Perceptions have certainly changed a lot in the last few months. As recently as three years ago there were so few analysts who were skeptical about the sustainability of Chinese growth that we rarely disagreed among ourselves. Now, however, the group of skeptics has become large enough that there are serious disagreements among us as to what will happen next.
One source of disagreement is about whether Beijing can turn around the current growth slowdown. Some argue that business confidence is so low that it will be all but impossible to get growth up during the rest of this year. They point to the falling demand for loans as proof that Beijing cannot simply force up credit by relaxing loan constraints in the banking system. My friend Patrick Chovanec, at Tsinghua University, seems to be in this camp, as his recent blog postings suggest.
Weak loan demand certainly does seem to be a problem. Friday’s Bloomberg has the following story:
China’s biggest banks may fall short of loan targets for the first time in at least seven years as an economic slowdown crimps demand for credit, three bank officials with knowledge of the matter said.
A decline in lending in April and May means it’s likely the banks’ total new loans for 2012 will be about 7 trillion yuan ($1.1 trillion), less than an estimated government goal of 8 trillion yuan to 8.5 trillion yuan, said one of the officials, declining to be identified because the person isn’t authorized to speak publicly. Banks are relying on small and mid-sized companies for loan growth after demand from the biggest state- owned borrowers dropped, the people said.
The drying up of loan demand attests to the severity of China’s slowdown and may add pressure on Premier Wen Jiabao to cut interest rates and expand stimulus measures.
Times have certainly changed. It used to be that the incredibly low interest rates set by the central bank all but guaranteed infinite demand for credit. After all if you are paying almost nothing for capital (perhaps even a negative real rate), and your risks are guaranteed, it almost always makes sense to borrow and invest in anything that offers even the most meager or evanescent of returns.
In those days Beijing could pretty much set the pace of growth simply by capping the maximum level of loan growth permitted to the banks (actually not so simple because for the past decade Chinese banks have expended all their ingenuity in figuring out how to cheat the loan caps). Borrowers had infinite demand and banks would lend right up to (and sometimes even over) the cap because their profits were guaranteed and their risks socialized.
Where will demand come from?
Now, it seems, the expected returns to investment are so low that even cheap capital and socialized credit risk is not enough to tempt privileged borrowers into borrowing and investing. This fact alone should worry those of us who are still not yet convinced that China has a serious investment problem. Over at The Economist there is a long section on the Chinese economy in the current issue, which is well worth reading because it puts the bull case very intelligently, but it does so in part by making a distinction between “over-investment” and “mal-investment” which I think is irrelevant.
The problem is the sustainability of debt and the cost of servicing it relative to the economic wealth generated by investment, and this occurs whether China overinvests or mal-invests. At any rate those who are very skeptical about China’s ability to regain growth this year certainly have a strong case.
Nonetheless I am not so sure I agree with them. I suspect that Beijing has a few arrows left in its quiver. I think that current loan demand may indeed be low, but if Beijing were simply to force local governments (or allow them, since they anyway love to invest bank money wantonly) to engage in another round of infrastructure investment, bad as that may be for China’s eventual rebalancing, I think it would cause another spurt of growth in the short term. On that subject here is an article from Monday’s South China Morning Post:
Premier Wen Jiabao said yesterday the country would step up efforts to maintain stable economic growth, in a statement that many read as a signal for imminent monetary easing. During a fact-finding trip to Wuhan, in Hubei province, over the weekend, Wen said macroeconomic controls should be “improved and fine-tuned” in line with the latest economic situation and problems, if any, Xinhua reported.
The central government should “properly handle” the relationship between maintaining growth, reforming economic structures and managing consumer price inflation, he said. ”We should continue to implement a proactive fiscal policy and a prudent monetary policy,” Wen said. “More priority should be given to maintaining stable economic growth.”
Many economists said Wen’s remarks showed policymakers were worried about the economic slowdown, which has already spilled into the second quarter from the first.
Certainly this, and lots of other similar signaling by Beijing, suggests, that the slowdown in growth has become so serious that it may break through the political gridlock typical of the period before a leadership transition. In my opinion, then, the rather alarming slowdown in Chinese growth is likely to be reversed in the next quarter and we will get GP growth close to either side of 8%. I hope it is lower rather than higher, because the more debt China creates to generate growth, the more difficult the ultimate adjustment, but this is politically a very important year and I don’t think anyone wants it to end with a whimper.
But whether or not I am right about China’s ability to increase loan demand by forcing more infrastructure spending there is still a lot of reason to worry about the lack of natural demand for credit. In that light I found this article from Monday’s Financial Times very interesting:
Chinese consumers of thermal coal and iron ore are asking traders to defer cargos and – in some cases – defaulting on their contracts, in the clearest sign yet of the impact of the country’s economic slowdown on the global raw materials markets.
The deferrals and defaults have only emerged in the last few days, traders said, and have contributed to a drop in iron ore and coal prices. “We have some clients in China asking us this week to defer volumes,” said a senior executive with a global commodities trading house, who warned that consumers were cautious. “China is hand to mouth at the moment.”
A senior executive at another large trading house also confirmed there had been defaults and deferrals in both thermal coal and iron ore.
The source of imbalances
This is the kind of thing, of course, that experienced economists always worry about. Companies are having trouble raising cash, with many forced to default on obligations, debt is rising, and even the most foolhardy of investors are having second thoughts. When borrowers who never worried much about profitability are reluctant to take on free loans, they must be glum indeed about their prospects.
And to cap it off, my friend Mark Williams at Capital Economics sent me his latest piece on China where I saw the following:
In broader terms though, coming quarters are likely to highlight the growing fragility of China’s growth model. Figures released this week confirm that investment spending rose last year to 49.2% of GDP, up one percentage point from 2010. Meanwhile, the share contributed by household consumption remained rooted at 34.9%, dashing hopes that rebalancing had already started. With the government now embarking on another investment-led stimulus, prospects that the economy will soon be put on a more sustainable, more consumer-led footing still look remote.
So investment is up as a share of GDP and investment flat. If Williams is right, it suggests that even in 2011, the latest year in which the China bulls have promised that the long-awaited rebalancing towards consumption had finally begun, there has been no rebalancing.
I have argued, of course, most recently in my April 6 newsletter, that absent a massive and unlikely privatization program I cannot even conceive of how rebalancing could occur with growth rates much above 5 or 6%. That is why I have asserted, without evidence of course, that there has been no major rebalancing in 2011. Perhaps the evidence is finally emerging.
Before closing I wanted to mention a very interesting study prepared by a group of economists at HKUST. The abstract of the paper is
This paper documents a hallmark feature of China’s state capitalism as the state controlling the economy in a vertical economic structure: State-owned enterprises (SOEs) monopolize key industries and markets in the upstream, whereas the downstream industries are largely open to private competition. We develop a general-equilibrium model to show that this unique vertical structure, when combined with openness and labor abundance, is critical in explaining a puzzling fact about China’s economy: SOEs outperformed non-SOEs in the past decade while the opposite was true in the 1990s.
We show how the upstream SOEs extract rents from the liberalized downstream sectors in the process of industrialization and globalization. It implies that the unusual prosperity of SOEs in China can be merely a growth-undermining symptom of the incompleteness of market-oriented reforms rather than a proof of their efficiency dominance over non-SOEs.
The paper was sent to me by one of the authors, Xi Li, who also sent me a link, which I assume works. The paper is called “A Model of China’s State Capitalism” (co-authored by Xi Li, Xuewen Liu, Yong Wang). Parts of the paper are pretty math and statistics heavy, but the point is that the structure of the Chinese economy has resulted in upstream monopoly pricing power by SOEs, and this explains why their profitability over the past decade has been increasing rather than decreasing, as one would expect. Monopoly pricing, of course, means that profitability does not arise from greater efficiency but rather from the implicit ability to tax households, and unfortunately rebalancing requires that among other things we undermine the ability of SOEs to remain profitable.
To me, the quote below from the OPEC monthly oil market report shows China potentially in recession, if not, very close to one. Certainly they cannot be growing anywhere near 8%.
“Chinese oil demand grew by a moderate 2.7%, or 260 tb/d, y-o-y in April, to average 9.9 mb/d. The country’s second-quarter oil demand growth is forecast at 0.45 mb/d y-o-y”
“Certainly they cannot be growing anywhere near 8%.”
By saying they are growing at 8% Pettis and all other economists are including money supply inflation in the growth numbers. All you have to do is compare the GDP deflator and/or CPI against the actual money supply increase to realize what % of GDP growth this is. Or as you noted you can look at actual volumes instead of dollar figures.
You can even read the top of this article which states: “banks’ total new loans for 2012 will be about 7 trillion yuan.” New credit is money which is an increase in the money supply or inflation. As I recall M2 was 80 trillion yuan at the end of 2011 and its growth was ~13% that year after having almost doubled over the 3 years prior.
Michael,
What do you think of this view?http://brontecapital.blogspot.com/2012/06/macroeconomics-of-chinese-kleptocracy.html
It’s worded a bit provocatively, but the substance is real.
appreciate the links, dr. pettis. I guess we’ll see how things progress over the summer. I really don’t see how another bout of infrastructure can really help China at this point…
The government has been skeptical of the sustainability of growth since the 9th FYP! The problems are well known, and have been. Commentators don’t get the way the political economy works here. What you call imbalances represent an equilibrium with so much precedent I don’t know what you read. Meditate on the difference between form and substance and you might get it.
Wonder if you could give an example of a household or individual progressing through the last ten years and how their consumption /savings might have developed?
CJared, there is always a big debate about what China’s “real” GDP growth rate is, and there have been many attempts to correct for distortions. I would argue that if you correctly subtracted the losses that should have shown up in non-performing loans, GDP growth rates over the past decade would have probably been at least 2 percentage points lower every year.
HI, I think some part of the report is accurate but some parts are a little exaggerated and the author doesn’t seem to understand the difference between household savings and national savings.
LuckyWu, there certainly are a lot of precedents for what we call imbalance, but you would have to be incredibly ignorant of economics or economic history to refer to them as a form of equilibrium. While I meditate on the difference between form and substance you might want to trace some of the precedents to which you refer and see what happened next. As for your claim that “the government has been skeptical of the sustainability of growth since the 9th FYP”, I am not sure if you could possibly come up with a more meaningless statement.
Curiouser, I am not sure what you mean by that.
Professor, I think in that last statement LuckyWu is making the argument that
1. China’s development model is not unsustainable, and anyone who thinks it is is crazy, and
2. Anyway the government has already known for many years that it is unsustainable, so there’s no reason to worry because they know what they are doing.
I notice that this kind of illogical defense has been the fall-back position of the “what, me worry?” crowd for the past two years at least. Since most real economists, Chinese, foreign, and even government-related ones, now fully buy into the argument you have been proposing for so many years, I think you can assume that a lot of the disagreement you face now is likely to come from people who have no understanding of economics but still greatly resent your skepticism.
And another thing, I congratulate on your failure to express the kind of triumphalism that most others in your place (and me certainly) would be expressing. You have been so resoundingly right that even those who insisted just a few years that you were crazy now pretend that they agreed with you all along — I won’t mention names but you know who they are. How you can refrain from rubbing their noses in the dirt I don’t understand. You are obviously a nicer man than I am.
Professor, I think in that last statement LuckyWu is making the argument that
1. China’s development model is not unsustainable, and anyone who thinks it is is crazy, and
2. Anyway the government has already known for many years that it is unsustainable, so there’s no reason to worry because they know what they are doing.
I notice that this kind of illogical defense has been the fall-back position of the “what, me worry?” crowd for the past two years at least. Since most real economists, Chinese, foreign, and even government-related ones, now fully buy into the argument you have been proposing for so many years, I think you can assume that a lot of the disagreement you face now is likely to come from people who have no understanding of economics but still greatly resent your skepticism.
And another thing, I congratulate on your failure to express the kind of triumphalism that most others in your place (and me certainly) would be expressing. You have been so resoundingly right that even those who insisted just a few years that you were crazy now pretend that they agreed with you all along — I won’t mention names but you know who they are. How you can refrain from rubbing their noses in the dirt I don’t understand. You are obviously a nicer man than I am.
Professor, as mention by Jackson you have been largely right in your arguments for in recent years and now the sustentability of growth without reforms is largely perceived by most analysts as very unlikely. However to me recent measures in giving flexibility to banks to fight for deposits, increase in wages, tax rebates to consumers, SME bond measures and strong gov. speach towards reforms have encourage to think that we are indeed going to see at least in part first real steps towards a rebalance of the economy. Off course, I agree with you that intent is not enough when you have a whole economy build around special incentives, and reforms not necessarily going to be able to sustain growth at high rates, as investment decisions will be passed from gov. to individuals, but again, for me recent measures were encouraging. Wonder what is your thought regarding recent measures. On the absence of stimulus package it might not be able to sustain growth at 8%, but if TFP growth sustained at 3% and aggregate hours still growing for a decade, i dont see why China cant grow around 6% in the next decade, which is not bad at all for a country as big as China is today.
“So investment is up as a share of GDP and investment flat.”
I think you mean “consumption flat”?
Hello Professor Pettis,
I am wondering if you have anything to say about the recent depreciation of the rmb. Is it caused mainly by market sentiment or do you think the central government is trying to devalue the rmb once again to support its export sector? Is there any importance to the weakness of the rmb and what do you think will be the trend in terms of its appreciation/depreciation?
The US appears to be putting less pressure on the rmb’s appreciation while the rmb is depreciating which confuses me.
A bit touchy Professor. Why you automatically assume that my statements presume there is nothing wrong is interesting to me. That there is a cyclical equilibrium between state and economy similar to what is currently acknowledged as ‘state capitalism’ is not really subject to any debate for someone who knows China’s economic history. In economic terms this usually ends badly, and the same can be said for the political convulsions that often lag the breakdown. The relevant point is that on a recurring historical basis the government fails to break the cycle. Some in government have pressed to acknowledge this publically, going back to the 9th FYP, but predictably nothing much has been accomplished to address what are now called ‘imbalances’. This is not meaningless, as you propose, and delineates a major fault line in the government. THe more important point is that in political economy terms administrative excesses (like the current ‘state capitalism’ are the only ones that matter. They determine everything else that is eventually measured in the balance of payments. Anything measured in the GDP accounting identities that everyone is addicted on are by definition ex post, and explain little about how China got where it is, and what will happen next. This is the difference between form and substance that you ridicule. The economics that matters is in the creation, not in the accounting. The numbers means less than the mechanicism that produces them. In this respect China is much more insulated from the world than is often appreciated. Find me a model somewhere in the world that is sustainable, and then tell China to do that. The model you are talking about is not really a model. It is simply a more balanced GDP accounting identity. Your reply seemed angry. I am sorry you harbor anger in your heart. Now meditate on what sustainability means. What it really means. I don’t know, and I dont think others do either. Please tell me.
It’s interesting that Mr. Pettis’ writings continually inspire two types of general comments here and at Seeking Alpha.
1) The Chinese government will engineer a virtuous cycle of uninterrupted economic growth for the forseeable future. The commenters generally believe that the Chinese model works better and/or the Chinese government has tools unavailable to more market-oriented economies. Sometimes the comments manifest into an obvious nationalistic tinge. Sometimes commenters point out that the U.S. and Europe have screwed up their economies. This last point is of course not an argument at all, but further support that the entire global economy is need of rebalancing. In regards to the superiority of the Chinese development model, Mr. Pettis has merely stated that no economy in history has ever escaped general principles of economics or the business cycle. It is not a debate over economic superiority.
2) In another direction, there are comments stating globalization is unfair to the masses, immoral, parasitic and unsustainable. I am not sure how these commenters find their way to Mr. Pettis’ writings. I have my own issues with globalization, but more of a practical matter of its application and regulation.
Although I find the latter type of comment interesting sometimes, the former is a denial that is of more concern. As Mr. Pettis’ postings have described, Chinese growth has been dependent on investment and exports. In my opinion, this rapid development model is rather simple (repeated by many countries) in that it relies on cheap labor, managed trade policies and accessible export markets. I don’t think anyone now believes the U.S. and the rest of the world can absorb more Chinese exports nor will they be able to allow it. The resulting rebalancing process in China will not be painless.
I think Lucky is absolutely right in the sense that the government is well aware of the inbalance in the economy. Their leaders make endless speeches about addressing the inbalances. These speeches amount to form over substance. While the Party is well aware of the inbalance, the higher priority is maintaining power while maximizing the personal wealth of the Party elite and the princelings. The Party cannot allow free flow of capital or a truly market based economy or a substantial migration towards a consumption based economy because it would mean giving up a foundation of their power and it would reduce their ability to put the fingers in the rice bowl.
Jackson. I assume that everything is unsustainable. Unsustainable is different to me than unstable. It is differently mathmatically too. So what people want to say is that China economy is unstable. This I agree with, and this points to break points in the equations to look at the future. Unsustainable is not very descriptive to me. We all know for many years that Japan is unsustainable. But is has been remarkably stable. The numbers make a clear case why. Can China make the same stability. I do not think so. The US fiscal situation is not sustainable. It has not been this way since the 9th FYP. Ha ha ha. But is it unstable? I am not sure.
Sorry. One more question and I go away. Professor – why is Japan so stable for so long, and why China cannot be unsustainable and stable also, like Japan? Yes, bubbles come and go, but the world did not fall apart. Thank you.
You can argue about China growth rate. What you can’t argue about is a tremendous difference in life style China has achieved for its citizens during the past decade. All in the face of stagnation in the West. In the face of high oil prices, instability around the world, increased protectionism from US etc.
Anyone who thinks consumption as portion of GDP can not be increased is kidding themselves. This is the easiest thing to do. There could be so many stimulus programs, and they are very easy to implement. That does not take PhD to figure out. It is all made in China already, all they need to do is simply leave it for its own citizens to consume.And it makes your citizens happy while you are doing it, perfect!
China has money, resources and political will to see through whatever it decides to do. Its consumption is about to accelerate to rates not seen in history. They can only be stopped by lack of natural resources, they have everything else. I suggest academics with skeptical views of China start to look for a back door with their grim predictions. Because they are not going to come true. If you think you were right predicting collapse while GROWTH rates went to 8% from 11%, you are deluding yourself and your readers. Watch for that consumption/GDP ratio, it is about to explode to >12%
We all need to listen to Mr. Wu. Not because he understands economics, for that we should continue to wait anxiously every month for Mr. Pettis. But because Mr. Wu is expressing an important component to the way many Chinese think. That they are above economics and free markets.
I know this is heresy to the readers of this blog, but it is our blind spot. We cannot presume that policy making in China will be based on good economics. The re-birth in the last ten years of the SOE is being rationalized economically. But was the reason good economic policy? Or was the reason for the re-birth closer to what Mr. Wu is describing?
China is very comfortable with the rule of man. Having a strong government, strong party and strong SOEs work naturally. Economic rationalizations are only an afterthought to satisfy the outside world.
Mr Wu, please don’t go away. Although your comments make my mind spin, they do help with a better understanding of China.
Growth from investment at 49,2% is clearly unsustainable. Investment includes housing, infrastructure and business (including FDI). FDI has been a large component and it is down, especially related to real estate. It is specifically because of the global crisis that China is in trouble. Lending doubled from 2008 to 2009 and held that level for 2010 & 2011. It was not stimulus spending that was the big driver of growth during this period it was bank lending. Any banker knows that you cannot double lending without taking on high risk credits that you were formerly turning down. China’s government owned banks have lent a lot of money to government related entities that have lost their cash flow. As much as 25% of local government revenues previously came from land sales and developers are not interested in buying more land at the moment but are more interested in getting projects compeleted to get the cash out of them to pay both banks and the shadow banking system that is charging them sky high rates. China is in trouble; growth coming from continually increasing debt is a road to ruin. It is critical that borrowed money go into productive assets that cash flow and create future income otherwise you are eating the seed corn.
Prof Pettis,
First, thank you for writing these articles for us. They have been very enlightening.
Secondly, I have a question. I’ve recently started to worry that China may inadvertently gotten into a ponzi like situation. That is, it must keep investing more and more money in its businesses to hide that many earlier investments aren’t as profitable as they are supposed to be. As long as most money earned keeps being reinvested (augmented with fresh loans) things are ok but as soon as investing stops real revenue streams aren’t enough to pay what the investors expect. I don’t mean this is done on purpose – just that a combination of strong pro growth government policies and millions of very enterprising people might accidentally create such a situation.
Is it possible that such a thing may have happened? I find the possibility rather scary. It would mean rebalancing is almost impossible since increasing consumption is similar to taking money out of the ponzi. It would also make a trade war almost unavoidable because China’s industry would have to keep growing at the expense of others, and eventually the social costs of that become unbearable to other countries.
I am no economist, hence why I read this blog, yet as a specialist in the international coal market, I can to add some color to the comments from the FT referring to thermal coal (helpful or not in the strength of this aspect to the argument).
The request for deferrals are as much to do with the introduction of 1. leveraged market intermediaries (i.e. domiciled individual commodity traders who link international producers/traders to the Chinese power producers), 2. the heard mentality to enact “price majeure” on inbound commodity cargo to limit trading losses and renegotiate lower prices, and 3. the lower power generation growth during a period of high hydro availability and good domestic coal availability.
In my mind, certainly 3. is a virgin sign of a struggling economy, although this should not disaggregated power structure seasonality, and the remaining two points are likely to transpire as irrelevant to signs of a faltering economy given that they are driven in the most part by short term profitability protection of leveraged individuals acting in the commodity markets, and in fact the flow of commodities will continue unabated (albeit at lower prices).
Lucky Wu writes:
>> what people want to say is that China economy is unstable. This I agree with …
and then writes:
>> why China cannot be unsustainable and stable also, like Japan?
I hope the meditation is going well, because that is a really difficult question.
By the way i agree with the comment about the Economist’s distinction of malinvestment versus over investment. I read that and started laughing. I still don’t know what they are talking about, although it sounds good. How is one to determine which is which? Is it like the famous line about pornography…”i will know it when i see it”?
There is no doubt that this second slowdown will be solved with QE (indirect or direct), so there will not be a significant slowdown in the 3rd and 4th quarters. This will lead to more imbalance between export and import with a stronger inflow of USD on the balance of payments (the QE will be focused on the export sector).
This short term development is not as interesting as asking oneself how can the Chinese economy balance ? I guess being right just means, that you by default are “forced” to give solutions.
My hope is that the new VAT based tax-system on pilot now in Shanghai and Beijing could be implemented in the “bargaining” structure of the political system. If cadres are measured based on VAT growth in selected sectors, then private consumption could increase significantly as privatization and transparent implementation of rules become key factors in creating growth. In the classical flow between fixed investment, export and private consumption the two first have won each time in the last 30 years, because they fit the political structure. If the relationship was changed there would be hope of a rebalance. It would deminish the public sector, and it would also diminish the relationship between the political structure and the economic actors. During these new reforms local government agencies should be allowed to increase wages and staff. So the SOEs would disappear while other parts of the political system would be strengthend. That is why reform is possible.
Critics always point to China’s low consumption to GDP ratio as one of its key problems or symptom to its problems. But what is how hard about consumption? Hypothetically, couldn’t the Chinese govt just give its people x% of GDP (by way of a tax rebate, or consumption voucher) every year and “force” people to spend? (Chinese govt is probably the only major economy in the world that could afford to do this, due to its fiscal surplus.) Wouldn’t this boost consumption and lower investment? And if so, would critics then say China has effectively re-balanced?
I had always thought that making things were a lot harder than consuming things and a country increases its competitiveness by improving its ability to make things rather than increasing its appetite for consuming things. I had always thought that this whole argument is a way for capitalists to push Chinese consumers to buy more of their products.
Prof. Pettis, could you enlighten me? Thanks.
Huang,
China does not often have a fiscal surplus, only once in the last 16 years actually.
China promoted growth of its auto industry by offering incentives to consumers. When those incentives expired Chinese auto sales tanked.
You need to understand analysis and comment on China’s growth is not necessarily criticism. Even China’s leaders recognize the imbalance is unsustainable but are not able to effect reform. My humble suggestion has two parts: First enforce the current labor and pay laws (this would create more disposable and employee more workers), Second, scrap the hukou system, a feudalistic control system that provides low cost labor while saving governments health and education expense.
As to your idea, the vast majority of Chinese do not pay income taxes, either failing to earn enough, or, working for ‘capitalists’ who do not report wages paid in order to avoid paying social security contributions. Thus, tax rebates would benefit the educated and rich who are already consumers above the subsistence level.
Huang, as Crispus rightly points out, the Chinese government is running a trade deficit, estimated at 1.5% of GDP for 2012: http://www.bloomberg.com/news/2012-03-05/china-plans-lower-budget-deficit-for-this-year-as-economic-growth-cools.html. Maybe you are confusing the fiscal budget with the balance of trade? Also, the banks are probably underestimating their bad loans by a large amount (see e.g. http://www.bloomberg.com/news/2012-05-10/china-s-big-banks-look-more-like-paper-tigers.html), and if some become insolvent, the Chinese government could end up paying for the bad loans, which would make its fiscal deficit even larger.
Possible financial strategies for the world that is sustainable is now being tested in Iceland, it would be wise to follow their progress in this respect.
Sure, sure. The government will hav to pay big to bail out the banks. They did last time, and will again. What if the government issued special debt of equivilant to 10% of GDP, taking the explicit debt ratio to closer like 65% of GDP? This would sell quick. Just look every time the government has an auction of debt, and it sells out in a morning. With high growth potential, government revenues growing at 2x nominal GDP, the government can bail out the model that keeps them in their seats at least a couple of more times. This blog and many others use the wrong logic. This is the form and substance distinction that like to ridicule.
Paul Krugman made a case for Japan.
“We have already gone straight into the issues. The conversation turns to the Japanese crisis of the 1990s. In retrospect, I suggest, the Japanese seem to have managed the aftermath of their crisis quite well.
He agrees. “What we thought was that Japan was a cautionary tale. It has turned into Japan as almost a role model. They never had as big a slump as we have had. They managed to have growing per capita income through most of what we call their ‘lost decade’. My running joke is that the group of us who were worried about Japan a dozen years ago ought to go to Tokyo and apologise to the emperor. We’ve done worse than they ever did. When people ask: might we become Japan? I say: I wish we could become Japan.”
http://www.ftchinese.com/story/001045131/en
Lucky Wu: “The government will hav to pay big to bail out the banks. They did last time, and will again.”
I probably shouldn’t rise to the bait since you don’t spend a lot of time on these things, but you are completely wrong about how the last banking crisis was cleaned up. It wasn’t the government who paid to clean it up but the household sector, as Pettis has shown many times, and they cannot possibly do it again if they expect rebalanced consumption to drive the Chinese economy for the next decade. You do understand why, don’t you? Substance sure is useful, although understanding what happened in the last banking crisis might should be part of the definition of substance, but if you paid attention to form too maybe you wouldn’t say things that are self-contradictory.
Also do you really think borrowing 10% of GDP is enough to clean up the Chinese banking system? Wherever did you get that number? That means less than 6% of the loans are going to go bad (much less when you include the informal banks). I think even the most wide-eyed optimists don’t believe that. During the last crisis NPLs were around 40% of total loans, with a much healthier economy. Today total bank lending is roughly 180% of GDP. Add in all the SOE debt and possibly huge amounts of informal banking debt, which may be even dodgier than what is in the banks, and I’d be surprised (very surprised!!!) if China can clean it up for less than 50-60% of GDP. And I am not even including the hole in the central bank’s balance sheet, which I have heard estimated to be about 5-10% of GDP.
Anyway the only reason government debt sells quickly is because banks are required to buy it. You do know, right, that borrowing money from the banks in order to recapitalize them does not constitute real recapitalization, especially when the banks are already guaranteed? Perhaps you should be reading the newspapers about what is happening in Spain.
One of the reasonsI am much more pessimistic about China than Pettis, who thinks China can muddle its way thought the mess without too much of a disaster, is because in my opinion far too many Chinese stick their fingers in their ears and shout “lalalalala” whenever anyone points to the risks. When the problem comes it will catch everyone completely flatfooted. Even in well-managed economies, policy leaders should always be aware of the risks, but in such a methadone-addled economy like China’s it seems that Chinese considered it treasonous even to suggest being careful. But then again very drunk drivers always get furious when you warn them to drive carefully.
Rebalancing consumption will fail, sure that is obvious, and had been for some time. The argument that banks are bailed out on backs of households…this applies the world over. You do some analysis of comparative financial repression and you see it. Actually the ministry of finance issued bonds to buy bad debt, and they have been rolled over, not paid back, so no one has paid got it. Ha ha ha. Look back at 1993 to 1997 and you see back then local governments were quietly forced to work with banks to process almost r,b 1 trillion even before the bailout, which was still huge. This time, forced extensions of debts,forced asset sales will handle a big chunk. Explicit bailout is upper limit to save face. This is not market economy, so make sure your models and mechanisms are not mismatched. People in china smart like everywhere else. If they forced to choose bailout or financial abyss, they choose bailout every time. Bailing out banks also means bailing out corruption, which 20x or more the number of corrupt officials in compromised business people, who do most of the consuming. You don’t want bailouts, then you also don’t want new sporty Audi cara for mistress, and fancy handbags and makeup to make old lady pretty. That it consumption, plus subsistence of rural china. I don’t disagree with you about who manages economy well. China in trouble because mainstream belief is institutions don’t matter,mso you get strong arm bailouts which work contrary to transitional goals. Oh, and you are wrong about government debt.mpeoplemline up at bank to buy medium and long term debt before the banks open. Better than savings deposit. Anyway, I shudder to think what it really required to shake up system. It is more than pullin a few levers connected to GDP accounting identity.
The bottom line, if i interpret this correctly, is that it is difficult to know how far can the chinese growth model go on until the government throws the towel and changes policy to a consumer driven economy.
thanks crispus and Pierre. i enjoy these exchanges as i find it educational and stimulating. i just hope we don’t take up too much of prof. pettis’s valuable space.
you are right about the fiscal surplus. my mistake.
usually China will generally have a fiscal surplus until the last quarter/months of the year as departments rush to spend wildly to avoid under-spending and getting their budgets cut the next year. for example, for the first half of 2011, the fiscal surplus was reported to be 6.1% of the GDP. my point is that i believe the Chinese government has the financial capacity and flexibility to simply reduce its budget and give a lot of it back to its people, if it wanted to. and that it is in a much more flexible position to do so more than other major economies. i hope that you will agree with me on that.
as for the method of getting the money to the hands of the people, i am not arguing that what i have proposed are the two only/best ways. i am saying that analysts/critics tend to focus on or quote China’s low consumption as a % of GDP as the problem, when in theory, isn’t giving it back or forcing consumption a rather easy fix to the problem of over investment and under consumption?
finally, my key argument is really the last part of my previous post, which is understanding the goals and reasons of the Chinese govt’s actions. The Chinese govt is subsidizing key and strategic industries, because it thinks that by doing so will increase the long term competitiveness of the country in manufacturing. This is why they are subsidizing industries like cars, tools, infrastructure, etc. Because I believe that only when you are competitive at manufacturing, will you be able to sustain a higher level of consumption. Without making more things, how can you ever possibly sustainably consume more? Are we arguing that by consuming more will give us the ability to consume more sustainably?
I also don’t think that by simply giving people money to spend, which will automatically increase domestic consumption, will help the long term competitiveness of China, since people will probably consume and buy perishable goods which most likely will not help China increase its competitive. I hate to sound like a bigot but to me, it plays into the west’s desire for Chinese to spend more and focus less on competing with them on the manufacturing side.
Look forward to your thoughts.
Huang, the best part of my blog is the quality of the debate in the comments section. Take as much space as you like.
Huang 40
The Chinese government giving back is an interesting idea. But from Caixin, Chen Zhu, China’s Minister of Health says of 2010 spending:
“In 2010, the budget for primary health care institutions was 63.2 billion yuan when only 69.4 percent of the budget was spent. The money spent represented 94 percent of 2009′s expenditures.”
It seems spending on primary health care DECLINED from 2009 to 2010 by 6%.
As China runs a fiscal deficit, 30% of the planned spending on primary health care did not happen in 2010. Where was the 19.3 billion yuan planned, but not spent, for primary health care actually spent?
I believe, but can’t now find the source, that the Chinese government also fails to spend all money budgeted for education as well.
I assume you are referring to China’s competitiveness relative to other nations. Ten years ago, local governments were harassing Chinese entrepreneurs that sold retail goods to consumers claiming offering lower prices to consumers was unfair. Retail competition is not harmonious.
Dependence on exports makes China subject to external demand. These days, lower demand is affecting Chinese exporters and their workers. The export manufacturers could, if the relevant laws and regulations permitted, begin selling these higher quality export goods to domestic consumers. However, without the VAT export rebates, the prices would be higher while the supply of goods would increase. What is needed is a way to increase demand.
Most Chinese workers are paid less than the propaganda minimum wage per month and work 28/29 days a month, 10 to 12 hours a day. If the existing China labor laws were enforced, most Chinese workers would be paid 21% more, or, more workers would be employed. Either way, it is easy to infer disposable income in China would increase at least 15%. That should give a nice bump to aggregate consumption. Demand would also rise.
Paraphrasing Henry Ford: If you pay workers more, and give the workers more time off, they can buy more of your goods.
Hello Michael, thoroughly enjoyed watching the May2012 CFA webcast. Very lucid explanation of some of the underlying mechanics. May I ask you some questions in relation to this and China’s future -
1. Many sovereign trade reports list HongKong and Taipei (ROC) separately to China (mainland PRC) as separate trade entities/accounts. Is there any reciprocating benefit to PRC (mainland China) from any surpluses or deficits traded by other countries with HK/ROC?
2. Will China formally resolve/amalgamate the Governance of these 2 separated regions HongKong and Taipei (or have they already?) … or another way … do these two regions present any significant ongoing liability to the stability of the PRC?
3. Is there a larger role played by China in influencing the immediate APEC neighbours than the broader global influence that is worrying everyone else? i.e. would China benefit more in (re)balancing within the consideration of it’s APEC neighbours as a primary concern?
Thanks and regards,
RT
Thank you Professor, for making such a good debate and not filtering out the least smartest comments. I wonder, if the investment boom in China was not so much directed by state, but more private and independent in the nature, the resulting income flows would balanced more in favor of private households. If this were possible, also would result the willingness of entrpreneurs to invest their wealth, rather than cash out (or cash into real estate) and go defensive. Back to hailout question, it has started. This is not just local governments selling their cars to raise the money, it is also coordinated workouts with local governments to keep local economy alive. Not pretty process, but it might stave off some defaults. Like starting in 1993 the local governments are going to have to sell away lots of assets, and they should go to be sold to the private parties, rather than selling them back to themselves in new package. Look at the Hangzhou and Zhejiang. High systemic interdependency means cascading credit accidents ahead in road. LIke cross-shareholding in Japan, cross guarantees habits of industry groups may be big problem. Thank you.
During this recession US average family wealth decreased by 40%. In the last
30 years average family wages adjusted for inflation were stagnant. In addition,
after WW II baby generation about 70 million is retiring which drove most of the growth. Since US has a debt , the taxes would have to increase next year.
Plus the demand for health and social security will put additional crimp on new generation wealth.
My main point is that the demand for goods from US shall be minimal or balanced.
We cannot run trade deficits if we want to keep present military. Thus the demand
for China products has to come from someplace else.
Huang: “since people will probably consume and buy perishable goods which most likely will not help China increase its competitive”
First, it is easy to forget, when consumers are consuming, sellers are selling. How does China increasing consumption reduce competitiveness?
Second: Let’s discuss the ultimate perishable good, recreation. Does China not want the type of economic activity that exists around Orlando? Of course they do. Milk left outside on a hot day is less perishable than a ride at Disney World. (I would like to plug Universal Studio’s in Singapore, loved it)
Third: The economy to admire on this front is Japan. When I lived there back in the early 90s, they were on top of the world. But at the time they had reservations about their own success, many told me the next goal for Japan was to become a lifestyle superpower. That was 20 years ago, and I believe they have accomplished that goal. Life is not a dress rehearsal, China’s growth model is breaking the backs of it’s population. It’s time to go to see Micky.
@40 Huang
I’m not trying to be unnecessarily cynical, but I think it’s a lot more difficult for the government to stimulate consumption than you think, for political reasons. Privatizing SOEs would remove a lot of political/economic control from top government officials, not to mention create a class of wealthy investors that aren’t necessarily friends of the Party. Genuine full-scale social housing programs that would sink the cost of housing would also eat in to government officials’ investments (one story I saw on Weibo says the Zhejiang Food and Drug admin chief personally owns over 800 properties). Allowing deposit rates to be set by the market would restrict the ability of government leaders to pad their pockets from infrastructure investments. Any move to transfer money from the center to citizens decreases top officials’ wealth obviously, but more importantly their power. That is the true road block to developing Chinese consumption, and the reason why investment is still so high. Does China need another $11 billion dollar, state run steel mill? No, but they’re building one because it increases wealth and power of the people at the top.
Too many pro-consumer policies could give rise to a class of people that aren’t necessarily beholden to the Party, and have the economic clout to question the status quo. The current system of using SOEs to regulate employment and investment funding distribution is much easier to control.
crispus 42, thanks. i am not sure that i quite understand your earlier points, but responding to the Henry Ford quote, from Henry Ford or US’s perspective, you will need to be competitive as a manufacturer first in order to hire American workers and pay them so they can buy more Ford cars. If Ford simply gave workers more money to spend, it would certainly increase their consumption for sure, but would it really make Ford more competitive? Ford would be less competitive because they have less resources to allocate to R&D and capacity expansion, Ford will also be less competitive as their cost will be relatively higher vs. the rest of the auto makers. And it’s not like Ford’s workers will use 100% of the increased wage to buy Ford cars, because they would buy other things and/or other cars. And what if Ford goes bankcrupt or loses market share as a result of this rise in cost? Would Ford have to cut wages or lay off people, which would be worse?
I really fail to see how increasing consumption can help China become more competitive. without making more things, how can we ever sustainably consume more? I feel like we are saying that by consuming more will give us the ability to consume more sustainably. Yeah, we might be making more in the process, but we are paying for those resources, and if we don’t become more competitive as a result of consuming these resources, then we will go back to a lower consumption level. I believe this is the problem that the U.S. is facing now. Its people have consumed excessively without improving its ability to produce more things, as a result, the consumption will have to come down.
Adam 47, so if I understand you correctly, you are not really disagreeing with my point that the country needs to invest more to increase the its competitiveness, which is the only way I see to increase consumption, but you are saying that the state or its agents have distorted incentives when it comes to investing. But can we be so optimistic that the private sector will do the right things in the long run? I find it very contradictory that the very people who say that China has a consumption problem think that China has huge real estate bubble. These bubbles are the result of (semi) free market forces. You give people money and they go and speculate and CONSUME it on real estate. Isn’t it relatively better to have roads than empty villas?
Historically, it has been very difficult for national economies to transition smoothly from a dominant investment/export sector to a demand/market economy with a sustainable balance of domestic supply meeting domestic demand. That’s a mouthful, but the following hopefully explains this better. Many Asian economies (Japan, the “Tigers”) have followed the investment/export model to promote rapid growth. I mentioned that I thought this was a relatively simple model in that it relied on cheap labor, managed trade policies and accessible export markets. I don’t want to dismiss the challenges of increasing education, infrastructure, management skills and organization (both business and political) in developing economies. However, in my crude economic vocabulary, I would call this strategy “displacement supply”. Local producers look at richer markets and find products and industries where they can “displace” the current supply with cheaper products. Generally, there are no new products or technology created just an ability to source cheaper products. As has been pointed out by Mr. Pettis, this model can only take you so far before it hits obstacles and the resulting imbalances become unsustainable.
The next evolution is a rebalancing with domestic consumption providing more sustainable growth and relying more on local demand/market economics. The Chinese government’s ability to quickly increase domestic consumption will likely be limited. Programs that encourage one-time pops to consumption (housing, cars) don’t always lead to sustainable patterns of consumption which is the key to a balanced growth model. (The U.S. is currently dealing with this reckoning in its housing market.) I think the challenge is even greater for local producers who have to forecast and meet local demand and bankers/investors who have to find the winners. Determining what Chinese consumers will demand in the future will likely be more challenging than supplying mature Western markets. Producers looking outside China have generally found willing and predictable markets (demand) for their products. Hopefully, China will find ways to encourage consumers and local producers will meet that demand. There will certainly be impediments because the institutions (SOEs, State-controlled banking, etc.) that have remained intact from the days of planned economy will not be conducive to this transition.
The Chinese economic miracle has rapidly increased China’s productive capacity, management skills and wealth. Now the opportunity is to create a truly modern economy that takes the well-being of the general population to even greater levels.
Good discussion All!
A little bit off topic, and I don’t know how data is collected today. But I used to contribute (for my department) employment data that was submitted to the government that eventually ended up as part of an employment statistic.
In the past (90s), we reported under one code that represented the industry our company fell under. And every month we reported a lower number. This number rolled up to the view that fewer and fewer people worked in manufacturing.
But we were operating the same number of machines in the back and were producing more than ever. The employment number was lower because we outsourced so many of the front office functions. Payroll, IT, the list goes on.These jobs were now belonging to other companies with industry codes within the services component of employment statistics. This is reflected in the participation numbers which were very high prior to the current recession.
I tell this little story in response to the idea that China must continue to make things, and more things, and that America does not make things. This has to be challenged, it’s more complex than that. It should be a story about increasing productivity. And the story for the future is good, both in China and America.
@Huang,
Yes, I think your points are correct but the incentives are so skewed its almost a waste of time to discuss them in this context. I think the only way a pro-consumption plan in China can be structured would have to motivate consumers to purchase goods in which top officials have direct economic interests in. Maybe top officials can divest in steel mills and invest in BYD, then crank out pro-car-buying policies. At the current political situation, I don’t see anyway why politicians could or would want to shift, as it does nothing but hurt them.
Classifying housing as consumption is a sticky point. Perhaps economists say as much, but I would lump housing much more in the “investment” bracket. A huge portion of Chinese housing is obviously “consumed,” but that ignores the vast, vast developments of unoccupied, investment properties. I hate relying on anecdotal evidence, but seeing forests of finished skyscrapers with so few residents has left me deeply skeptical.
I would also argue that the lack of free market pushes people into investing in housing. If China had better investment opportunities (better regulated stock market, bonds market, liberalized interest rates) and allowed its citizens to invest abroad, I think market forces would push housing prices down as investors flee to better returns. As it stands, the only place for guaranteed returns is the housing market. Its not much of a “choice” if deposits and equities are loss-making, while housing is not.
A pretty good article from Mpettis.
Huang:”I really fail to see how increasing consumption can help China become more competitive. without making more things, how can we ever sustainably consume more? I feel like we are saying that by consuming more will give us the ability to consume more sustainably. Yeah, we might be making more in the process, but we are paying for those resources, and if we don’t become more competitive as a result of consuming these resources, then we will go back to a lower consumption level”.
1.Huang, I don’t think Mr. Pettis has any argument against Chinese competetiveness. China is of course competetive, but thats not the question here? The barometer to measure prosperity is not merely being competetive producer but rather how much you consume. The more rich you are, invariably the more consumption you would resort to. So If the Consumption to GDP of the chinese economy is low or is not growing very fast then we all fear chinese are not getting rich. This is worrisome not only for the Party (eventually) but others as well.
2. you said “without making more things, how can we ever sustainably consume more?” But Huang, in my understanding, you seem to presume that every produced good has an automatic demand somewhere which is incorrect. A good is only marketable when it is in demand. so merely “making more things” wouldn’t help unless there is somebody to consume that “thing”. Mr. Pettis argument is about optimal and efficient use of resources, if the money is used to produce a good whose demand is sustainable (like Auto Servicing shop) than say a steel producing mill (which china already has in plenty) then it would not only create sustainable jobs but also improve the “competetiveness” of the economy. Competetiveness does not improve by merely producing a good but producing (or servicing a good) which is in high demand. In a world awash with over production, the goods which are in demand wins over the others but not a good which is in large supply (and probably cheap).
3. you said “Its people have consumed excessively without improving its ability to produce more things, as a result, the consumption will have to come down.”
I think you are right in this case that, there must be a balance in what you consume and what you produce. But remember if there is an over demand you have the possibility of restricting it by trade intervention but if you have oversupply it results in wastage of resources which you must pay at some point of time. The fact that Chinese growth model reached its saturation is clear here. As Chinese try to move to the manufacturing of more high tech goods, the question of serviceable industries (for those goods), adhering to international regulatory practices and intellectual property rights and more market based production come into the picture and this is where China cannot reform without reforming its politico-bureaucratic culture. Someway or the other history has forced countries to move into this direction. Its only a question of when than a matter of if.
Huang, China does not need to produce more in order to consume more. It needs to consume more of what it already produces instead of exporting the majority of it. Also increased displacement of workers in the countries that China exports to eventually weakens those countries ability to consume Chinese goods.
The world has a consumption problem. Not a production one.
“That should give a nice bump to aggregate consumption. Demand would also rise.
Paraphrasing Henry Ford: If you pay workers more, and give the workers more time off, they can buy more of your goods.”
Paying everyone in the economy 15% more doesn’t boost consumption or demand, it simply raises prices. Your economic position is a result of the value of what you can produce and will not change with a 15% rise in pay for everyone. About the only thing you can do by playing God like that is 1) steal from people’s savings as you’ve now cut 15% off its value. 2) Distort the market creating instability until an adjustment is made.
Of course the source of the problem you are trying to correct is the inflation of the money supply. Economic stability requires a stable money supply and of course that was thrown out the window a long time ago in preference to lending out money that will never be repaid.
I think it will come down to the ability of the Chinese government and politicians to take a hard look at the state of economy and make some tough decisions. Whether the monolithic state enterprises will be privatised is anybody’s guess. It would most likely be not in the foreseeable future. Increasing infrastruce expenditure in the short run may be able to push credit growth temporarily but I am not sure whether that is a long term solution.
54 Mark: Increasing wages of workers by decreasing profits does not lead to higher prices, and it does increase demand.
Mr. Pettis
Great article and excellent speech at the CFA.
I have several questions regarding China and the US.
1) The banking system will have to be bailed out sooner or later. Lets assume that it will be bailed out on the back of the saving/working class through financial repression and currency debasement as you stated. With such a heavy burden on the consumer class, how can consumption see real not nominal growth? Is it likely that we see continued negative consumption as a % of GDP if such actions were taken?
2) You state that China from the bottom would still be stable if we had real growth in consumption regardless of the slowdown in GDP growth. If policies detrimental to the working/saving class continue and exacerbated to maintain the status quo (as has happened in the rest of the world) how do you think this effects the political stability of China going forward? Do you foresee unrest?
3) In a dynamic equilibrium where multiple factors interact with each other to constantly produce new states of balance, can so many factors inside and outside of China force real GDP to go negative? Factors such as continued suppression of the consumption class, low global demand for Chinese goods, rising bad loans and the need to bail out the banks, and flat investment.
4) Why does the current account deficit must contract? This has not been the case as the Fed and primary deals have stepped in to fill the void. So the US never needs another foreign entity to purchase its bonds, but not for the reason you stated. Also isn’t this the basis of Triffin’s dilemma? That as a reserve currency, the US is require a growing current account deficit. Yet at the same time growing current account deficits undermines the credibility of the reserve status.
Hello Mr.Pettis
Whats your take on the news today that real estate prices are moving up again? A Temporary increase or a rebound in the real estate sector?
Thanks
China to build 3bln pounds theme park in Tibet
Shanghai News.netChina is Close to One Hundred Million Cars
The number of cars in China, the largest producer and buyer of the automobile sector since 2009, reached 98.46 million in mid-2011, an increase of 8.3 percent over the figures of last year, said an official report published by Ministry of Public Security.
In total, the number of vehicles in the Asian giant (also including motorcycles, tractors and trucks) in late June reached 217 million units, up 4.8 percent compared to figures of December 2010.
According to the ministry, 11 cities have already exceeded one million vehicles on its roads, including Shanghai, Shenzhen, Tianjin, Chengdu and Beijing, where the number of vehicles exceeds 4.64 million. Of these, 70 percent are private cars.
China, Mercosur eye $200b trade in 2016!China’s economy will grow at a faster pace in the latter half this year on recovering export, rising investment and expanding housing market, a report released on Sunday July 1, 2012
When googling your website, I see a message “This website may be compromised”. Just FYI.
Thanks for your good work.
CF