks now constrained by deposits and capital? What is projected for coming years? Do they need to raise capital and will they get it?
Second, M2 grew 20% or so through the 2000s, correct, as a result of booming exports, capital inflows and loan growth–does anyone have the correct figures? What are the figures for 2009, 2010, and 2011, and what is projected for this coming year?
Third, pre Lehman, China pushed loan growth to SOEs against a fundamental backdrop of surging exports and capital inflows. How may flat or declining exports and capital flight affect the equation, from the point of view of a rational central banker?
Finally, pre 2009, the PBoC and MOF was not shy about creating money and ignoring bad loans, but then again, deposit growth was also very strong. So, if we didn’t have the post 2009 ramp in spending, would the prior binges have become a footnote, overwhelmed by the growth in deposits? Would the Chinese economy be much healthier if we hadn’t had the post Lehman panic-stimulus, or would it face the same issues due to the prior lending to SOEs and localities?
This is surely one of the best econ blogs and the comments are always brilliant; thanks everyone for participating because it is so endlessly fascinating and pertinent. I suppose I should also say that considering how desperately the world should have been addressing its environmental issues over last couple decades, the story told in this blog is also kind of tragic.
Interesting post as always, professor, and I agree with your reasoning and your predictions. You mention the need for “massive privatization ” frequently in your writing in order to transfer wealth to the household sector in order to support an increased consumption share of the Chinese economy. Are there any particular methods of doing this that would avoid the mess that resulted in Eastern Europe and Russia in the 1990′s? If you have already written about this, I apologize in advance.
@seatrus 7,
Demographics are like a supertanker; they take forever to turn around. China’s one child policy doesn’t affect the entire country, and it’s impossible to know if abolishing it would return China’s fertility rate to above replacement. The current situation has been decades in the making.
I think the urbanization point is a crutch often used to dismiss bearish arguments. Edward Chancellor wrote an excellent white paper about how China’s definition of an “urban area” often means that even huge industrial centers aren’t considered “urban.”
But I think these are sidebars in the overall discussion. One reason I’ve found Professor Pettis’ arguments more noteworthy than those of the Economist or Martin Jacques is that he examines some of the details of how China reached its current state, e.g. with reliance on debt and household transfers. These make more sense than broad-brush narratives about East vs West or China vs the US.
“The key is how the transition takes place. If there is a massive privatization program in which large amounts of wealth are transferred to the household sector, it will be possible for household consumption to grow much more quickly and so pull GDP growth behind it at higher rates than I assume. But such a program of wealth transfer is, of course, not politically easy, and perhaps in recent events we have seen just how hard the debate over reform has become. ”
I think a lot of people really underestimate this task, or they simply refuse to accept this, or i dont know… but as somebody said it is hard to predict human madness.
@JChen: sure, we could fit into your living room, but it’s much better to fit in his new bar, don’t you think? Especially since he’ll be rolling in pricey booze at that point. Admittedly 2018 is a long time to wait for a drink. And that’s assuming Prof. Pettis doesn’t decide to do something sensible like drink it himself.
It cracked me up to see two headlines right next to each other on Google News today:
“China manufacturing at 1-year high” from CNN.
“China factory output falls for fifth month: HSBC PMI” from the Chicago Tribune.
The explanation is in the CNN story:
“China’s government reported Sunday that its manufacturing sector expanded in March, while a closely-watched private report said factories struggled with poor demand for their products.”
Michael worried about agreeing about a GDP deflator. I wonder about the reliability of any GDP figures as well. The Soviet Union reported amazing crop, steel production, GDP and other numbers, and nobody believed them. Will China also keep GDP growth up in their official statistics, for PR reasons, if growth slows down in real life? There certainly are incentives at the local level to do so.
It seems that currently following 4 major economic powers are in/heading into troubles,
(1)USA-14.7 T
(2)China-5.8 T
(3)EU-16.2 T
(4)Japan-5.6 T
Total of 42.3 T
Guess what % of the world GDP they comprise?about 68.2 % out of a total value of 62 T.
We won’t have to wait until 2018 to see who is rigth. On the other hand I have written down the names of those bands and will pass them to our public broadcaster to see if they do a special program on beijin’s musicians. I have to tell you, that recently I discovered an excellent Beijin style restaurant in Madrid: “El Bund”, which takes its name from a Beijin district if I remember well. It is, by far, the best chinese restaurant I’ve been.
Regarding the bet, Do I have to give up to my well-deserved 4-year subscription?
Buahahahaha!
A bottle of piss is such a flat prize. Why not push for, if the economist loses, they have to print a music review of some of your bands. . . Written by kaiser kuo, or gady epstein . .
The experience of Japan, and now China, surely shows that an economy must be built in a balanced way right from the start – and that such balance must be maintained, within some required range, as it grows. The current crisis shows us clearly that there are sustainable and unsustainable economic mixes in terms of the ratios between C+I+G+EX-IM; get these ratios out of whack for long enough and you have a dead-end economic structure that is simply unsustainable. To try to rectify the situation well down such a path beyond a certain threshold of such distortion simply isn’t possible – for both economic and political reasons. Vested interests hinder transition while the economics won’t work – in this case, how can we expect the required explosion in consumption to happen at the same time that exporters must downsize? Such an environment is one of rising job insecurity; are workers more or less likely to increase their consumption in such a situation? Less, I would say. I think it has been left too late. If ever the old saying that an ounce of prevention is worth a pound of cure was apt, this surely is it. As Richard Duncan has argued so well, there was no mechanism to early nip the imbalances in the bud and so keep us on a a balanced and sustainable path – the role that the gold standard and quasi-gold standard played for so long prior to the mid 1970′s. It is no coincidence that the greatest international trade and economic structure imbalances have occured since that fateful change.
Gloria, I agree with your post in fact.
That’s entirely my point. Without actual deflation and investment shrinking in absolute terms, there’s no way for China to get to 60% consumption in the time frame they need. The fact is that China’s investment strategy has become increasingly inefficient in terms of $ of debt per $ of GDP gain.
The kind of restructuring that China needs to undergo in order to rationalize their economy will require sub 4-5% growth rates for the next decade. The longer they put this off, the worse it’s going to be. At some point, everyone has to answer for bubbles, and China’s investment bubble is no different.
JohnWax, thanks. The point you are making is very hard to explain to most people because we generally tend to be much more comfortable with the idea that predictions are linear, and that a prediction about China, for example, must fall into either the “it will go up forever” camp or the “it will collapse in six months” camp, when the reality is that imbalances can persist for a long time but as they do their resolutions become more costly.
Seatrus, relaxing the one-child policy is not likely to be a stimulus at all since it means a sharply deteriorating dependency ratio for the next two decades before it becomes positive for GDP growth.
Doc, the success of privatization in transferring wealth efficiently and fairly is likely to be a function of transparency and good corporate governance. I leave it to you to decide if either is likely to be the case.
Ignacio, thanks for passing on the names of the bands to your radio station. By the way the Bund is probably named after the famous street along the river in Shanghai, not a Beijing district.
Excellent !!
I will be stumping for your side, Professor.
Talk about balance sheet recession and a shortfall in aggregate demand–China seems to show those characteristics in abundance…Sorry, but I don’t quite understand how China can maintain any growth when it is so dependent on stimulus from banks that are capital constrained and exports which may fall due to a worsening economy in Europe. And how can they lift the savings rate when have so many bad loans outstanding? Is the income growth all due to the boom in what will be non-performing loans?
Hi Daniel Kw,
these are the questions I keep on thinking many times. I believe it is only inflation that can stop them printing and based on the example of Japan and the SovietUnion (I guess the Chinese model is inbetween the two) they can hide inflation or channel it to politically irrelevant goods or there will be deflation for a long time. China is most likely to have sluggish growth as it have exhausted its economic resources, most notably labor to mobilize. The most interesting question for me whether the SOEs with political backing can crowd out otherwise competitive SMEs.
Professor，I support you。Also I write a letter to my hometown goverment to show my worry，I also send them some of your articles that I translated。I hope it can works。
Patrick Chovanec expresses the trouble China faces in keeping GDP growth high in a debate with
“For the past several years, most of China’s GDP growth has come from a massive investment boom fuelled by easy credit. Unless China sees a major increase in export demand – highly unlikely – or a huge shift towards domestic consumer spending – a lot easier said than done – the only way to hit 8-9% growth is to keep that investment boom going like gangbusters. The problem is, all that easy credit is generating bad debt and inflation. The state banking system can brush bad debt under the rug, but the more bad debt gets rolled over, the less capital is available to fund new projects………………………
Last year, out of China’s 9.2% real rate of GDP growth, five percentage points came from investment in fixed assets. If China builds all the roads, bridges, ports, airports, high-speed rail lines, condos, villas, etc this year that it built last year – an absolutely astounding amount of construction – but NO MORE, GDP growth would fall to just 4.2%. That’s a “hard landing” by anyone’s definition, and from what I can see, it’s already under way.”
http://chovanec.wordpress.com/2012/03/24/debating-a-hard-landing/
The real takeaway point here is that freezing investment at today’s already high levels would automatically decrease GDP by 5% next year.
Would someone please take the cocaine of tthe table!
Prof is wrong, I bet he knows he is wrong.
Check present chinese GDP per capita and check Janpanes GDP per capita 20 years ago. Also go to China and see how people work. You don’t need to be a professor to figure out your own answer.
Ming
The chinese GDP components are calculated verty differently than western countries. How can nobody in this blog take this into consideration?!!
For example: Many items are categoried into Comsumption in USA, but into Investment in China.
For another example, about 10% GDP in USA is about rent/living generated in housing sector, and in China, this part is not counted into GDP at all.
for one more example: there are much bigger hiden comsumption in China which are not reported into GDP number.
Overall, when using the same USA stat standard, the comsumption in Chinese GDP is much higher than current 33% number. If the actual comsumption ratios is 50%, most of the reasoning in this blog doesnt hold at all.
Michael Pettis has been dead wrong on the Chinese economy since the Asian financial crisis. Chin is on course to put the American empire into the dustbin of history. There is nothing, I repeat NOTHING will stop the rise of china to superpower status. It is china’s birthright to be the most dominant country on this planet.
There is nothing anyone can say or do to stop the rise of china.
Pettis can continue his failed predictions just like in the last decade, china will go from strength to strength while America will weaken and lose influence to china. Pettis will just have to suck it up and learn to live with reality. His mental masturbation of china collapse is to massage his own ego hurt from china’s Awesome success.
China is now gaining power and influence all over the world from Africa, Latin america, middle east, eastern Europe, south Asia, southeast Asia, central Asia.
Guys like pettis is too scared to get challenged from others, he knows his doomsday predictions for china have been 100% wrong and guys like John Ross have exposed pettis for his failed predictions.
Michael Pettis knows as much about the Chinese economy as Stevie Wonder knows about sightseeing. Pettis has been dead wrong about china for as long as I have read this guys blogs on china.
I think Pettis is just a frustrated old man, otherwise he would have no reason to have so much venom and hate towards the emerging superpower. Most people find pettis a nutty professor, a wacko, a nutjob.
Let’s see if pettis has the guts to respond to me.
But once a coward, always a coward. Isnt that Michael?
Shaun, so the person who explains his views clearly under his own name is a coward, and the person who spits vicious and illogical attacks under a false name is brave? My, you certainly think differently in China than we do. So that the rest of us can understand how brave you are, would you tell us your name and where you work? Or is that too frightening?
Just by publishing your comment, Shaun, Pettis has responded to you and beaten you. His response is to demonstrate your level of intelligence by letting you speak. I think you probably do not understand what I mean, but nearly everyone else will.
33 DM
Nobody know who you are either. you are very rude in this blog. you basically make personal attack to every person who disagrees with Prof. Michael Pettis. so this is only a place to worship the Chinese bear ideas?! no different opninions are allowed?!
in your own words, “would you tell us your name and where you work” first? do you wanna make a bet with me that you and I who is doing better in our career?
I look at GDP per head figures for china and other countries and they indicate that China is still a third-world country. Dont believe me, thats what Chinese leaders always said in response to american demands to lift trade barriers and the yuan exchange rate. They stopped doing this in recent years, but GDP per capita is still very low, 8K or so. What is more important is that i dont see it lifting above countries like Mexico and Russia even in the long run. It might overtake Brazil but i doubt. Even that is probably not enough to overtake America in total GDP even with quadruple the population that China has. I bet on Michael.
“Sorry, but I don’t quite understand how China can maintain any growth when it is so dependent on stimulus from banks that are capital constrained”
You are very confused over a simple point. Most economists of course are also confused over this point. THERE IS NO GROWTH IF THAT GROWTH IS ‘DEPENDENT ON BANKS’. What you just said is that Chinese growth is dependent on banks making new loans and increasing the money supply. The point of using REAL GDP is to remove that inflation of the money supply from our measurement of growth.
” I just told the old couple next door that prices only rose 5-6 % on average the last 4 years and that they will only rise 4% over the next 4 years. The reply I got is not suitable for a public place like this.”
This poster was referring to the fact that the GDP deflator used to calculate real GDP was 5-6% the last 4 years. Yet the Chinese money supply doubled over 3 of those years. That is a 24% rate of inflation. So you need to subtract another 19 percent from reported real GDP over that time period – which means China was actually shrinking not growing.