The IMF’s Il Houng Lee, Murtaza Syed, and Liu Xueyan have published a very interesting and widely noticed study called “Is China Over-Investing and Does it Matter?” In it they argue that there is strong evidence that China is overinvesting significantly. According to the abstract:
Now close to 50 percent of GDP, this paper assesses the appropriateness of China’s current investment levels. It finds that China’s capital-to-output ratio is within the range of other emerging markets, but its economic growth rates stand out, partly due to a surge in investment over the last decade. Moreover, its investment is significantly higher than suggested by cross-country panel estimation.
This deviation has been accumulating over the last decade, and at nearly 10 percent of GDP is now larger and more persistent than experienced by other Asian economies leading up to the Asian crisis. However, because its investment is predominantly financed by domestic savings, a crisis appears unlikely when assessed against dependency on external funding. But this does not mean that the cost is absent. Rather, it is distributed to other sectors of the economy through a hidden transfer of resources, estimated at an average of 4 percent of GDP per year.
The article is well worth reading because it makes a very strong case, perhaps a little late, for what many of us have been arguing for the past seven or eight years. China’s investment rate is so high, we have argued, that even ignoring the tremendous evidence of misallocated investment, unless we can confidently propose that Beijing has uncovered a secret formula that allows it (and the tens of thousands of minor government officials and SOE heads who can unleash investment without much oversight) to identify high quality investment in a way that no other country in history has been able, there is likely to be a systematic tendency to wasted investment.
Interestingly enough, while two of the authors of the study work for the IMF, Liu Xueyan, the third, is a Senior Fellow in the Institute of Economic Research at the National Development and Reform Commission (NDRC) of China. I don’t know how much we should read into this, but it is worth noting that both the World Bank report in March and this IMF study have involved input from important mainland think tanks.
This is noteworthy because both the World Bank report and this study have come out very strongly in the direction that the China “skeptics” have been arguing for many years. They identify the urgent need for adjustment and suggest – very delicately – how difficult it will be. I assume that this is all part of the tough debate that is taking place within policy-making circles over the need to implement the very difficult political reforms that will be a necessary part of the economic rebalancing, and I guess the reformers are eager to recruit the World Bank and the IMF to their points of view.
How much overinvestment?
One of the implications of the study is that households and SMEs have been forced to subsidize growth at a cost to them of well over 4% of GDP annually. My own back-of-the-envelope calculations suggest that the cost to households is actually 5-8% of GDP – perhaps because I also include the implicit subsidy to recapitalize the banks in the form of the excess spread between the lending and deposit rates – but certainly I agree with the IMF study that this has been a massive transfer to subsidize growth.
This subsidy also explains most of the collapse in the household share of GDP over the past twelve years. With household income only 50% of GDP, a transfer every year of 4% of GDP requires ferocious growth in household income for it just to keep pace with GDP, something it has never done until, possibly, this year.
The size of the transfer makes it very clear that without eliminating this subsidy – which basically means abandoning the growth model – it will be almost impossible to get the household and consumption shares of GDP to rise if China still hopes to maintain high GDP growth. The transfer of wealth from the household sector to maintain high levels of investment is simply too great, and this will be made all the more clear as the growth impact per unit of investment declines.
Another implication of the IMF study is that to get into line with other equivalent countries at this stage of its economic takeoff, China would have to reduce the investment share of GDP by at least ten percentage points and perhaps as much as twenty. Aside from pointing out that the sectors of the economy that have benefitted from such extraordinarily high investments are unlikely to celebrate such a finding, I have three comments. First, after many years in which China has invested far more than other countries at its stage of development, one could presumably argue that in order to get back to the “correct” ratio, investment should be lower than the peer group, not equal to the peer group. In that case investment has to drop by a lot more than ten percentage points.
After all if China’s deviation from the experience of other countries is meaningful, then after a few years of substantial deviation, it cannot be enough for China simply to return to the mean. It must come in lower than the mean for a few years so that on average the deviation is eliminated.
Second, even if China had kept investment at the “correct” level, as measured by the peer group, this would not imply that China has not overinvested. I haven’t been able to dig deeply into the comparison countries, but the study does list them, and a very quick glance suggests that many of these countries, after years of very high investment, themselves experienced deep crises or “lost decades”.
This implies to me that these countries themselves overinvested, and so even if Chinese investment levels were not much higher than that of the peer group (and it was mainly in the past decade that Chinese investment rose to much higher levels than that of the peer group, and not in the 1990s, exactly as we have been suggesting using more qualitative measures), this could nonetheless be worrying. China would still have a difficult adjustment for the same reasons that many if not most of the peer group countries also had difficult adjustments.
The average number driven by the peer group sample, in other words, is not in itself an “optimal” level of investment. It might already be too high. That Chinese investment levels have been so much higher than theirs is all the more worrying.
How much would growth have to slow?
My third point is more technical. If Chinese investment levels are much higher than optimal (assuming the peer group average is indeed optimal), of course the best solution for China is immediately to reduce investment until it reaches the right level. The longer investment rates are too high, the greater the impact of losses that have eventually to be amortized, and the worse off China is likely to be.
But it will be very hard for China to bring investment down as a share of GDP by ten full percentage points very quickly. Let us assume instead that China has five years to bring investment levels down to the “correct” level, and let us assume further that the “correct” level is indeed ten percentage points below where it is today. Both assumptions are, I think, dangerous because I am not convinced that an investment level of 40% of GDP is the “correct” level for China going forward (I think it must be much lower) and I don’t think China has five years to make the necessary adjustment without running a serious risk of a financial crisis.
But let us ignore both objections and give China five years to bring investment down to 40% of GDP from its current level of 50%. Chinese investment must grow at a much lower rate than GDP for this to happen. How much lower? The arithmetic is simple. It depends on what we assume GDP growth will be over the next five years, but investment has to grow by roughly 4.5 percentage points or more below the GDP growth rate for this condition to be met.
If Chinese GDP grows at 7%, in other words, Chinese investment must grow at 2.3%. If China grows at 5%, investment must grow at 0.4%. And if China grows at 3%, which is much closer to my ten-year view, investment growth must actually contract by 1.5%. Only in this way will investment drop by ten percentage points as a share of GDP in the next five years.
The conclusion should be obvious, but to many analysts, especially on the sell side, it probably needs nonetheless to be spelled out. Any meaningful rebalancing in China’s extraordinary rate of overinvestment is only consistent with a very sharp reduction in the growth rate of investment, and perhaps even a contraction in investment growth.
In fact I think over the next few years China will indeed undergo a sharp contraction in investment growth, but my point here is simply to suggest that even under the most optimistic of scenarios it will be very hard to keep investment growth high. Either Beijing moves quickly to bring investment growth down sharply, or overinvestment will contribute to further financial fragility leading, ultimately, to the point where credit cannot expand quickly enough and investment will collapse anyway.
This is just arithmetic. The extent of Chinese overinvestment – even if we assume that it has not already caused significant fragility in the banking system and enormous hidden losses yet to be amortized – requires a very sharp contraction just to get back to a “normal” which, in the past, was anyway associated with difficult economic adjustments. It is hard to imagine how such a sharp contraction in investment will itself not lead to a sharp drop in GDP growth, and the IMF paper recognizes this:
To the extent that elevated levels of investment during the post-crisis period in China were somehow abnormal and necessitated by the sharp external slowdown, the challenge now is how to return to a more “normal” level of investment without compromising growth and macroeconomic stability.
This will be my last post of 2012. I wish all my readers a wonderful 2013.
This is an abbreviated version of the newsletter that went out three weeks ago. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at chinfinpettis@yahoo.com, stating your affiliation, please. Investors who want to buy a subscription should write to me, also at that address.
Feliz navidad, Michael
Mr. Pettis, can you provide a bit more background on how you came up with that 4.5% you used in calculating the relationship in growth rate between GDP and investment?
Thanks and happy holidays!
You use two fairly simple equations. In one equation you calculate what China’s GDP will be in five years, using different estimates for the GDP growth rate. In the second equation you calculate the required investment growth rate that will take investment from 50% of today’s GDP to 40% of the GDP you calculated for five years from now. The difference between the two will be roughly 4.5%, depending on which assumption you use for GDP growth.
Many thanks Michael, for your wonderful insights and generosity in sharing them this year and previous years. I bought your book recently (The Volatility Machine) and I highly recommend it to any other readers of this blog and I am looking forward to any further formal publications that may be forthcoming.
Given that there are important political contexts embodied in your explanations and given that you have at least an abstract interest in fairness and a concern for the welfare of all economic participants perhaps at some point a text outlining the various ways a government can manage the affairs of a country so that an optimal and fair economic result can be achieved. You do this to a certain extent in the Volatility Machine, in relation to comparing the sovereign balance sheet to the corporate balance sheet etc, but clearly your ideas have developed much further since. Perhaps I am anticipating what is already in the pipeline. I hope so.
I am interested in the mechanisms by which wealth tends to percolate upwards and the roles a government plays to redirect the wealth back to the bottom of the pyramid and in doing so keeps economies as a whole functioning fairly and efficiently. I have not yet seen this mechanism discussed comprehensively anywhere except here.
Thanks Simon. I describe in a small way some of those mechanisms in my next two books, one coming out in February, on the global rebalancing, and the other coming out in May, on the process of Chinese adjustment. This is a very important issue. I especially recommend two 19th Century economists on the subject, the American Charles Arthur Conant and the British JA Hobson, who show how rising income inequality, by forcing up savings rates relative to domestic investment investment needs, must automatically result in speculative investment domestically or capital export. In fact Hobson famously argued that the root source of European imperialism in the 19th Century was the need to export savings because of rising income inequality at home. The Marxists picked up his argument in Lenin’s big piece on imperialism, and by now it is widely accepted among economists of both the left and the right, although supply-side economists, perhaps without realizing it, would disagree with the idea that rising income inequality leads to excess savings.
Thanks Micheal, I will look those guys up on Amazon.
But China can easily adjust with a 10% GDP reduction in investment, and a 10% GDP increase in healthcare and education spending, both of which was woefully underfunded during the past decade. In China, this probably can be done overnight. GDP growth needs not slow down too much because of the rapid growth in productivity.
There are two problems, Seatrus. First, while it is widely acknowledged that China could use a substantial increase in healthcare and education spending, it is politically very difficult to direct money into the most appropriate uses. For example much of the increase in educational spending in recent years went into expanding the university system rather than expanding primary education, where it would have been much more useful in the long run. It went into the university system probably for political reasons — partly, under Zhu Rongji, as a way of addressing the rise in youth unemployment in the late 1990s and early 2000s — and the consequences include a sharp decline in the quality of university education except at the top schools (enrollment increased much faster than spending) and a very serious unemployment problem among university graduates. For obvious reasons I will not speculate on why it is easier to spend money on a dam or a bridge or a new university campus than to spend it on rural kindergartens and healthcare for the old, but it does seem to be a problem.
The second problem is much more important. If investment misallocation has caused an unsustainable increase in debt, and if this has become a problem that must be resolved in the medium term (5-10 years), then the only investment that resolves the problem is investment in projects which cause debt servicing capacity to rise faster than debt in the medium term. I think Beijing, perhaps a little late, now recognizes that there is indeed a debt problem and one that must be resolved quickly. The recent WMP defaults and the bank runs in Jiangsu province show why this must be addressed quickly and forcefully.
Unfortunately the kinds of investment projects that address the debt burden do not include health and education. Socially these are very good investments, and in the long term education is also economically a very good investment (at least if it is directed to the very young, and not to more university spending, which tends to dominate), but in the medium term both kinds of investment make China’s debt management more difficult, not less difficult. It takes many, many years for educating the young to pay off in the form of higher productivity, and better health care for the old never pays off economically, although of course it is very important for the good of society.
Since China already has a problem with too much debt, and debt is rising extremely quickly, solutions that involve faster growth in debt than in medium-term debt-servicing capacity are not going to address the over-investment problem. By the way you are probably overestimating the real growth in productivity of recent years.
Remember that misallocating investment tends to overstate real GDP growth by overstating real growth in productivity. If the IMF numbers are right, and I suspect that they actually understate the problem, real productivity growth in recent years has not been high enough to keep up with the real rise in debt. China must reduce investment spending in order to deal with the debt problem, but it will not resolve the debt problem if it replaces that spending with spending in areas that do not cause medium term real productivity to grow faster than real debt.
[Unfortunately the kinds of investment projects that address the debt burden do not include health and education. Socially these are very good investments, and in the long term education is also economically a very good investment (at least if it is directed to the very young, and not to more university spending, which tends to dominate). ]
I appreciate the thought of helping younger children, but there doesn’t seem to be any mathematically sound correlation between spending on education and improved results. As with the incessant demands by school officials for smaller class sizes, there is no data that suggests more favorable results from smaller class sizes. In fact most Asian countries’ primary schools have significantly larger class sizes than in the USA.
With regard to China, I’ve visited a few primary and middle schools in the last three years, including in impoverished areas, and although the facilities were fairly spartan, I found a pretty good environment for learning, similar to what I experienced myself, in the early 1970s in Bethesda, Maryland, USA. My major suggestion for China, which I’ve shared with ministerial-level officials, is to get better-trained English teachers by offering higher salaries and being more choosy. Unlike the lack of objective data that proves a correlation between academic spending and improved results, there are many studies that show the benefits of creating bilingual and trilingual students as early as possible.
If one visits well-off government primary schools in the USA, one notices that the physical plant and equipment are superior to what you see in rural China, but you also notice a lot of spending on things that don’t correlate to improved educational results.
My conclusions, after raising a child, tutoring about ~50 kids over 10+ years, and visiting most of the Asian countries, is that primary schooling in Asia is doing pretty well, and should largely be left to continue on with its success. They’ve taken what once made western primary schools great and ran with it, while the USA discarded “what worked” over many years.
I had a different experience than you did as a teacher in China. I thought the facilities the public school I worked at were far superior to those in US public schools (digital projectors in every room, campus wide wifi, pristine gym facilities). Both the gym and the library were huge boondoggles though, built at massive expense when no one actually used them except for ceremonies and the like. Debate the merits of PE class, but at least in the US they tend to use the gyms they build.
I don’t think parents or students are very satisfied with Chinese education, regardless of what test scores reveal. Have a walk through Hong Kong customs on an early morning, and see the hundreds of children – even kindergartners – being shuttled from the mainland to get what their parents believe is a better education.
@Andao – I agree with you as my wife is an English teacher teaching TESL to foreign students mainly from China,such is the impression she gathers from interaction with Chinese parents.They seldom complaiin about the school facilities in China or praise the facilities available in Singapore-one of the richest countries in the world.
Another good read. I note in the quoted abstract echoes of your own words on the FT Alphachat podcast mid-2011, professor.
Many thanks for making these great articles available on your blog. All the best in 2013.
Here is an article from a foreign press that says the government are increasing control of the internet: http://www.ft.com/intl/cms/s/0/7ab3e9d4-50d4-11e2-b287-00144feab49a.html#axzz2GQy7uVpJ
Of course we canot find such an article in the Chinese press. In the future a successful economy must be successful in internet and information technology, but the government is trying to prevent China from becoming successful in inovation and advanced technology by making China more backwards in the internet. Doesn’t this prove the growing the economy is not the main goal of the government?
Thanks you for teaching me and many other people about Chinas economy. Many Chinese economists, and also in the government, are waiting for your book on China. Of course I will read it too. I wish you a merry christmas and a happy New Year!
Thnaks, He Fan. The main goal of every government, whether democratic, authoritarian, republican, etc., is the maintenance of stability, not economic growth or anything else. My old professor at Columbia University, Ambassador Howard Wriggins, called it “the ruler’s imperative”. In that case the best political system for any country is one in which the political incentives are designed in such a way that the government is best able to maintain stability by doing what is best for the people of that country.
Of course there is no question that limiting access to the internet reduces Chinas’s long-term growth potential, and weakens its ability to influence the global development of information and communications technology, but it may increase political stability, which may itself be a pre-condition for China’s long-term development. I can’t argue one way or the other which is better for China because of course it is up to Chinese people to decide which makes China better off.
I do think, however, that many if not most policymakers involved in economic and financial decision-making, and even more of their academic advisors, now recognize the the urgency of economic reform and the development of a new growth model for China. This will not be easy politically, of course, for the many reasons discussed, however delicately and carefully, in the Chinese press, but I do think that there is by now pretty widespread agreement in principle about what must happen.
This article once again shows why I love reading you – and yet don’t believe your predictions.
This seems to me to be very insightful:
“Unfortunately the kinds of investment projects that address the debt burden do not include health and education.”
The investments that make old investments look better are more infrastructure: the more roads/rails you have, the better the network is. Up to a certain point, of course.
But this point raises my big problem with your analyses:
“The article is well worth reading because it makes a very strong case, perhaps a little late, for what many of us have been arguing for the past seven or eight years.”
Yes, you’ve been saying this for a long time. And China has conspicuously failed to have a big crisis for the last seven or eight years. I don’t particularly doubt that there’s one coming – every country goes through a crisis sometime – but it’s not at all clear to me that your analysis is useful for telling us when it’s going to happen. Obviously you’re right that the current trends can’t go on forever – no trend can – but you don’t seem to have a clear grip on when it’s all going to burst.
Another problem I have with some of the analyses I read, yours and others’, is ideas like this:
“…households and SMEs have been forced to subsidize growth at a cost to them of well over 4% of GDP annually.”
Household spending has been rising at what, 8% per year? Slower than GDP, but probably the fastest sustained rise in consumption anywhere at the moment, comparable to the other Asian miracle economies. The idea that they should have/could have been rising faster seems… excessively hopeful.
So while I don’t deny the accuracy of the type of analysis you’re doing, I’m not so sure how powerful it is. I’m not sure that it’s telling us useful things about the future, or useful things about policy.
For example, if I were a Chinese politico, I might think this: yep, OK, at some point things are going to change, and yes, there’s a significant chance that they might change through a massive financial crisis. A bit like the one America just went through. And yes, it’s possible that the longer we delay the financial crisis, the bigger it will get. But I’m not seeing any evidence to tell me whether a medium sized financial crisis now, in our middle-income economy, would be any better or worse than a big financial crisis in ten years’ time, when our economy has moved up an income bracket. Plus, in that ten years, our courts and financial sophistication will have improved a lot, so we may be much better equipped to handle it.
So, I find it hard to feel the “urgency” which you seem to have been feeling for the last seven years.
Nonetheless, I love your blog. Thank you for continuing to share with us for free what you can obviously get paid good money for!
Dear Sir,my layman’s (engineering graduate) prediction is that it will happen after the new year,2013,let’s hope that I am slightly luckier than Gordon,happy new year 2013.
Hi Phil H,
I’m quite certain you’re not the only person that has a problem with this blog (along the lines you mentioned).
It’s kinda like reading week after week that “hey, if you leave the stove on in the kitchen unattended, it will eventually burn down the house.”
Yes, we all know that. But it can go on for a long time. It can go on for weeks…months….even years (if the stove is sturdy enough and gas is supplied.)
But we’re not interested in being told that the stove can’t keep on burning. We’re interested in identifying the signs that tell us when and if the house will imminently burn down. Anticipation is the key word here.
What if the kitchen’s window was open, and paper are blown around dangerously close to the stove’s fire. Wouldn’t that be something that’s much more meaningful to watch for?
Yet, this blog keeps going on and on and on about the stove can’t burn forever.
OK. I get it. But this seems not the place to look for analysis deeper than that.
Also, this blog puts into long written form what can probably be summed up in one simple spreadsheet. And much of what’s written has no commentary regarding the personalities involved in China’s economic process. Who is Xi JinPing and who is Li Keqiang? What are their predispositions from their past legacies? Are they running the show? Zip, zero, zilch about those.
Andy
@Andy,probably you are a well trained economist,but for a non-economist like me,I find the messages very useful,cheers
Actually Jack, I am pretty sure Andy is not a well-trained economist because he seriously misses the point of my (or anyone else’s) analysis of the Chinese economy. The idea that the reason we try to understand a country’s economy is to give retail traders advice on timing their market speculation is simply wrong, and far more likely to be found among followers of TV shows like Mad Money than among economists. well trained or not.
Someone wrote a very interesting critic to Michael in one of the comments, which I find particularly hard to reject: what if this all is just an accounting trick? GDP is in fact not growing at 9-10%, most of the investments are in fact public consumption. In that sense consumption is not very low compared to the real value created. China is in fact growing balanced, there is just a strange kind of redistribution – through state owned banks.
And yes, when the non-state sectors of the economy reach their limits (export, private consumption) the growth will slow down. But no crisis, no headline news. no bear sterns. no lehman brothers.
@Lemmiwinks I remember those so called “invisible consumption”points were responed by Mike Pettis in this blog then,I found his explanation reasonable,did you see his response?
Andy,
When the vast majority of (extremely well paid) sell side research starts by ignoring you, then insults you and then slowly comes around to your opinion, I think it’s safe to say what you’re doing is valuable and repetition may have been a requirement to get the message across. It wasn’t that long ago that informed opinion had it that that China had figured out the key to growth and were the model for other countries to follow. And even now you don’t have to look hard to find people saying that China’s bottomed out and the future looks great. I think more repetition may be needed still.
You also need to be careful with the measuring sticks you use. The desire to be told how and when the house will burn down is exactly why those sell side guys make as much money as they do. The difference between them and somebody like Pettis is that one will tell you the truth about how hard it is to make any sort of prediction like “2013 is the year China’s growth tanks”, while the other gladly profits by releasing another 50 page powerpoint with pretty charts that has as much chance of being right as a monkey throwing darts. Remember when Paulson was the genius who understood the US economy and forecasted the crash? Or take a look at how Bill Gross’s last few years of predictions have done.
This stuff is hard and predictions from even the smartest of people are most likely to be wrong. You’re better off looking for a conceptual framework for understanding the way the world works. The financial crisis showed that much of modern economics was on the wrong track and Prof. Pettis is laying out the case that the problems in understanding how the economic systems works extends to China and the international economic system as well.
I disagree with your simple and, IMO, incorrect analogy. Michael is one of the few and first to debunk notions about the utility and impacts of China’s economic decisions. To use your analogy, It is Michael whom is warning that if you leave the stove on eventually the house will burn down. Most others are comforted in thier belief that if the house dose’nt burn down after 10 minutes it never will.
Michael is in the same position as Dean Baker was in being the first to call out the US housing bubble. Dean was derided by the majority of his peers and the media at first but ended up being prophetic.
I have to agree with Andy. Even if there is a house bubble, the Chinese officials already act on this issue with higher equity and apartement ownership rule. It seems like that they are aware of this chance. It won´t result in a “crash” like in Spain, Ireland or the US.
This whole “consumption rebalance” is an euphemism for “we want to profit from Chinese money” argument.
There’s a few thousand empty apartments in Shenzhen I can show you if you’ve got the wheels. It’s hard to see how this can NOT end badly just based on the extremes you see on the ground.
Also, Michael specifically refuses to give investment advice or endorse any investment opportunity, so I’m confused where you get the idea he’s going to profit from Chinese money some how.
And I can show the many Chinese men, who are looking for a bigger apartement, because they need one for marriage. I guess you have heard of this problem. But I don´t deny that really could exist a housing bubble, but more consumption won´t stop the problem. (Why should it? Ever heard of the consumption bubble / overconsumption in Greece?) There is no problem to shift from housing investments to another infrastructure investment or to SOE investments or to SME investments, too.
In the end the big banks are owned by the state anyway. The central bank can bail them out and start a stimulus (Keynes), a reflation (Irving Fisher) or restructering/default of bad loans (Minsky), if necessary. The central bank has enoug money and with the reserve ratio a mighty tool to preserve price stability and prevent a big inflation. There is no big moral hazard problem like in the West, where the banks are private banks.
I don´t accuse Michael of being a profiteur. But his arguments sounds similar to the ones of the banking and hedge funds industry. He may fall for the lobby schemes of his old colleagues. Usually “consumpton realance” is in reality aimed at a deregulation of the financial market, a lower reserve ratio, lower equity securities for credits, less control of the borrower, less rules for the cash-flow and liquidity, which of course would boost debt-based consumption, but also increase the propbability of a debt crysis and a financial crash.
Thanks Phil. There is too much stuff in here for me to respond, but two points. First, the argument that household consumption has failed to keep pace with GDP growth is not an argument that household consumption is growing too slowly. It is an argument about the structure of demand and the sustainability of that structure.
Second, you may be right that my writing does not lead to policy recommendations, but I am not sure too many Chinese “politicos” agree with you. I obviously cannot go into detail, but many policymakers have incorporated my arguments into their own policy recommendations and I do spend time (more than I would like) discussing these things with policymakers and their advisors. In fact one of the things that I worry about is that my work has become too embedded in the domestic debate, and not always accurately cited. I think the policy recommendations that flow from my analysis, whether right or wrong, are very obvious and in fact my upcoming book on China, which should come out in May, draws out systematically the policy implications for those who agree with my analysis, and who are now, I think, the majority of economic policy advisors in China. I have also been criticized domestically by a umber of people, generally not economists, for my arguments and more than once I have even been blamed, astonishingly enough, for having created the very crisis I predicted. This suggests to me at the very least that some people do think this analysis has policy implications.
Phil H,
The US great depression in 1929 happen in 4 days. US Banks had enough to provide 10 cents for every dollar. Banks called in loans. Many people were wiped out, selling businesses and loosing their life savings. But you might say that our banks will start printing more currency, but then which country will be willing to accept your currency. They all will demand to be paid in dollars . Will people accept to be paid in meters of a bridge? or centimeters of a train?
So you see crises arises very unexpected and as Prof says is never predicted accurately.
This is an important point, Stan. It is possible systematically to understand the strains that lead to financial crisis, but anyone who says he can predict the date at which it will happen is as credible as someone who predicts the date of earthquakes. It simply is too complex a system for that level of prediction. What is far more useful is an analysis that recognizes how strains are being generated because this tells us about both the relationship between the occurrence of the break and its severity and the kinds of policy that will minimize the long-term costs of the break.
Michael,
The government has identified urbanisation as a growth engine. Urbanisation will increase both consumption and investment. Will it aggravate or improve the imbalances?
It’s only a growth engine if there’s jobs. And most of these jobs are migrant workers building houses. I don’t think you can just say “we ought to urbanize” and it happens. I don’t know where all those people are going to work if the housing boom slows down, or even maintains its current pace.
This is not the first time that urbanization has been proposed as the great growth engine that justifies all investment. After all the US experienced massive urbanization in the 1920s and this was — inevitably — one of the reasons that bulls insisted that the 1920s was not a bubble and was sustainable. Urbanization is more a consequence of growth than a cause of growth, and historically the effect of large scale urbanization has been to exacerbate growth on the way up and contraction on the way down.
Do you think that an unravelling of WMPs is imminent?Due to investor runs and regulatory clampdowns?I believe this could be a trigger for a credit crisis as WMPs are the devices for masking away credit risk,like CDOs were in the US.
To all: regarding the burning house, many thought that Roubini was a quack in 2006. Michael’s arguments are sound. You cannot ignore the math. What is keeping the house from burning is the amazing ability for the government/regulators/banks to cover up a massive bank debt problem and the amzing ability of the 1 billion or so unconnected/unprivledged lao bai xing to tolerate the gross inequities of a system stacked against them.
And yes investment wasted is still consumption. The problem, as Michael has pointed out ad nauseum, is that this spending is financed and that debt must be paid back.
Interesting article about Chinese voting with their feet: http://online.wsj.com/article/SB10001424127887323635504578213933647167020.html
I think Michael is wrong regarding the Chinese growth model.
The standard neoclassical economic model tries to seperate between investment, consumption and saving. This is only right on paper, but in reality investment and consumption overlaps and are part of the demand side. How one can distinct a house purchase in consumption or investments? As we see in the debt crysis of the West, there can be massive malinvestments in either systems anyway.
China should stick to its economic policy.
Is there a difference you can point out between the Chinese model and the Japanese one that led to a lost decade(s)?
Prof Pettis, if China’s investment to GDP is unsustainable and is approx 10% of GDP higher than the “sustained” level, could you give some comment on India’s consumption to GDP, it has touched 67% in the last 5 years aided by Govt hand outs. Which of the two is the lesser evil and will have a lower distortion in the long run. Hope, you will comment
Anoop, unfortunately I don’t nearly as much about India as I would like, and I am slowly trying to climb up the learning curve. The important thing to remember is that neither investment nor consumption is good or bad in and of itself. It depends on a number of things, including how it is funded.
Since the 1990s, the accelerating global debt and now money printing (QE), has created an excess capacity of low-wage, manual labor production, that would otherwise be uneconomic in the face of technology we possess for automation.
For example, Google has cars driving themselves autonomously producing their “street view” images for their maps application.
Companies have very low incentive to automate, because developing markets are expanding so rapidly in this peaking phase of globalization (historically always driven by excess debt and money printing), so companies choose inefficiency for expediency.
Imagine when this retreats, the cost of an employee will skyrocket as politics of failure dictate labor protections.
The retreat will be non-linear (i.e. exponentially abrupt), because the demand for efficiency (i.e. automation, reduction of labor) will create more demand for political subsidies to the unemployed, thus increasing the costs of labor and thus increasing the demand for efficiency (i.e. eliminating labor).
The move to massive automation is going to in the short-term enrich only a small portion of the global population (and impoverish the rest in an abrupt adjustment phase), while the standard-of-living of all will increase in the long-term due to greater efficiencies.
For example, imagine in the Philippines (and probably also in China), much accounting is still done manually with physical books. Most every company in not fully interfaced with the cloud (the internet), and even when they are, their websites don’t function properly, aren’t kept up-to-date, etc..
We are going to see a radical shift in our world, once the global debt and money printing bubble peaks, and the stampede to automation gains momentum.
This adjustment will be particularly severe and politicized globally, so war is a distinct possibility. Kyle Bass explaineed this is usually how such severe imbalances play out.
As for the timing, a potential likely catalyst to set off the global dominoes is Japan, here is the link to the video of Kyle Bass on that:
http://www.mpettis.com/2012/12/04/three-cheers-for-the-new-data/#comment-20395
How will a monolithic China and its 1.3 billion adjust to a new world order, where automation and control over cheap energy is wealth?
The resolution will be political. We will have the economic means to produce more for everyone, but excesses of capacities of inefficient manual labor production, so the distribution of wealth will be grossly concentrated as the adjustment process ensues abruptly.
In order to distribute to the general population, the government must have the means to tax those who are enriched from the automation. But what if most automation is created for example in the USA tax jurisdiction, yet most of the global population is in Asia?
The developed world is ramping up massive money printing (QE). So we are in the crackup-boom phase of the end of the globalization debt bubble. 2015 looks very compelling as the end game.
More succinct summaries of Kyle Bass’s argument that Japan will set off the global dominos within 12 to 18 months:
http://www.businessinsider.com/kyle-bass-japan-has-a-full-crisis-2012-11
http://annual.cfainstitute.org/2012/12/07/kyle-bass-on-japans-debt-crisis-this-is-how-it-falls-apart/
http://www.zerohedge.com/news/2012-11-20/kyle-bass-end-debt-super-cycle
I have been harping on the coming robotics wave. 60 Minutes did a story on this recently:
http://www.cbsnews.com/video/watch/?id=50138922n
Everything I had postulated is mentioned by these MIT experts.
Jason wrote else where:
Jason indeed, but the adjustment process can include significant unemployment.
Mostly because the people resist the adjustment process with socialism and statism, i.e. redirecting capital from the productive future to forestalling the present.
Robotics will increase productivity yielding more resources to involve humans in a greater diversity of activities.
The most free societies will be best able to capitalize on the greater diversity of activities coming…
@Shelby
“The most free societies will be best able to capitalize on the greater diversity of activities coming…”
This is probably the point that knowledgeable Jamba has missed,and the point that Dr Morris Chang has made,that is where I as an overseas Chinese,can detect that “detest” feeling that China has been wrong by the Western imperial powers who have also been responsible with the present world crisis and that this is an unique opportunity for China to rise to the top of the world,it’s like a Chinese saying: “恨铁不成钢”(It is such a pity that iron can’t be steel.)
There are quite a number of Chinese intellectuals who think along this line including some smart Chinese economists,I read most of them in the Asian Tmes on-line and the Diplomat magazine,etc.
I mentioned this:
http://www.mpettis.com/2012/12/28/the-imf-on-overinvestment/#comment-21099
Also Mish has picked up on my robotics theme:
http://www.financialsense.com/contributors/michael-shedlock/fed-cannot-win-fight-against-robots
Globalization Technology Cycle
Housing Recovery Illusion
Continued inflation-adjusted housing decline due to technological unemployment.
http://www.coolpage.com/commentary/economic/shelby/Housing%20Recovery%20Illusion.html
The first historical chart on the linked page will make you believer that we can get several decades of persistent unemployment from the technological innovation.
Goodbye to doctors:
http://www.extremetech.com/extreme/148220-ibm-makes-watson-the-size-of-a-pizza-box-starts-offering-cloud-access-to-doctors
More links of the technological shift underway:
http://esr.ibiblio.org/?p=4781&cpage=1#comment-394556
http://esr.ibiblio.org/?p=4781&cpage=1#comment-394688
http://www.theatlantic.com/business/archive/2013/02/the-mystery-of-the-incredible-shrinking-american-worker/273033/
http://endoftheamericandream.com/archives/we-are-witnessing-the-slow-tortuous-death-of-the-american-worker
Today I initiated a potentially key element towards solving this global jobs crisis:
http://copute.com/edu/
It is amazing how woefully unadopted is computer science education as compared to all the other sciences.
Phil H and Andy, I think you guys are looking for a nostradamus of sort and best for you to be consult your astrologer. What you are looking for is – “someone tell me the day and date when economy is going to tank, so that I can short and make money. ” I don’t think anyone is brave enough to give it a timeline.
I like the blog because it helps me understand Chinese economy better. If the house catches fire, at least you would know how can that happen and not stand there with cluesless in disbelief when the sign were always
Based on my experience, you can maybe predict the timing if it was a corporate but given the room a sovereign has to delay things, it is difficult.
Luhar, 2nd half of 2013 and 2014!
For those who are interested in accounting tricks, this is a good article refuting the idea that the investment rate is too high and not sustainable. http://www.ftchinese.com/story/001048246. Worth a read. If the data hints strongly at something that didn’t happen, it may be worthwhile to double check if the data is right in the first place.
“How one can distinct a house purchase in consumption or investments?”
I think that would normally be done by asking if the house is a new addition to the stock of housing (investment), or a case of consuming from the existing stock of housing.
If I buy a house, which already exists, and rent it out in the hope of a higher return than the house price, ..
Investment? I think yes.
Consumption and investment are both expenditures. The difference is the intention.
Investment: Hopefully higher returns. – But you can fail..
Consumption: You don´t expect any returns. – But returns can sometimes occur.
Thanks Michael for enlightening articles. They answer a lot of the pertinent questions and make sense of the big picture in China. Look forward to purchasing your next book.
One aspect of the economy that has been in the media as of late is how Chinese companies are regulated when dealing with foreign companies and governments, be it in China or abroad.
One end of the situation there’s the examples of the huawei dealings (American government seeing certain Chinese companies as security threats based on murky evidence) and the regulations on being audited when listing on the US stock exchange (possibly banning the Chinese auditors from the list of US approved regulators therefore forcing a large number of Chinese companies to de-list. In my opinion this would have a chilling effect on business dealings and maybe kick off some trade/regulation dispute tit-for-tat, but, they are listing on the USA stock exchange and that is subject to USA laws so what can be expected from a USA regulatory body).
The other is the apparent double standard of regulation that foreign companies have to deal within China and the company vs country ethos rather than company vs company ethos.
These seem to be a major stumbling block for international multilateral business integration, innovation, efficient business management and broader private sector growth.
When China does move to a more consumer driven economy, the next logical question in my mind was will the Chinese government allow an equal platform for foreign entities?
I’ve read and heard quite a bit recently, even from China hands that have been there 30 years that indicates it’s getting harder and harder to do business in China as a foreign company.
Any thoughts on that?
Curl, it is very hard to find managers of foreign businesses, whether they are Chinese themselves or foreign, who do not think that foreign businesses are severely discriminated against in China and have a very tough time here. Many blame explicitly discriminatory polices by the government, and although they may be at least partly right, I suspect that there may be something else going on. In Japan, Brazil, South Korea — not to mention the USSR — and nearly every other country I can think of that has experienced this kind of growth model there has been the same kind of complaint by foreign companies, and I suspect it has to do not with explicit discrimination so much as it has to do with access to credit. Remember that one of the hallmarks of the investment-driven growth model has always been financial repression, and control of access to credit and credit costs is key to controlling much of any economy.
Jamba,
Your comparison to the west is apt. It turned out badly for the west over the last 5 years wouldn’t you say? Your allusion argues for exactly what Michael is saying.
The issue as i see it is that the gdp impact of investment and consumption is the same. It creates economic activity. An exchange is happening and that is what gdp attempts to measure. However, to use accounting terms, consumption is an income statement item. Consumption is financed by income or revenue to use the proper accounting term. To the extent that income is insufficient to fund the consumption, debt is incurred. The debt must be paid back by either future positive income or by some kind of transfer of wealth (assets). In the US, this is the situation. Private households and the government together consume more than their income and therefore as a nation, the US is a debtor nation. China, however, calls many of its expendituress investment. This still has the same cash impact as investment on gdp and it is quite easy to grow gdp by pumping investment However, by definition, that investment is financed by savings (let’s call it debt or borrowed money).
The issue that michael is pointing out is that to the extent that these investments do not provide accompanying future cash flows to repay that debt, then you have the same situation that the US has. Since investment is close to 50% of gdp, that is a massive pile of debt to be paid back. If even 10% of those projects fail to generate any debt service, then you have a 5% of gdp deficit which is significant. With all the bridge to nowhere boondoggle projects that you see traveling in China, it’s not hard to imagine that 10% of investment is an air ball.
The prc government recently announced that it would run a 1.2 trillion RMB deficit for 2013. That is already in excess of 2% of gdp. If one were to layer on to that number the recognition of bad bank loans for all those boondoggle projects, it would not be hard to see that number explode.
That’s the issue. You are right. In the final analysis, when you strip away all the finance and economic mumbo jumbo, the west and china are not that different. It’s just the west acknowldeges its problem. China is in denial.
I think your definitions may be a bit off. There is no accounting definition or requirement that investment be financed with debt. Investments may be financed with debt or they may be financed from current income or by drawing down past savings. Examples: I own stock in several companies. Some have a lot of debt, some have essentially no debt, and in all cases the amount of investment well exceeds the amount of debt. Similarly, consumption can be paid for from current earnings, by accumulating debt, or by drawing down past savings.
Yes you are right but since we are mixing The definitions used by Keynes/macroeconomists with accounting terms. I was merely trying to use accounting analogy to point out what Michael is saying. True, investment must be funded by debt or equity. In your scenario, you are an equity holder. But Both are savings. And that is Michael’s point…savers are getting screwed by malinvestment made by party cadres.
What i was trying to show,using accounting terms is that the US, if it were a firm is showing losses as expenses exceed revenues. China does not show losses but it is making investments on its collective balance sheet, whose cash flows will not be able to pay back debt or return to the equity holder sufficient funds to cover the investment principal. These are embedded losses that will need to be covered by recaptializing the state owned enterprises, the local government financing platforms or the banks…just like in the 90′s for the soe’s or 1999 and 2004 for the banks.
Of course you are right, G Steven. Neither investment nor consumption need be funded by debt. I think this is why Jamba’s analysis is so hopelessly confused. He does not seem to understand the role of debt.
Hua Qiao,
I disagree, Michael argues that “consumption rebalance” will hopefully help China to avoid a fall of future cash flows. (As spectators we cannot even correctly seperate the expendituress into consumption and investments outside the theory model world everytime.) He doesn´t explain why consumption is superior to investments. Isn´t the opposite claim,
Investments has higher chances to secure future cash flows, but cannot guarantee it (malinvestments), while consumption doesn´t even has the intention to secure the future cash flow.
much more accurate? Of course you can argue that consumption doesn´t have to be based on debt. However the very problem of all this is that we live in a debt money system. I´ve once read the doctor thesis of Josef Ackermann, the former CEO of Deutsche Bank and Chairman of the Board of Directors of the IIF.
He states
- that within our debt money that it is unavoidable that future growth only can grow on future non-central-bank debt (by the state, private banks, households, companies) or debt-free issued money by the central bank and
- that we are damned to grow or else we will fall into Irving Fisher´s “debt deflation” trap.
This means that a higher consumption GDP only can be based on more debt (or money printing). At the very moment you can see the results in the US, where the FED has to print money and save the economy.
China should be aware that it cannot avoid a debt crysis for everytime and everywhere within a debt based money system anyway. Consumption won´t help to avoid it. Investments will sometimes lead to malinvestments. But the solution isn´t “consumption rebalance”, which can lead into a crysis like in Greece, or the US, too.
The solution is defensive awareness. There will be a debt crysis. It is unavoidable. Even in consum-driven countries they can occur. But one can take for this scenario. If the debt crysis occure, the central bank has to buy the debt back like in the US – but immediately and without this Bernanke bashing – and the state has to tackle the problem with a stimulus, which they can finance with central bank money. China has the power of the central bank: Use it. The inflation can be controlle through the reserve ratios.
I think one problem i would identify here is that the purpose of investment is to stimulate future consumption. But in China that consumption is repressed because of the controlled interest rate spread. Letting the market set the interest rate would boost consumption at the expense of infrastructure. So people could more easily afford to take the high speed rail, but the high speed rail wouldn’t be able to service it’s debt after it started paying market-based interest rates. The implicit guarantee of all SOE debt is another way of suppressing consumption. Practically every major enterprise in a locality is guaranteed by the local government, so bond yields are low (consumers can’t make money on them) and inefficient enterprises can borrow with impunity (again, good for investment) while small start-ups and citizens cannot.
The way it looks is like all this investment spending is being done, without the “and then…” of the boosted consumer spending. At least not in a way that would allow these investments to service their debt with a realistic, market-set interest rate. I don’t see how investment can only exist for investment’s sake. The purpose is to improve consumption.
The problem with your argument is that you believe that the market is a perfect or atleast better mechanism in this case. It isn´t. The market consists of emotional, unemotional, rational, irrational, stupid and smart people. The market mechanism is merely a tool.
Look at Euro-Zone for example. Who finances the trillion-big housing bubble in Spain and Ireland? It was the financial market. The very same financial market, who are bailed out by the European governments, because they couldn´t risk a depression with massive uprisings. Why do you believe that the same financial market will do any better in China?
Regarding the consumption suppression argument: What does the interest rates have to do with this? You gain advantages with other interest rates, if you either invest in your bank (park money on the bank account) or if you borrow money for consumption. The first doesn´t boost your consumption behaviour and the second is just stupid and irresponsible in the middle run. This is more social security question. The Chinese should install a better welfare state.
I think most investments are investments in general living standards. Look at all the new education buildings, the highways, the efficient energy and water supply, the health centers, etc. and then compare this situation with India.
By the way I am not denying that there could be a housing bubble. I think that a consumption-driven economy won´t help to avoid it. A more conservative valuation and stricter rules for credits are better tools to control it. And I argue that if the bubble gets out of control like in the West, it will be better that the financial institutions are state-owned rather private-owned, because the state has to bail them out either way. (And China should act/bail them out immediately or they will end like the Japanese with their zombie banks..)
Additionally I am not against more consumption. The Chinese living standards improved much over the last decades. I just don´t see why they should abandon their current system, which serves them so well.
The interest rates have everything to do with it. The government fixes interest rates so A) banks pay very little on bank account interest; and B) loan rates are low for those who can get them. This has the effect of stealing money from Chinese savers and giving it to huge enterprises who get really cheap loans. Those enterprises then build into overcapacity and destroy wealth, thus making everyone worse off.
If the market was allowed to set interest rates and governed bank loan decisions, politically popular (yet uneconomical) projects would either not get approved, or be forced to pay high levels of loan interest. In China, neither of these are a constraint. Who pays to give cheap loans to uneconomical projects? Chinese savers.
At the same time, banks would offer higher levels of interest on savings to attract customers so they have more working capital. In China it’s impossible to move your money abroad legally, and all the banks are owned by the state so there is zero competition. If Chinese want to get a return on their money, they either have to invest in real estate (high barrier to entry), the stock market (casino), or wealth management products (no one knows the underlying assets).
And all of these could be vastly improved by letting the market set interest rates.
“The interest rates have everything to do with it. The government fixes interest rates so A) banks pay very little on bank account interest; and B) loan rates are low for those who can get them. This has the effect of stealing money from Chinese savers and giving it to huge enterprises who get really cheap loans. Those enterprises then build into overcapacity and destroy wealth, thus making everyone worse off.”
1. The government would only steal the money, if the interest rates were negative. They are positive. You probably talk about real return. But doesn´t this sound strange, when a “saver” demand atleast 0% real return from an investment in his bank account, which therefore usually means a verified positive nominal return? Why does the saver believe that he has a right to avoid the inflation tax?
2. A higher interest rate for “bank account investors” doesn´t improve the consumption. It does the opposite.
3. You claim that the enterprises invest in overcapacity. But how one can know that?
“If the market was allowed to set interest rates and governed bank loan decisions, politically popular (yet uneconomical) projects would either not get approved, or be forced to pay high levels of loan interest. In China, neither of these are a constraint. Who pays to give cheap loans to uneconomical projects? Chinese savers.”
You are the one, who wants higher consumption credits. Please tell me in which context consumption credits are economical. Further you claim that banks don´t give loans to economical projects, while you wrote above that the banks give cheap loans for enterprises and investments. There are major logic flaws.
“At the same time, banks would offer higher levels of interest on savings to attract customers so they have more working capital. In China it’s impossible to move your money abroad legally, and all the banks are owned by the state so there is zero competition. If Chinese want to get a return on their money, they either have to invest in real estate (high barrier to entry), the stock market (casino), or wealth management products (no one knows the underlying assets).”
Higher interest rate = Higher bank deposit investments. Liquidity isn´t a problem of the Chinese big banks. After all they can create the money in a good ratio to the bank deposits…
“And all of these could be vastly improved by letting the market set interest rates.”
The same markets, who drove the West into trillion-big malinvestments. The market is a tool, not a magic bullet.
Very nice explanation of the difference between consumption and investments. However two points:
in China the corporate sector is both the major debtor and creditor. Debt can accumulate as long as they dont start consume it in a different way (e.g. paying salaries from their bank deposits)
Secondly the real costs of malinvestment are continuosly being taken by the creditors, they are losing in real terms from year to year, because they get less interest than inflation. So maybe thats why it can go on for so long and potentially for very long without a really bad credit crisis. Of course in case of WMPs this does not hold, there debt generation clearly exceeds value generation, so they must collapse rather sooner than banks.
All
Many point out important issues, but I have respected michaels position since “follow the money”, he is in very good company and many of his perspectives will last the test of time as those concerned come to review how it is that countries develop, need to develop, and what must be considered. He has done a great job, in explaining clearly, lucidly, and easily many of the large mechanisms at play in the development of nations. As others have alluded, the story has changed, and Michael and others were there first, as some are lost itching for Gold, others in decrying neo-liberal Economics others fashioning critical conceptions of their own delusion reinforcing the old adage that a little knowledge is a dangerous thing. As economic evolves, I suspect Michaels perspectives, more than mere prediction to be more readily included in discussions of what it is to develop. It seems that there might be some misunderstanding as to the value of this blog, and the perspectives offered by Michael here. More important than if Michael will rise to the stature of a Hollywood starlet, or a Madison avenue guru, or if he will ever be the PT Barnum of the contrarian camp of economists are the notions and modes of evaluation that he has simplistically made available to us all.
More to the point of those who were waiting for Michael to be the returned messiah of our economic deserts, our saviour from economic distress, or the new, drum roll, economic prophet, he has offered a clear call. It seems the contrarian perspective, against all cheer leaders expectations simply has reminded that while it can go on, it is more destructive, and will likely hold longer term implications, the longer it continues. I guess for one who has discussed with Michael these last 7 years, perhaps slightly longer, it is less important when, even if, china has a hard or soft landing, ends in crisis, etc… He (as others) has brought a nuanced discussions, with perspectives rare to find alive into the current discussion.
With theories, one need consider that they should try to be 3 things, yet only are able to be 2….
Simple
Accurate
Generalizable
If simple and generalizable
Not accurate
If simple and accurate not generalizable
If accurate and generalizable not simple.
For what it’s worth, keep up the good work Michael.
For those who came here to learn the timeframe of chinas demise, perhaps keep on moving.
For those concerned with how the world will evolve as the world becomes even more populated, more resource constrained, more competitive, as it needs to become more flexible, more adaptable, more equal within nations, and eventually, perhaps between nations, you have stumbled onto a gem, which has evolved my own conceptions, and I expect will invade dialogues within development, economics, international affairs, etc…for some time.
Simple and generalizable……..and as accurate as it need be.
Michales accuracy or inaccuracy if it has been is likely influenced by his desire that the right thing would have been done sooner, is done sooner, wherehe does not seem to buy into the zero sum game thinking that wrought recent dialogues.
Excuse spelling and punctuation submitted from iPad
Thanks, CSteven, but I do not consider myself a contrarian at all. I don’t think the consensus is wrong so much as irrelevant. I am more of a skeptic, well-grounded, I hope, in history. Of course as a skeptic grounded in history it is all too easy to pick off the kinds of absurd and completely ahistorical nonsense that one hears about China, especially since anyone with historical knowledge will recognize that this same nonsense was proposed many times before during the same stages of previous cases, so that makes me seem like a contrarian, but I hope my analysis is not self-consciously contrarian. The consensus is right at least as often as it is wrong. What is interesting to me is not so much to be able to predict the future, as to analyze and predict the systematic ways in which are predictions tend to be mistaken. Perhaps that is why I seem like a contrarian.
Hua Qiao,
Well said!
If you had your own blog I would certainly read it
For some perspective Dean Baker called the US housing bubble in 2002. Well before Roubini or Keen.
In reality it doesn’t matter where the money comes from, either it’s government investment, subsidize or paid by the consumer. The deal is if it gets used.
For the high speed rail, I haven’t taken it much, but I’ve never been on an anything like empty train. For Shanghai’s Metro, the same. It gets used, it’s a good investment.
Housing, you see many many empty appartment, but not only appartments also houses and villas. They are not used and therefore for the society/country whatever. A bad investment.
One should in this case also think over the long run, 10 – 20 – 30 years.
I think.
Shanghaier, the fact that the train is used is not the relevant point. After all if the Concorde had been free, every single flight would have been packed, but it would still be an investment that left France and England poorer, not richer. From the macro point of view, what makes an investment appropriate is if the total resulting increase in productivity exceeds the cost of the investment. That’s all. You are of course right that an empty house creates no social or economic benefit and os it results in a loss.
Housing bubble: the only people who didn’t were the pop infused financial media, during dot.com the real money ( buffet) was buying blue chips, and real estate by at latest 1998′, that prompted the market that followed afterwards were lowered post911.
Less important than a firm prediction is the direction.
Everyone talks about the crisis as 2008, backdated and people with short memories, I told my students in the fall of 2007 that the crisis would hit the news after the Beijing Olympics told my friends at least by early 2007, new of the issues as early or earlier than 2003-4.
Importantly, and hopefully in his books Michael goes much further.
Have you people seen the world, experienced the many different lives that there’re to live.
Or are you locked in your urban surbaban electropia.
Anyway, the state led capitalism, the tool of greedy politicos upon nationalistically infused materials of mass delusion whose sole goal has been the status of rentiers is dying. Tobe replaced by greater global or regional, inter- regional cooperation as the storyofdevelopment marches on.
Now, how to get large swathes of the parody
Hilly minded global people to understand a broader more comprehensive place for personal responsibility leading for the impact of a man on the greater global community.
Hopefully, soon, rentiers put the genie of nationalism back in bottle, and bury it in a very deep cavern. Ok, people, you have your countries now, the early nineteenth century, the mid 19th century, and the mid 20 th century have passed. Now focus on freeing and equipping you people to see, understand and tackle the many, true, grave problems facing a world where all is accelerting nd proliferating.
Excuse spelling,
Michael, you said “First, after many years in which China has invested far more than other countries at its stage of development, one could presumably argue that in order to get back to the “correct” ratio, investment should be lower than the peer group, not equal to the peer group. In that case investment has to drop by a lot more than ten percentage points.”
Would that not also hold true for trade surpluses? At some point, however far in the future, the trade account must balance.
Regarding the discussion on the facilities of Chinese primary schools: Chinese schools indeed have good facilities, but not because governments invested enough in them. The big secret is that China don’t really have free public education. Charging the parents for school improvements, and for additional income of the teachers is wide-spread. The parents willingly pay them to get their kids a better education. This is part of the reason why consumer spending in China is low.
This is new to me,what are the charges involved?and if CCP gives free education,then people would have more money to spend,increase in consumer spending?how are the Chinese teachers paid?thank you.
The ones I have heard of involves two types:
1. Asking for contribution from parents for school infrastructural projects. This is technically illegal, but I have heard of several cases.
2. Mandatory weekend classes for a fee. This, from what I’ve heard, is wide-spread. In many cases, the majority of the teacher’s income could come from this.
In addition, the good schools often will sell some admissions at staggeringly high prices.
Teachers are paid similar to civil servants, which is not high. However, like civil servants, there are many opportunities the “grey income” like the ones I mentioned.
Thank you,K Zhang,yes indeed,the bribing of school teachers in China is now a day to day news,the other point is about the “pay” to civil servants,isn’t a job with the government now consider more prestigious compared to working in Western MNCs?
If you look recently in Shanghai you will see newly built schools of a far higher standard, and muche more and better facilities than before. These schools can hardly be parent-sponsored.
Many schools outside the big cities are still far below that level.
As I noted above, the deal is not if there is investment or not, or how much. The deal is if it gets put to a good use.
Michael
Just a quick question on your comment Re this year, which I pasted below: did this year turn out better for household income because of some accelerating improvement, or because of a lower denominator given slower GDP growth? Just wondering if there are any “green shoots” to be inferred here.
[With household income only 50% of GDP, a transfer every year of 4% of GDP requires ferocious growth in household income for it just to keep pace with GDP, something it has never done until, possibly, this year.]
@jamba
First,, the big issue is not whether consumption is better than investment per se. The issue is that by definition, investment is financed by savings.
Savings, as per my prior post, manifests in the form of lending or equity contribution. There are a great amount of household savings lent to the chinese banks in the form of deposits. But there are also savings in the form of the “people’s” equity holdings of SOEs. Of course, the lao bai xing never see this money as the equity is managed by the central, provincial and municipal SASACs on behalf of the public. These SOE firms report profits but rarely return anything in the form of dividends (except the banks who must dividend to give Huijin money to service the bonds of the AMCs from the last 2 bank recaps in 1999 and 2004). The SOEs have great power to marshall funds for investment projects with very little worry about meeting shareholder demands for return of capital. Bigger is considered better and there is an almost obsessive presumption that bigger means lower costs and market share. This equity in SOEs is forced savings by the Chinese society, savings that the household will never see until such time as the SOEs are privatized, something that Michael has called for.
The point is that savers expect positive real returns as you have pointed out. To the extent the invested projects do not return principal plus some additional amount expected by the saver, then the investment is unproductive and is no better than consumption. (by the way, some consumption such a preventative health care could be seen as an investment since it may reduce future health care costs). The big takeaway is that to the extent the bridge to nowhere projects do not return the capital to the saver, then the savers have been fooled. The government will have to step in to make the savers happy by recapping the banks, the LGFPs and the SOEs. So my point is that China purports to be frugal and investing for the future when in my opinion, a good part of this investment is unproductive and will need to be monetized. Ultimately, just like the US, the result could be longterm inflation.
As to over capacity, how about these industries…shipping, ship building, steel, aluminum, most nonferrous metals, fertilizer, solar panel production, petrochemicals such as pvc, construction machinery, textiles, pulp paper, and commercial real estate in 3rd tier cities. These are the ones that are obviously overcapacitied (even in a normal demand market) as a result of overinvestment. There are a lot more that are overcapacity because demand has fallen away.
@jamba
“First,, the big issue is not whether consumption is better than investment per se. The issue is that by definition, investment is financed by savings.”
It is only defined as this within the neoclassical standard model. Sadly it isn´t completely true within models, where fractional banking and the central bank are integrated.
Within a fractional banking system the major source for loans is money creation by banks. You can easily see this, when you compare central bank money to commerical bank money ratio. Investments through savings play a minor role.
“Savings, as per my prior post, manifests in the form of lending or equity contribution. There are a great amount of household savings lent to the chinese banks in the form of deposits.
But there are also savings in the form of the “people’s” equity holdings of SOEs. Of course, the lao bai xing never see this money as the equity is managed by the central, provincial and municipal SASACs on behalf of the public. These SOE firms report profits but rarely return anything in the form of dividends (except the banks who must dividend to give Huijin money to service the bonds of the AMCs from the last 2 bank recaps in 1999 and 2004). The SOEs have great power to marshall funds for investment projects with very little worry about meeting shareholder demands for return of capital.”
Then the investors shouldn´t buy the shares and speculate on a miracle in the first place. It is well-known that the big SOE´s aim at global market share, long-term developments, high liquidity and investments. Look at Zuckerberg, the Google brothers or the legend Steve Jobs for example, everyone of them shit on their short-term-visual-money shareholders.
“Bigger is considered better and there is an almost obsessive presumption that bigger means lower costs and market share. This equity in SOEs is forced savings by the Chinese society, savings that the household will never see until such time as the SOEs are privatized, something that Michael has called for.”
Usually the economy of scale works. How can the Chinese savers be forced into buying some shares? And a sell-out of the SOEs is a bad idea. It will only end like in South-Korea, where the big SOEs are private-owned Chaebols, who control the whole country. It will only end like in the West, where short-term shareholder-value hunters drive companies regardless of the long-term prospect. The Chinese state will be unable to control employment rate and therefore has to fear uprisings, too.
“The point is that savers expect positive real returns as you have pointed out. To the extent the invested projects do not return principal plus some additional amount expected by the saver, then the investment is unproductive and is no better than consumption.”
The “saver” isn´t a saver in this case. He is an investor. A saver would hold his money at home and accept the inflation tax. And consumption usually aims at zero return in despite to investments.
“(by the way, some consumption such a preventative health care could be seen as an investment since it may reduce future health care costs). ”
I want a better a welfare state (and higher wages), too.
“The big takeaway is that to the extent the bridge to nowhere projects do not return the capital to the saver, then the savers have been fooled. The government will have to step in to make the savers happy by recapping the banks, the LGFPs and the SOEs. So my point is that China purports to be frugal and investing for the future when in my opinion, a good part of this investment is unproductive and will need to be monetized. Ultimately, just like the US, the result could be longterm inflation.”
But the solution isn´t to swap to more debt-based consumption growth like in the US then. This will only accelerates the accumulation of bad loans. China won´t be able to find good investments for the next hundred years. It can only take preprarations for the coming disaster and try to monetarize the problem calmly. We live in a debt money system after all.
“As to over capacity, how about these industries…shipping, ship building, steel, aluminum, most nonferrous metals, fertilizer, solar panel production, petrochemicals such as pvc, construction machinery, textiles, pulp paper, and commercial real estate in 3rd tier cities. These are the ones that are obviously overcapacitied (even in a normal demand market) as a result of overinvestment. There are a lot more that are overcapacity because demand has fallen away.”
These areas are a global overcapacity problem for years now. There will dead companies everywhere. However if the Chinese stop to help their companies now, the surviving companies won´t be Chinese. Look at France, Germany, the US etc.. They subsidize their key industries with tax holes, bail outs and legislatures for the last ten years, because they know that a major clean-up is on the way. I am a Westerner, but the Chinese deserve to know the truth.
@jamba
One thing we agree on is that a system based on debt fueled consumption is not sustainable. The US showed that. So China better hope all those things it calls investments pay off.
Savers are investors. Even if you keep your wealth in cash in a mattress, you still expect to have a certain amount of consumptive power from that savings.
Apart from the few that buy shares in the Shanghai or hong kong stock market, the vast majority of stock holdings of every SOE is the Chinese government. These holdings (aka investments) are managed by SASAC. The chinese people have no say in whether the government provides more equity capital or takes dividends. As those companies increase their equity through undistributed profits a great amount of wealth (and therefore, societal savings) accumulates which cannot be tapped into by the public. This is trapped, forced savings. Indeed, it is even worse if one considers these lumbering giants accumulate their wealth by enjoying significant favoritism from banks and regulators vis-a-vis their privately held competitors.
As to your dismissal of overcapacity as being a world problem for years, i think you are incorrect and i can cite many studies, articles and even statements of the ndrc officials themselves indicating that China continued to irrationally invest in new capacity well beyond the point of any rational return on investment metrics. Shipbuilding, solar, steel and aluminum are particularly guilty of Chinese overinvestment.
“@jamba
One thing we agree on is that a system based on debt fueled consumption is not sustainable. The US showed that. So China better hope all those things it calls investments pay off.”
I agree with you. If China base its economy on consumption debt growth, one day it will have to monetarize the consumption debt. If China base its economy on investment debt growth, one day it will have to monetarize the malinvestments debts. These are dead ends. What will the Chinese accomplish till this moment and what kind of preparations it should take then? We should hope that it will work.
“Savers are investors. Even if you keep your wealth in cash in a mattress, you still expect to have a certain amount of consumptive power from that savings.”
I think this is a linguistic problem and the economists failed to agree upon something important like a definition again.. What is a saver? Is it a guy, who withold his money and doesn´t spent it? Is is someone, who spent money and expect a return of 0%? A return between -0,5% and 0,5%? In real or nominal?
“Apart from the few that buy shares in the Shanghai or hong kong stock market, the vast majority of stock holdings of every SOE is the Chinese government. These holdings (aka investments) are managed by SASAC. The chinese people have no say in whether the government provides more equity capital or takes dividends. As those companies increase their equity through undistributed profits a great amount of wealth (and therefore, societal savings) accumulates which cannot be tapped into by the public. This is trapped, forced savings. Indeed, it is even worse if one considers these lumbering giants accumulate their wealth by enjoying significant favoritism from banks and regulators vis-a-vis their privately held competitors.”
The Chinese state own the companies and can force them to whatever it wants. That is sometimes good. For example the Chinese officials forbid mass dismissals during the financial crysis in despite to the US or the South Europeans. Dividend withholding has also some advantages: More money for expansion and more liquidity, which makes them less dependent on bank loans. I doubt that the Chinese state need that money at the moment.
Why do you believe that the Chinese population/public as a whole will benefit from a SOE sell-out? Or that the Chinese public will have more influence than now? It is much more likelier that very very few Chinese persons will get it all. Did you hear of the big families of Hong Kong? Or of Taiwan?
Additionally even when the banks and SOEs are private-owned, the same favoritism will take place. Germany´s former Deutschland AG; Japan´s Keiretsus; How does the Chaebols grow so big? Big and save companies are always treated better.
“As to your dismissal of overcapacity as being a world problem for years, i think you are incorrect and i can cite many studies, articles and even statements of the ndrc officials themselves indicating that China continued to irrationally invest in new capacity well beyond the point of any rational return on investment metrics. Shipbuilding, solar, steel and aluminum are particularly guilty of Chinese overinvestment.”
You are not aware of the massive overcapacity problems here. I can provide you so many links, you want. The European automobile industry in France and Italy lives on subsidizes. The German solar industry and shipbuilding industries had massive subsidizes. There are warnings regarding the Western steel industry, still it get support. Only few big companies are able fullfill the demand of the whole world in the future. This is dumping and predatory pricing till “Last man stand”. For the governments it doesn´t matter to burn some paper money, as long as they win the competition in the end. Yes, it is stupid to do this kind of investments. Sadly everyone does it – and not everyone can win.
Regarding the overcapacity, interest bearing (debt-based) economic (and thus political) systems concentrate capital and destroy productivity:
http://www.coolpage.com/commentary/economic/shelby/Demise%20of%20Finance,%20Rise%20of%20Knowledge.html
Note passive capital inherently seeks replicated activity (not individual innovation), because it is implicitly dumb (it seeks only an interest bearing return backstopped by the sovereign).
Historically, the only thing that bails out society are technological innovations that increase productivity faster than the passive capitalists (and their dependent masses) can steal and destroy.
In other words, the human mind is the weapon of the free market.
As far as I know, China’s problem is they stifle individual creative innovation, so they will be stuck at the level of economic productivity that can be managed monolithically, i.e. activities that can be replicated on grand scales and not on individual innovation. That is unless the political system changes, which would probably only occur with extreme social upheaval and disruption of the economy.
The most significant technological innovations come from the individual and this will be more so as information technology (unlike the Industrial Age) doesn’t need passive capital, e.g. all by myself (no employees!) creating arguably the world first million user social network in 1998, coolpage.com (in conjunction with Yahoo Geocities and other free hosting available at the time). Which was roughly 1% of the internet population at the time. Friendster followed 2002:
http://en.wikipedia.org/wiki/Friendster#History
Wikipedia isn’t aware of Coolpage.com, but download.com (one of many download sites) is a historical reference with 675,000 downloads:
http://download.cnet.com/Cool-Page/3000-10247_4-10153585.html
Although it has faded by now, the link popularity of sites created with Cool Page, used to be about 335,000 (as reported by altavista.com) circa the peak in 2001:
http://www.google.com/search?as_lq=www.3dize.com
Add to my prior comment, that I was originally hopeful that China’s population was aware of the limitations of their political system in a way that they were taking steps to be individually creative behind the radar of the centrally managed economy. But then I talked with that young Chinese man who told me that no one in China wants to create a software business, because Chinese steal (do not pay for) all software, so this indicates a widespread cultural disrespect for the value of the Information Age. If a society believes it can prosper by stealing from itself in the Information Age, then it is doomed to be stuck in the overcapacity and dying Industrial Age (the passive capital age). I am not aware of any individually inspired software made in China that is marketed outside of China. I know there is game programming done in China, but I think this driven by corporate specifications.
The computer science graduates I have been aware of in Asia think in terms of fulfilling corporate specifications and do not think entrepreneurially. Whereas in the USA, many graduates are thinking to launch or work for an internet startup.
The entreprenuers in Asia tend to focus either on lodging, resort, and food services, or on fixed investment activities (driven by government spending and debt).
As for the success of S. Korea rising above the middle income trap, it appears to me to be maybe just lucky timing, in that they could compete with Japan and Taiwan at the time of a peaking global debt bubble. I am not convinced that Korea has the individual creativity to sustain their economic position as the industrial age wanes, but they may be the Americans of Asia. I need more experience and data on S. Koreans.
In summary, as far as I can see, Asia (including India) is not part of the Information Age yet (including India’s software technology center in Bangalore which is as far as I know is driven by corporate specification). They are culturally still stuck in following the large passive capital.
And the information age will come on rather abruptly as the multi-decade (since rougly 1970 detachment of gold from the dollar by Nixon) global passive capital bubble is peaking and will soon crash (circa 2015/6), i.e. the Industrial Age is its final blowoff peak economically and politically.
Imo, Pettis’ globalization theme is repeating, with a significant retreat for Asia ahead:
http://www.mpettis.com/2012/06/11/what-is-globalization/
Going forward from now and after the retreat, Asia will be stuck for a while doing the low-end information activities, basically data entry with specification interaction, where it is cheaper to pay them than to automate it. For example, the computer science graduate filipina lady I know who does 30 corporate annual reports per day on her $8 daily salary.
So the cost of production will decline with automation, thus those on the low-end of the information age scale, so will see rising standard-of-living, but their relative value in the economy will be orders-of-magnitude lower than the creators of innovation in the information age.
I guess i just don’t get it. You keep saying that China is different…not as bad and yet every rebuttal you come up with is that the west has the same bad stuff.
@Hua
- GDP consumption/investment growth usually force the creation of money, which translates into debt creation (or money printing by the central bank).
- Consumption debt is worse than investment debts. However both can lead into a debt crysis one day.
- China should therefore grow on the investment route further, because it won´t want to stop GDP growth and investment debt is the lesser evil.
- Overinvestment exists in some areas – not in all. However if China stops to invest in these areas, China will lose against the overinvesting/subsidizing Western countries and will be dependent on Western productions and companies in the end.
Or in other words: Don´t do worse things, just to avoid bad things.
It’s an interesting point that this blog doesn’t make specific trading recommendations. For me, I can just turn on CNBC here in the U.S. and listen to a guy who told me last week to buy commodities to now sell commodities. There is a difference between trades and long-term trends. You certainly don’t want to be on the wrong side of a long-term trend when the momentum starts to build (i.e. U.S. real estate 2006). Having said that, Mr. Pettis has provided insight on many levels that translate to sound investment decisions. For example, he was bearish on Chinese growth very early on and Chinese stocks have been in the dumps for awhile. When others were touting runaway commodity prices, Mr. Pettis was sounding the alarm on the demand for commodities. You certainly could have bought and sold Chinese stocks at a certain point in time and done well, but the trends are something to pay heed when entering the market.
Thanks to those who replied to my comment above. I’m just looking at Eichengreen, Park and Shin: http://www.nber.org/papers/w18673.pdf?new_window=1
“China has slightly higher average years of schooling at the secondary level than the median for our slowdown cases (3.17 years in China versus 2.72 years in our slowdown cases). It has a higher share of high-tech goods in exports (27.5 per cent in China versus 24.1 in our slowdown cases). In this sense China appears to be doing slightly better than average in moving up the technology ladder in order
to avoid the middle-income trap.”
I see lots to be hopeful about.
That’s an interesting paper, but the conclusions are hardly controversial. Higher skilled labor and exporting stuff that requires high skilled labor is good for growing the economy. Well, no kidding. With no constraints, every country would do that.
The charts suggest that China still has a long way to go until it hits the wall though. I had previously thought the middle income trap was around $10,000 per capita, but the article suggests it’s more like a range between $11,000 to $20,000. Technically China’s economy could double without hitting that wall. Interesting thought.
I wonder how they control for the increase in high tech exports just being an increase in stuff. Other countries may have had a lower high tech export ratio because there weren’t so many consumer gadgets.
Bruce Bueno de Mesquita is a political scientist who has spoken about the limited usefulness of the Chinese tertiary educational system. It’s designed to promote math and science skills, but not creative skills for obvious political reasons. I think it is fruitless to rank universities on a list from best to worst, but I wonder how that plays into Korea and Taiwan’s success stories. Granted neither started from a very politically liberal environment, but today they do have universities that are certainly “freer” than Chinese ones, and I believe that plays an important role in entrepreneurship, innovation, and critical thinking.
The fundamental failure is not whether consumption is better than fixed investment or vice versa, nor whether investments are in use or empty (people use a lot of things financed by debt and go bankrupt).
Rather the fundamental failure is that large imbalances (i.e. between consumption and fixed investment) can only develop in a economy that allows massive levels of debt due to that debt being backstopped by the sovereign. Without the sovereign backstop, these debts would default much sooner and the free market would balance the economic growth.
Thus in every case you find these imbalances are coincident with massive levels of corruption in the sovereign by the vested interests of debt-based growth and finance.
The failure China faces is not just that it has massive imbalances due to centralized management of exchange rates and other means used to backstop the debt-expansion, but that the debt bubble is global and China is dependent on exports.
On top of this, the global debt bubble is hiding the true productivity of human labor and the genres of higher education people are getting now. Pull away the false demand for fixed investment, foreign consumption, exports; then we may see that China has a billion people who are uneconomic (they can’t truly produce more than they can consume on the free market for skills once the debt bubble isn’t misallocating demands for skills).
We can and will radically automate production and not just manufacturing. We can automate even fast food. We can automate accounting. We can automate document filings. Etc, etc, etc.
Economics 101 tells us that any activity that costs more than the highest marginal cost producer that supplies the demand at that price, is thus uneconomic.
So what do you do with a world that has billions of people who are rendered uneconomic?
I keep hearing how we can recapitalize the banks and paper over the debt to reset the economy for a fresh start. But such a transfer of wealth, does not render uneconomic people economic. It takes considerable time for people to reposition their education and skills to be competitive.
Yes, debt is the key issue here.
Jamba,you state that “Investments have a higher chance to secure future cash flows.. while consumption doesn’t. Switching to consumption would create new service industries which would support employment for people on steady state. It would assist in creating innovations
faster than big SOE could accomplish. China needs to improve the quality of its products to compete with the world. It is very difficult to imagine that China can continue excessive exports while the whole world is out of balance and seeks to export more. Total dependence on exports creates volatility to the employment because it depends on outside economies.
Excessive investments wastes capital and adds to the debt which will have to paid.
“Jamba,you state that “Investments have a higher chance to secure future cash flows.. while consumption doesn’t. ”
More precisely I´ve asked whether this statement isn´t likelier, since investments aim at securing futute cash flows and consumption not.
“Switching to consumption would create new service industries which would support employment for people on steady state. ”
And it would create less jobs in other industries. I am not even sure which kind of service jobs, you aim for. Hairdressers? More restaurants? Artists? Some vodoo hedge funds managers? Non-productive investment bankers? Whenever I hear this service argument, I cannot imagine the wide range of economical possibilities, but only doctors and teachers, which should be state services. If the introduction of a better national health insurance or better education fascilities is your aim, I will agree on completely.
“It would assist in creating innovations faster than big SOE could accomplish. China needs to improve the quality of its products to compete with the world.”
South Korea with its big Chaebols doesn´t seem to care about their size. The reason why China lacked innovations in the past wasn´t about the consumption expenditures. It was about the lack of the high-skilled scientists, research fascilities, patent laws, state subventions for innovative market entrances and cheap bank loans for projects. And of course it was cheaper for the enterpreneurs to copy the already existing inventions. The marginal costs for own innovations was too high. The same goes for the development routes of South Korea, Taiwan or Singapore. With the reduction of these points, the Chinese patent registrations steadily rise and rise over the last decade.
“It is very difficult to imagine that China can continue excessive exports while the whole world is out of balance and seeks to export more. Total dependence on exports creates volatility to the employment because it depends on outside economies.”
That is true. I think that STAN is completely right, when he says that the states will automatize everything and there won´t be enough economical jobs for everyone. The question remains: Where will the manufacturing machines stand in the end? In Germany? In the US? Or in China? If China goes on with its industrial politics, it will able to produce everything alone; probably even in high-tech industries. A frightening imagination. In the very end China will have to subsidize uneconomical consumption jobs – but not now.
I think that this is the strategy anyway. The consumption rebalance isn´t aimed at China´s long-term growth. The rebalance is aimed at the global trade equilibrium, because some Western states are afraid to lose the competition against China. However Zhou Xiaochuan already propose Keynes´ bancor reform. As long as the US cannot accept the price for the equilibrium (the global reserve status of the US dollar/ Triffin dilemma), I don´t think that China has the obligation to balance the trade.
“Excessive investments wastes capital and adds to the debt which will have to paid.”
Excessive consumption does the same. Our current money system usually force GDP growth to be based on debt growth. (And we are damned to do it.)
It would be interesting to listen to what Chinese are saying for themselves, one of them,煤炭神话的破灭 THE MYTH
http://3a5a.com/caijinglangyan/video_208.html
Jamba, consumption does not do the same. I think your understanding of the issues are so confused that I wonder if rather than trying to understand the Chinese economy you are merely “defending” China by insisting that everything is fine (or, alternatively, its ok because things are worse abroad). This is, by the way, not very helpful because China is much better off when people understand its problems than when people deny them. That is why I am cautiously optimistic. It is hard to find anyone in the economic policy-making elite who no longer fails to see why Chinese demand must rebalance away from investment towards consumption. If you are a member of that elite I would suggest that you might be, fortunately, one of the very few exceptions.
It is hard to disentangle everything that you write, but you should remember two things. First consumption and investment are both sources of demand. Obviously investment is postponed consumption aimed at increasing future consumption. To the extent it does so, investment is successful and increases wealth. To the extent that postponing consumption today results in a less than equivalent increase in consumption tomorrow, it is wealth destroying, not wealth enhancing.
On the other hand, as sources of demand, consumption tends to be better for the development of innovation and the kinds of economic growth with which Shelby is much concerned. But that is not the key point. You confuse consumption growth with debt growth, and as others have pointed out, this is absurd.
Consumption can be funded by debt, in which case it must result in an unsustainable increase in debt, or it can be funded by increases in household income or wealth, in which case there are no adverse debt implications. I am not sure why you find this so hard to see. Perhaps the fact that the US has recently suffered a debt-fueled consumption boom may be confusing you as to the relationship between debt and consumption. The problem in the US was not that consumption rose (this is always a good thing). The problem is that it rose faster than real wealth, and so had to be funded either by reducing savings or (which is the same thing) by borrowing. This is what made it unsustainable.
The reason China must reduce investment and increase consumption is not because consumption is “better” or “worse” than investment. Consumption is the whole point of economic activity, and the investment decision is simply about increasing consumption over the long term by reducing it today. But there lies the problem. China must reduce investment because it is no longer wealth enhancing. It destroys wealth, and since it is funded by debt, it as as unsustainable as debt-funded consumption.
All of this rather confused discussion about the accounting treatment of consumption and investment completely misses the point. What matters is the wealth impact and the sustainability of different sources of demand, and that is why we must focus on the relationship between the growth in debt and the growth in debt-servicing capacity. I am not sure how to put it more clearly.
Surely many Chinese elites believe that a rebalance is necessary. After all that´s what the Western economists and Western educated Chinese economists tell. It´s very diffcicult to change their minds, when many stick to their textbooks and ignore, that the Western education lacks the key points of their smartest minds caused of political reason. I never fully comprehended how neoclassical models could come thus far, when the West had people like Sraffa, Knight, Keynes, Fisher etc.
“First consumption and investment are both sources of demand. [..]
Consumption can be funded by debt, in which case it must result in an unsustainable increase in debt, or it can be funded by increases in household income or wealth, in which case there are no adverse debt implications. [..]
What matters is the wealth impact and the sustainability of different sources of demand, and that is why we must focus on the relationship between the growth in debt and the growth in debt-servicing capacity.”
I completely understand and I fully agree with you.
However I am not on your side in other points:
-You write that “Obviously investment is postponed consumption aimed at increasing future consumption.” That isn´t always true and typical phrase from a textbook. A national economy hopefully aims at raising the living standards of the population. This doesn´t only include the demand/(consumption) power of the population, but also could mean better health fascilities, better environment protection, education fascilities, better streets, better local traffic or well-paid white-collar jobs. The problem is that consumption and investment are not well-defined and therefore can sometimes overlap – it can also be that a expenditure isn´t part of any of those two in despite to the models.
-”Consumption can be funded by debt, in which case it must result in an unsustainable increase in debt, or it can be funded by increases in household income or wealth, in which case there are no adverse debt implications. I am not sure why you find this so hard to see.” I would never argue against this. My rebuttal wasn´t aimed at that every consumption has to be debt based at all. It was aimed at that “GDP consumption growth” usually is debt-based. (Additionally where does the increase of money income and money wealth come from to serve the debt?)
Money creation has two/three sources.
Monetary base / central bank money:
1. Printing: The central bank create money and donate the printed money 100% to its government (Bundesbank) or some part to its private owners (FED). This is called seigniorage: https://en.wikipedia.org/wiki/Seigniorage
-> This kind of money creation only can increase the money supply. Okay, you can burn it, but it is unlikely. Too much money printing leads to inflation.
2a. Lending: The central bank create money and lend it to the private sector. Usually only private banks borrow from the central bank.
-> The lending increases the money supply. Too much money creation creates inflation. (Debt inflation)
-> The payback of the debt decreases the money supply. Too much money decreasement creates deflation. (Debt deflation)
Commercial money creation:
2b. Lending: The commcercial banks can create their own money and lend it to the state, the households, other financial institutions or the companies.
->Same as above (lending 2a). Compared to central bank money, commercial bank money is the main source of money creation.
GDP growth and money supply strongly correalate. So if the GDP grows, the money supply will follow. The opposite is also true to some degree -not always-, if the money supply grows,..
Therefore GDP growth means more a) debt through the banks or b) money printing by the central bank. The question is therefore: a) Is the additional credit money sustainable? Which kind of credit would be more sustainable? (You write yourself that consumption debt is bad.) b) And at which point the central bank has to print money to maintain the possibility of paying the debt back?
Receivables = payables
If the money supply should stay the same (no deflation/inflation) and for example the households want to reduce their debt level
- either the central bank has to print money or
- the state has to take the debt or
- other private sector participiants (banks, companies etc.) have take the debt.
We have seen this case in Japan, Ireland, Spain, Greece or the US. The bubble could have been created by any sort of demand (consumption/investment). But in the end someone will have to take the debt to save the economy and prevent a debt deflation (Fisher) with a paradoxy of thrift (Keynes). Usually it was the state, who saved the households, the commercial banks, financial insitutions and companies and burdened itself with debt. But sometimes the debt burden for the non-central-bank sector is just too high, which forced the central bank to either decrease the interest rates (higher chance of lending/money creation) or to buy the debt directly back, which translates into money printing.
In conclusion I cannot understand the Western idea of a “consumption rebalance” regarding the Chinese long-term growth and econmical prospect. If there is a housing bubble, one could say that the credits for housing should be decreased and the housing investments should shift to other investments – and he would be right. But why ultimately to consumption? It is just a too unlogical proposal, if neither demand side can fully prevent a bubble.
There have to be other goals for a consumption rebalance.
Good goal:
The rebalance is indirectly aimed to increase China´s imports and to balance the world economy. I completely agree in this case. China should strenghten its domestic market regardless of whether it is more economical or not, just to ensure a balanced trade ratio. It can be done with a better health care system (investments or consumption?) or just higher wages for consumption or something else.
Not that China has an obligation to do it, but because China should act as responsible
country. Trade imbalances lead to bad feelings on atleast one side of the trade partners, which isn´t in line with a harmonic world order and usually ends in protectionism or war.
Bad goals:
-The West believe that they can use consumption rebalance as a Trojan horse for financial market deregulations and as an excuse to buy the SOEs out. They will use their commercial banks then to create a massive credit bubble (stock markets, CDS, derivates, housing, consumption – it doesn´t matter where) through cheap loans, which the banks create. In the end the bubble will burst and lead China into recession, where it cannot control the employment rate, because it sold its SOEs and other key industries and cannot force the commercial bank to act anticyclic. Uprisings will pressure the current government.
Neutral goals:
-The West knows that it cannot run the industrial overcapacity race forever and subsidize the Western companies till eternity. Therefore it hopes that China will stop to subsidize its companies and let them go bankrupt before it is too late.
I am a supporter of the presumption of innocence. I believe that you want the best for this world and humanity, Michael. But please spare me with economical reasons for the rebalance. We both know very well, how politics work at the moment.
This is my last post, therefore
Farewell, Michael.
Jamba
Jamba, my god I must agree with professor. You understand nothing about economics. You think the reforms professor is saying are Western and what China is doing now is what? Chinese? All Chinese economic policy, including during 1949-1978 and 1978-2012 is as Western, and as Chinese, as the professor’s reforms. Do you think Communism is invented by a German or by a Chinese? Do you think Chinese investment policies that copy Japan and many other countries are Chinese? Do you think stealing from the people and making the rulers rich is only Chinese? Many countries have done what China is doing. You must learn economics before you become the defender of China. It is embarrassing.
Jamba, I think you confuse knowing how politics works with believing in the kind of conspiracies that are popular only among people who have been wholly left out of the political process. It is weird to me how rabid Chinese nationalists can, like you, accuse me of secretly trying to trick the poor foolish leaders of China into selling their companies to foreigners, while at the same time also accuse me of secretly trying to prevent foreigners from investing in China altogether. I suppose I can in principle be the source of all that is evil, but even the devil has to be consistent.
By the way it is absurd to claim that privatizing means selling to foreigners. It doesn’t. It means transferring ownership to the private sector. There is no reason why that private sector cannot be Chinese, and I really doubt China would ever permit foreigners to buy large Chinese companies anyway. What’s more I am afraid that any foreigner who reads my work seriously is very unlikely to buy SOEs.
It is also absurd to imply that GDP growth automatically means growth in debt, and that if GDP growth is created by consumption, it must therefore result in rising debt (or, you say, money creation, but here I am not sure you understand what point you are trying to make). This is incredibly confused and really makes no sense at all.
You force me to answer.
No, I am not nationalistic at all. It is disguisting to see how some people reacted over the tiny Diaoyu/Senkaku islands.
The Chinese officials don´t need to sell the companies to foreigners. I just write of a sell/buy-out. They can sell them like you said to very few allied Chinese citizens, who are supported by the West, too.
It works in Hong Kong like this: http://blogs.wsj.com/hong-kong/2011/01/27/hong-kongs-feuding-families/
And in Taiwan: http://english.cw.com.tw/article.do?action=show&id=12500
I never accused you of preventing investments in China.
-GDP growth strongly correalates with money supply growth.
-The money supply can only grow through money printing by the central bank or lending/debt by banks.
-Usually the central bank doesn´t print money as fast as the commercial money grows.
->So if the GDP (investment or consumption) grows, what will happen? The debt will rise.
-It isn´t “automatically” so, but the “usual” case.
Can you refute these points?
Jamba, it doesn’t matter if the centralization of economic policy come from a central bank and/or from the political process, in either case when ever a large elephant sits on individual incentives, then the economy is misallocating capital in terms of optimum fitness of how the participants deploy their capital (i.e. time, savings, educational choices, etc)..
Chinese politics can promise that “we will do it differently” and prioritize the welfare of the masses. This is a the lie of communism, because it is just the same effect of a large elephant sitting on individual degrees-of-freedom by any paradigm.
And this is why I don’t share Michael’s optimism about Chinese being able to rebalance. Any monolithic form of rebalancing is going to perpetuate new misallocation of capital. But this political outcome is what humanity is locked into now, especially given that most people do not have sufficient skills to be economic in the coming knowledge age.
We are going into a decades adjustment period to the new knowledge age, and the political repression and socialism will be very heavy.
Again to reiterate and expound on my prior comment above, imo it is pointless to argue about whether consumption or investments are more appropriate. For the economy to secure productivity (i.e. future cash flows) then it can not be managed monolithically. Fitness is dependent on degrees-of-freedom. One can imagine monolithic means of balancing consumption and investment, inherently requiring increasing debt and thus imbalances and misallocation of capital continue due to a lack of fitness.
An economy is only efficient when individuals can make local opportunity cost decisions, i.e. to maximize the degrees-of-freedom and fitness in the economic productivity. They can’t make such decisions when the metrics they are using (e.g. the exchange and interest rates) have been centrally managed to force monolithic statistical outcomes.
Prof Pettis i would like to withdraw my two prior comments and not publish them on your blog. They were written in haste and not articulate enough.
But if possible, could you personally address them in your blog if and when you have time, it would be much appreciated. I am talking about behavioral economics and culture. Thanks
Interesting points made by Jamba who is probably an overseas Chinese and who has a strong dislike of the Fed and its system of ripping off people,he is saying that The Western System is a proven failure,but the not so intelligent Chinese leaders are adopting them partially where those are convenient to them,he does not the possibility and the many problems that we expect,in short,a new financial frame work is required for the world if we are going to move from the present global troubles which is an impossible task.
I just happened to watch the speech given by Dr Morris Chang,the founding Chairman of Taiwan TSMC,on The new economic model of Taiwan’s economic development.
1/2 小英教育基金會「台灣經濟發展新模式」講座-張忠謀
http://www.youtube.com/watch?v=95sHSd8kdTU
There are 2 parts followed by another 2 parts interesting discussion,Dr Morris Chang made the following points:
(1)21st century moves from Capital industry – knowledge Industry (Innovation & Value creation),there are critical factors will determine economic development during 21st century.-Capital,Labour Force,Productivity & Innovation.
(2)Call on government to reduce GINI coefficient ,Higher taxation on top earners, Rich people are paying too little tax , even Taiwan government tax high income earners atthe highest tax rate of 40% but the richest tycoons only pay 7 to 8% income tax,
Government should study the income of Top 2% vs Middle Class 20%,to tighten the current loopholes on legalised tax avoidance.
(3)”Industry Policy” should focus on creating an enviroment to encourage
innovations,openness and fair competition,but not on picking winners or rescuing losers.
Businesss should put more emphasis on innovations and value creations-more emphasis on innovators and added value creators.and less emphsis on capital.
(4)Educational policy should focus on
a.Training people to perform a useful economic rule in society
b.Innovators and value creators
c.Leaders of society
(5)The importance of an “OPEN SOCIETY” for the country to move forward.
So looking forward,China economics is linked to its politics,and it is futile to spend all our time talking about economic development.
I am sorry to Jamba if I misunderstand his points.
His points about shift to the knowledge age are what I have been writing in my comments in the past several blogs on this website.
Asians are still predominantly beholden to the capital industry.
Thank you,Shelby,well,it looks to me that Jambo’s main grouse is with the Fed Reserve Bank,USA which I share.
“We know the secret of Federal Reserve
http://www.facebook.com/WKTSOTFR
Thank you,Shelby,I just went through your posts on the coming crisis in Japan which no one is paying much attention to,yes,I do agree that the huge debt of Japan is not high on the screen of most economists,after going through what you have written,my reading of the Bible comes into mind,the seven years tribulation in book of revealation.To those who are not familiar with the Bible:
What is the Tribulation? How do we know the Tribulation will last seven years?
http://www.gotquestions.org/tribulation.html
The 2nd Part of Dr Morris Chang and the discussion as belows:
The new economic model of Taiwan’s economic development
2/2 小英教育基金會「台灣經濟發展新模式」講座-張忠謀
http://www.youtube.com/watch?v=2Boj5tcpw3M
1/2「台灣經濟發展新模式」講座-蔡英文與張忠謀主題對話
http://www.youtube.com/watch?v=uyy-i0bKU9U
2/2「台灣經濟發展新模式」講座-蔡英文與張忠謀主題對話
The biggest problem with all these arguments is that it relies on China’s official statistics. This country has perhaps the most unreliable statistics in modern economic history. What is considering consumption, investment, etc are all over the map. There is also evidence indicating that many activities are not captured in the official data. Anyone who thinks they really know what is going on (regardless of bullish or bearish arguments) is just fooling themselves as it is nothing but academic exercise. Not even god knows what is actually going on.