My ten-day trip – partly holiday on Phuket and Phi Phi islands (even more beautiful than I had expected) and mostly meetings in Bangkok, Hong Kong and Singapore – finally ended yesterday. Besides three presentations to large investment groups, I met about twenty to thirty institutional investors in small meetings, and those meetings were very instructive. There is a real mix out there it seems to me of tentative optimism about Chinese prospects on the part of the majority of investors and deep pessimism on the part of a minority, which included both Chinese nationals and foreigners.
Perhaps this is because of my own prejudices as a former bond-markets trader, but the pessimistic minority seemed much more experienced and literate to me. They were also generally a lot more senior. That might not mean much but it does suggest to me that there is a risk of bad news in the future causing a stampede of pessimism. Of course the majority is not necessarily wrong (in spite of the claims of contrariarans, who paradoxically enough include nearly everyone, it seems), but the volatility impact of information that confounds their expectations is much greater than that of information that reinforces their expectations.
I may discuss the impressions I got from some of these meetings more later, but I wanted to talk a little about consumption growth in China. My Financial Times OpEd piece published two weeks ago about the consumption constraint on Chinese growth seems to have generated several letters in disagreement. I don’t think most of them made much sense as far as I could understand. One seemed to have an overly optimistic assessment of the Chinese banking system. It seemed to claim that since officially reported NPL ratios today are much lower than unofficial private estimates of ten years ago, the banks are in very strong shape, and so we don’t have to worry about the NPL effect of the recent surge in lending. That seems to me to be a defensible if illogical claim, but pretty implausible.
The letters also generally assumed – and this confusion seems to happen an awful lot – that the accounting identity GDP = C + I + G is something prescriptive, with GDP growth largely independent of consumption growth and sustainable in the medium and long term by forever-increasing amounts of government-financed investment. Apparently the argument that foreigners won’t consume this rising current and future capacity, and that Chinese won’t consume this rising capacity either, which must lead either to forever-rising inventories, to dumping and trade tensions, or to write-offs, none of which is a happy solution, can simply be resolved by repeating GDP = C + I + G several times.
Nonetheless one of the letters in disagreement, by Professor Peter Williamson of Cambridge University made a lot more sense and identified the main weakness of my argument, as I see it. According to Williamson:
Michael Pettis is right to remind us that correcting the fundamental imbalances in the global economy means that China’s export-orientated growth model is no longer tenable (“Get ready for lower Chinese growth”, July 31). But he is unduly pessimistic about the potential of Chinese consumers to generate sustained, double-digit growth in Chinese gross domestic product.
Between now and 2025 some 350m Chinese are set to become new city dwellers. This alone will give a boost to demand equivalent to the size of another Germany. The government’s stimulus package will also initiate more spending by consumers. The £73bn to provide universal cover for basic healthcare in China by 2011, for example, will encourage savers fearing medical bills to spend more freely. Workers made redundant from export-processing jobs, meanwhile, are adapting quickly – finding new work and retraining (4m in Guangdong alone). Their consumption will rebound.
Local consumption is, indeed, the key to China sustaining high growth over the next decade. But that should be cause for optimism rather than despair.
Professor Williamson accepts the argument that China’s medium to long term growth rate will be constrained by the growth rate of domestic consumption, but he disagrees with me in assuming that the rate of growth in Chinese consumption (roughly 8-9% annually over the past several years) will remain the same or even decline in the next few years. He thinks it is likely to grow much faster.
He may be right, and whether or not he is right is I think the key to the validity of my argument as a prediction of the future. But I am not convinced. For reasons I have discussed many times, I don’t think by his first argument, that China’s plan “to provide universal cover for basic healthcare in China by 2011,” will cause a future explosion in consumption – at least not in the time needed to address the adjustment in the global imbalances.
For one, simply because the government has announced the plan to put into place a good healthcare system by 2011 doesn’t mean that this is a done deal. The government also announced several years ago that Chinese growth would become much more environmentally friendly, Chinese income would become more fairly distributed, corruption would be reduced, the banking system would be cleaned up, SMEs were to receive a growing share of loans, and the corporate bond markets would become a major source of funding, and yet anyone living in China might wonder if any progress had been made on any of those things. Putting in a good health care system is very difficult in the best of circumstances, and with almost no accountability in local governments and local hospitals, and with rapidly rising deficits at both the central and provincial levels, I am pretty skeptical about their ability to achieve anything close to their stated ambitions.
But more importantly, even if they do pull it off, and give China Swedish levels of health care within a year or two, we shouldn’t assume that it will immediately affect consumption levels. Anyone living in China knows how skeptical many Chinese are about government promises, and I would guess that it will take many years of testing the system successfully before even a significant fraction of Chinese household feel that it is no longer necessary to save enough to protect themselves from medical emergencies. After all there are not many responsible adults who will throw caution to the winds when it comes to the possibility of an aged parent or, even worse, a son or daughter, needing serious medical treatment, and cash for that treatment. In that case you don’t give up your safety net of hoarded cash until you are thoroughly and totally convinced that you will no longer need it, and that conviction only comes through experience.
I am also skeptical about his other claim for a surge in consumption based on a flexible work force quickly replacing export jobs with other jobs. Unemployment seems to be rising (of course the official urban employment data is nearly worthless, but the anecdotal evidence isn’t good), and the main reason it hasn’t surged is probably because of the massive stimulus package, so once again we circle back to the argument about the sustainability of the stimulus package. In that light let me just highlight a passage from the ft.com’s Dragonbeat by my friend Arthur Kroeber, a very smart China watcher with whom I used to disagree in the past a lot more than I do currently (perhaps a little to my chagrin, because given how much he knows about China, debates and disagreements with Arthur were always very educational for me):
China’s ability to maintain economic growth of around 8 per cent despite the global shock took many by surprise. But this ability has nothing to do with systemic advantages, a distinct “China model” of growth, or skill in macroeconomic management.
Still less has it anything to do with the reasons cited by the People’s Daily editorial [Note: this is in reference to an especially silly editorial you can find here]. China’s present economic vitality results from a Great Wall all right – a Great Wall of borrowed cash. There is nothing remarkable or spiritual about an economy growing at 8 per cent when credit is allowed to expand by 34 per cent.
The fact becomes even less remarkable when we recognise that nominal GDP (the appropriate comparator for nominal credit growth) grew just 3.8 per cent in the first half. In other words, 10 dollars of new loans were required to generate just one dollar of economic growth.
In fact China’s first-half growth shows one thing and one thing only: the existence of a powerful state with the ability to commandeer its citizens’ wealth and plough it into more buildings, bridges and roads, with no regard for the return those investments will bring.
Not to be outdone, Shen Minggao, Caijing’s chief economist, also worries about the Chinese adjustment in an article in this week’s Caijing. In particular he is concerned that Chinese consumption needs to accomplish the very difficult task of increasing at a rate commensurate with the increase in US savings:
During the S&ED the United States highlighted signs of healthy economic adjustments. For example, the savings rate for U.S. residents climbed to over 7 percent in June and will likely reach 10 percent in the future. The United States has done better than China in terms of these adjustments. China has to change its current exports-driven growth mode because a U.S. recovery does not necessarily boost consumption, given the soaring saving rates.
…The wealth decrease for American households did not shake the foundations of consumption. Though the recession led to negative consumption growth, the largest year-on-year decline was only 4.4 percent, recorded in the last quarter of 2008. It was far less than the 8.9 percent drop during the late 1970s oil crisis.
However, it is uncertain whether deleverage of household balance sheets and rising savings rates are a one-time thing or a permanent change. As U.S. financial regulators tighten systemic risk supervision and easy lending becomes no longer available, American consumers have to rely on savings rather than borrowing to spend.
…In contrast, China’s high saving rates and constant inflows of foreign funding compel the Chinese government to make a hard choice: continue investing in infrastructure or buy Treasury bonds? China will have to suffer additional risks if the dollar depreciates but to continue investing in infrastructure will bring about low efficiency caused by overinvesting.
If China wants to avoid such a dilemma, it must boost domestic consumption. Chinese consumers must lower their savings rates. Meanwhile, the percentage of residents’ incomes in the gross national product should be increased greatly. Second, China needs to push for the appreciation of the yuan. Chinese firms have to rely more on domestic markets than overseas markets. Finally, China needs to turn potential consumption into real consumption during its industrialization and urbanization. Only in this way can China become a new engine for global economic growth and gain a bargaining advantage in future U.S.-China negotiations, which is commensurate with China’s economic size.
In another article another writer in the same magazine warns of growing overcapacity in steel:
The government will freeze approvals of new steel projects for the next three years in a bid to curb overcapacity, Ministry of Industry and Information Technology chief Li Yizhong told a news conference August 13. Li said oversupply is a serious problem, with annual production capacity of 660 million tons far exceeding estimated demand of 470 million tons. China will produce a record 580 million tons of prime steel in 2009, far above the government’s target of 460 million tons, according to China Iron and Steel Association data.
So it mostly boils down to what policymakers can do to boost consumption growth – net consumption growth – in the short and medium term, and the sustainability of the fiscal stimulus to get the economy over the hump, and there is a whole lot of skepticism on my part, and on the part of many of my favorite China-based observers, that this is not going to be easy.
Of course Williamson may be right that there is a possibility of a surge in Chinese consumption, and if he is right my entire argument about a sharp slowdown in Chinese growth over the next decade will thankfully get thrown out the window. That is the main point – my whole argument rests, I think, on whether or not consumption growth can be positively and, more importantly, sustainably affected by the current fiscal stimulus. It is hard enough to present one’s full case in a letter to the editor, so I may be slighting the full extent of Williamson’s argument, but for now I think the evidence is still far more bearish than bullish on Chinese consumption growth.
Can I suggest one way in which consumption might rise quickly?
I think you’ve argued that the big factor in China’s low consumption is savings by companies, and in part the government, depressing household incomes. During an export-recession, isn’t it likely that many industries are going to take a hit, and stop making the big profits that used to characterise export sectors? If their profits drop (and if bank lending can be normalized (depoliticized) somewhat, so that business financing starts to flow more through banks than from private investment), then maybe these large corporate savings will be reduced. Government savings have certainly come down, and could well remain low for a long time. Thus, household income could naturally rise as a percentage of GDP.
A lot of people like Williamson seem to still be talking about household saving and consumption levels, and to some extent this seems misguided. However, I haven’t heard many people talking about Chinese corporate savings levels. What’s happening to the companies?
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Michael – an excellent post, following a set of posts, and a nice set of complementary URL pointers. All pointing to a fundamental imbalance problem. Taking the SI shift as your given premise then the problem problems (to summarize) are: 1)can China adjust away from the export-led economic development model, 2)is the institutional framework in place and 3)does the political leadership and willpower exist. On the last the level of sheer technocratic skill and steely determination of the leadership has been impressive for decades but it seems to me we’re already running into the “iron rice bowl” problem (one is reminded of the goldsmith’s story in Olson’s “Power and Prosperity”). On the first, again pointing to Kroeber, the institutional framework needs some work. It more closely resembles a refreshed and updated version of traditional Chinese administration that what will be required.
It seems to me that the critical question is #1 – can the Chinese economy be re-structured ? And IF so at what pace and force over what timeframe using what funds ? Here on might point to Hirschman’s classic on economic development and the notion of backward and forward linkages. The other problem intimately related to this is the internal dynamics that have driven down manufacturing quality so badly in the pursuit of volume at the expense of quality trying to make underbid and profitless contracts marginally profitable (if you detect Midler’s argument in “Poorly Made in China” you’re correct).
So, coming full circle, this seems to me to be THE question that should be added to your, Kroeber, et.al.’s portfolio on the China Question.
BtW – been meaning to make this point but Gregory Chow’s systemic and systematic analysis of China’s economic transformation might be well worth your time. While the original is slightly dated there is a new edition. More importantly he is a world class economist who was an influential sr. adviser to both Taipei and Beijing who was intimately involved for decades and does as good a job of framing the overall situation and specific sectoral situations in deep framework as anybody I’m familiar with.
Dave Livingston
Llinlithgow Associates
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Firstly, how can China expand its domestic consumption without some equivalent decrease in consumption by other economies sharing the same pool? There is only that much oil we can extract from the ground, so unless we can harness sunlight to power our vehicles, and there is unlimited supplies of coal to generate power in the world, we will soon, if not already, max out on what we can cheaply rely on existing fuel sources to power global economic growth. Chinese cannot drive more miles unless the ‘Americans’ of the world drive less.
The hope of invigorating China domestic consumption may artificially power global equity markets, but it is bumping the underbelly of Mother Nature. There is simply no way we can sustain equivalent increase in economic growth in China without decreases in other linked economies. If the Chinese were to consume as much beef as the western economies, where will the beef come from? Or chicken (a meat that goes to market in 21 days) for that matter.
The hypothesis of 350million rural Chinese moving to the city cannot happen in isolation. It cannot happen in a vacuum. The driver of urbanization must be availability of jobs in the cities. Farmers cannot decide to urbanize for fun. There is no scope for lifestyle choice at such grand scale. If (1) traditional export markets are diminishing and thus the availability of urban jobs do not keep up, and if (2)domestic consumption attitude take s along time, more like generations than years, to change, how is there going to be attraction for farmers to relinquish farmland for urban livelihood? Furthermore, Urbanization creates higher living expectation, more chicken, more petrol, more steel. Thus one can count on the planners to control pace of urbanization, if it is not checked by economic considerations. 350million urbanization is another pie in the sky. It simply cannor happen unless there is more urban jobs created.
To parlay domestic consumption increase on creation of national health coverage is also a wishful thinking. Besides the fear of healthcare funding, there is also a concurrent fear of securing a home for the next generation (son or daughter in most cases). As home prices shoot higher because of credit expansion (without equivalent increase in earning power), the need to save for housing stretches to the next generation. And we expect more Chines to spend more on buying petrol and chicken?
Thus urbanization of 350million rural Chinese is a dream, and thus the impact on increasing domestic consumtion from that source is a dream.
While stimulating Chinese domestic consumtion may be a welcomed result as long as it can fill the voids left by slowdown in export markets, that will clash head on with the same markets for resources if they start growing in tandem. Then what?
My bet is the worst is yet to come.
Nice piece, Professor.
I share similar skepticism about the ability to change consumption habits rapidly. Over time it’ll happen, but I think it will come more with an appreciating RMB down the road than through the subsidies the government is providing and the promised improvement of the health care system.
Government and private industry will need a longer period of investment to keep GDP growing, and that’s what they are happily are doing. To take one sector as an example, telecom equipment manufacturers are showing triple digit revenue growth right now as 3G networks will be built out over the next 3 years: http://finance.yahoo.com/news/China-GrenTech-Corporation-prnews-26329444.html?x=0&.v=32
I still think the big issue most commentators are missing is that China’s past and future growth is coming because of a strong focus on making its industries the most competitive. In spite of all the talk about boosting domestic consumption, the real progress is being made in retooling industry to compete in new markets higher up the value chain. Solar power and battery technology are just two sample sectors. China will subsidize and protect these industries to guarantee continued growth in the future.
One last comment on the explosion in credit during the first half of this year: It was needed when foreign capital was fleeing the country. Now that foreign capital is rushing back in, loan growth will normalize.
Michael,
While not wishing to be repetitious, I’d still be very glad if you could comment briefly on my question posted in response to your last posting already.
Whenever I read arguments like the one brought forward by Shen Minggao that “the percentage of residents’ incomes in the gross national product should be increased greatly”, I wonder what the benefit is for the (mostly corrupt) officials to allow their ordinary citizens to become richer relative to themselves. What is the price of not allowing their citizens to consume more? Would they see a reduction in their quality of life relative to the overall Chinese population?
Michael.
Having just returned from China I would like to voice my concerns on a massive mistake the Chinese are allowing to build up. From Shanghai to Gongbei there are condo city after condo city. You can see the size of the condos from 35,000ft. The 350m people might exist BUT, the salaries and permanence of those salaries simply doesn’t exist. As well, their demand can only be increased through salaries &/or borrowings to the level of german spending.
These cities are simply unaffordable to the country Chinese who are supposed to move into them. Unless the developers take a massive hit to their bottom line. That portends huge bank losses and subsequent bank failures. Look out!!!!!! Instead of building sewerage treatment plants and water purification plants they are constructing the biggest property bubble of all time.
regards
(it cannot end well)
“For one, simply because the government has announced the plan to put into place a good healthcare system by 2011 doesn’t mean that this is a done deal. The government also announced several years ago that Chinese growth would become much more environmentally friendly, Chinese income would become more fairly distributed, corruption would be reduced, the banking system would be cleaned up, SMEs were to receive a growing share of loans, and the corporate bond markets would become a major source of funding, and yet anyone living in China might wonder if any progress had been made on any of those things. Putting in a good health care system is very difficult in the best of circumstances, and with almost no accountability in local governments and local hospitals, and with rapidly rising deficits at both the central and provincial levels, I am pretty skeptical about their ability to achieve anything close to their stated ambitions.”
This is rather disingenuous arguments. Saying China has not achieved many of its long-term, idealistic goals is not equivalent to China’s inability to introduce structural changes and implement difficult reforms. On the contrary, China’s economic success in the last three decades – as much as you might want to put down China’s success, let’s just agree that most of the readers of this blog understand that it’s no small feat to get where China’s economy is today from where it was – can be largely attributed to implementing one difficult reforms after another successfully.
Moreover, what’s important to the argument here (that if China can still achieve rapid growth in the medium- and long-term) is not so much a national health-care system will suddenly and magically boost China’s consumption and change China’s growth model. It takes many trial-and-errors, local experiments and a series of incremental changes to gradually introduce structural changes in the economy. Health-care is but one of the many changes and reforms that China will need to do.
To that end, it would be a stupid policy to introduce a Sweden style welfare system in China today – it is neither feasible nor sensible. What China needs is a health-care system that is compatible with its stage of development; much of the wealth and welfare still need to be created and earned.
“China’s ability to maintain economic growth of around 8 per cent despite the global shock took many by surprise. But this ability has nothing to do with systemic advantages, a distinct “China model” of growth, or skill in macroeconomic management.
Still less has it anything to do with the reasons cited by the People’s Daily editorial [Note: this is in reference to an especially silly editorial you can find here]. China’s present economic vitality results from a Great Wall all right – a Great Wall of borrowed cash. There is nothing remarkable or spiritual about an economy growing at 8 per cent when credit is allowed to expand by 34 per cent.
The fact becomes even less remarkable when we recognise that nominal GDP (the appropriate comparator for nominal credit growth) grew just 3.8 per cent in the first half. In other words, 10 dollars of new loans were required to generate just one dollar of economic growth.
In fact China’s first-half growth shows one thing and one thing only: the existence of a powerful state with the ability to commandeer its citizens’ wealth and plough it into more buildings, bridges and roads, with no regard for the return those investments will bring. ”
I can’t believe it when I read some people’s bogus arguments about the effectiveness of China’s stimulus program here and elsewhere: that it takes X trillions of credit and loans to generate only X% of economic growth in the first half. I mean, seriously, these people can’t be ignorant of the fact that these trillions of credit are NOT immediate investment; much of them are long-term loans that will be invested over multiple years. Do we forget that we’re in a severe global recession and China’s export in the final quarter of last year suddenly dropped from 20-30% growth to negative 20%? The extraordinary time requires extraordinary actions.
The remarkable turnaround of China’s economy in the first half, contrary to the claim of Pettis’s friend Arthur Kroeber, speaks volume of the “systemic advantage” of the China model, and China’s macroeconomic management skills, at least in terms of handling the current crisis(and more broadly at this stage of China’s development). The key difference is not how much liquidity you pumped into the monetary system, but more importantly the velocity of the flow and how fast they’re deployed to the real economy.
To understand, read the recent article from Fortune: “China’s amazing new bullet train.” (“http://money.cnn.com/2009/08/03/news/international/china_high_speed_bullet_train.fortune/index.htm?section=money_latest”). Pay attention to how the various projects are planned, initiated, funded and implemented and how quickly they benefit the real economy.
To contrast, Western monetary authorities and governments have pumped so much more liquidity to the system, how much and how quickly do they benefit the real economy?
There are more to the success of China’s stimulus program: the remarkably successful rural consumer appliance subsidy program which has since been expanded in scope, the preferential tax treatment to the purchase small engine automobiles that has really boosted the auto market.
To read some of the China doubters, it would seem that all China’s stimulus does is to invest in the excess capacity of export sector and flood the world market. That’s totally untrue.
I have said it before, and I will say it again: China’s stimulus package is the gold standard of economic stimulus program.
I think that Beijing has at least one card that has still not been played that would unleash a new wave of consumer purchasing power, albeit with possible social and political implications.
This would be the transfer of rural property ownership to individuals so that banks could lend against the property.
The transfer of urban apartments to their residents in the 1980s and 1990s was the main source wealth that apparently got the whole Chinese domestic economy moving.
CSFB (now just CS) wrote a report in Dec 2003 with a graph showing the Average urban household wealth from 1991-2003
In 1996 the figure was 20,000 RMB with approximately half being savings and half being property
In 2003 the figure was 160,000 RMB with about 130,000 of that being property.
Your thoughts?
Professor Pettis: A very interesting post.
Prof. Williamson rightly point out that China’s rapid rate of urbanisation could (should) raise private consumption. My national accounting is a bit rusty, but a shift from rural to urban population should lead to a drop in the number of self-employed (farmers) and a rise in dependent employment (urban workers) and ceteris paribus a drop in the savings rate.
But how this works out in practise is unclear, as the impact of urbanisation will depend on who moves and productivity gaps. By memory, around 2/3rds of the population is rural, but barely half are farmers. Further, the productivity of rural, non-farm workers is around twice that of farmers; while the urban-rural income gap is now over three.
In sum, productivity of farmers is low and total farm output could even rise despite big rural migration. That said, the biggest sectoral dividends (and higher consumption) would arithmetically come from shifting farmers into labour intensive light industry.
But the dilemma you underscore is that this model is broken. So the question is not whether China will urbanise, but how and especially into what activities?
Kelaido is right. The Eastern coastline cannot absorb another 350 million urban dwellers — hence the go West Strategy? Small business and the service sector are similarly under developed compared to say India, but encouraging such activities would require big institutional changes and a relaxation of tight government controls (including free trade in agricultural products, enforceable rural property rights and a market based financial system).
In short, I agree with Greg, it all boils down to political will and the CPC’s capacity to adapt and change to big new challenges. China’s track record over the past 30 years has been impressive and confounded the sceptics, the more so given their quick reactions to the current crisis. Your thoughts? regards James
[...] Predicting consumption growth in China MIchael Pettis [...]
How is 73 billion pounds supposed to provide comprehensive healthcare for 1.3billion people? I know it is just a starting step, but 70pounds per person doesn’t really seem like a huge drop in the pool…?
My favorite indicator of Chinese consumption is McDonalds comps in the country. In past earnings reports they’ve noted a slowdown due to the Chinese seeing said fast food as a somewhat premium discretionary item. McDonalds is the best international franchiser in the world. If they can’t tap into the main vain of Chinese discretionary spending then tight wallets await others.
In the recent book by Yasheng Huang “Capitalism with Chinese Characteristics”, the author suggests that entrepreneurial capitalism is quickly decreasing in favor of the large state companies.
When a turn-around needed in the direction of the China economy is headed, one must have faith that these large, nepotistic firms are capable of such redirection. A country dependent on the innovative ability of 100 General Motors type companies gives little comfort.
Also new directions would mean a general reorganization of the graft networks that attend all Chinese business.
What has been happening in China under their stimulus package is is doing more of exactly what they had been doing before. More roads, housing towers, steel mills. Copper hoarding is I think not some masterstroke but again doing more of what was done before.
The heavy hand of Statism is rarely produces innovation. And China is certainly becoming more and more controlled.
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Arel
I am friends with one of the government bankers who were researching this Rural property transfer thing. I think private ownership of land is already quite high in rural areas. The key was the ability to borrow against the land / transfer ownership etc. The process has already begun.
Some of us are a little concerned that the end result (via the intended rural to urban migration) will end up increasing wealth imbalances as urban real estate will be greatly boosted in value if such demand can be created. Although i think it does have the potential to increase consumption, we should not forget that rural land values are not always extremely significant, and that the massive price differentials between urban areas and rural areas mean that the “new consumers” may suffer some limitations (and perhaps a strong desire to save their windfall rather than suddenly buy cars etc.)
Prof Pettis,
It seems that pessimists are still living in late 2008 and talking like they are in late 2008.The world has changed.Look at the consumption growth plz.It is pretty healthy.
I and a group of fellow biz men have a long-standing feeling that China’s GDP may be significantly higher than officially recorded.For example,China’s GDP are calculated using industry+second industry+third industry,and third industry,although hard to catch,has been the most robust and ever more creative.
Very good self-analysis. I would just note that you skipped past Williamson’s primary assertion (that of urbanization), and jumped to a secondary factor (health care reform).
On the health insurance issue, I agree with you the process is entirely to work itself out so smoothly. But frankly, I think the entire debate about health insurance is a bit of a red herring anyways… saving rates are extremely high throughout east Asia, including societies with universal health coverage (like Taiwan).
On the urbanization issue, I think the comments left by other visitors tell us exactly why the situation *could* work itself out perfectly. On the one hand, you have folks questioning how China’s infrastructure could possibly support 350m more urban residents; on the other hand, there are folks (including yourself) questioning how the Chinese government can be plowing so much into infrastructure investment + “condo” residential development, etc.
The answer is: the Chinese government is investing in physical infrastructure because it’s believed this will (economically) be extremely rewarding in the medium-term, because rapidly growing cities will require all of this infrastructure and more.
I realize there are alternate (more pessimistic) outcomes possible, but I frankly agree with the Chinese government that this is a very likely result, and one worth targeting.
Lately I have been thinking that China is pursuing the right policy – a capital intensive recovery strategy – but diverge in that it seems that they are building too much of the wrong stuff. By that I mean that efforts to invest in new industries has been crowded out – by policy, scale and local protectionism – by new capacity where there is already more than enough. This is the “razor’s edge” hypothesis, that structural distortions beget more distortions that are hard to unwind. If China were redeploying enough capital in new sectors of the economy where corporate profits might be more abundant (hyper-competition and capacity will kill profits in China far more than occurred in Japan), then these profits could create a new wave of growth, employment and productivity. Presently, the momentum of the old is still too much for the new to contend with, and this is a cycle that has to be broken. China cannot accept ‘creative destruction’, and this is a big problem for them. Under such a framework, capital investment leads and consumption follows later. The problem is that I don’t see the investment mix now generating or distributing income well, which is a medium-term constraint. Social safety net spending could be a huge boost for the economy – consumption by government first – but whereas the OECD spends 20-30% on health, welfare and education, China is still in single digits of GDP. With the working age population set to peek in a few years, where is there time or non-debt funding for such a system? It would be fine for the government to run deficits for a while to get this system going, but unfortunately they won’t. There is also the practical issue of how well social services structures can absorb large increases in budget and grow as fast as the funding in terms of capacity. So assume that China reorients investment towards new segments of the economy on a scale large enough to slow the momentum of old industries, and puts in motion a plan to build up social infrastructure – these are medium term plans, and these goals may be set correctly, but it is filling the time in between without falling into the legacy quicksand that will be the ballgame.
An interesting consideration is to look at the experience with “flow of funds” data from the 80s. The data is easily obtained from the Fed Reserve website: search for the “Z Tables” and “flow of funds”.
At that time, especially in the early 80s, Dr Doom and Dr Death – Kaufman and Wojnilower – used these tables to predict interest rates.
The household data is a “residual” or basically an error factor where all the known data that is required to be filed from the corporate, public, and the foreign economic sectors are tabulated and the residual is assumed to be the household and non-profit.
Kaufman and Wojnilower thesis was the larger this residual grew, the more likely interest rates would rise to entice households to hold the lower yielding treasuries. This was part of the “crowding out” thesis then popular as well.
While the Z table approach was very useful for anticipating household participation, it did not work for predicting interest rates. While the household participation soared to accommodate the growing Reagan deficits, interest rates rallied substantially throughout the decade. What was shown to determine interest rates was the long term anticipated efficacy of the Federal Reserve and their dialogue with unemployment and inflation as per their mandate.
But the Z tables does a great job at showing what took the “state of the art” analysis in the 80s off guard – just how large the USA household savings pool is and how flexible that pool is in its allocation to various sectors.
If the Chinese withdraw from the US Treasury market and the US savings rate moves to 7% to 10% of income, the 80s experience will show we will have absolutely no problem at all in funding the USA deficit with USA domestic flows.
That will be very interesting to observe if we go that route as it will make plain the gargantuan the USA is and I often wonder if that power and size is correctly priced into the world’s asset values. Perhaps some explanation of the USA equity values and the brisk rally we have experienced is reflecting anticipation of this being demonstrated. A thought is that the USA is successfully exporting the USA housing bubble to China, the original causative if one buys into the Bernanke and other thoughts of the world “savings glut”.
Another thought is Japan went down this route in the 80s, an inefficient pricing of Yen which resulted in excess US dollar holdings which at first were invested in US treasuries. Later as Japan tried to diversify into USA real estate and FDI, the US dollars were “contaminated”, if you will, as they were sourced to some degree from inefficiently priced Yen. Then as Japan started to believe their press and invested in the Nikkei, the Japanese stock market went into an obvious bubble.
If it is thought that China’s economy is even more dependent on managed currency level, and if China ignore that reality and the Japanese precedent and do not realize they have little or no “power” in negotiating with the USA as shown how easily household savings met all increased need of funding the USA deficit in the 80s, if China does try to disinvest from US Treasuries and either invest in Chinese assets or non-USA sovereign – it is reasonable to expect the outcome for China will be as severe or even more so as that Japan experienced in the 90s.
In the end China’s only “power” is presenting and working with the USA to prevent chaos and a security issue in Asia for the USA hegemon. To do otherwise and to think there is “power” in the size of the US dollar reserves could be a most critical error in China’s consideration.
I think the risk of China not recognizing their true status is high, and they could repeat the Japanese errors. Only unlike Japan, China will likely revert to a “blame America” policy and an extreme global security risk could result as the chips fall where they will.
I also have grave doubts as the true efficacy of the Chinese stimulus and the resulting Chinese domestic growth.
on the personal savings debate, aside from the health care, social security and other “structual” explanations, there is also a “memory” explanation.
That is, if you can remember a period of serious and painful upheaval – including civil war, famine, disastrous economic shocks etc, then you will naturally be inclined to save more. (Although i admit that economic shocks can actually show people that saving was pointless – eg the Russian crisis in 1998 – which wiped out savings for a huge portion of the population).
At the moment in China, we are only just over 30 years from the Cultural Revolution, and we are only 40/50/60 years from other very disturbing upheavals including most significantly…famine.
I would suggest that people with living memory of such events would have a higher propensity to save compared to those who have only known the “good times”. So basically anybody over 35 may be inclined to save. The same can be said of Europe, where those born in the 30s / 40s with living memory of war / hunger were much less inclined to spend on credit and binge borrow.
This generation issue in China will probably affect more than just personal financial habits, very soon the majority of the population will have been born in the reform era, with no living memory of severe hardship (of course there are differences between rural / urban population). These people will have very different expectations for what constitutes “improvement” and “progress” – take note those at the top!
chan-lee james:
“Kelaido is right. The Eastern coastline cannot absorb another 350 million urban dwellers — hence the go West Strategy? Small business and the service sector are similarly under developed compared to say India, but encouraging such activities would require big institutional changes and a relaxation of tight government controls (including free trade in agricultural products, enforceable rural property rights and a market based financial system).”
I recently spent a month in China, traveling to Beijing, Yunnan, Chengdu/Sichuan and Xian/Shaanxi, the last three cities/provinces are in the western part of the country, a much less developed area with a total population of 160 million (if you include Chongqing, that’s close to 200 million people).
Yunnan, a mountainous province located at the southwestern corner of the country, has traditionally been at the periphery of the China core; Sichuan is inside a basin surrounded by mountains; souhtern Shaanxi is sandwiched between Qinling Ranges and Daba Ranges, although Xian is located at the geographical center of China.
Geographically, most of these provinces are isolated from each other and are far away from the coastal areas and any of the economic centers of the country. Currently, it takes nearly forty hours by train to get to Beijing and fifty hours to Shanghai from Chengdu, respectively.
(Quick quiz: what are the top 10 airports by passenger volume in China? It’s easy to guess that Beijing, Shanghai, Guangzhou and Shenzhen airports are at the top; Hangzhou is also within the top 10. But where are the rest of the airports in the list?)
There have been currently massive infrastructure build-outs within these provinces, and linking them with each other as well as to the rest of the country with expressways, conventional trains and high-speed trains. All the major airports are expanding due to increased traffic volumes.
Until late ’90s, Yunnan wasn’t known for much of anything except its cigarette and tobacco industry; but since the ’99 World Horti-Expo in Kunming, Yunnan’s tourism has taken off. Within a few more years, much of the Yunnan’s scenery and tourist spots will be easily accessible by expressways and/or trains. Yunan is actively promoting the railway connection with Southeast Aisa (Kunming to Singapore), which Yunnan hopes will help the trade with Southeast Asia.
Sichuan is developing its infrastructure even more impressively, due both to the economic stimulus and to the earth-quake reconstruction. After this wave of buildout, Sichuan will be connected to the neighboring provinces and the rest of the country more easily. For example, a high-speed rail from Chengdu to Xian is planned, cutting the travel time from currently over 10 hours to just over 2 hours. Via Xian, Chengdu/Sichuan can get to the northern China much more quickly. Similarly, another bullet train will be built to link Sichuan to the booming Pearl River Delta and to cut the travel time to a few hours. With better transportation links, more trades and investments are expected.
Both in Chengdu and Xian, I saw the rapid urbanization under vivid display. The much improved roads and car ownership bring the city traffic to the nearby rural areas and, with it the consumption and investment and creating a lot of service business for the farmers. The recently opened Xian – Hanzhong expressway (through tunnels in Qinling mountains) cut short what used to be almost a day’s trip to less than two hours. The city of three million people is now calling their city the backyard garden to the provincial capital of Xian; the Xian-Hanzhong expressway has quickly become congested during the weekends.
20-30 years ago when China opened to the world, the coastal region brought in the foreign investments and trade, developed the infrastructure and made itself the world’s factory shop. Today, a similar dynamics is happening to the China’s interior provinces. The different levels of development in the coast region and the interior are such, the development will spread from coast area to the interior and from the urban areas to the rural areas.
China’s coastline and cities do not need to absorb 350 million people in three years, it just needs to absorb 10-20 million people a year, enough to sustain the rapid growth. In ten years, we will see a China much different from the China of today, just like the China of today is so much different from the China of ten years ago.
Greg.
The current plan is for the Pearl Delta to be the home of 80-100 million people. The over supply of condos is already a drain on sensible development of proper infrastructure like sewerage and water.
It will take another 2 decades before the present lot of eyes-wide-open Chinese youth are represnted in the political and business elite lists, then China will become the new “Emporer” in place of the fading West.
regards.
40 hours from chengdu to Beijing by train??? 50 hours to shanghai? Has it got slower than it was 10 years ago?
With all th news of stellar auto sales in China, one has to ask…just what are they running on?
Fuel stockpiles rose 43.5 percent at the end of June from a year earlier and gained 4.7 percent from May, the association said on July 28. Gasoline, diesel and kerosene demand fell 2.6 percent to 103 million metric tons in the first half, after a 6.5 percent decline in the first quarter, the association said then.
http://www.bloomberg.com/apps/news?pid=20601089&sid=a.tk1xScqjec
[...] appear convincing the average Chinese citizen that they will be there when needed is a tall order. Michael Pettis addressed this point in a post recently. From his view inside the country, he is bearish on any [...]
http://www.scmp.com/portal/site/SCMP/menuitem.2af62ecb329d3d7733492d9253a0a0a0/?vgnextoid=e459a1ca55333210VgnVCM100000360a0a0aRCRD&ss=Hong+Kong+%26+China&s=Property
this story caught my attention after recent discussions on this blog about real estate.
I knwo SCMP requires registration
“Unprofitable sites left undeveloped in mainland cities” is the name of the story