In the middle of writing several longish posts at the moment on Hobson and under-consumption, Austrian Economics and some thoughts on ‘Money’. It’s been a bit of a ‘China week’, and I do hope I’m not boring people to death… But one more ‘China’ post to finish the week.
An interesting debate is developing on China’s economic performance.
Economic acceleration was evident as China’s year on year growth rose from 6.1% in the first quarter to 7.9% in the second. Industrial production in June was up 10.7% year on year. In terms of annualised quarter on quarter growth, official figures for which China does not publish as it considers its data on seasonable adjustments are not yet sufficiently accurate, the Wall Street Journal notes private economist estimates of 15% annualised GDP growth in the second quarter. It therefore appears highly likely China will hit its 8% annual growth target this year.
Despite this rapid growth there was no sign of inflationary pressures in consumer or output prices due to overheating – on the contrary year on year consumer prices in June were down 1.7% and the producer prices declined by 7.8%.
These are evidently stellar figures in the context of the international financial crisis – by far the best results of any major economy. (My emphasis).
He goes to note that China’s stimulus is not based on a traditional fiscal stimulus (the budget deficit is only expected to hit 3%) but instead on:
The largest part of China’s $585 billion stimulus package is going into urban fixed investment which rose 33.5% year on year in the first half of 2009 and 35.3% in the year to June. As, in the same period, producer prices were falling sharply it is likely that the real increase in investment in fixed assets approached 40%. China is able to achieve this due to its large state company sector which can be issued with ‘administrative’ instructions to increase investment, thereby countering any downturn.
The second part of the stimulus package is expansion of bank lending. M2 was up in China by 28.5% year on year in June with bank lending rising by RMB 1.5 trillion ($220 billion) in June and RMB 7.37 trillion ($1.1 trillion) in the first half of 2009. The fact that China’s banks are state owned allows them to be instructed to increase lending – whereas in the US and Europe only indirect, so far relatively ineffective, methods can be used to attempt to persuade banks to counter-cyclically expand their lending.
Essentially state owned companies have been told to invest and state owned banks to lend.
John goes on to say that:
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. Indeed Pettis in his latest post, commenting on China’s GDP figures bizarrely, in the light of the facts, claims: ‘I think China will be among the last countries to escape from the effects of the global crisis,’ This is roughly the economic equivalent of continuing to believe that the world is flat despite the fact that all evidence shows it is round.
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. (Again, my emphasis).
I’m not sure John is right here and I’m not sure that he is being fair to Pettis.
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.
Now, I’m sure John would respond that the Chinese trade surplus is becoming smaller.As I said this week though, I’m not sure that John is taking into account what may prove to be a temporary increase in copper imports in his analysis.
Pettis’s second point is crucial. He clearly does not disagree that China has achieved strong growth. He simply asks if it is sustainable.
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.
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 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.
And this is the crux of the debate. John Ross notes that China is growing quickly and dismisses Pettis concerns as ‘wrong advice’. He seems to argue that growing 7.9% in the second quarter is a vindication of Chinese policy.
But that’s not Pettis’ argument. Instead Pettis argues that, of course as state run economy, China can generate high growth. But the real question is whether this is helpful in the long run. His parallel with Japanese policy in the 1980s in especially interesting.
I think John Ross’s analysis is always interesting, but I also think that I’m siding with Michael Pettis on this one.
The world is changing and the global imbalances are starting, slowly but surely to reverse. China needs to start adapting to a world where it can’t rely on Western consumers to generate demand in the short to medium term. I’m not sure it’s doing that right now.