My blog has been blocked in China. Given all the internet blocking that has happened in the past few months I guess this is not much of a surprise buy generic cialis uk, and I was sort of waiting for it to happen, even while I was hoping that it wouldn’t.
I think after a few months – probably once the 60th anniversary of the founding of the People’s Republic on October 1, 1949, is truly behind us – they will begin unblocking sites and my students once again will be able to read my blog without having to jump through all the proxy hoops. On a related note I was pretty pleased when Doug Paal, one of my Carnegie Endowment associates, told me yesterday that certain local policy analysts with whom he had recently met told him that they had been reading my blog and found it useful, but unless they are allowed to use proxies in government offices I guess whatever use I may have provided will be dramatically reduced.
Because I picked up a flu a couple of days ago (no, not swine flu), and so have been working much shorter hours, I haven’t really been able to comment on all the economic news that has come out recently. Since if I am feeling better I plan to go to Wuhan tomorrow and Shanghai Saturday to see some of my Beijing bands perform a couple of big shows, I figured I would make a few comments today before going home to recuperate.
The first comment is about reserves. Chinese central bank reserves surged in the second quarter of the this year, with evidence suggesting that we are once again seeing a flood of hot money pouring into the country. According to an article in today’s South China Morning Post:
Reserves rose US$178 billion in the second quarter, the biggest quarterly increase on record and up from the US$1.95 trillion yuan at the end of March, the People’s Bank of China said yesterday.
Most of the increase was driven by the usual suspects – the very large trade surplus and smaller but still high net FDI inflows, plus of course returns on the existing portfolio – but the important point I think is that the unexplained portion of the increase in reserves, which serves as a proxy for hot money, has turned from negative in the first quarter to very positive in the second. I will do my calculations later, but for now it seems pretty clear that hot money is returning to China.</p>
This is not a surprise. With optimism returning to China, and with stronger real estate and stock markets, investors are bringing money back into the country. Hot money, of course, is intensely pro-cyclical, and its effect will be to intensify growth in the short term, even as it increases volatility and makes monetary policy more difficult. Remember that the PBoC must recycle the net surplus on the current account and the capital account, and with the very high current account surplus, China would be creating a huge amount of domestic money just from that source. The fact that it is also running a large capital account surplus makes the PBoC’s monetary management that much more difficult. Worst of all is that as long as this fiscal-stimulus-induced boom continues, hot money inflows will heat things up even more, but once the government is forced to scale down the stimulus, the resulting slowdown in the Chinese economy will likely be seriously exacerbated by hot money outflows. The PBoC has a lot of difficult work to do.
One thing that many observers noticed is that the huge jump in reserves means that China must continue buying US Treasury bonds, and of course this still seems to promote very muddled thinking among the cognoscenti. For example today’s Bloomberg had an article which argues that:
…President Barack Obama’s administration is seeking to sell a record amount of debt to pay for measures to revive the U.S.economy.New York-based Goldman Sachs Group Inc; buy generic cialis uk.estimates that government borrowing may total $3.25 trillion in the year ending Sept.30, almost four times the $892 billion in 2008, to finance the budget deficit.
“ Buy generic cialis uk: china’s reserves will allow the U.S.to run a higher fiscal deficit than other nations buy generic cialis uk,” said Bilal Hafeez, the London-based global head of currency strategy at Deutsche Bank AG, the world’s biggest foreign-exchange trader.
No, no, no. The fact that China’s reserves have surged will in no way make it easier for the US to fund its fiscal deficit even though, as I have argued for a very long time, China has no choice but to invest these additional reserves in US Treasury bonds.
Why? Because besides valuation changes and interest income there are two reasons for the increase in the reserves – the very high trade surplus and net capital inflows into China. Take the second reason first. If money flows into China for investment purposes, it must flow out of somewhere else, and that somewhere else for the most part means the global pool of dollar savings which would anyway have been available to fund the US fiscal deficit directly or indirectly.
In that sense China is acting as kind of upside-down bank that takes risk-seeking money and intermediates it into low-risk assets – as an aside almost the opposite of what the US does, and whereas the US profits from this intermediation, China runs a significant negative carry. Of course the fact of intermediating risk money into low-risk assets will have some impact on US Treasury rates, but the impact is minimal (technically risk-free rates will decline a tiny bit and credit spreads will increase by the same amount).
What about the dollars generated from the trade surplus and invested into US Treasury bonds? Won’t that help the US fund its fiscal deficit?
Again the answer is no. The US government is not borrowing for abstract reasons, but rather is borrowing in order to spend locally to generate domestic employment. The amount of borrowing it needs to generate a fixed amount of domestic jobs is correlated with the US trade deficit, because it is through the trade deficit that domestic consumption “leaks out” to create jobs abroad. The higher the trade deficit, in other words, the more the US government needs to borrow to generate a fixed number of American jobs, and so the fact that China is reinvesting the dollars generated by the trade surplus with the US does not make it easier for the US to borrow since it simultaneously requires the US to borrow more.
Remember that China does not fund the US fiscal deficit. It funds the US current account deficit, and it has no choice but to fund it. In fact this is true for every country – foreigners must fund current account deficits, and they do not fund fiscal deficits. To breathe a sigh of relief because a very high Chinese trade surplus means that China will buy a lot of US Treasury bonds is no different from breathing a sigh of relief because the US is running a very large trade deficit. As I have said many times before, if the US wants China to buy $1 trillion of new bonds every year all it has to do is ensure that the US runs a $1 trillion trade deficit with China every year.
My second comment is about the GDP growth numbers, which are both a cause and partial consequence of hot money inflows. As a Bloomberg article today reports:
The figure, announced by the statistics bureau in Beijing today, exceeded the 7.8 percent median forecast of 20 economists in a Bloomberg survey and a 6.1 percent gain in the first quarter that was the slowest in almost a decade.
China, the biggest contributor to global growth, overtook Japan as the world’s second-largest stock market by value yesterday after a 4 trillion yuan ($585 billion) stimulus package spurred record lending and boosted share prices.The first-half expansion laid the foundation for meeting the year’s 8 percent growth target for creating jobs and maintaining social stability buy generic cialis uk, the statistics bureau said today.
“China’s growth is getting back on track after being pulled down by the global export slump,” said David Cohen, an economist with Action Economics in Singapore.“It’s leading the turnaround in the global economy.”
Besides the fact that I don’t see a turnaround in the global economy, and in fact I think China will be among the last countries to escape from the effects of the global crisis, I have a small problem with the earlier claim that China is “the biggest contributor to global growth.” This is true if a country’s contribution was simply the number we get when we algebraically calculate global growth (each country’s GDP growth multiplied by its share of global GDP).
But with the largest trade surplus in the world, and remembering that the trade surplus represents negative net demand, I would argue that if you want to contribute to global growth in a world of excess supply and collapsing demand, you do so by increasing your net demand, or in this case by reducing your negative net demand. One of my friends, a government official from a neighboring Asian country, told me furiously last week that through its aggressive export policies China is simply expropriating growth from other Asian countries. I am not sure if I completely agree with him, but I suspect that he would be even more furious to hear that China was the greatest contributor to global growth.
Was China’s “surprisingly” high GDP growth numbers a big surprise? Not really. I have argued several times since last year that in fact China can achieve very high growth numbers by throwing a huge amount of resources into achieving short-term growth, but the real question is whether these policies are sustainable and whether the kind of growth they achieve is in China’s best interest.
In my opinion, these policies involve such a huge expansion in fiscal debt and especially in new bank lending that they are certainly not sustainable. Even without including the almost certain surge in future NPLs caused by the unprecedented explosion in new lending, China’s debt is much higher than people think and it is growing quickly. There is a limit to how much further the fiscal expansion and the surge in bank lending (which amounts to the same thing) can go on.
Furthermore I think the focus on investment in infrastructure and manufacturing will make much more difficult China’s ultimate transition towards an economy in which surging debt-fueled US household consumption plays a much smaller role. In addition much of this new investment is in projects with very low, or even negative, returns (and I suspect they would almost all be negative if interest rates weren’t kept so low by the PBoC). This is not a way to increase Chinese wealth.
I have discussed this too many times to go into it again, but I am worried that China’s high growth rates today can only last another year or so at best, and will result in a much more difficult transition period. This is a lot like the way Japan’s response to the collapse in US consumption after the 1987 crisis resulted in two spectacular years of credit-fueled growth followed by two very difficult decades of transition. Chinese policymakers are in the very tough position of having to choose between policies that make the transition easier but result in rising unemployment today, and policies that spur employment growth today but may create even greater excess and wasteful capacity. I am glad I don’t have to make those decisions, but I am pretty sure that if I did I would be more worried about the impact of the fiscal stimulus on China’s long-term growth – buy generic cialis uk.
I for one simply don’t believe these GDP numbers, and think that all of the independent forecasters out there are victims of their own model convergence. So how real is this real growth figure? Who knows. The government has trained itself to simply proclaim “look, we made more output”, and expect everyone to take it as a universal good. Sure, good news is needed and appreciated, but if it is bogus or slightly bogus news, well, we all suffer more in the end. This is part of how we collectively got to where we are. The feigned indignance of the government when anyone dares to question things has become decidedly stale. Show me the jobs, and I will believe purported real output gains. There have not been any decent (meaning credible) reports about what unemployed migrant workers are doing these days, etc in either the Chinese or English language media (that I have read – I you know of one, please send).
Just read JK Galbraith’s Great Crash, which he opens and closes with the point that faced with an adjustment that is both nasty and inevitable, policymakers will never choose to precipitate the adjustment, which only assures that they get blamed for the nastiness.
Michael, would be very grateful for your thoughts on the follwing:
How can credit grow so fast without any meaningful impact on the currency vs USD? Are hot USD/trade flows enough to offset the credit (money) creation? Is credit supported by reversing the sterilization of money created earlier by the PBOC (I guess that would mean velocity increases but not supply, but supply is increasing ~28%)?
Also, what do you think is the best evidence that stimulus money is being used to create additional manufacturing capacity? The official FAI breakdown? How do we know they aren’t retooling export capacity for the domestic market? How do we know project returns are low/negative?
Finally, if I understand your thinking correctly, when China calls for a “new reserve currency”, they are effectively calling for an end or at least a reduction in their trade surplus with the US (since they would either have to stop/reduce selling goods to the US or use the USD they receive to buy non-USD assets and undermine their currency advantage). They seem pretty committed to the surplus, though. So why does the government keep bringing this up? Is there any advantage to trading w/ Hong Kong or Argentina in CNY, where all of the CNY, ARS and HKD are to varying degrees pegged to the USD? Don’t you still have mostly USD risk?
Glad you’re back; feel better.
From John Ross, Visiting Professor Jia Tong University Shanghai, Former Director of Economic and Business Policy for the Mayor of London.
Michael Pettis’s views on the Chinese economy continue to get increasingly bizarre and out of touch with reality. In this post he concludes that ”I think China will be among the last countries to escape from the effects of the global crisis’.
This is in the context where China’s GDP expanded 7.9% year on year in the second quarter while, on the latest available figures, US GDP was falling at an annualised rate of 6.6% in the first quarter of 2009. So, apparently, according to Michael Pettis it is China that faces the problem and will be ‘among the last countries to escape from the effects of the global crisis’! This is rather the economic equivalent of continuing to believe that the world is flat when all facts show it to be round.
As I have noted on my blog elsewhere: ‘A number of non-Chinese commentators have accurately judged that the Chinese stimulus package will be successful – the most prominent probably being Jim O’Neill, Goldman Sach’s chief economist. In contrast theorists that China is ‘oversaving’, and must change its economic model… such as Martin Wolf of the Financial Times and Michael Pettis, have been proved inaccurate.
‘It would be hoped that as economic theory has not led writers such as Wolf and Pettis to change their analysis facts might now lead to an acknowledgement their analysis is wrong. As, however, they have maintained views which are false from the point of view of economic analysis, and from the point of view of economic facts, for many years it is probably unlikely there will be any change in light of the latest data… Fortunately for the health both of China’s and the world economies the Chinese authorities have continued to pursue their own policies and ignore such advice from outside. The latest GDP data confirms just how right they were to do so.’
If a theory and the real world do not coincide there are only two things that can be done. A sensible one is to abandon the theory in light of the facts. But when you are led to deny the real world to try to save the theory then it is a certain sign the theory is wrong.
The ‘oversaving’ theory, and therefore the alleged crisis of China’s growth model that it flows from it, has always been false from a theoretical economic point of view. It is simply now also out of line with the most immediate economic facts.
That is why Michael Pettis is forced to deny the real world.
Related, I think, to your banning in China I wonder if you heard about the relatively hard line the US Sec’s of Energy and Commerce took in China on their recent visit. Their comments on China’s contribution to Climate Change seem to been largely censored in the official press. Movement in the US is gathering for carbon tariffs as China and India dig in their heals on promising any reductions.
This, combined with your observations about the rest of Asia’s growing anger at Chinese policy, bodes quite ill for trade relations over the next few years. If the ‘green shoots’ turn out to be as effemeral I suspect they will be I would look for an intra-Asia trade dispute (Japan and Korea trying to pull final assembly back home for example) and a Enviro/Product safety tinged West-China trade dispute.
The degree to which China’s government is preceived to be authoritarian is already coloring perceptions on their trade behavior abroad, and vis-a-versa.
And that’s before one even begins to worry about NPL’s.
Commiserations for being blocked. Like you say I guess it is in the run up to National Day (and I think you mentioned a certain sensitive province in your replies to the comments on your last entry!). Hopefully whoever it was will see sense soon!
Bloomberg have been mentioning some govt. bill sales recently as the govt beginning to tighten monetary policy. I think
http://www.rgemonitor.com/asia-monitor/257293#184352
Rachel Ziemba today mentions that this is a “return of sterilization”. With Brad Setser on holiday the reserve numbers are not getting their usual analysis. Perhaps this hot money inflow will push up the monetary tightening? National Day seems to be a very long way away if the current lending / hot money situation continues…
I fully agree with what you say, the hot money acts like giant pendulum, whichever way the government goes, the hot money eventually adds its own weight and over-steers the economy! The next few months should be interesting.
I wonder how many posters in China can get through the Great FireWall?
Hi Michael, this is Long @Vaneck.
Great to see you start writing again. Take care of your body!
[...] Read the rest of this great post here [...]
[...] I wasn’t impressed by China’s high reserve and GDP growth numbers [...]
don’t you have a lot more confidence in china’s ability to reel it in and persevere than america’s?
From Tuesday’s Shanghai Daily: http://english.caijing.com.cn/2009-07-14/110197456.html
Whenever I find myself recoiling in near disgust from the vapid pap which passes for financial reporting on China in most circles, I find my way to your website for a rejuvenating dose of thoughtfulness and coherence.
We live in truly strange times when China’s indiscriminate loan deluge is considered a “positive” indicator for the global economy.
7.9% is a nice touch, though. That .1% away from the required 8% was enough to convince me of the soundness of this impressive figure. Some official in the Ministry of Truth is congratulating him or herself on that one.
On a more serious note regarding your last paragraph, I do not envy Chinese policymakers in the choices they face. It seems clear to me, though, that short-term panic has taken the day and a choice has already been made: more of the same. Much, much more.
Prof. Pettis,
1) The blocking of your blog shows that the Chinese authorities see it as a risk if red by locals specially those who are involved in decision making and can be influenced by your analysis. It means that you are touching very sensitive issues. Most probably the highest Chinese decision level has already opted for the first of the two sets of policies you mentioned, it is already implementing them, will reinforce them during the month of October and will try to hide the decision, as a whole, as long as possible. It is mainly a political decision and has to do with a strategic power dispute with the US. It is very difficult to imagine that they will let pass by the chance opened by the weakness of the US economy to weaken it even more and at the same time strengthen the geographical extension and dimension of its power. This is also, historically proven, the best choice to preserve and improve their economy and well being.
2) Can you explain the recent surge in auto sales in China? Does it mean that the government is being successful in growing the country´s internal demand?
Christopher.
Until China stops undervaluing their currency how can you trust any of their numbers
I would venture that China is in a much more precarious position than either Japan was or the US currently is in now.
China MUST grow. As you mentioned, a lack of growth will see unemployment shoot up more than it already has in China and its likely that the authorities assign a much higher risk to that outcome than any other. (IOW, there are political reasons besides economic ones for their decision-making and they might be keen to avoid any path that will increase the potential for unrest given the proximity to several important dates and events in Chinese history).
However, as you also pointed out, these policies are short-term in nature and not sustainable. Perhaps the view is that China will have more flexibility to rein in inflation in a period where the global economy is doing better. (IOW, play hopscotch with demand — inflate, hope the world recovers, and tighten when global recovery can cushion the pain internally). There might even be asymmetry in the impact China has on the world (greater impact because of expectations of Chinese demand on the upside, but lesser on the downside).
However, even giving this sort of benefit of doubt to decision-makers in China, it is still a thread-the-needle outcome and I wonder whether the Chinese authorities have a Plan B for a L-shaped global recovery. If equity and credit markets falter once more in China, they will have run out of ammunition and the problem will be orders of magnitude bigger. What out then?
I am skeptical that this sort of monetary easing is helpful even on a short-term basis. While auto-ownership has been pushed down deeper into the Chinese social strata, the recent rise in auto/retail sales or financial asset pricing still seems a function of rising confidence on part of the well-to-do or upper-middle classes (and for me, is not stable demand). Inflation numbers or sharp rise in demand for staples (food, energy, rents) would be more convincing but reliable data seems to be harder to get.
Get well soon, Michael, and thanks for taking the time to post.
Good point about the negative carry. This is a cost of maintaining the effective peg to the dollar. Many foreign investors (including myself) are betting that China will yield the best returns. Many international companies are investing in China as a growing market. China fighting to keep the RMB low makes this an even better bet. No doubt when China does start to let the dollar fall again it will be done gradually, as it was from mid-2005 to mid-2008.
China is going to do whatever it has to in order to maintain near full employment. Stimulus is needed until the global economy recovers. It is also largely being spent in a way that will make Chinese industry more competitive once the global economy recovers. I take the view that recovery is still a good ways off (especially in the US), but China has no shortage of ways it can spend money internally.
Alternative energy is still relatively untapped, and it seems that building out a national health care system is an ongoing project.
Boosting domestic demand has been done mainly through subsidies, but I think a stronger RMB, will do much more to free up discretionary spending boost consumption.
On the down side, it looks like housing has been way overbuilt in a lot of areas and they’ve been building more out of habit. It also looks like the strategic reserves are piling up a bit too fast. It won’t be easy, but I’m sure they’ll manage to keep the economy growing fast by finding ways to keep the masses constructively employed.
PPI decline accelerated to -7.8% from -7.2% in may…all of that in the face of 5x more lending than all of last year. CPI was also -1.7 vs. -1.4 in may. So…despite the almost 10tr yuan in ytd lending, prices are falling. Makes no common sense.
I just found your blog and think it’s terrific. Just wanted to pass along the compliment.
“Furthermore I think the focus on investment in infrastructure and manufacturing will make much more difficult China’s ultimate transition towards an economy in which surging debt-fueled US household consumption plays a much smaller role. In addition much of this new investment is in projects with very low, or even negative, returns (and I suspect they would almost all be negative if interest rates weren’t kept so low by the PBoC). This is not a way to increase Chinese wealth.”
Lots of infrastructure investment has low rates of return, public roads don’t have any rate of return in most countries, railroads are subsidised worldwide, electricity systems are nearly always installed at a loss, as are hospitals, schools, subsidised housing, sewerage treatment works, dams, nuclear power plants and so on. If all of these basic investments were required to pay for themselves, they wouldn’t exist anywhere in the world.
So how will they increase Chinese wealth? In a few ways, first if the investments last a couple of years, then most likely the world will have by then pulled out of its present crisis, so they will have done their work. Second by enabling the separation of peasants from the land and creating a modern working class they will massively raise productivity, increase profits, and paradoxically indirectly pay for the infrastructural investments that the government is instructing the banks to fund.
They may result in an increase in debt. Frankly its a moot point, all deficit public spending results in an increase in debt, how high it is all depends on what happens next, but its certainly lower than that currently underway in the US for example.
The income per capita in Japan in 1987 was 5-6 times greater than China’s in 2008. The economical structures are also totally different in the two countries: SOE dominant in China vs family dynasty in Japan. I doubt China’s economic development will follow Japan’s pattern at the end of 1980s.
From Standard Chartered’s Global Economic Focus on China:
The risks from China’s growth model
For many years, there has been valid criticism that China’s growth is too dependent on excessive amounts of (ineffi cient) investment. This has recently been worsened by the global slowdown, which has triggered a policyinduced take-off in bank lending since the start of 2009. In Q1-2009, new loans totaled CNY 4.7trn (USD 690bn), and lending growth continued at a pace of 29% y/y even in April. We expect total new loans in 2009 to reach CNY 8-9trn (USD 1.18-1.32trn).
Loans being made for non-commercial reasons increase the potential for a rise in non-performing loans (NPLs) in
the future. However, there are some key reasons why this will not necessarily result in a sudden crisis. First, only
the interest payments are made on a loan, with the capital being repaid at maturity. Therefore, a deterioration in
the borrower’s repayment ability does not necessarily result in a reclassifi cation of the loan. Average loan tenors
are getting longer, pushing out the potential ‘day of reckoning’. Second, loans could just get rolled over at maturity, again lengthening the time that it takes to recognise an impairment. Third, while collateral is committed for most
loans, this only ends up covering 20-30% of the loan. Fourth, the defi nition of problem loans is so broad that they
can be disguised at the branch level. Finally, if the local government is the loan guarantor, then the bank may be
even more hesitant to classify the loan as impaired. This is a risk worth watching closely, given the potential size of
the problem that may have to be faced at some point in the future.
One way to address this problem in the longer term, beyond changing the incentive structure so that more attention
is paid to the return on assets, is to change the composition of growth in the economy. However, it is extremely
diffi cult to shift growth in a short time away from investment and towards private consumption. China’s move to a more sustainable growth path is a crucial part of the transfer of economic power from West to East. One policy which worked very well in the past to boost retail spending was when the government organised a mass sale of urban state-owned housing to its occupants at fi re-sale prices during the late 1990s. This reduced the incentive for households to hoard their incomes and was very successful in boosting private consumption during the subsequent decade.
Changes that could be made now to boost consumption further include making property ownership more widespread, giving more legal protection to the private sector, and increasing the provision of social welfare. This last point could be very powerful. Boosting spending on rural and urban health insurance schemes and committing a larger share of state enterprise profi ts to social spending could have a profound impact on marginal consumption choices.
BCG, lots of good but not easy questions. My brief answers: The value of the RMB is not set by market conditions but simply determined by the PBoC, who is willing to buy unlimited amounts of dollars to hold down the value of the RMB. In that sense a massive credit expansion has no impact on the exchange rate. That doesn’t mean that the exchange rate is irrelevant, of course, but it just means that monetary policy is incredible difficult to manage.
It is always hard getting to the truth via the published numbers because the numbers often tell us what we want to hear more than what is actually happening. In the medium term I would watch two things: The trade surplus, which is one measure of excess production above the ability of local consumers to absorb it, and inventories, which is another. The problem with the latter measure is inventories sold to companies who plan to use it for projected projects are removed from the “inventory” account even if the projects aren’t up and running and never become viable. Still, at some point all this production must result in higher inventory.
I am as puzzled by the third point as you are, and I can only say that it probably reflects the great muddle in which these things are held by most analysts. I am considering writing a paper which argues that the US should push for a required use of only SDRs in reserves because this eliminates the US ability to run unbalanced accounts while also eliminating the ability of countries that are determined to grow through mercantilist polices to absorb large shares of US consumption. Of course the use of SDRs would kill off the Asian development model for all but the smallest economies.
CNM, there continue to be questions asked about the accuracy of the numbers but I think it is a reasonably safe bet to say that there has been an improvement in the GDP numbers although, as you point out, whether there has been a decline in unemployment is much more questionable. My main takeaway, however, is that either way whatever growth achieved was only done so through a massive and unsustainable stimulus which actually makes the long germ adjustment more, not less difficult. In that light I was very surprised to see the following report in Wednesday’s Telegraph about Justin Lin, who is usually a cheerleader for Chinese policymakers.
Justin Lin, the bank’s chief economist, said factories running idle around world threaten to trap economies in a vicious cycle, risking further spasms of financial stress, requiring yet more rescue packages. “Significant excess capacity has been built up and unless this issue is addressed, we will face a deflationary spiral and the crisis will become protracted,” he told an audience in Cape Town. Mr Lin said capacity use had fallen to 72pc in Germany, 69pc in the US, 65pc in Japan, and as low as 50pc in some developing countries, mostly touching lows not seen in modern times.
Under conditions of serious global excess capacity it doesn’t seem to me to be a good idea to expand capacity so relentlessly.
John Ross, I am afraid the few points in which you make sense are undermined by your (to me unexplained) bitterness. I am sure you understand that to argue that I must be wrong because Goldman Sach’s Jim O’Neil disagrees with me is easily refuted by my saying that on the contrary I must be right because Morgan Stanley’s Steve Roach agrees with me. This can’t seriously get us anywhere, can it? Let us just agree that these kinds of “proofs” are too silly to be taken seriously. By the way I am delighted to be dismissed for being in the same camp as Martin Wolf.
To address the one reasonable, although thoroughly muddled, thing you said: when I say that China will be the last one out of this crisis my point is not that China will collapse and the US surge in the next few weeks. Obviously that is not the case, and the most basic sense of charity in discussion should convince you that neither I nor anyone would make that case. On the contrary, the most cursory reading of my work should have made it clear that when people ask me about China’s response to the crisis I always says that they will be both the first one out and the last one out, and then explain what that means. To recap: just as Japan’s response to the 1987 US crash, which was a very small-scale dress rehearsal for the current crisis, was to use credit inflation and a massive increase in investment to work its way through what it thought would be a very short term reversal in the US ability to absorb Japanese excess capacity, so might China be doing the came thing.
Of course I am sure pundits like you in 1988 and 1989 would have pointed to the high growth and surging asset prices in Japan as proof that Japan was the first country out of the 1987 crisis, whereas annoying people like me would insist that the two decades Japan has struggled to adjust to the change in the conditions allowing for the success of its development model, which were exacerbated by the post 1987 credit response, is proof that they were the last country out. However you define first or last, the serious debate among us is not whether China’s current growth exists; the serious debate is over whether China must change its development model that relies on large foreign trade deficits, whether the current stimulus is sustainable, and whether it helps or worsens the transition.
Of course it is possible that I am wrong, but your claim that “fortunately for the health both of China’s and the world economies the Chinese authorities have continued to pursue their own policies and ignore such advice from outside,” is manifestly silly, and I am guessing that you have so far spent too little time in China to know better. Quite a few Chinese policymakers know me and other analysts, Chinese and foreign, who think like me, and ask for our opinions quite regularly. Perhaps this is all just a dastardly plot to make us feel good about ourselves before making fools of us all, but I think even the most superficial analyst knows that there is a real debate going on at the highest levels in China about just this issue.
By the way I often deny the real world, but usually in very different circumstances than those recorded on my blog.
Gregorylent, no. The US is much more sensitive to market signals whereas many of them are repressed in China. This makes policy making harder, in my opinion, not easier.
Lukman, thanks for the link. As you may know Huang Yiping is a widely read and very influential commentator who in this piece argues that “China’s recent asset market boom is caused by excess liquidity. The country risks repeating Alan Greenspan’s mistake: injecting excessive liquidity which leads to asset bubbles and eventually a financial meltdown.” I think that is exactly right. Of course he’s no Jim O’Neil, so perhaps his views should be ignored out of hand, but he seems to worry that the cost of the recent lending-fueled growth means that “an even bigger disaster is awaiting.”
RodegerRafter, I am hoping to do a piece about real estate soon.
OGT and Christopher Patterson, I don’t think I personally was banned. What usually happens is that when any of the blogs hosted by a site is deemed unacceptable, all the blogs are banned. As for the surge in auto sales, I have discussed this a few times in previous postings. Part of it may be for one-off reasons (tax cuts and anticipated purchasing by government departments) and part because of rising consumer confidence. What strikes me as bizarre is that the surge in volumke has not been accompanied by a surge in revenue or profit. In fact depending on what period you look at, numbers of cars purchased surged even as revenues declined slightly and profits dropped sharply. This is certainly not the normal pattern.
Houhui, the several failures of government bond auctions are pretty interesting and I hope to talk to Logan Wright a little more about that. On that note I am reading a couple of books about Japanese monetary policy in the 1980s and find some very weird parallels.
BillJ, the fact that some investments with low returns nonetheless have social and economic benefits is not to say that all such investments do, as the Japanese showed in the late 1980s and 1990s. The point is not whether in theory it is possible for some Chinese investments to be positive for the economy. Of course they will. The point is whether under conditions of nearly unlimited liquidity, enormous pressure on banks to lend, and an implicit credit guarantee from the government, the banks will not make investments in unprofitable activity that will undermine the banking system. By the way you say that the rise in Chinese debt is “certainly lower than that currently underway in the US.” I am curious about your numbers. What are your estimates for hidden debt, recorded and unrecorded provincial and municipal, AMC debt, and contingent liabilities? What percent of the new bank lending do you consider fiscal expenditures and what percent self-financing?
Seatrus, I have discussed these types of objections many times. Simply pointing out random differences between China and Japan and concluding that what happened to Japan cannot happen to China is completely a-historical. You have to specify why the differences you identify will preclude similar outcomes. You say that Japan’s per capita income is higher than China’s – is the implication that rich countries cannot have financial crises? You say China has SOEs rather than keiretsu – aside from the fact that the governance frameworks were very similar, is the implication that countries in which the state owns a significant part of production capacity cannot have overinvestment crises?
“the fact that some investments with low returns nonetheless have social and economic benefits is not to say that all such investments do, as the Japanese showed in the late 1980s and 1990s.”
But China today is not Japan in the 1990s. The points been made before but it bears repeating, China is still going through the phase of initial urbanisation/development akin to Japan in the 1950s, UK in the 1850s, USA in the 1870s. There is therefore a massive need for infrastructural investments which will in general raise productivity and output simply by increasing the proportion of the urban population and transforming farmers into workers.
How high are the NPLs in the current lending splurge? Lets say theres been $1.1 trillion new lending in the first six months, of which 30% has been speculated in stocks, 20% used to cover short term funding requirements, that leaves $500 bn. Take your figure of 20% losses, that gives $100bn NPLs. Nothing to get excited about. That’s assuming that stocks don’t rise in price and profit rates don’t rise as PPIs fall and margins recover.
In fact its better to regard these losses as a form of public expenditure, the price China pays for digging itself out of its current hole.
John Ross: “Michael Pettis’s views on the Chinese economy continue to get increasingly bizarre and out of touch with reality. In this post he concludes that ‘I think China will be among the last countries to escape from the effects of the global crisis’.”
Me: Not to bust your bubble but he has been arguing that for over a year, so I don’t think you should say his bizarreness is increasing. It has been pretty stable, although I found the politeness with which he responded to you a little bizarre. Actually quite a few very smart people in and out of the government read him very carefully and agree with him but, as he himself has pointed out many times, China faces a policy dilemma between short term employment needs and long-term adjustment needs.
I am curious about the preface to your comments, which struck me as pretty pompous and even funny. Should I put my credentials in the hope you will take my comments more seriously? If it helps, I work for Goldman Sachs, although I agree with Michael more than O’Neil.
PMJ thanks for defending me but there was absolutely no need.
Billj, I agree that there are substantial differences between China today and Japan in the 1980s, but I am not sure how those differences – that China “is still going through the phase of initial urbanisation/development” – imply greater stability in the Chinese financial sector and less risk of overinvestment crises. In fact it was interesting to me that you compared China today to “Japan in the 1950s, UK in the 1850s, USA in the 1870s”, because this is a point I have tried to make many times, especially when I argued that to understand the risk of financial crisis in Chinese today you shouldn’t focus on the 1997 Asian crisis, the 1994 Mexican crisis or the LDC debt crisis of the 1980s. It seemed to me that the US in the 19th Century, with its periodic overinvestment and banking crises, was a much better model.
Your dates are probably accidental, but telling. They were all periods during which even though the respective countries were undergoing the productivity processes you mention they nonetheless suffered awful overinvestment crises. In 1847 England went through one of its worst financial crises in the 19th century, involving mainly a massive overinvestment in railroads and production facilities. The 1870s in the US were, of course, another fascinating comparison since the 1873 crisis in the US has generally been considered the worst American crisis in history, until of course the 1929-31 crisis, and the subsequent 7-10-year period was the first to called the “great depression” by the general public. I confess I am not as much an expert on Japanese history (I am racing to catch up on my Japanese reading) but I want to say in the early 1960s Japan also experienced a very tough financial crisis (although please don’t quote me on that).
And that is precisely my point. In every case as you point out the relevant countries were going through then, as China is today, “a massive need for infrastructural investments which will in general raise productivity and output simply by increasing the proportion of the urban population and transforming farmers into workers.” But that in no way protected them from the consequences of excessive monetary expansion, too-rapid bank lending, and misallocation of capital. And I am not sure why the fact that China more closely resembles those countries then than it resembles Japan in the 1980s can be used to argue that therefore China is less vulnerable today than Japan was then.
That is also why I get a little tetchy (apologies to all) when someone tells me for the millionth time that “China today is different from Japan in the 1980s (or some other country)”. Of course it is, and of course I know that, but how does this imply that China cannot have an overinvestment crisis? This would logically be true only if the argument can be made that countries that are different in the way China is different can never, or have never, had overinvestment crises, but no one has ever taken the next step in the argument.
Enough on that point. I also am not sure I agree with your estimates for NPL losses. Even if I accept your 20% on new lending (not mine – I estimated it on total lending) I think you are implicitly making three assumptions that would never accept explicitly. First, and least importantly, you assume that the money that goes into stock speculation is safe from losses. But it is only safe if everything works out fine, but when there is a problem it is almost certainly likely to be bad money (and more than 20% bad). My book, The Volatility Machine, was in part about what I called “inverted” balance sheet structures, which do fine when everything is going well, but collapse at exactly the wrong time. These types of structures are very, very risky because of their pro-cyclicality. Remember in the 1980s the huge arguments the international banking community had with the Japanese MoF about the valuation of the banks’ stock and real estate portfolios, with the MoF saying they should be fully valued because prices never went down in Japan. And they never did – until 1990, when the banks were in trouble. These valuations only matter when everything has turned south.
Second, you assume that bad loans will only occur in the new loans made this year. I, on the other hand, believe that there are huge problems in the banks’ existing loan portfolios that have been covered up in part by creative accounting and in part by furious GDP growth, but once the economy slows, a very large portion of these loans will suddenly become problematic. You will recognize this as another case of “inverted” balance sheets.
Third, you assume that new lending stops this month. In fact there is no evidence that the PBoC will prevent banks from increasing their loan portfolios further, and I suspect we have several more quarters of very rapid growth in the fiscal deficit and, more importantly, in new lending.
For these reason I think your $100 billion in NPLs is unrealistic even as a best-case scenario. The reality is likely to be worse, but the most important point is that the reality is likely to be much, much worse at exactly the wrong time, when China hits a serious speed bump. Those are the danger of these kinds of lending sprees.
Prof Ross, what’s the point of joining a debate about the credibility of the latest GDP print and the consequences of the policies that produced it (if it’s true) by accusing someone of being out of touch with reality for not simply lapping up the number and its ostensibly positive implications as ‘fact’ at face value? If you haven’t heard, Goldman’s been taking profits on their A-shares since April, and you sound like their kind of buyer. Give Jim a call before they’re all gone.
btw, I’ll bet Jim voted for Boris
I would be interested in comments on two data points: new lending at 7.8 trillion during H1, and corporate deposits up by more than 5 trillion. Where is the real activity in the manufacturing/corporate sector? I would almost be reassured if the commercial banks were shovelling short-term loans onto their customers books, and they are smart enough not to make investments that will face deflationary risks.
Of course as you say the fact that China is presently in an extended period of dynamic growth due to the strength of urbanisation/productivity dynamic does not exclude the possibility, indeed inevitability of periodic overaccumulation crises.
Another obvious example is the so called “belle epoque” between 1890-1914 and the financial crash of 1907.
So the question is really – will there be a crisis of overaccumulation in China now or at least imminently as a result of the present lending splurge?
That seems to me unlikely (I’m being cautious, not impossible), mainly due to the rising profit rates of Chinese industry in the period up to the end of 2008. This rise was rudely interrupted by the crash in the latter half of the year, but now that the economy has been redirected towards internal domestic accumulation, albeit mainly fixed capital investment, it has recommenced. Profit rates are on the up again due to the combination of low raw materials prices – reflected in the slumping PPIs – and rising demand enabling firms to restore margins and the inherent strength of China’s domestic accumulation process, with still abundant supplies of very cheap labour and frankly relatively cheap fixed capital.
That seems to me to be the key, if profit rates are rising then NPLs will be lower, and those that do occur can be met more easily. Once the world economy has begun to recover (later this year onwards) then the combination of the two will provide the impetus for a very strong upward trend in profits and growth.
That won’t go on forever. There is a business cycle. There will be an overaccumulation crisis. Expect the next crash around 2017.
Prof Pettis.
I have noticed there was another failed debt auction today or yesterday. Is this the beginning of the tightening? Some sterilization?
Have you read DBS’s “When will China tighten monetary policy?” research from today? They are expecting the current loose policy to continue until 1st Half 2010 – with a few tweaks before then. With about 800billion RMB of hot money having flowed in in 2Q, do you think that we should revise forwards are estimates for the “tightening”?
Quote from the DBS report:
“That said, a lot of economic literature published in China supports that a loose monetary policy will generate more inflationary pressure than raise real economic output in the long-run.”
John Ross – disappointed that China is not as far-left as you’d hoped? Does this explain your vitriol?
China’s stimulus package is aimed at some quite short term, and in many peoples’ views, quite political goals. Whilst this is understandable, given the sudden vanishing act of exports and FDI (and job creation) the fear is that the long term consequences of these “band-aids” will be depressed growth or perhaps even more serious pain down the line. Have a look at M2 relative to GDP, and how much it has grown with this “stimulus lending”. Surely you wouldn’t disagree with the argument that China could channel some of its money more towards helping people with education and healthcare rather than subsidizing semi-corporate exporters / allowing SOEs to get away with hardly any dividend payments?
How is Socialist Action coming along? Has Ken got more time to spend with his many children since the defeat?
Michael Pettis:
“you assume that bad loans will only occur in the new loans made this year. I, on the other hand, believe that there are huge problems in the banks’ existing loan portfolios that have been covered up in part by creative accounting and in part by furious GDP growth, but once the economy slows, a very large portion of these loans will suddenly become problematic.”
I think this is a very important point that many people are forgetting. It’s not as if the Chinese economy is launching from a clean slate with this stimulus- it should be pretty obvious to even the semi-casual observer that overcapacity has been building in Chinese real estate, manufacturing and infrastructure for the better part of a decade now.
In all honesty, how many times can you rebuild your cities or add more empty floor space? I know it makes the financiers salivate- China is an economic dream on paper – but grounded in more physical reality I would argue that this state of affairs is now bordering on the absurd.
As you illuminate the global context of chinese economic policy like few others do I wonder why this time you see the problem with hot money. Put in a global perspective I would say it can hardly be called procyclical. (Although you are perfectly right on this in normal times). You argue that this hot money is withdrawn from somewhere else and logically so. But in the US the money sits mostly idle or is invested in speculative bubbles so why not invest it in chinese infrastructure? In the long run I believe it will be even productive because there is so much need for infrastructure buildup in 1.3B China that there should be enough capacity of absorption for many years. So while you are right that a fundamental change in the economic model is not achieved that way I still think it can in the end prove to be the best way for China to cope with the current crisis.
Concerning stimulus packages the argument often goes about how much bang is obtained for the buck. And given the hot money inflows this certainly seems to speak for Chinas stimulus measures. So this time they reinforce an anti-cyclical measure.
There was and remains a “massive need” for productivity-enhancing investment in Russia, Ukraine and Kazakhstan, all of which are still running largely on the Soviet-era capital base. After more than a decade of ‘investment’ it appears they have very little that is sustainably productive to show for it, but DO have the most troubled banking systems outside the developed world (with full-on banking crises in Ukraine and Kazakhstan and Russia trying to figure out how to prevent one for the second time in a year). Neither the need for investment nor the fact of your making it ensures it’s going to create any value or earn any return.
Great post, and comments/responses. I hope you feel better soon.
Here’s one of my pundit gauges: how certain is the pundit that his, or her, forecast is correct?
Michael Pettis, Steve Roach and Robert Shiller tend to explore broad forces at work, and possible consequences.
Jim O’Neill never has a doubt and has no problem speaking with certainty and sees the world as fairly simple. This is Jim explaining how the BRICs will be helped by western finance crisis:
“On a relative basis it definitely allows the BRICs to develop faster as they are going to take an even bigger share of GDP sooner,” O’Neill told in an interview at an economic forum in Russia’s former imperial capital of St Petersburg held in June.
5 Jul 2008
http://economictimes.indiatimes.com/News/Economy/Indicators/BRICs_helped_by_western_finance_crisis/articleshow/3201005.cms
Enough said. (This was not a defense of Michael, just a personal observation.)
Michael,
I found the comment made to you by that government official, ” expropriating growth from other Asian countries”, interesting. I have maintained that trade conflict will happen first among other countries following the Asian development model. I think that Japan will lead the protest, mainly due to the dilution in the value of there USD holdings.
I was hopping though that you would share your opinion on China’s reserve growth. How much is too much? At some point it must be counter productive.
Michael Pettis,
Naturally I don’t think that you must be wrong because you disagree with Jim O’Neill. I was simply making the point that there are at present two assessments of China’s stimulus package and listing some of those who think it is not on the right track, yourself and Martin Wolf for example, and some of those who analyse it will be successful, which Jim O’Neill does and so do I (probably for different reasons). Naturally appeals to ‘authority’ don’t settle anything, only the facts do.
I am sorry to have to reply to your rather childish put down ‘I am guessing that you have so far spent too little time in China to know better’. The first substantial article I wrote on China was in 1992, with the self-explanatory title ‘Why the Economic Reform Succeeded in China and Will Fail in Russia and Eastern Europe’, I visited China on numerous occasions, and have met many senior Chinese figures, before taking up the visiting Professorship at Shanghai’s Jiao Tong University. I am not going, in reply, to ask for a comparison of when you first starting analysing and writing about China, as that doesn’t settle anything anymore than do appeals to ‘authority’, but I would think 17 years analysing and writing on a subject would be enough to establish knowledge on it so could we instead discuss the actual issues?
I also know from those 17 years there has been an entire industry repeatedly predicting deep economic crisis in China, the analysis of all of which turned out to be false – for typical examples see Gordon Chang’s ‘The Coming Collapse of China’ or The Economist’s ‘Out of Puff A Survey of China’ published in June 2002 when China was about to enter one of the greatest booms in economic history! The ‘oversaving’ and ‘overinvestment’ thesis put forward by yourself and Martin Wolf is one of the latest of these of such arguments. Naturally the fact that it is one of a line of views that inaccurately predicted the failure of China’s growth model doesn’t make it wrong – it has to be dealt with in its own terms. But it is legitimate to make the point that the factual track record of those predicting crisis in China is considerably inferior to those who have pointed out the reasons why China has continued to enjoy very rapid economic growth.
The error of your and Martin Wolf’s ‘oversaving/overinvestment’ thesis can be explained very simply. Econometric research demonstrates that, provided an economy is enjoying the economies of scale which require an orientation to foreign trade (which the USSR did not for example), capital inputs are the primary locomotive of economic growth – that is unless you still adhere to the now refuted 1950-70s Solow/Kuznets thesis that the main cause of economic growth is technology. For an overview of the factual econometric literature see Jorgenson and Vu’s ‘Information Technology and the World Economy’ or see Dale Jorgenson’s The Economics of Productivity for a comprehensive survey. As they conclude: ‘growth in the world economy and the G7 economies was dominated by growth of capital and labour inputs before and after 1995. Productivity growth played a subordinate role and fell considerably short of the contributions of capital and labour inputs to world and G7 growth.’ In short China’s strategy of massive mobilisation of capital (that is a very high rate of investment) and of labour was in line with the fundamental determinants of economic growth and therefore entirely rational. Reduction of China’s investment rate will, therefore, necessarily lead to a slowdown in its economic growth.
The necessity for a high savings rate is only a function of the necessity for a high investment rate – by definition every act of investment has to have an equivalent act of saving so if China is to have a very high investment rate it has to have a very high savings rate.
A related, but actually different, issue is that of China’s balance of payments surplus – i.e the export of part of China’s savings. Your statement that ‘China must change its development model that relies on large foreign trade deficits’ is simply not factually accurate. China’s economic development model certainly does rely on a high level of investment, and therefore of savings, but the emergence of a large trade surplus is, however, a recent development occupying only four years out of the thirty years since the launching of its current economic policies – basically since 2005/6.
You do not point out that so far this year China’s trade surplus is rapidly shrinking – in June it was only $8.25 billion. The reason for this is evident if you look at the present macro-economic fundamental. At present China’s investment level is rising as a proportion of GDP – the first half’s 7.1% GDP growth being constituted by plus 6.2% from investment, plus 3.8% from consumption and minus 2.9% from exports. Unless China’s savings is rising by an equivalent amount (highly unlikely given that the state budget is moving into moderate deficit and company saving will be under pressure from the international financial crisis) then as the investment-savings gap narrows the balance of payments surplus will shrink – that is China will be using more of its savings in domestic investment and less in accumulating assets abroad.
That China invests its high savings rate internally is definitely preferable to its running a trade surplus – both because the rate of return on such investments is likely to be better in China and because it will avoid some of the losses on its holdings of US Treasury bonds as the latter probably fall in price over the coming years, under the impact of the US stimulus package, and as the dollar exchange rate declines.
A situation, where China invests a still higher proportion of its high savings level in China is, therefore, certainly preferable to one where it is accumulating savings abroad through a very high balance of payments surplus. But the fact that such a trade surplus has only existed for four out of the thirty year period of China’s economic reform shows clearly that it is not ‘fundamental’ to its development strategy at all – while a high level of savings and investment definitely is.
In short China’s development strategy is successful because its macro-economic fundamentals are right – orientation to foreign trade, achieving among other things the economies of scale that follow from this, and high levels of mobilisation of capital which is the primary determinant of economic growth. It is precisely because its economic fundamentals are right that China has achieved such economic success. And it is also because its economic fundamentals are correct that the facts continue to refute those who predict crisis.
The Wolf/Pettis claims of ‘oversaving/overinvestment’ is wrong from the point of view of economic theory, does not state accurately the causes of economic growth either in China or internationally, and therefore unsurprisingly produces wrong predictions regarding the stimulus package.
I mentioned that Japan’s per capita income was several times higher than China, because I thought it was pretty obvious that this implied that Japan was at a much higher development stage, therefore was much more prone to overproduction than China. For example, the car ownership in Japan is 400-500 per 1000 persons, and in China it is 20-30 per 1000 persons, and China’s total population is 10 times that of Japan’s. A substantial increase in investment in the car manufacturing and servicing industries would exacerbate the overproduction problem in the Japanese industry, but not so for China. It is the same thing for roads, railways, airports, residential buildings, hospitals, schools, cements, aluminums and so on and on… China has not reached the stage of building “bridges to nowhere” yet, and has a long way to go. So overproduction is not a major problem in China in general.
Also, since the economic structure is totally different in China and Japan, China can avoid some major pitfalls that trapped Japan. For example, the prolonged Japanese recession was preceded by a huge bubble in Japanese land values. This is less likely to happen in China, because almost all lands are public in China, this effectively prevents individual speculation.
Michael,
Great post & comments. I wonder if your blog is being blocked in the United States. There doesn’t even seem to be the beginnings of a serious debate, within the Administration, about how sustainable it is to be feeding China’s experiment with mercantilism.
I would wager that Japanese and Korean shipbuilders are not happy with the stimulus funds for China’s shipbuilding industry.
http://www.joc.com/node/410114
http://www.businessweek.com/globalbiz/content/mar2009/gb2009034_996383.htm
http://www.chinadaily.com.cn/bizchina/2009-03/20/content_7601759.htm
The back and forth between Michael Pettis and John Ross is quite interesting and thought provoking. I personally side with Michael, but it stems from my experience doing business in China. However i come at it from some different angles. I believe China has kept interest rates at artificially low levels, thus guaranteeing businesses an “arbitrage profit”. Let me explain. If i can borrow at 4% and GDP growth is 8%, then i should be able to generate a profit of 4%. What do i do with my 4% profit? Well of course i build more productive capacity so i can make the 4% on a larger capital base…and so on and so on. This is not the case in other countries where the cost of funds is usually a little higher than GDP growth.
Another thing that nobody talks about is the level of corruption in China as well as bureaucratic red tape. The commodities biz in china is riddled with corruption. This is troubling and does not bode well for long term growth as it hampers the efficient allocation of capital (neither does the red tape….just ask any Indian about that one).
I find Mr. O’Neils and Mr. Ross’s views slightly optimistic. To pin my hopes of global growth on a mafia state (Russia), a totalitarian state (China), one of the most bureaucratic red taped riddled nation on the planet (India), and Brazil (I cant say more than I have seen the same movie about Brazil many times throughout my life, all with a healthy dose of corruption is very questionable. Until China becomes a free nation where market forces can allocate capital efficiently, rather than have it done by policy makers in Beijing, i cant support these well respected analysts. Not with my money!
I also want to ask Mr. Ross what he thinks will happen when the big bet China has made that the OECD starts growing like 2006-7 in a years time fails? If it fails they will have an NPL problem, and rampant unemployment, unless they of course decide to build even more useless capacity (the developed world already has a cap utilization rate of about 65%) and negative NPV projects. I guess China has enough money to put out another stimulus package in a years time, but by then their credibility will be in question (oh my god you mean policy makers in beijing are actually human and fallible?), and the property and stock market bubble will be pricked.
Let me ask Mr Ross what are the yields on residential real estate and comercial real estate in China? Hmnn negative? Didnt we see that story somewhere else? How about p/e ratios on equities.
Mr Ross can stay in his ivory tower, but as a business man i see some sizable risks in a years time and im not talking of the fat tailed black swan variety.
Lets all be rational and agree that both sides of the argument make good points (Pettis and Wolfe more so). However as in all analysis, it comes down to what the distribution look like around the mean. The word Kurtosis comes to mind. I am of the belief that looking 12 months out, i see a fat tail on the negative side of the distribution, while a short tail on the positive side. On that basis, when one looks at investing in real estate or stocks in China, given current valuations, one must tread carefully. Lets all remember the well documented human behavioral bias towards underestimating risk (standard deviation). What Mr. Ross articulates (as did Jing Ulrich recently in NY where she sounded more like a cheerleader for Chinese policy makers), flies in the face of statistics (they posit policymaker infallibility in what has become a fat tailed world), and thus cannot be taken too seriously. Mr. Pettis simply seems to be pointing out the dangers and shedding light on what the outcome universe looks like, rather than argue for a one branch in an outcome tree as do others.
Just some words of caution and healthy skepticism.
Professor Ross:
Professor Pettis will no doubt scold me for coming to his defense, but as an admirer who has appreciated him since his days in Mexico I do have to make a few small points. First, it comes as a surprise to me that you have accused the professor of being childish in his response to you. His saying that you haven’t spent enough time here to know better is perhaps a little more rude than he normally is, perhaps because he has the flu, but to call him childish after your having posted such a self-important and rude message (as you can see I am not so charming as the professor) is lacking in self-awareness.
But let us move to a more substantial point. Several years ago a comment such as “there has been an entire industry repeatedly predicting deep economic crisis in China, the analysis of all of which turned out to be false”, was a very common rebuttal to people like Nicholas Lardy, who warned about a banking crisis in the late 1990s, and Professor Pettis more recently, but perhaps in part due to people like Professor Pettis this argument is no longer heard much.
Let me explain why. First, it is intellectually silly, as I am sure you agree, to say that Mr. Pettis must be wrong today because Mr. X was wrong twenty years ago. Second, even if it is true that China has not had a financial crisis in 20-30 years that is in no way evidence that it cannot have one soon.
But the most important reason your rebuttal is false, as Mr. Pettis himself began pointing out several years ago, is that it is very bad history. It is the result of a misreading of history that insists that an economic crisis cannot exist unless Western workers are not thrown out of jobs or, to put it in the less charitable way Professor Pettis always put it, unless investment bankers lose money.
In fact there is very strong evidence that China suffered an inflationary and employment crisis in the mid-1980s, one that led directly to the famous events of 1989, although since information on the crisis was extremely difficult to obtain for foreign economists, perhaps it doesn’t count as a real crisis. Chinese workers can lose their jobs and livelihood but this is not a problem if we do not read about it in the New York Times or Le Figaro.
In 1993 and 1994 it seems a second inflationary crisis occurred, one so severe that it threatened the leadership of the CCP, and in response the CCP brought in the very ruthless and very unpopular Zhu Rongji to force very difficult reforms. This included a huge rise in unemployment, especially in the state sector, although once again since the effects of the crisis were off-limits to the foreign press, the unemployment data was restricted, and China then was too small to affect the jobs of foreign investment banks, perhaps it too, does not count as a crisis.
Finally Nick Lardy predicted a banking crisis in the late 1990s. At first he was ridiculed by the Chinese authorities, and by the horde of foreign experts, perhaps including yourself, for failing to understand the Chinese reality. Soon the authorities, mercifully a bit faster than the foreign experts, changed their minds and acknowledged the banking disaster. I believe the World Bank estimated the cost of the clean up at more than 50% of China’s GDP at the time.
A very simple glance at economic history – and I don’t mention the history of my poor county – makes me very puzzled by claims by people like you that it is even conceivable for a country to experience many years of growth without periodic crisis. I am old enough to remember that these claims were also hugely popular about Japan in the 1980s, even though Japan itself had had many crises. No one is foolish enough to say this about Japan anymore, so perhaps that is why they have moved to China?
This is not to say that Chinese per capita income has not risen substantially. It certainly has. But this is true of every successful country – income has grown in spite of many financial crises. Even less successful countries, like my own, can make the same claim. And when people like Mr. Pettis say that there are nonetheless imbalances in the current model that may lead to crises, history, even recent Chinese history, is on their side, not yours.
I see my comment is too long although I have more to say on the matter. I will stop here. Thank you for reading so far.
Prof. Ross:
I like many read Prof. Pettis’ blog for his insightful analysis on internatational financial issues and interpretation of the murky data and political currents in China.
I personally find the theoretical and econometric evidence on growth theory you cite unconvincing. All that I have learned is that rich countries are rich, while poor countries are poor because “they are poor”(i.e. they dont have the physical and human capital or institutions needed to break the poverty cycle and to raise productivity). In short, theory doesn’t tell us much about how to get the machine up and running by creating the necessary savings to kick start sustainable growth in dirt poor countries.
The PRC has been very successful since 1978 as you state — by using an atypical version of the Asian Developmental model.
But history shows that “good policy” in the past, may be bad policy in the future. Sticking to a 1980-90s “game plan” would be a dumb strategy in a world economy likely to be dominated by excess capacity and sharply higher unemployment over the next 5 years.
Moreover, China’s earlier reforms were highly successful, as they created winners without losers against a backdrop of strong growth. The next generation risks being much more difficult, as there will be many losers — including the CPC’s monopoly power over rent distribution through the financial system.
I agree with you and Gregory Chow that the nay sayers have been too pessimistic about China (in the short-run). But, the shelf life of the Asian export-cum investment led model is rapidly approaching expiry. That is why so many people read this blog to see what ideas Prof. Pettis and other informed readers can come up with to negotiate this necessary tricky transition. Good luck in Shanghai. I hope the Jazz band is still playing at the Peace Hotel, regards James
John Ross
RMB-pegging => trade surplus (i.e external, not internal investment)
Let us keep it simple:
The Chinese have produced consumer goods for the Americans. The Americans have printed dollar-notes for the Chinese. What remains today are the printed dollar-notes. The Americans are sovereign to decide on the value of printed dollar notes. If the Americans notice that a large holder of dollar notes refuse to circulate them, the Americans are well advised to print more. That’s it.
To explain WHY the Chinese like to hold these notes is just as difficult as to explain why people like to own gold.
Yes “economies of scale” has been created in China, and yes American competitors may have been out-competed. But the result – a huge amount of dollars – is only worth as much as the Americans like.
If China looked for government created economies of scale – there was no reason to do this through a peg-induced trade surplus.
Are we discussing this Jim O’Neil?
“The overwhelming evidence of the past few months is that the rest of the world is doing just fine, and that some places are doing better than just fine,” says Jim O’Neill, London-based head of global economic research for Goldman Sachs. Even if the U.S. economy remains soft for much of the year, O’Neill adds, “we’re pretty confident that the rest of the world will withstand it.”
January 2007
Sorry, couldnt’ help it
These days, whenever anyone
RdeR,
Michael Pettis and Martin Wolf have a theory which does not accord with the facts of economic development and is, therefore, also theoretically wrong.
Let us reiterate these key facts. There are more than a few studies of the distribution of economic growth between productivity and factor inputs (capital and labour) in China. Given the importance of the issue these have been carried out by the leading experts in the field of econometrics. Alwyn Young arrives at the conclusion that Total Factor Productivity (TFP) growth in China is ‘a respectable performance, but by no means extraordinary’. As Young is probably the leading sceptic regarding productivity growth in Asia, providing much of the statistical data for Krugman’s well known article ‘The Myth of Asia’s Miracle’, the fact that even Young finds China’s TFP growth ‘respectable’ may itself be taken to discredit the various claims, typically based on rhetoric and not backed by any statistical evidence, that China’s productivity performance is bad.
Dale Jorgenson, probably the world’s leading expert on the economic statistics of productivity, concluded that TFP growth in China was actually high in terms of international comparisons. Working with Khuong Vu his international comparison shows that China’s annual TFP growth in 1989-95 was by far the highest for any major country in the world and its 1995-2003 TFP growth, tied with India, was the highest for any major country except for Russia – where TFP growth was recovering from its extreme collapse in 1989-95.
In short the authoritative estimates for TFP growth for China range from ‘respectable’ to high. For present purposes we will take the most favourable case for Wolf/Pettis and assume it is only respectable/average.
What does emerge from such studies, of course, is that whether China’s TFP growth is respectable or high it is far smaller, as a cause of its economic growth, than China’s capital inputs. In addition to the studies on the overall economy already cited, and analysing detailed industry breakdown, Ruoen Ren and Lin lin Sun* conclude regarding China that ‘growth in capital input is the most important source of growth in value-added, TFP growth is the next most important and labour input growth is the least important.’
This finding that the most important source of growth in China is capital inputs means that it is… like the rest of the world and in particular just like the US. As Jorgenson and Vu note: ‘The growth trends most apparent in the U.S. have counterparts throughout the world. Investment in tangible assets… was the most important source of growth… The contribution of labour input was next in magnitude with labour quality dominant before 1995 and hours worked afterward. Finally, productivity was the least important of the three sources of growth.’
I have outlined on my blog the relation between capital inputs (i.e. the level of investment) over longer time periods than Jorgenson and Young.
It is unclear why at Wolf/Pettis never refer to these econometric studies by the world’s leading experts on economic statistics.
One explanation is that they are unaware of them. Wolf’s book Fixing Global Finance, for example, does not contain a single reference to the relevant econometric research despite writing at great length on China. But people should not be making assertions about China’s economic growth without reference to the authoritative comprehensive studies of the evidence. It is legitimate to ask Michael Pettis what is his view of these econometric findings. Does he dispute the findings of Young or Jorgenson, who despite their differences are probably the world’s leading experts on growth? And if he does where are his studies refuting their conclusions?
Second, perhaps Wolf/Pettis are trying to defend the now refuted thesis that factor inputs, in particular capital inputs, are not the chief determinant of economic growth – that is the thesis originally put forward by Solow and Kuznets which has simply been shown to be wrong factually. In that case they should dispute the huge accumulated relevant evidence and immediately protest to the OECD and US statistical authorities who have revised the way productivity data are compiled in order to adjust to the statistical findings that factor inputs, above all capital, are the primary causes of economic growth.
The pattern that the dominant role in high growth is played in China by capital inputs is, in short, internationally typical. This fact, however, that China is absolutely normal in being a country in which capital inputs are the most important source of economic growth has an evident corollary. International experience shows that productivity increases (even if they could be accelerated further, which would be difficult if China’s productivity performance is average/respectable, and likely to be impossible if it is high) is in any case incapable of compensating for a slowdown in capital inputs. The call by Wolf/Pettis for China to decelerate its investment rate is therefore actually simply a call for China to slowdown its economic growth rate – and China’s high savings level is merely the corollary of the need for a high investment rate as investment must be financed by savings.
If Wolf/Pettis want to sustain their theory they have to attempt to dispute these facts regarding international and Chinese economic growth. The fact that they don’t do shows that their theory is wrong. And because it is wrong it comes up with judgements that are shown to be wrong factually – such as on China’s economic stimulus package.
* Ruoen Ren and Lin lin Sun, ‘Total factor productivity growth in Chinese industries 1981-2000’ in Productivity Growth in Asia ed Jorgenson, Kuoroda, Motohashi Edward Elgar Publishing Cheltenham 2007.
Bill & Michael:
Your comments about NPL’s should be compared with the latest reports from PBOC regulators:
“Banks see fall in non-performing loans in H1″
Check it out…
http://www.chinadaily.com.cn/bizchina/2009-07/18/content_8444715.htm
These reports paint a different story.. showing NPL’s at around $75B (USD)down about 1.75%, despite the surge in new loans by PBOC to 7+ T ??The regulators in related reports actually point to “improved internal control measures” for the drop in NPL’s and also cite “asset quality improvement” and improved risk control measures as reasons for thinking NPL’s will also be lower going forward.
Are the reports credible or did the Chinese government hire some former AAnderson accountants?
Keith,
I would not want to dig too deeply into those numbers. The problem is that it is widely believed that most of the real NPLs are actually carried in the “Special mention” category (Category 2), which technically does not qualify as NPL, or in the “Standard” category (cATEGORY 1). It is interesting that NPLS only rise just before a major initiative is announced about retireng NPLs, like the decision last year to clean out a part of the ABC NPLs.
Since the professor warned he would be traveling this weekend I assume he won’t mind if I ask Mr. Ross what the connection is between his claims and those of Mr. Pettis. Mr. Ross seems to criticize Mr. Pettis bitterly for insisting that Chinese productivity growth is zero, but I have never seen Mr. Pettis even come close to making this claim, and I have read quite a lot of his work. In fact several times, even on this blog, Pettis has mentioned that productivity has grown rapidly in China, albeit at a slowing pace. In fact this isn’t a topic anyone seriously disputes.
What probably puzzles Mr. Ross and exemplifies his criticism is something that Pettis wrote about in his book. This is the complete mystery that balance sheet analysis is to most economists. He argues that while economists focus almost wholly on what he calls the operational and asset side of the economy’s balance sheet, they ignore the liability side, and that this is the area he finds most interesting. In that sense, he claims in his book, issues of productivity growth and revenue composition are relevant to the extent that they affect the asset liability mix. He has said similar things in his blog.
Pettis’ criticism of the Chinese development model is not that it hasn’t delivered productivity growth in the past. His criticism, as I understand it, is that it has come at the cost of a very large misallocation of capital, an excessive dependence on US consumption that is not sustainable, and a worsening balance sheet that ultimately must be repaid. These are in his readings part of the balance sheet analysis that intrigues him. From my reading of Martin Wolf, this is also a pretty apt description of his thinking, although I don’t want to insist on that.
By the way, Mr. Ross you should specify the periods in which the studies you cite draw data. It has become widely accepted that until the early 1990s China indeed achieved high levels of productivity growth, but that this level declined thereafter, ad especially rapidly in the past decade, and came at the expense of rapidly increasing capital amounts of investment per unit of growth.
thanks JZ. until your post i found ross’s criticism as hard to figure out as his manner. i couldn’t see the connection at all but now i think you’ve got it. he’s misunderstanding a criticism of one aspect of the development model for a criticism of the part he understands. and ross, it is perfectly possible to disagree with an extremely knowledgeable but out-of-the-box thinker like pettis, and many do, including me on ocassion, without assaulting him as being a lunatic out of touch with reality. that’s just childish. and you never addressed RdR’s rebuttal of your big claim that all these crazy guys have been warning about problems in china but for thirty years china has never had a problem, so they are all and always will be wrong. do you consider the events RdR lists as inaacurate, or were they consequences of the monetary and balance sheet problems that people like pettis and lardy have been worrying about?
TR,
so if the popular press reports on “normal” NPL’s, where would you find reliable details on “special” NPL’s? And, if you’ve seen these numbers, what do they show?
Keith
Further to TR’s points…
The NPL ratios are a bit misleading. If you are looking at % of total outstanding loans, then of course they fell as the massive lending surge came into effect – new loans cannot go NP for a while. China’s NPL classification system also leaves quite a lot of leeway on areas including
– Interest v principal repayment failure
– Time periods that can be allowed to elapse before a loan shifts categories. (Any of the new lending that turns NPL may take 2 years to show up as such)
In addition, we can’t discount that some of the massive borrowing that took place in 1H was used to pay off previous debt obligations.
From Bankers i know, they are expecting a modest uptick in NPLs this year, but they feel that for this year at least, they are capable of handling them in the normal ways. Confidence about 2010 / 2011 is not so obvious! We should remember that the authorities ordered provision coverage ratios of 130% earlier this year – and some banks went as high as 150%.
Chan-lee james:
You write: ‘the shelf life of the Asian export-cum investment led model is rapidly approaching expiry’.
This phrase ‘Asian export-cum investment’ model, or variants of it, is frequently used. But it is highly confused as it mixes up at least three ideas which are not the same. Let us disentangle them.
The first is a high level of investment – which requires a high level of savings to finance it. This certainly is necessary for any country to undergo rapid growth – econometric evidence shows that a high level of investment is the main source of economic growth at the level of the whole economy not only in Asia but internationally. Dale Jorgenson concludes, for example: ‘Input growth is the source of 80.6 percent of US growth over the past half century, while productivity growth has accounted for 19.4 percent.’ Therefore a high level of investment certainly is a feature of Asian economies which have enjoyed economic success – but there is nothing specifically Asian in that.
The second idea is that of a high (and rising) level of exports in GDP. This again is highly desirable not only in Asia but anywhere. An increasing percentage of exports in GDP is a reflection of an increasing (in this case international) division of labour – which every economist since Adam Smith knows is one of the most powerful possible tools for raising growth and one of the reasons why globalisation is successful. All successful economies, including the US, Germany, France and China, now followed by India, have experienced rising proportions of exports in GDP and it is to be hoped this will continue. But again a high and rising percentage of exports in GDP is not specifically Asian – it is a precondition for success of any economy.
The third idea, which I assume is the one you are criticising, is where a high and rising level of exports is not matched by an equivalently high level of imports – i.e. a high trade surplus is being run (strictly speaking the issue would be a high balance of payments surplus, not specifically a trade one, but as trade dominates the balance of payments in most Asian countries we will take the two as approximately the same). But the issue here is not the high level of exports as such but the trade surplus.
So as to avoid confusion let us term an economic model in which there is a high level of exports, matched by a high level of imports, a ‘high trade model’ and one where a high level of exports is not matched by an equivalently high level of imports a ‘high trade surplus model’. I assume your objection is to a high trade surplus model and not a high trade model – a difference with someone who opposes a high level of trade in a national economy (who opposes globalisation) is a different discussion.
The facts show that a high trade surplus is not essential to China’s model of economic development – although a high level of investment and a high level exports certainly are. For the first 27 years of the Chinese economic reform process (1978-2005) China did not run a significant trade surplus. One appeared in 2005-06 and there is some evidence, which I have discussed in more detail elsewhere, that the trade surplus is now shrinking because China’s investment level is rising up towards its savings level. It is to be hoped this trend continues, for the reason that Manmohan Singh, before he became prime minister, set out for India: ‘A poor country like India cannot afford to have a current account surplus. It means that the country is not able to absorb imports, and the Indian savings are not being converted into investment. That is why, Indian savings are being invested in US government securities for an interest rate of one-and-a-half per cent.’
Investment of China’s savings domestically is preferable to accumulating excessively large quantities of US Treasury Bonds which do not contribute to the productivity potential of the Chinese economy and on which large losses are likely to be suffered if, as is likely, the dollar exchange rate declines.
In relation to this while in general, obviously, the international financial crisis is a negative for China, as for every other country, there is one feature of the situation it can use to its advantage – and it appears to be doing so. Under conditions of inflationary pressure, such as existed until the summer of 2008, it was difficult to add further to investment in China without risking overheating – i.e. stoking up further inflationary tendencies. Today China is faced with the opposite problem – deflation, particularly deflation in producer prices. Under those circumstances stepping up the utilisation of China’s savings for domestic investment does not add to inflationary pressures and in fact counters deflationary ones. This is what is occurring as shown by the components of the increase in China’s GDP in the first half of 2009 – 6.2 per cent accounted for by rising investment, 3.8 per cent by rising consumption and minus 2.9 per cent by falling net exports.
However, unless China’s savings rise by an equivalent amount (which is improbable given that the state budget is moving into modest deficit and company profitability is under pressure due to the decline in exports and the international financial crisis) then as China’s investment level moves up towards its savings level, that is China utilises more of its savings domestically, its balance of payments surplus will necessarily shrink – which is what happened in the first half of the year. That is, China will move back more towards the pattern which existed in 1978-2005 of a high level of investment and a high level of exports but not a large trade surplus.
Evidently the factual development of trends during 2009 has to be watched to see if the current trends continue. But whatever turns out to be the case the attack on a ‘export-cum investment led‘ confuses issues – and confused ideas are not helpful ideas.
A ‘high investment/high trade’ model is one thing – a precondition for rapid economic growth in any country. It is, indeed, a foundation of China’s development strategy.
A ‘high investment/high trade surplus’ model is something different. The latter is not desirable, but as it has only existed for four years in China’s thirty year reform period neither is it a foundation of China’s development model.
Quite possibly we agree on this point once it is clarified. But, to avoid confusion, it should be made clear that ‘high investment’ is not the same as ‘high export’ (it is possible for a country to have a ‘high investment and low export’ policy – the old unsuccessful import substitution strategy pursued in some Latin American countries and elsewhere) and a ‘high trade’ policy is not the same as a ‘high trade surplus’ policy.
China’s development model, as shown over the last thirty years, is ‘high investment and high trade’ – which is why it is so successful.
John Ross
I think it is a bit disingenuous to lump Prof Pettis in with Gordon Chang et al. ALthough that might undermine his position in some less educated readers’ eyes, anyone who has read his writings will know that his views are very very different from the “collapse theory group”.
Jzhang makes some other good points about your (intentional?) misreading of Pettis’s position. Saying that capital misallocation is bad is NOT logically the same as saying that investment rates should be lowered, unless one is being very simple minded about other possibilities.
Equally, you might approve of large state-owned / state controlled enterprises slashing wages and continuing to produce absent end demand rather than laying off workers, but you cannot argue that this will not lead to trade tensions (another point Prof Pettis has made repeatedly) if the resulting products end up furthering the GLOBAL problem of oversupply.
I know many countries have followed undervalued exchange rates and other trade protectionism throughout history, but again, by definition not every country can have an undervalued currency.
Keith
The cheap credit push down the quantity of the NPL loans.
It was the patter in the US in 2002-2006.
Keith, it is really hard to get good numbers, which is why everyone tries to develop his own measure, and I have too little expertise to develop my own and so simply read everything I can. Caijing, as Professor Pettis points out, is a great place to get some of the most hard-hitting reports. Otherwise the popular press reports the official NPL numbers which are those classified 3, 4, or 5 in the 5-point system (with 1 being standard and 2 being special mention). Various analysts regularly attempt to determine the real status of category 2, which is typically anywhere from 2 to 4 times the total amounts of recognized NPLs. They usually claim that in the US and Europe, areas where the rigor of NPL classification has also recently been questioned, much if not all of category 2 would probably be considered bad loans. I believe, but please check with them, that Fitch, which does the most consistent work here, routinely dumps 50% of category 2 into their measure of problem loans. Like much Chinese data, there are serious debates about the real NPL problem and the best way to get some feel for it is usually to talk to bankers and NPL specialists. If you have good contacts at the regulatory agencies, public officials will often voice their concerns in private.
I think what Bomlat is adding is that in many case loans are priced at very low interest rates as a way of keeping them out of “special mention” or worse categories. In fact a PBoC official admitted two years ago in a conference that one of the reasons for keeping mortgage rates from rising was fear of raising the volume of mortgage NPLs.
Well let me jump in again because I couldn’t resist. In this blog Pettis has always defined the Asian development model as a system that “implicitly or explicitly constrains consumption to raise savings rates, and channels high levels of resources into subsidizing production”. This kind of a model leads to trade surplus for obvious reasons. Ross makes a bunch of airy but irrelevant generalizations about the Asian model and concludes that trade and investment are good things. Great, but that was never the issue. I am pretty sure no one who reads this blog has ever disagreed. It is overinvestment, and relying too heavily on forcing domestic supply of tradable goods to exceed domestic demand, that is the problem. Then this: “The facts show that a high trade surplus is not essential to China’s model of economic development – although a high level of investment and a high level exports certainly are. For the first 27 years of the Chinese economic reform process (1978-2005) China did not run a significant trade surplus.”
I suppose I just find people annoying who keep announcing with great flourishes what the facts are, but he misses the whole argument. The argument is whether or not China has locked itself into the development model that Pettis defines. Ross chooses the wrong facts and declares them to be conclusive. Let me read out my facts.
Until the mid-1980s China was actually running, like many developing countries normally do, a fairly large trade deficit. Around that time we began to see a big reversal in which the deficit had turned into a surplus by 1990. I didn’t have time to find earlier numbers, but DB Research shows the current account as a share of GDP from 1994 onwards (and I think the current account underestimates the trade account because there is a net outflow on non-trade items), and with the exception of 1995 and 1996 it exceeds 1% every single year, hits 3.4% in 1987-88, and then as other Asian economies struggle with the crisis and devalue their currencies, China’s trade current account surplus drops to a “mere” 1.3% in 2001 before taking off to an astronomical 11% by 2007, or 0.6% of global GDP, a level never before achieved even remotely. Of course inevitably someone will make the totally annoying point out that some very small, open economy (Singapore? Taiwan?) has had equivalent levels, which is why I restate it in global GDP terms. It is not fair to compare China to Singapore for reasons that no one should have to explain, but nevertheless China’s trade surplus has never before been matched in history, not even by exporting countries whose share of global GDP have been three or four times China’s share.
This was a big, fat shift in the current account in twenty years from very negative to “holy smokes, Batman” positive. If you suggest that it may have been the result of policies that “explicitly or implicitly promote production and constrain consumption”, to use Pettis’s words, you are not going to feel even remotely threatened by Ross’s “facts.” Not only have they been extremely high for most of the past twenty years, but they started at very negative. This is a big change and the policies that caused it have hade a very big impact on Chinese development. Just the facts.
Ross then argues that additional proof that he is right is his prediction that the current account surplus will shrink in the coming year. Unfortunately for him Pettis has made exactly the same prediction. He says China’s current account surplus will be forced to shrink, but not because of natural and sweet changes in China but rather because of changes in US savings, and the fact that China is trying to forestall those changes is why he thinks they are on the wrong track. Pretty simple, right?
I am finally back. For those who care Wuhan seems to have been, as its reputation suggests, one of the hottest places on the planet and Shanghai, although much cooler, wasn’t exactly fresh. The five bands that performed in the two cities put on really exciting shows and I think the Shangahi show in particular was truly memorable.
While traveling I couldn’t use the really cool proxy my students installed on my office PC and instead had to use stupidcensorship.com, which while it allows me to read everything and to input simple instructions, did not allow me to add comments or new entries. Nonetheless I have been reading the comments avidly and have enjoyed them enormously.
RdeR, in spite of your care of course I recognized you and I was so happy to see that you are reading my blog, even if you exaggerate the extent to which you do. It is a great honor for me that you want to know my opinions. If you ever come to this part of the world please let me know so that I can invite you to my university and impress my students by parading you in front of them.
It is late and I will try to respond to some of these comments tomorrow, but it seems like a much better debate without me.
bomlat: “The cheap credit push down the quantity of the NPL loans.”
Yes, absolutely. During the bubble all the bad lending is invisible because any borrower who gets into trouble can just refinance. Subprime loans in California were being refinanced every 12 months.
Defaults on subprime loans were at historic lows as recently as 2005, at the top of the bubble. That seems hard to believe now, but its true.
So you probably won’t see evidence of bubble trouble in the performance of the loans while the bubble is still inflating.
Wait for the Shanghai composite and real estate prices to fall 20-30%, then check on the health of the loans.
The Xing. riots were a direct consequence of domestic industries turning to even cheaper labor to combat the downturn. The dispute started in a factory in the south where minorities were pushing out ‘more expensive’ Han workers.
Michael, glad you had a good time supporting some of your favorite bands. Hope you are feeling much better. I thought that your site would be restricted a long time ago. I appreciate your insights and the debates they create. Take care
[...] I wasn’t impressed by China’s high reserve and GDP growth numbers Well.. so far the market is pretty impressed which is what matters to us dumb traders. At some point Helicopter Wen's actions might can come back to bite. Then it's 2008 all over again maybe? [...]
Houhui:
I do not group Professor Pettis with the collapse theory of Gordon Chang. He has the ‘oversaving/overpending’ analysis in common (overall not necessarily in detail) with Martin Wolf. As Michael Pettis himself replied ‘By the way I am delighted to be dismissed for being in the same camp as Martin Wolf’ I do not think that is a misrepresentation of his position.
Sorry for typo in my last comment. Should have been “‘oversaving/overinvestment’ analysis” in common (overall not necessarily in detail) with Martin Wolf’ (not “‘oversaving/overspending’ analysis…).
John Ross,
you seem to state that an increase in investments is inflationary, while a decrease in investments is deflationary.
“Under conditions of inflationary pressure, such as existed until the summer of 2008, it was difficult to add further to investment in China without risking overheating”
One would think higher capacity pushes CPI down.
Do you have some publications for backing this?
I find your analysis on the role of investments pretty well based, but I would like to ask how these models/studies incorporate the efficiency of capital accumulation?
E.g is the efficiency of market allocated investment in US, Uk and Germany comparable to the Soviet Union or China investment cycles?
Also dont you find China’s FAI share of GDP a bit high and unprecedented? If I can believe Chinese statistics, FAI made up 58% of GDP in H109. This is as far as I know unprecedented in history. Certainly not characteristic to Western growth models, but neither is it for Asian models, where the highest amount of FAI was around 40% of GDP for a longer period.
BR
Prof. Ross: I second PMJ’s rebuttal to your “clarification” on the Asian Developmental Model.
I would add that China’s reserve accumulation over the past decade has been somewhere between 50-75% of nominal GDP GROWTH ! (You CAN CHECK THE NUMBERS!) These numbers underscore the magnitude of the “mercantilist” cheap currency, export “dumping”, and hence low wage, low consumption bias of the present model.
That said you do underscore a real paradox. The capital destruction (misallocation) school points to the massive stock of NPLs and risks of big problems to come with the wave of new bank lending. Martin Wolf claims China’s ICOR is over 5 — much higher than Japan and Korea at comparable stages of development — and hence there is clearly big capital waste. But others rebut that the investment data are overstated as they include land sales, etc. Similarly, the GDP data are greatly understated (bad and incomplete sampling, a huge underground economy). Hence ICOR guestimates are rubbish, the more so as a huge share of investment has been in infrastructure unlike Japan and Korea in the 1960s 70s.
And yet, as you point out the TFP numbers (including the World Bank, OECD and ADBI studies) are surprisingly good (but dated). The HKMA study points to subsidised credit as the culprit.
But the paradox may be much more complex, as 2002-07 profits and ROE data reported by MNEs (US Chamber of Commerce) in China matched or exceeded their other foreign operations. Similarly, survey data show that the gap between MNEs and Chinese firms in terms of TFP and profitabilty has been closing (3rd generation reforms?). Unfortunately, most of the TFP studies we have are dated and were dominated by a period of “excess demand”.
In short, I have never been able to square this circle except to lament that Chinese data are terrible. Could you or others throw light on these vexing issues? regards James
John Ross,
Sorry, i mistook your writing “the latest of these of such arguments” to be suggesting that Pettis / Wolf were the “latest of such arguments”. My mistake!
“I also know from those 17 years there has been an entire industry repeatedly predicting deep economic crisis in China, the analysis of all of which turned out to be false – for typical examples see Gordon Chang’s ‘The Coming Collapse of China’ or The Economist’s ‘Out of Puff A Survey of China’ published in June 2002 when China was about to enter one of the greatest booms in economic history! The ‘oversaving’ and ‘overinvestment’ thesis put forward by yourself and Martin Wolf is one of the latest of these of such arguments.”
Bob_in_MA
I would recommend a read of Andy Xie’s article in Caijing yesterday (?). He was looking at stock market, tightening, inflation, stagflation, bouncing bears etc. A very good piece
http://english.caijing.com.cn/2009-07-20/110200154.html
I don’t think a 30% fall in Shanghai bourse or real estate market would instantly show up as defaults and a migration to the Non-performing categories (3,4,5) from special mention. Maybe a year later if things don’t pick up.
We are limited because some of the largest lenders – ABC, CDB, ADB don’t produce decent accounts yet, neither do most of the numerous smaller lenders. Together, only about half of new lending surge was coming from banks with reliable and up to standard reporting practices (when i checked after Q1). I haven’t had the time to to total up lending at each bank after Quarter 2 yet, and i think the 2Q results are not all out anyway.
Lemmiwinks and JZhang:
As both your points deal with investment and its efficiency I will reply to them together if that is OK.
Lemmiwinks:
If we abstract from the business cycle the overall point you make that higher capacity will reduce inflation due to increased capacity (and/or increases in productivity) is right – that is, over the whole cycle it would, all other things being equal, restrain and not stimulate inflation. However in early 2008, prior to the international financial crisis, China was under strong inflationary pressure. There is a timelag before extra investment spending adds capacity during which expenditure is increasing but capacity is not. Under the circumstances of early 2008 a further increase in demand through an investment stimulus might have been likely to/would have been more likely to add to inflationary pressures. Certainly the situation was different to the present one where deflation is real and where a strong investment package can be launched without such concern about it causing inflationary overheating. So overall (over the whole cycle) your point is right but timing in the business cycle has to be taken into account.
The most fundamental issue is about the efficiency of investment in China which is also raised by JZhang.
To take the most macro-level JZhang argues that the point being made by Professor Pettis is that China’s development model has led to ‘large misallocation of capital’. A moment’s reflection might have led to the conclusion that it is very curious that in the present international financial circumstances the issue of China having been guilty of large ‘misallocation of capital’ is apparently the point that has to be grasped. We are currently living through the results of one of the greatest misallocations of capital in world economic history… in the US (to a lesser but also significant extent in Europe/Japan). This ‘misallocation of capital’ in the US has indeed been so large that it has led to bankruptcy of the majority of US investment banks and only gigantic subsidies by the taxpayer prevented the collapse of the entire US banking system. This evidence is rather conclusive that China’s capital was actually rather well allocated in comparison to the US (and Europe/Japan).
If this fundamental sense check does not suffice let us consider the issue in more statistical detail. This is the question of ‘efficiency of capital accumulation’ raised by Lemmiwinks and by JZhang.
JZhang argues that it is ‘widely accepted’ that China’s investment is inefficient. First, as we will see, it is not at all ‘widely accepted’ among those who have carried out the authoritative studies of the issue. Nor, incidentally, even if correct, the fact that something is ‘widely accepted’ is irrelevant to whether it is true or not. Only accordance with the facts make something true – it used to be ‘widely accepted’ that the sun went round the earth but unfortunately it is false.
It is important to understand, first, why this issue of the relation between investment and growth is so critical for, and devastating of, the Wolf/Pettis thesis of China’s ‘overinvesting/oversaving’.
Everyone with a cursory knowledge of the subject knows China has an extremely high growth rate which is not merely important in itself but has allowed 620 million people to be raised out of absolute poverty – as Professor Quah of the London School of Economics has recently pointed out China is responsible for the entire international reduction of absolute poverty. Wolf and Pettis therefore would have a pretty hard case to argue that China should reduce its growth rate – not only on economic grounds but because of the immensely negative effect on world social conditions of such an outcome. At least if Wolf/Pettis do want to argue China should slow down its growth rate they should do so explicitly.
Almost equally well known, is that China has an extremely high rate of investment. As Wolf/Pettis’s main thesis is that China is ‘overinvesting/oversaving’ (bad) they therefore have to argue that such a high level of investment is unnecessary for the (good) high rate of economic growth.
One attempt to achieve that is to claim that there is not a close correlation between investment and growth. The problem for such a claim for China is that econometric research shows, not only for China but internationally, that the most important quantitative element in economic growth is the increase in factor inputs (capital and labour) and the increase in capital (investment) in particular.
As Dale Jorgenson has noted for the US, for example: ‘Input growth is the source of nearly 80.6 percent of US growth over the past half century, while productivity has accounted for only 19.4 percent’.
More precisely, and taking the international and not just US economy, Jorgenson and Vu note in their comprehensive comparative international study Information Technology and the World Economy: ‘We allocate the growth of world output between input growth and productivity and find… that input growth greatly predominates.’ More precisely statistically: ‘The contribution of capital input to world economic growth before 1995 was 1.18 percent, slightly more than 47 percent of the growth rate of 2.50 percent. Labour input contributed 0.79 percent or slightly less than 32 percent, while productivity growth contributed 0.53 percent or just over 21 percent. After 1995 the contribution of capital input climbed to 1.56 percent, around 45 percent of output growth, while the contribution of labour input rose to 0.89 percent, around 26 percent. Productivity increased to 0.99 percent or nearly 29 percent of growth…. the contributions of capital and labour inputs greatly predominated over productivity as sources of world economic growth before and after 1995.’
Jorgenson and Vu similarly found that that it was differences in inputs, not differences in total factor productivity, which predominated in explaining different levels of output per capital between countries:. ‘‘We find that differences in per capita output levels are primarily explained by differences in per capita input, rather than variations in productivity.’
This decisive role of inputs compared to productivity applied not only to the world economy, or to less developed countries, but to the most advanced economies – in short a thesis that China can use large factor inputs now, but as it becomes a more developed economy this will be less relevant is false.
As they noted regarding the most advanced economies in analysing, ‘the contribution of capital input to economic growth for the G7 economies’: ‘Capital input was the most important source of growth before and after 1995. The contribution of capital input before 1995 was 1.28 or almost three-fifths of the G7 growth rate of 2.18 percent, while the contribution of 1.43 percent after 1995 was 55 percent of the higher growth rate of 2.56 percent. Labour input growth contributed 0.49 percent before 1995 and 0.46 percent afterward, about 22 percent and 18 percent of growth, respectively. Productivity accounted for 0.42 percent before 1995 and 0.67 percent after 1995 or less than a fifth and slightly more than a quarter of G7 growth, respectively.’
Given that there is an enormous literature on this subject, showing that capital inputs are the main source of growth, and the system of writing national accounts has been altered to take account of it, Wolf/Pettis will therefore get nowhere attempting to argue there is not a relation between the rate of growth of capital inputs (i.e. investment) and the rate of economic growth. Strangely they do not even refer to the fact that the evidence on this is so overwhelming that the system of calculating national accounts has been revised to take account of such studies. (As Jorgenson notes: ‘The traditional approach of Kuznets (1971) and Solow (1970)… has been replaced by the new framework presented in the OECD (2001) manual, Measuring Productivity… The OECD productivity manual has established international standards followed by Jorgenson, Ho and Stiroh… and the EU (European Union) KLEMS (capital, labor, energy, materials and services) study.’ )
But perhaps Wolf and Pettis want to argue that the system of calculating national accounts on an international scale is erroneous, that the OECD, US etc national statistical sources etc are all in error – but in that case they need to produce some rather substantial evidence for such a view rather than a few polemics on China.
It is therefore evident that an attempt to defend the Wolf/Pettis thesis by the claim that there is not a relation between investment and growth will get nowhere. Once it is accept that a high investment rate is required for a high growth rate then the need for a high savings rate follows automatically – as investment has to be financed by saving.
The crude version of Walf/Pettis therefore having no basis, the more sophisticated variant of the thesis is that there is a correlation between investment and growth, but the facts show that China’s investment is very inefficient, particularly compared to countries such as the US. Therefore, provided it is more efficient, China could maintain the same rate of growth (good) without this ‘overinvestment’ (bad). The problem is that this won’t stand up to examination.
Let us compare the efficiency of China and the US. Doing so will also deal with the issue raised by JZhang regarding dates – i.e the claim that I am only dealing with earlier periods of China’s economic reform process and not the present one.
Most comprehensively (i.e. ideally) one would use Total Factor Productivity (TFP) studies on China for such comparisons, of which many exist. As Chan-lee james acknowledges in his comment: ‘ the TFP numbers (including the World Bank, OECD and ADBI studies) are… good.’ As TFP studies require detailed statistical information to calculate, they do not bring us right up to date – although they do go up to 2005 so Chan-lee james claim that such data is ‘dated’ is, to put it mildly, somewhat exaggerated. However more quick and dirty methods get us as up to date as possible and reveal such clear orders of magnitude, and are also so clearly in line with the TFP studies, that they leave no doubt as to the situation.
Chan-lee James lists a number of older TFP studies on China, all of which he acknowledges produce results for China which reveal ‘good’ performance. The most up to date comprehensive international comparative studies of productivity for China that I am aware of are those by Dale Jorgenson, of Harvard University, and Kuong Vu of the University of Singapore already citied. Danny Quah in autumn 2008 updated this work for some countries but his study is it is not as comprehensive in coverage.
Jorgenson and Vu conclude China’s level of productivity compared to that of the US was 24.0% in 1989, 30.9% in 1995, 35.0% in 2000 and 40.3% in 2005. That is China’s productivity growth is significantly above that of the US, and there is no evidence that that China was slowing down in closing the gap in the recent period – it continues to gain at about 1% a year.
Glancing at these figures it is obvious that the gap in productivity between China and the US is significantly narrower than the gap in output per head between them. The reason for this is that China actually slightly lags more in inputs (capital and labour) per capita compared to the US than it does in productivity per capita. Taking the same years as for productivity China’s inputs per capita, compared to the US, were 24.1%, 29.9%, 32.5%, and 39.5%. This fact that China’s lag is actually slightly more in inputs of capital and labour than it is in productivity is an evident supplementary reason why China is right to emphasise mobilising factor inputs.
As already pointed out China is not at all untypical in this. The lag in developing countries compared to the US and other advanced economies is in general, as already noted, larger in terms of mobilisation of resources of capital and labour than it is terms of productivity. For example taking developing Asia as a whole Jorgenson and Vu conclude the: ‘shortfalls in output per capita, relative to the industrialised countries, are due primarily to input per capita, rather than productivity gaps.’
Even within the G7 the productivity gap between the US and the other economies is narrower than the input of capital and labour gap. The superiority of the US is therefore relatively greater in its ability to mobilise large quantities of capital and labour than it is in productivity – that is the input gap between the US and other economies is greater than the productivity gap. I dealt with implications of this, regarding an exchange with Paul Krugman at Shanghai’s Jiao Tong University, elsewhere
There is, therefore, data up to 2005 done to the highest statistical standards. This all shows the efficiency of investment in terms of total factor productivity in China – particularly compared to the US. But if that is still not recent enough, provided the differences are big enough, back of envelope calculations will give an order of ranking.
In the five years up to the latest available IMF figures for China and the US, those for 2007, the rate of fixed investment in the US economy averaged 19.1% of GDP, annual average GDP growth was 2.8%, and the correlation of the two therefore shows 6.9% of GDP invested in the US generated 1% a year GDP growth. For China for the same period the equivalent figures are average rate of fixed investment 40.8% of GDP, annual average growth rate 10.6%, and 3.7% of GDP in fixed investment generated 1% GDP growth. Or to put it another way, China invests about twice as much as a proportion of GDP as the US but its rate of growth is four times as high – i.e. a far higher level of efficiency.
I would immediate stress that such an extremely a ‘quick and dirty’ calculation is only to get a ranking order, and is not at all intended to claim statistical precision as with Jorgenson and Vu or the other studies noted. It is merely to get us as up to date as possible. But the difference is so huge that it leaves no doubt of the rank order. In terms of growth per unit of GDP invested the efficiency of investment in China is higher than the US – which is, of course, just another way of expressing the finding of all the studies, which use far more precise statistical methods, that total factor productivity growth in China is much higher than in the US.
Therefore, to summarise,
1. Econometric studies confirm capital inputs are the most important quantitative source of economic growth in China, the US and internationally. Any claim that economic growth is not correlated with the rate of investment therefore has no statistical legs to stand on. Any variant of the Wolf/Pettis thesis which doesn’t admit the link between investment rates and growth rates therefore doesn’t stand up. China, to maintain its high rate of growth, therefore requires a high level of investment.
2. The Total Factor Productivity studies, right up to the most recent available, which is 2005, show that China’s TFP growth is not slowing but continues to catch up with the US at approximately the rate it has for the whole of the reform period – i.e. about 1 per cent a year. A variant of the Wolf/Pettis thesis which admits in principle the link between a rate of investment and a rate of growth, but claims that China’s investment is inefficient won’t stand up either at least up to 2005 as regards detailed studies of TFP, and quick and dirty calculations for even more recent, periods show this trend has continued.
3. Therefore the ‘weak’ form of the Wolf/Pettis thesis, which argues that there is a link between investment rates and growth rates, but states China’s investment is particularly inefficient, won’t stand up either. [1]
In short the whole Wolf/Pettis thesis doesn’t stand factual examination. The actual situation is:
1. China is entirely right to prioritise large scale capital inputs because econometric studies show that capital inputs (i.e. the level of investment) are the main determinant of growth. Once it is admitted that China requires a high investment rate then the need for a high savings rate follows as an immediate consequences because investment can only be financed by saving.
2. The Total Factor Productivity studies, which are the most comprhensive, all show that the utilisation of factor inputs in China (capital and labour) is efficient – and certainly far more efficient than the US.
3. As China has both a high level of investment and a high productivity in use of this investment its economy grows very rapidly – which is highly desirable.
The Wolf/Pettis thesis therefore simply doesn’t deal with the facts of China’s growth. As examination of the facts would lead to their theory being rejected therefore facts have to be ignored or denied – both on China’s overall economic development and, more immediately, on the success of China’s stimulus package.
PMJ:
Probably it is not a good idea for non-members to get involved in your internal discussions in Goldman Sachs. And I don’t always agree with Jim O’Neill –regarding BRIC to my mind he is too optimistic on BR (the economic dynamic of Brazil is much weaker than the others and Russia has much more misguided economic policies) and right on the dynamic IC.
But regarding the success of the Chinese stimulus package Jim O’Neill, in predicting success, has so far been proved quite right against the Wolf/Pettis pessimistic analysis – and therefore against your own as you state you are closer to the latter.
To the reply to this ‘it is still early days yet’ the underlying reasons why China will continue to enjoy the economic success brought by its development model have set out in my replies to Michael Pettis and RdeR above – a more comprehensive and long term account can be found on my blog.
The Wolf/Pettis ‘oversaving/overinvestment’ is wrong factually, as regards the determinants of economic growth, both in China and internationally and is therefore wrong theoretically. That is why it is inaccurate in its failure to recognise the success of China’s stimulus package.
The unfolding of events in the next year, or more, will give plenty of opportunity to decide who is right or wrong. But in the first half of 2009 the facts of China’s GDP growth are definitely on the side of those who take the view the stimulus package is working and not on those of the Wolf/Pettis overinvestment/oversaving theory.
PS For a further analysis of the success of China’s stimulus package, which I noticed since writing my first contribution above, see Danny Quah’s entry on his blog at the London School of Economics.
Mr. Ross, there are so many non sequiters and so much muddled thinking here that it is really hard to know where to start. I think most of your substantial points have been pretty much blown up by others on this site, but at the very least I would suggest that any claim that the debate has been once-and-for-all resolved, and that you have “the facts” that prove it, is more likely to be pompous than accurate. You would gain substantially in credibility if you acknowledged at least some possibility of complexity
Just to add to the points made by many others, your implicit argument that there cannot have been a misallocation of capital because so many people in China were moved out of poverty has to be one of the most bizarre pieces of I-wanna-be-politically-correct nonsense. No one, to my knowledge, and certainly not I, have ever argued that the misallocation of capital immediately leads to negative growth rates, and if you tried to read my posts rather simply than gallop in to announce your access to the Truth you would have seen that. Amazingly enough, you then “prove” your point that capital was not misallocated in China by insisting that it was misallocated even worse in the US. I won’t try again to explain why that logic is faulty, but I wonder if you disagree that the huge misallocation of capital caused by the massive consumer lending binge did not create any growth in the US economy (and if not, why has the removal of the particular misallocation caused growth to collapse)?
Misallocated capital can create growth. Just look at the current surge in growth in China or, if you prefer, look at the late 1980s in Japan. That is not the point. The point is that it is unhealthy and unsustainable growth and must at some point be reversed. Just ask the Japanese (or the US or almost any country in history that has suffered asset and credit bubbles, which is pretty much all of them). This shouldn’t be so hard to grasp.
John Ross,
I am reiterating a few comments that I have already posted on your blog.
1. I think you are perfectly right in stating that latecomer economies have to maintain an ever higher rate of investment in order to catch up with leading economies during history.
2. However misallocations can clearly happen on the way as the crisis of 97 or Japan’s lost decade have shown it.
3. Microeconomic efficiency of investments can be radically different in the same country in different phases of development.
I mean if a country is lagging very heavily in capital, then the marginal product of capital input is very high. So even Stalinist buerocrats of the 1930s could make very good investment decisions in the Soviet Union. The same system made an enormous misallocation of capital from 1960 on. Because investment decisions were not so straightforward anymore.
4. The sources of financing and demand for the capacity.
During the 20th century, the latecomer countries relied heavily on the rest of the world for demand creation and/or financing of investments. This is clear – a country cannot expand its consumer demand and savings to finance investments at the same time.
However now, that demand in the rest of the world has collapsed in 2008, China can only rely on itself for both financing (savings) and demand creation. Can this work?
http://online.wsj.com/article/SB10001424052970203946904574301110723410346.html
Interesting (though blocked in China) piece with some relation to what is being discussed here.
Another little anecdote that may or may not be relevant to what has gone on following this blog entry:
2 Lesser known comedy BBC radio 6 DJs (Adam and Joe) earlier this year devised a strategy (mostly as a joke) to increase their own popularity / fame. They attempted to pick a fight (verbal) with members of a hugely popular BBC TV flagship series “Top Gear”, hoping that the resulting arguments / controversy would increase their own position and fame…
Michael Pettis says 21/07/09 ‘Mr. Ross, there are so many non sequiters and so much muddled thinking here that it is really hard to know where to start. I think most of your substantial points have been pretty much blown up by others on this site,’
having read the blog and most of the comments in considerable detail including the linked articles i would like Mr Pettis to do us the service and not just defer to his blog fans but answer the convincing demolition of his essential line by John Ross-Please Mr Pettis i would like to see factual and reasoned responses to Ross’ arguments so i can take a more balanced view-as well as the clear evidence of non-sequiturs-none stood out to me and i do not like to believe i am being led astray unknowingly-otherwise your blog does you no service-which is a shame as i would hope to come back to it in the future and har the debate continued and expanded-
lemiwinks said
However now, that demand in the rest of the world has collapsed in 2008, China can only rely on itself for both financing (savings) and demand creation. Can this work?
can anyone answer this?
Which Ross argument? As far as I can see he has simply announced that Wolf and I are wrong and that the facts prove it, but although some of his facts are simply wrong, even bizarrely so, and others I fully agree with, I am not sure how they indicate that Wolf and I are wrong. It seems that he completely misses the point of our arguments, so I am not sure how to reply.
For example he spends a long time insisting that China’s investment-led policy has led to growth, and that Chinese growth in the second quarter of 2009 proves once and for all that there is no problem in China with excess savings, but both claims are patently absurd. Of course it has led to growth. Investment surges always lead to growth, whether they are well or poorly allocated. It is only much later that we see why capital misallocation is a problem. So this year’s growth doesn’t prove there wasn’t misallocation or the systematic creation of excess capacity. In order to believe this you would have to be almost totally ignorant of economic history.
His argument reminds me of the triumphalist claims that Japanese growth in 1988 and 1989 “proved” that the worriers about the Japanese model were wrong. Not at all. I have said many times that China would surprise us with the amount of growth they generate this year and possibly next year, but that this would be because this huge surge in credit, both misallocated and unsustainable, would inevitably generate employment growth. It is as silly to say that because China is growing there cannot have been a problem with the fiscal stimulus than to say that because the US was growing rapidly in the early part of this decade there could not possibly have been excess consumption and poor real estate lending
In spite of a huge amount of his writing I still don’t understand which of our claims were wrong and why. Perhaps you could paraphrase his argument and help me?
ok Professor Pettis, thanks for your invitation,
let me recap some of the key elements i think i understand of professor ross’s arguments which i do not think you have responded to and which undermines the basic premise of your arguments:
the essence you have not responded to is spelt out in ‘Why Asia will continue to grow more rapidly than the US or Europe’. This showed that the US now lags far behind the key Asian economies in the proportion of its economy which is invested – with a consequent continuing decline in the international competitiveness of the US economy.
http://ablog.typepad.com/keytrendsinglobalisation/2008/09/data-on-long-term-trends-in-investment-and-economic-growth–this-post-deals-with-the-historic-trend-of-investment-and-econo.html
this mis a trend over literally hundreds of years of capitalist development now being led by a non-capitalist economy-
and the role of china is very significant
http://socialisteconomicbulletin.blogspot.com/2008/11/china-and-international-financial.html
the particular role of the state in China means that as well as showing historically high growth rates it can potentially weather the current 1929 scale crisis much better than capitalist economies
http://socialisteconomicbulletin.blogspot.com/2009/01/sunday-times-gets-it-on-how-china-is.html
how china responds is crucial
those not wanting to see China grow and US continue to fade due to its economic and poltical dead-end, will of course want China to pursue a different course- the different outcomes of China and Russina economies since 1989, show that western prescribed models had huge negative consequences for Russia (which China took a totally different and succesful direction to)-for n intro see book by peter Nolan.
One element neglected in this discussion is the deeper reasons for Japans’ economic crisis, and its relation to US economic and political interests-which has been mapped out very well in other blogs-those prescribing China to cut investment i fear have other interests- and i wold welcome Professor Ross to respond to your claim on 16/7 above that ‘To recap: just as Japan’s response to the 1987 US crash, which was a very small-scale dress rehearsal for the current crisis, was to use credit inflation and a massive increase in investment to work its way through what it thought would be a very short term reversal in the US ability to absorb Japanese excess capacity, so might China be doing the came thing.-my understanding is very different and it is part of a pattern of US global economic intervention that started in 1973-
China does not seem to be taking similar steps to japan-it is a very differnt type of economy
i would welcome your comments on these points which draw on trends of economies since the beginning of modern global capitalist development
Oh dear…
I find it a bit startling that hyper-capitalist China has now become a torch for “socialists”. Surely “not Being America” is no longer enough to warrant support people? I remember a few years ago that Socialist Worker Newspaper was calling for the return to Maoism so as to put the Chinese revolution back on track – fringe groups will be fringe groups i suppose.
I hope also that no one from here gives Mr Ross what he wants and gives him the blog hits that i suspect were his intention from the start – why else all the links??? I also hope that Jiaotong university realise their folly before Boris Johnson or one of his advisors is hired by Fudan university in retaliation. I suspect it won’t be long.
For the record I have no problem with people disagreeing with others’ positions, but the manner in which one debates is very important, especially if one is accredited by a univeristy – supposedly a centre for educated and academic discussion. Many people have raised contrasting opinions on this blog before, and (aside from the 2/3 known nutters) have usually done so in a polite and academic fashion. It is a shame that someone affliated with a university should choose to proceed in a fashion that hardly does credit to the students / faculty members with whom he / she associates. Being a “maverick” can only carry one so far.
There are a lot of blogs out there nowadays, i could start one with a few clicks of my mouse. Worth reading blogs…considerably fewer in number.
I suspect Mr Ross would have faired better had he not announced himself in such a shameless fashion and entered the debate in such an oddly impolite manner.
Michael Pettis:
There are two discussions, but which are highly interrelated, going on. Both are subject to factual testing. As you, reasonably, made a request for a paraphrase let me set them out.
The first is over the success or failure of China’s stimulus package. One school of analysis is that this package will fail, or even worsen the situation (either immediately or in the longer term). Those holding such views include Stephen Roach, Martin Roach, and yourself. As regards the fundamental reasons why the stimulus package will fail yourself and Martin Wolf have (overall, not necessarily in detail) a common thesis that China is overinvesting/oversaving. As the present stimulus package is, evidently, driven most powerfully by investment (in the first half of 2009 investment accounted for 6.2% of GDP growth, consumption for 3.8%, and exports for -2.8%) if China is ‘overinvesting/oversaving’ then such a stimulus package is likely to make the situation worse over any reasonable time frame.
A second analysis of China’s stimulus package is that overall it will be successful. I have set out my reasons for believing it will be below. Others who believe it will succeed, for somewhat different reasons, include Jim O’Neill of Goldman Sachs or Professor Danny Quah of the London School of Economics.
The assessment of the success, or failure, of China’s stimulus package is evidently a highly important issue for the world economy. People with serious knowledge of the subject support both opposed views. Quoting ‘authorities’ however does not settle any issue so let us consider the key facts. I will set out these out first as simply as possible, and linked to the underlying analytical points, in a positive fashion before dealing with the errors of the oversaving/overspending thesis you have outlined.
1. Put in technical terms the growth of factor inputs (labour and capital), in particular capital inputs, is the primary source of economic growth internationally, in advanced economies such as the US, and in developing economies including China – for a comprehensive survey of the factual data see Dale Jorgenson’s The Economics of Productivity. Therefore China is right to aim at a very high rate of growth of factor inputs – in particular, as this is the issue being discussed here, a very high rate of growth of capital inputs (investment). Once the goal of a high investment rate is considered correct then a high level of savings follows as a necessary corollary as investment can only be financed by savings.
2. A very high rate of growth of investment in China would not produce rapid growth if China used its investment inefficiently – then the alternative course, to maintain a high growth rate, would be not to invest at a high rate but increase the efficiency of investment. Theoretically an inefficient use of a high level of investment is entirely possible – indeed it is one of the main arguments against ‘import substitution’ models of growth which notoriously produce extremely inefficient use of capital whether they are based on market (e.g. Argentina) or non-market (e.g. the USSR) economies. However the most comprehensive studies, those based on Total Factor Productivity (TFP), find that China’s use of investment to increase productivity ranges from ‘respectable’ (the finding by a sceptic regarding Asian growth statistics such as Alwyn Young) to the view that China’s TFP is high. As even someone who shares your overall view, chan-lee james, concedes these are not a few but a large number of studies. Furthermore China’s TFP growth rate continues to be very high (1st or 2nd in the world in major economies according to the study by Jogenson and Vu noted above). Even if we take the worst case analysis that China’s TFP growth, based on a high level of investment, is ‘respectable’ then a high level of capital inputs plus ‘respectable’ TfP growth will produce rapid economic growth – the desirable outcome. If a high level of capital inputs is combined with high TFP growth, as found by other studies, growth results will of course be even better.
This deals with the ‘investment’ side of what chan-lee james refers to as the ‘Asian export-cum investment led model ‘. Now let us consider exports.
3. The problem with the accusation of ‘export’ led growth is that confuses two different issues. The first is the level of exports as a proportion of GDP. A high, indeed growing, proportion of exports in GDP is desirable – it is precisely the process of increasing international division of labour and securing the benefits of economies of scale that helps makes globalisation successful. As with high investment high exports are desirable.
A different issue is the relation of exports to imports i.e. not the issue of the level of exports but the question of a balance of payments surplus. Clarity would, however, be gained if people stopped attacking ‘export led growth’, which may be highly desirable, and simply dealt with the balance of payments surplus. A ‘high investment, high export’ strategy is intrinsic to China’s reforms and it is to be hoped it continues. In contrast there is nothing in either the facts of economic development or in economic theory that states that a high balance of payments surplus, as opposed to a high level of exports, and a high level of (efficient) investment, is desirable. Let us therefore consider the issue.
The appearance of a large balance of payments surplus is recent in China. From 1982-2003 its cumulative balance of payments surplus was $45.9 billion – an average of $2.2 billion a year or nothing to get excited about. Only after 2004 (by which time the cumulative surplus was still only $68.7 billion or an average of $3 billion a year) does China’s balance of payments surplus start to grow rapidly – i.e. the large balance of payments surplus is a phenomenon of the period 2005-2008 (2009 is discussed below). As China did not run a significant balance of payments surplus for 26 years out of the 30 year reform period (87% of the time) which constitutes its present development model and has run one for four years (13%) of that time it is, bluntly, difficult to sustain the thesis that what is crucial to China’s development model is that it have a large balance of payments surplus rather than that it has a high level of exports – the latter is certainly required.
However in 2005-08 China was in a position of a very large balance of payments surplus. As a country’s balance of payments surplus is necessarily equal to its surplus of domestic savings over domestic investment, China’s balance of payments surplus meant it was exporting part of its savings. This was not strategically desirable for reasons set out succinctly by Manmohan Singh, before he became prime minister, for India: ‘A poor country like India cannot afford to have a current account surplus. It means that the country is not able to absorb imports, and the Indian savings are not being converted into investment. That is why, Indian savings are being invested in US government securities for an interest rate of one-and-a-half per cent.’ Given that investment is the primary driver of growth, China would be better off investing a higher proportion of its savings domestically.
This is precisely what is beginning to happen during the first half of 2009 – and directly interrelates with the issue of the stimulus package. China’s investment level has risen further (as follows from the 6.2% of GDP growth in the first quarter coming from investment compared to 3.8% from consumption)in 2009 and therefore, given savings have not risen to the same extent, the balance of payments surplus has started to decline.
Once these key macro-economy facts are grasped it is evident why the stimulus package is successful. To summarise succinctly:
1. Capital inputs (i.e. the rate of investment) are the primary determinant of growth both in China and internationally – the stimulus package maintains (even increases by about 2% of GDP) China’s investment rate.
2. China’s TFP is respectable or high by international standards. Therefore the high level of investment will translate into a high level of growth.
3. The increase in the investment rate will move China’s investment level up towards its savings level therefore reducing the balance of payments surplus and utilising a higher proportion of China’s savings domestically.
In short, the stimulus package is a positively integrated package – evidently operating in a negative international economic environment. That is why it is successful.
The Pettis/Wolf ‘overinvesting/oversaving’ thesis wrongly believes the stimulus package won’t work, because it has a wrong picture of the macro-economy of China and of international determinants of growth. In particular it makes the following mistakes.
1. It fails to acknowledge that investment (capital inputs) is the decisive source of growth – not only in China but internationally. It therefore calls on China to cut its investment rate – which would have the inevitable effect, because capital inputs are the primary source of growth, of slowing China’s economy.
2. To attempt to claim that China could maintain the same growth rate it has to argue that China uses its investment inefficiently. This is straightforwardly contradicted by the major studies which show China has either a ‘respectable’ or a high rate of TFP growth.
3. Due to these two errors Pettis/Wolf even have the wrong proposal for how China should reduce its balance of payments surplus. Instead of arguing for China to raise its investment rate up to its savings rate (which would maintain or accelerate growth) they instead argue China should reduce its investment rate (and presumably, to reduce the balance of payments deficit, reduce its savings rate even more) – which will result in China’s growth rate falling, something which is neither desirable for China nor for the world economy.
Given this erroneous framework, which holds that China is ‘overinvesting/oversaving’ it is argued that the stimulus package, led by investment, will be a failure at best and more likely make the situation worse.
The connections between the different macro-economic frameworks and the assessment of the stimulus package should be evident from the above.
I hope that will suffice for the ‘paraphrase’ Michael Pettis requested.
I think it will be evident to readers that far from consisting of ‘non-sequiters’ this is a rather clear counter position of analyses and facts which is being tested around the practical issue of the success of failure of the stimulus package.
While there are different analyses within each overall view so far the facts support the position of those believe the stimulus package will work, and contradict the thesis of Pettis/Wolf (and for different reasons Roach) who believe it will not. This immediate issue of the stimulus package is, for the reasons outlined, linked to more fundamental questions of economic growth both in China and internationally.
Whoo boy, some interesting stuff and a lot of nonsense. Good grief!
This is from Mr. Ross:
“China is entirely right to prioritise large scale capital inputs because econometric studies show that capital inputs (i.e. the level of investment) are the main determinant of growth. Once it is admitted that China requires a high investment rate then the need for a high savings rate follows as an immediate consequences because investment can only be financed by saving.”
I agree with that, but the Chinese savings rate is an import; of the millions of high- paying US jobs relocated to China over the past decade. Without going into page- filling detail, that ‘wage/savings’ arb trade is coming to an end. With it goes the ‘real’ savings.
China’s savings are valuable to the Chinese and perhaps moreso to the US; they are a wasting asset. How will these savings be allocated?
This represents an unhedgeable risk for both China and the US that hasn’t been ‘stress tested’. The easy/bad answer is inflation. The amounts of Chinese risk are enormous and growing. Sufficient risk and the reserves China possesses become inadequate. How do I know? Just reading the statements of the Chinese goverment financial hotshots convinces me that when push comes to shove there are enough bad loans @ PBOC dependencies to leave them insolvent @ the root. Just like their counter-parties in the US.
China yuan gambit:
http://economic-undertow.blogspot.com/2009/07/greshams-law-writ-large.html
Hey! The carry trade explains the foregoing:
http://market-ticker.denninger.net/archives/1252-Welcome-To-Hell.html
One can determine the size of the carry by counting the increase in China’s dollar reserves. That represents FX risk that has been hedged by being joined at the hip to Mr. Helicopter. Good Grief!!!
China subscribes to the ‘Key Man’ philosphy in that any institution that represents systemic risk is nationalized so it cannot ‘Fail’ but institutional risk swept under the rug emerges somewhere else! The race to the bottom has shifted from wages (unemployment =’s unemployment) to currencies. The crisis is likely to emerge from the broken dollar/yuan peg. Everyone and his/her mother thinks the yuan is undervalued, so everyone is wrong! The dollar is stronger because of what it can buy; Hollywood! What can the yuan buy? Salad shooters and toys covered with lead paint. Ugh!
The yuan is garbage and the Chinese themselves know it! This is why they only trade with international finance powerhouses like Belarus and Argentina. This is also behind all the ‘SDR’ nonsense. When the yuan trades the emperor will be seen naked, the last thing the Chinese managers want or need.
Ross sez:
“Econometric studies confirm capital inputs are the most important quantitative source of economic growth in China, the US and internationally. Any claim that economic growth is not correlated with the rate of investment therefore has no statistical legs to stand on.”
I hate to break it to you but conomies are made up of people with seemingly clever, stupid ideas, not statistics. Ross, meet Herman Daly.
http://www.publicpolicy.umd.edu/faculty/daly/sciam-Daly5%20copy%201.pdf
The people need resources to work with, the first order inputs such as water, soil, energy, minerals etc. The world is learning the hard way that credit is no substitute for resources, no matter how much is ginned up by finance and CB’s. First order capital isn’t even fixed, it’s depeleted and becoming moreso every minute, largely by the actions of leveraged Chinese ‘capital’, btw.
China’s manufacturing advantages are cheap labor and cheap coal.
http://www.energybulletin.net/node/29919
http://www.energywatchgroup.org/files/Coalreport.pdf
Cheap labor and coal has given the Chinee people the ticket to a party that is ending very soon. Cheap coal will be gone in 5-15 years and then what? The world oil market has been driving economic policy since 1973. The Japanese embarked on building asset bubbles in the early 1980′s when oil prices were high. Inflating asset prices were to be a hedge against energy prices – sound familiar? Same asset bubble strategy tried in the USA beginning in 2000; same rationale, increasing energy costs rendering real production unprofitable. Send US jobs overseas and call it ‘trade’. Book the difference and invest in Wall Street and tract houses. Both the Japanese and the US are living the consequence with oil prices now past the point of energy- no return.
Peak oil took place in 1998: http://economic-undertow.blogspot.com/2009_06_01_archive.html
Here’s more: “Energy Secretary [Chu] was my boss,” David Fridley says. “He knows all about peak oil, but he can’t talk about it. If the government announced that peak oil was threatening our economy, Wall Street would crash. He just can’t say anything about it.”
http://www.bohemian.com/bohemian/06.17.09/feature-0924.html
One reason I can make relatively informed comments on China’s conditions is because that country and the US are joined at the hip, with the Chinese desiring to be more and more like America in all things. So, they repeat all of America’s mistakes and lie to themselves, calling the mistakes something else, like ‘development’ and ‘prosperity’. These are words that depend entirely on dirt cheap power and one other thing. What I read from Michael Pettis is the Chinese are too dependent on US customers. This is true. Now, the Chinese do not have them because the US customers have finally reached income parity with their Chinese counterparts. The Chinese themselves do not earn enough – recycled cash flows – to repay the enormous credit structure the government has grafted onto them, just like the dishwashers and landscapers lacked the means to support the subprime/securitization/structure finance credit regime erected upon them in the US. This is an insurmountable problem; it cannot be solved only coped with.
If ‘poverty’ cannot be ‘escaped’ by ‘growth’ in America, it certainly cannot happen in China.
The two countries for different reasons are attempting the same impossible task – to sustain the US consumption model – and are calling it an escape from poverty.
Escape from reality is more like it. A well- worn path leading to destitution, sprinkled along the way with momentary flashes of false hopes.
Prof Pettis,
I’m not sure how often you view comments on older postings, but I just discovered your blog and have been going through it over the past couple of days. I have a pretty simple question – why do you state:
“Furthermore I think the focus on investment in infrastructure and manufacturing will make much more difficult China’s ultimate transition towards an economy in which surging debt-fueled US household consumption plays a much smaller role. In addition much of this new investment is in projects with very low, or even negative, returns (and I suspect they would almost all be negative if interest rates weren’t kept so low by the PBoC). This is not a way to increase Chinese wealth.”
Why do you view their investment in infrastructure to have negative returns? I understand empty apartment buildings, but additional highways, etc… will be the basis for the growth of this economy for years to come. Haven’t we seen something like this in the US several decades ago?
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