Although various commentators (including our Marshall Auerback) have raised warning flags about the long-term viability of China’s growth model, the middle kingdom’s performance during the crisis seemed to prove skeptics wrong. Never mind that creditors like China tend to suffer most in the aftermath of major financial crises, or that no country has ever sustained such a high combination of exports plus investment (over 50% of GDP) for very long. And the ongoing reports of all those vacant cities seemed to be irrelevant.
The critics have been looking less off base of late. A report late last month in the New York Times discussed how the always unreliable Chinese official figures were looking even dodgier of late, reflecting an effort to mask flagging growth. Savvy investors had been using proxies for real economy activity, such as electricity consumption, to compensate for these shortcomings. But the officialdom has become so concerned about keeping up appearances that they’ve started to dress up those figures as well.
Michael Pettis, a long standing commentator on the Chinese economic model, provides a short summary as to why China is unlikely to have a soft landing. Remember that China has shown signs of overinvestment for years. On the eve of the financial crisis, it took $4 to $5 of investment in the US to produce $1 of GDP growth. In China, the ratio was closer to $7 to $8 of investment to $1 of growth. And recall that the way China came through the crisis relatively well was by massive spending….which again was weighted heavily toward investment.
I can see some readers shaking their heads. China is still a very underdeveloped country! There are still lots of opportunities for investment to bring more parts of the country up to a modern standard of living. True, but that does not mean it is economically productive. Pettis explains:
It also seems easy to justify intellectually the infrastructure upgrades. After all, rich countries have far more capital stock per person than poor countries, and those investments were presumably economically justified, so, according to this way of thinking, it will take decades of continual upgrading before China comes close to overbuilding.
The problem with this reasoning of course is that it ignores the economic reason for upgrading capital stock and assumes that capital and infrastructure have the same value everywhere in the world. They don’t. Worker productivity and wages are much lower in China than in the developed world.
This means that the economic value of infrastructure in China, which is based primarily on the value of labor it saves, is a fraction of the value of identical infrastructure in the developed world. It makes no economic sense, in other words, for China to have levels of infrastructure and capital stock anywhere near that of much richer countries since this would represent wasted resources – like exchanging cheap labor for much more expensive laborsaving devices.
Pettis later stresses that this problem is endemic in the “productive” sector of the economy as well:
The problem of overinvestment is not just an infrastructure problem. It occurs just as easily in manufacturing. When a manufacturer with privileged access to the banking system can borrow money at such a low rate that he effectively forces most of the borrowing cost onto household depositors, he doesn’t need to create economic value equal to or greater than the cost of the investment. Even factories that systematically destroy value can show high profits, and there is substantial evidence to suggest that in China the state-owned sector in the aggregate has probably been a value destroyer for most if not all the past decade, but is nonetheless profitable thanks to household subsidies.
And these subsidies are substantial. A mainland think tank, Unirule, estimated in 2011 that monopoly pricing and direct subsidies may have accounted for as much as 150 percent or more of total profitability in the state owned sector over the past decade. I calculate that repressed interest rates may have accounted for another 400 to 500 percent of total profitability over this period. Monopoly pricing, direct subsidies, and repressed interest rates all represent transfers from the household sector.
At some point, in other words, rather than create wealth, capital users begin to destroy wealth, but nonetheless show profits by passing more than 100% of the losses onto households. The very cheap capital especially means that a very significant portion of the cost – as much as 20-40% of the total amount of the loan – is forced onto depositors just in the form of low interest rates.
How? Because artificially lowering a coupon on a ten-year loan by 4 percentage points effectively represents debt forgiveness equal to 25% of the loan.
So thrifty Chinese savers are actually being ripped off by getting far too little interest on their funds and having the money channeled into businesses that would lose money if they had to operate without government subsidies and artificially cheap capital. Now he stresses that that still could be a good deal if the system produces a high enough level of growth. But he deems that unlikely to continue:
Under these circumstances it would take uncommonly heroic levels of restraint and understanding for investors not to engage in value destroying activity. This is why countries following the investment-driven growth model – like Germany in the 1930s, the USSR in the 1950s and 1960s, Brazil in the 1960s and 1970s, Japan in the 1980s, and many other smaller countries – have always overinvested for many years leading, in every case, either to a debt crisis or a “lost decade” of surging debt and low growth [The German experience, of course, ended in war, and not in a debt crisis, but according to Yale historian Adam Tooze, the German invasion of eastern Europe occurred three or four years earlier than the military command was prepared largely because the country was almost insolvent and could not afford to wait any longer. See Adam Tooze, The Wages of Destruction: The Making and Breaking of the Nazi Economy, London: Allen Lane, 2006]
The second constraint is that policies that force households to subsidize growth are likely to generate much faster growth in production than in consumption – growth in household consumption being largely a function of household income growth. In that case even with high investment levels, large and growing trade surpluses are needed to absorb the balance because, as quickly as it is rising, the investment share of GDP still cannot increase quickly enough to absorb the decline in the consumption share…
But by 2007 China’s trade surplus as a share of global GDP had become the highest recorded in 100 years, perhaps ever, and the rest of the world found it increasing difficult to absorb it. To make matters worse, the global financial crisis sharply reduced the ability and willingness of other countries even to maintain current trade deficits, and as we will see this downward pressure on China’s current account surplus is likely to continue.
So China has probably hit both constraints – capital is wasted, perhaps on an unprecedented scale, and the world is finding it increasingly difficult to absorb excess Chinese capacity. For all its past success China now needs urgently to abandon the development model because debt is rising furiously and at an unsustainable pace, and once China reaches its debt capacity limits, perhaps in four or five years, growth will come crashing down.
Marshall Auerback has pointed out that no country has managed the transition from export-led growth to consumption-led growth gracefully. Perhaps China will be the first, but the precedents bode ill.
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That’s a nice explanation Pettis gives for infrastructure building and wealth destruction by state enterprises. Some of us have been warning about China for a long time. Rapidly growing export driven economies tend to crash and burn in a general downturn. The other thing to keep in mind with China is that it is a kleptocracy. Much of its wealth is concentrated in a relatively small number of hands. This has led to political corruption. Or rather much greater political corruption as China’s political classes vie both to serve and become kleptocrats themselves. Their goal is not to convert the Chinese economy to one that is sustainable and serves the country’s 99%. It is to keep the casinos open for as long as possible to their political and economic 1%s. It seems like a recipe for political instability, and as Chinese history shows when China becomes unstable, it becomes very unstable, very fast.
Well, your predictions seem not to differ much from your whole controlling skeptical lost western system of governing
That is true. The 1% is a truly trans- and post-national class, and hence more alike everywhere than different.
You see it all over the world: Russia, China, the Middle Eastern authoritarian regimes, resource-rich countries in Africa, the Marcoses, Mubareks, and Ghaddafis, families and oligarchies that steal their countries’ wealth. Sometimes it’s blatant and sometimes it’s justified by a “system” that just happens to result in the powerful sucking up all the money. Here, of course, people get rich purely on ability and effort, not connections, rigged financial gains, or de facto bribery of government officials. Right.
I agree and would like to tweak your model slightly. When the 1% is dealing with the 99%, they often act in a unified manner. And the needs of the 1% as a kleptocratic class explain far more of actual politics than the nominal institutions. For example, the Federal Reserve will do _whatever_ the 1% sees fit, regardless of any laws.
On the other hand, within itself, the 1% is not unified. Far from it. Most of the 1% acts, not on behalf of the 1% but on behalf of some shard of it. In China, the largest shards are parts of the Communist Party, but even that is not internally unified.
This internal disunity means that the 1% viewed as though it were a whole will often act in ways that are contrary even to its own long-term interests. It will go overboard. A lot.
The lack of an organized left and the absence of international rivals makes our situation now different from the 1930s. But another difference is that the 1%, having become purely kleptocratic, lacks internal discipline.
I think that the Chinese 1% is in a transition from being like the Western elites of the 1930s and before: brutal, inefficient, culturally toxic, inhumane, but serving the role of organizing a multi-decade improvement in the infrastructure and standard of living. But at a much faster pace than in the West, they are transitioning into being purely kleptocratic = brutal, inefficient, culturally toxic, inhumane and all to no good purpose.
I am not sure exactly where the Chinese 1% is along this transition path, but the fact that they have had an actual historical purpose in pretty recent times makes their appearance more confusing. Some people are probably still seeing data from the past somewhat constructive phase and misunderstanding it as indicative of the present. More simply, the Chinese 1% has synchronized with its kleptocratic co-conspirators but without that being well noticed.
It’s been said that “democracies don’t fight other democracies.” But what about kleptocracies fighting other kleptocracies?
The reality is that most countries in the world are a kleptocracy. In the U.S., 400 of the wealthest people have the wealth of the bottom 60% combined. China is not nearly as bad as the “China is a kleptocracy” article claimed: http://www.washingtonpost.com/blogs/ezra-klein/wp/2012/06/24/the-billionaires-list/
There will be slowing in Chinese growth for sure. Nobody would expect China to grow 10% a year for the next 20 years. But a ten-year stagnation is also highly unlikely. To increase spending, all China has to do is to spend more in health care and education. Increasing spending is easy for the state, although not neccesorily so for individuals.
You are correct. There is no particularly difficult economic problem. But there is a huge political one. The obvious solutions given by everyone who looks at the economics all share one thing in common: they involve those with all the power and money giving a lot of it over to those who do not have power and money. That is just as likely to happen in China as in the US = When hell freezes over, pigs can fly, etc.
When political movements of the non-elite arise, then things will change.
they involve those with all the power and money giving a lot of it over to those who do not have power and money. Jessica
Not necessarily. NEW money can be created so there is no need to take existing money from the rich. And in real terms, there need be no wealth transfer even in real terms if the new money creation is combined with credit restrictions on the banks.
Yes, but shifting to the kind of new money creation you advocate would mark a massive shift in power. It would be much better than what the Chinese 1% in their knife-in-each-other’s-ribs way will decide to do, but it is not what those with power in China will choose to do. Until there is an alternative organization by the rest of the population.
Same true in the US.
The China elite get co-opted by the global inherited rich and the world never sees it happen.
The Chinese elite are not dumb but the global inherited rich have unlimited funds to tempt them into whatever direction they want.
Capital destruction and the low marginal productivity of the China model are long-term tendencies of the system. It is a mistake to cite them as reasons for this or that quarter’s fluctuation in growth. Currently there is a shortfall in global demand that is acute, temporarily exaggerating these weaknesses. If the system depends of export-generated surpluses, obviously there will be a crisis if these surpluses are not being generated. That’s the immediate cause of the slowdown in China. The other systemic tendencies will take a decade or two to play out and in theory, there is time to undertake a rebalancing. The ‘lost decade’ idea will hold if the western world also has a ‘lost decade’. Otherwise, it will become clear that the Chinese model despite its weaknesses is not an automatic recipe for economic suicide, crash, or depression. Though the state and state-owned banks have squandered a lot of capital, the private savings rate remains high. A long-term reduction in growth rates from 10% to 6% does present many problems, but the crash and burn scenario is just as unlikely now as it was a few years ago. When will they (the critics) ever learn?
No one has twenty years to work this out. Kleptocracy is already cracking apart the more developed economies of the US and Europe. Even if China did not have its own kleptocracy problem, it is too dependent on these other economic centers to avoid contagion from them. Also by 2030 the whole world will be struggling with the effects of global climate change, resource depletion, political instability, and overpopulation.
China’s leaders are too corrupt and too wedded to the status quo to avoid disaster. Get used to it.
I some times wonder if the Chinese capitalists are just a form of clever fortification or a counter – fight fire – with fire – MAD game.
Skippy… they’ve had a long time to observe and attempt solutions to the Wests desires. Whom knows.
China COULD pull off some radically correct solutions. Those factories really exist. The problem is simply lack of aggregate demand in China. But aggregate demand is just the desire and the ability to spend money.
From my talks with regional party members (some generational) and friends over there, I see things differently. They don’t think like westerners, full stop, since 7600 BC with only a few hundred shared with the west.
This befuddles many in the west, its hard to apply western metrics and divine what their next move will be. Their not as aggressive as the Russians were, until their sphere is broached, a defensive position imo. And seemingly only wish to avoid having the yoke placed back upon their necks in servitude to the old white masters.
Skippy… in the end its all just life to them, a billion people trying to make it too tomorrow, on their own, with out to much outside interference. Vacant city’s[?], do they care in the end[?], its just positioning with in the global game. Whom will run out of gas first? Whom will trade with whom. Will it even matter the way things are going?
“This befuddles many in the west, its hard to apply western metrics and divine what their next move will be. Their not as aggressive as the Russians were, until their sphere is broached, a defensive position imo. And seemingly only wish to avoid having the yoke placed back upon their necks in servitude to the old white masters.”
The European and Russian paradigm of an intellectual game is chess – you move pieces with defined and differing power sets over a limited board to attack the opponent through a combination of these powers. The Chinese paradigm is go, a game of surrounding territory on a much larger board through the strategic placement of pieces with limited power in themselves. The goal isn’t to attack, it’s to secure your own options and cut off those of the opponent.
Concur,
http://www.nakedcapitalism.com/2009/10/plans-to-move-away-from-dollar-pricing-of-oil.html#comment-58544
Skippy… On the seas the west wins… on the ground in their backyard I’ll give it to the East including the middle part. We play speed chess they play slow go.
Mandarin: When will they (the critics) ever learn? Dunno. Maybe when they learn some Chinese, learn something about China? And above all, want to be objective? China’s rulers are kleptocrats? For USAns or Europeans under the lash of the banksters, the ECB & its kleptoEurocrats to say this is amazing. Somebody once said something relevant about logs in eyes.
China’ll stop growing nicely once (a) the whole world hits real resource limits or an environmental catastrophe or (b) the Chinese 1% becomes as predatory and anti-China as the Western 1%s are against their own societies & the 99% behaves as ignorant suckers as well as the Western 99%. The (b) scenario is the focus of this article & many commenters – and is not bloody likely for a generation that has seen China grow on the scale it has for decades.
The willingness of the 99% to take the 1%’s shit is the determinative factor. Contra Mandarin’s conservative qualification, I don’t think that China will have a lost decade even if the West’s 99% allow their 1% to inflict one on them.
“but according to Yale historian Adam Tooze, the German invasion of eastern Europe occurred three or four years earlier than the military command was prepared largely because the country was almost insolvent and could not afford to wait any longer.”
Insolvency? Not the economic term I remember. Hitler rushed to war, or attacked at the exact right moment (the author’s view, and mine), because he had no oil.
Without oil, there could be no lebensraum. Without lebensraum, the Third Reich could never know, easy and perpetual, exponential economic growth.
Lebensraum and exponential growth. Since its revolutionary birth, the spacious and amber skied, resource rich United States had seen plenty of both. How could they not? One leads directly to the other. The virtuous circle.
And how the Fuhrer envied and resented us for it.
Our bestowed fortune!
Our outrageous fucking luck!
Note: Hitler loved Westerns, no doubt for thematic reasons.
Lebensraum … westward ho! Circle the wagons, boys, the untermensch have us surrounded. There’s gold in them there hills!
Well, not gold, exactly, Hitler didn’t give a shit about gold, gold. But black gold, the priceless thing he lacked? He most definitely obsessed about that.
There’s oil in them there Caucasus, soldats … and in the Badlands beyond!
Hmm…today, different superpowers, but same basic strategy. Not much has changed, eh?
Adam Tooze is far from the first who saw Hitler forced to move ahead with his plans for war, due to economic pressures. In German school books from the 1970s, it was given as the determining factor that war came when it came (and I assume the books were based on historic research). Hitler wanted war, but later.
Germany was short on oil, too, but it had been since 1914, so that doesn’t explain the German steps to war in 1938. Germany lacked by 1938 the foreign valuta necessary to buy the needed oil and rare metals. The German victories from 1939 until 1941 and the plunder of Europe helped the economic situation inside Germany a bit, but the lack of military exploitation from then on doomed, fortunately, the agression.
“Thus what if the banking crisis is less about bad lending decisions and more about overly successful investment?
First, consider some of the evidence. We know the Western economy has been plagued by overcapacity issues. Output gaps have been negative not only in developed countries, but on a global level.
…
As our charts attempt to explain, this could be because in a negative carry universe — one in which goods, collateral and assets are expected to permanently outnumber money in the future — bank profits can only be achieved through pariah practices rather than lending. Banks are ironically encouraged to destroy capacity, disincentivse investment, borrow money from the economy rather than lend it, and hoard wealth. All phenomenons we are currently seeing. All phenomenons which are economically destructive.
One of the best illustrations of this topsy turvy world, meanwhile, is that corporate cash piles are rising, with corporates not just weaning themselves off banks, but lending directly to the banking industry itself.”
http://ftalphaville.ft.com/blog/2012/07/05/1071671/pariah-profits-in-an-age-of-negative-carry/
In Shock Doctrine, Naomi Klein details how many of these kleptocracies arose based on The Washington Consensus/neoliberalism. These ‘free market’ principles were highly favorable to corporations not to workers and usually had to passed through at times of disaster where the populace was disoriented or intimidated.
Political agendas tended to be emphasized while these destructive economic forces snuck in the backdoor.
Tiananmen Square can be seen as workers and students wanting the opposite of the Washington Consensus/neoliberalism ie fair wages, job security, decent housing etc. The Communist leaders actually wanted unbridled capitalism which they could control to enrich themselves.. And looked to Milton Friedman for guidance..
‘In China roughly twenty-nine hundred of these party scions -known as the “princelings” – control $260 billion. ‘
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Joseph Stiglitz: “Klein provides a rich description of the political machinations required to force unsavory economic policies on resisting countries and of the human toll.”
“Marshall Auerback has pointed out that no country has managed the transition from export-led growth to consumption-led growth gracefully.”
Out of curiosity, do you have the links to this argument, or would you expand upon it? I know it to be true, but I was wondering if people have put together a working model as to why.
To me, the primary problem is that perpetual growth is impossible.
Witness what happened in America. Housing prices soard, building soared. But at some point there was nobody to buy these properties. Thus we invented NINJA loans and CDOs and CDO squared in order to keep growth going… but at some point it just can’t any longer.
Same with production. We saw ever higher amounts of production. But there comes a time when consumers simply can’t buy any more. There is a time when the oil supply needed to produce becomes constrained, not to mention all the other commodities. Rapid commodity costs reduce consumer discretionary spending and leads to less consumption. these same rising commodities lead to incrased costs of production, breaking the perpetual growth again.
In the end China must find a way to convert to more consumption… and the world must find an economic model that does not require perpetual growth… because striving for perpetual growth leads to bubbles.
“In the end China must find a way to convert to more consumption”
China earns foreign currency to buy and import raw materials for production from exports not domestic consumption, all domestic consumption does is burn up rescores for other important uses like war in the worst case scenario. Take oil for example in America we could have subways and electric busses in all the cities but in stead we just burn oil since we have a horrible public transportation system and even more horrible city planning by you’re local level wannabe fascist commies who want to stop progress in its tracks like effective public transportation and renewable energy for example which would allow us to export large amounts of fossil fuels rather than burning it here.
“even more horrible city planning by you’re local level wannabe fascist commies who want to stop progress in its tracks like effective public transportation and renewable energy”
That sounds confused.
When a manufacturer with privileged access to the banking system can borrow money at such a low rate that he effectively forces most of the borrowing cost onto household depositors, he doesn’t need to create economic value equal to or greater than the cost of the investment. Even factories that systematically destroy value can show high profits, and there is substantial evidence to suggest that in China the state-owned sector in the aggregate has probably been a value destroyer for most if not all the past decade, but is nonetheless profitable thanks to household subsidies. Michael Pettis [emphasis added]
Well, there it is. The ONLY excuse for allowing the so-called “credit-worthy” to steal purchasing power from everyone else – that such theft creates economic value – is hollow according to Mr. Pettis.
…and the world must find an economic model that does not require perpetual growth… because striving for perpetual growth leads to bubbles. Yearning to Learn
That’s simple. We need to abolish credit creation or at least all government privileges for it and encourage the use of common stock as private money. Common stock as money ALLOWS growth but does not REQUIRE it. Also, it is the lending of money into existence that causes the boom-bust cycle. But common stock is not lent into existence; it is spent into existence; there is thus no need to repay it or to continue borrowing to pay interest as is the case with debt.
“So thrifty Chinese savers are actually being ripped off by getting far too little interest on their funds and having the money channeled into businesses that would lose money without government subsidies and artificially cheap capital.”
Now, does that have a familiar ring to it, or what?
At some point, in other words, rather than create wealth, capital users begin to destroy wealth, but nonetheless show profits by passing more than 100% of the losses onto households.
Sounds like the Chinese SOE’s may have learned a thing or two from the Western Banking Cartel.
A couple of points:
1) I think Pettis is relying on judgemental semantics too much. If the Chinese govt can ensure low rates of interest for its industries, and savers are willing to accept those rates of interest, then how is this a “subsidy”? One could say the same thing about the U.S.: am I, as a saver, subsidizing unprofitable industries because I’m accepting 1% interest rates instead of the 15% rates available during Jimmy Carter’s time? How much of the U.S.’s industries would be forced to close if 15% interest rates were still the norm?
Rather than ask who is subsidizing whom, I think there are only 2 questions that matter: can China sustain such a low interest rate for the foreseable future? So long as capital controls and an underdeveloped equity market means local surpluses must be invested in govt debt, I think it can although the resulting inflation may not be tolerable.
Secondly, at current interest rates, would the money be better spent elsewhere? This is ultimately a political question about the allocation of resources. It’s hard to understand in America, but for the Chinese, and many other countries with real external threats, the economy is merely the extension of politics by other means. In other words, the economy is usually considered secondary to political goals such geopolitical influence, social stability, etc. (including personal enrichment through corruption, I suppose). So as long as investment and export-led growth continues to serve China’s other political goals, it may, in the larger picture, be the best policy for them.
2) Re: about Auerback’s point: what about post-war Europe? i’m not an economic historian, but didn’t it start as primarily an investment-and-growth economy (primed by the Marshall plan and U.S. corporate investments) and peacefully transition to a more balanced consumption-based economy?
and peacefully transition to a more balanced consumption-based economy? Lune
With ethical money creation, that process would be automatic and smooth. But instead, we have people dis-employed with automation that was paid for with their own stolen purchasing power!
Faced with low rates savers look for alternate options – hence the real estate bubble and the rows upon rows of unoccupied ridiculously priced apartments, or the rising sales of gold. China is dangerously unbalanced, and while things can stay unbalanced for longer than one thinks, the risks of an eventual tumble, and a big one at that, are very high.
If the Chinese govt can ensure low rates of interest for its industries, and savers are willing to accept those rates of interest, then how is this a “subsidy” Lune
Because if you are not privileged to receive that “credit” you nevertheless suffer the price inflation it causes. It’s called “a negative real interest rate on savings.”
Credit creation is the lending of stolen purchasing power for the benefit of the banks and the so-called “credit-worthy.” And as Mr. Pettis points out, it does not even achieve it’s supposed goal – “value creation.”
Also, your supposed libertarian argument ignores that banks are a government backed/enforced private money cartel.
Chinazilla, a.k.a. East Asia’s biggest developmental state, will be fine. Nothing wrong with the big lizard which some massive education, healthcare and pension spending couldn’t fix.
This neoliberal fixation on household wealth as the ultimate unit of economic analysis is madness (though not without its method: neoliberalism is, after all, the ideology of a tiny oligarchy of kleptocrats who produce nothing but think they deserve to own everything). China has succeeded — and will continue to succeed — because of heavy state regulation on finance, and massive investments in science, technology, green energy, etc. The place cannot and will not go bankrupt, because China largely finances itself and owes its sovereign debt to itself.
These “China Syndrome” stories also miss the fact that there are at least a dozen other budding developmental states out there, just beginning to unsheathe their claws (Russia, Turkey, Brazil, Vietnam, etc.).
Well, let’s see now. A population of approximately 1.3 billion mostly serfs living under a heavy handed quasi-democratic corporate capitalist regime of someone else’s design, 4x that of the first world’s presumptive capitalist consumption “engine of growth,” which is itself individually and collectively totally broke and devoid of new political economic ideas and in the throws of a massive conservative religious political economic austerity drama of epic proportions. All of that riding on top of the plateau (and soon to be epic fall off) of global cheap energy supplies which made all of it possible in the first place. Call me a corn pone idiot rube if you will, but I just have to ask: what could possibly go wrong with this picture?
Why does Pettis say that the Chinese are unproductive, as if productivity were entirely unconnected to the captial base? His argument is like saying “That child is ignorant, educating him would be a waste of time.”