Yves here. Below we are featuring an important comment from PlutoniumKun, where he weighs in on the debate over how serious China’s current and prospective economic problems are. We have pointed out that a Chinese economic crisis has been overpredicted for a very long time. But being early does not make one wrong; recall some experts like William White and Claudio Borio of the BIS, and Nouriel Roubini were warning of a housing bubble and the prospects of a very ugly implosion years before it happened.
However, as we have pointed out (following Michael Pettis and Marshall Auerback, among others) and PlutoniumKun highlights, China seems not just to be having what would be expected difficulty in changing from an investment/export led growth model to one with domestic consumption being far more important. But China also appears to have an ideological, or one might say political problem in making this shift. Higher consumption would require lower savings rates. Not only do Chinese consumers not feel secure enough to do that (too much history of crises in China and its neighbors) but China under Xi is unwilling to implement the social safety nets that would encourage more spending.
I don’t want to take up too much time with this intro, but some relevant recent sightings. Note that Setser among other things is the man on dollar holdings and flows outside the US:
I suspected that parts of China’s top leadership objected to a household focused stimulus. Turns out the epicenter of opposition is Xi himself: “Xi sees such growth as wasteful and at odds with his goal of making China a world-leading industrial and technological powerhouse”
2/
— Brad Setser (@Brad_Setser) August 27, 2023
Beijing’s mind seems made up — but Chinese policy makers have this backwards.
Using the central government’s clean balance sheet to support household demand would actually make it easier for households, property developers and local governments to delever.
— Brad Setser (@Brad_Setser) August 27, 2023
A hypothesis: there can be no durably stable Chinese and global economy so long China’s national savings rate stays around 45% of GDP …
(note that, contrary to the IMF’s forecasts, savings has been rising since 2020 …)
— Brad Setser (@Brad_Setser) August 28, 2023
China’s shoppers hesitate to spend big in face of deflation via @FT
🇨🇳
”Excess savings in China have increased in the first half of the year compared with the same period last year, and there is still a gap between pre-pandemic and current consumption” https://t.co/dvQvhP1lrU— Iikka Korhonen (@IikkaKorhonen) August 29, 2023
Don’t focus on GNP growth, it’s not a relevant measure for comparing developing and developed countries, especially how it’s measured in China. Pettis gives a long form explanation here. It terms of assessing what the ‘real’ economy is doing in China, it’s a pretty much useless measure.
Only time will tell if this is an existential economic crisis for China or just a very unpleasant blip. But the reality is that a crisis is inevitable for any country pursuing an unbalanced growth model – i.e. by focusing on investment and exports over domestic/consumer led growth. This is baked into the standard model – and the Chinese are fully aware of this, and have been since at least the 1980’s and 1990’s when I started following (from afar) the Chinese economy from a development economics perspective. Back in the 1990’s the Chinese devoted very significant resources to studying the Japanese late 80s collapse, later the 1990s Asian crisis, and the multiple crashes which foiled numerous countries over the past century or more from crossing the threshold from upper-developing to developed country status. There is a line of thought among some China analysts that Xi was selected and given extraordinary powers specifically to deal with what was foreseen to be a very difficult transition from a the current development model to ‘developed’ status, which has always overtly been the holy grail for the CCP.
I don’t think there is much doubt that the current situation in China is very serious. In my opinion, the housing crisis is a symptom, not the cause of the current problems (in reality, the Chinese economy started showing signs of strain even before Covid). The core problem being several decades of internal debt build up and chronic mal-investment along with an overdependence on rising property values to underpin spending at a local level. But the housing issue alone is gigantic – by any objective measurement it is vastly greater as a proportion of the economy’s size than the Irish and Spanish crashes of 2007-9. When you add in demographic issues and climate induced strains, this is potentially much more than just a cyclical downturn.
It is highly unlikely for there to be a financial crash as the Chinese banking and finance model is very different from in the west, or for that matter, most other Asian economies. In simple terms, Beijing has plenty of tools to stabilize the finance side of the economy, and not having external debt is a huge advantage – not to mention the enormous strides made in just the last decade in gaining competitive advantage in a wide range of important manufacturing sectors. But it is increasingly recognized within China (this is very obvious reading between the lines in various statements from Beijing) that the current model has finally run out of steam and needs fundamental overhauling.
The problem is that this has been pretty obvious for some time, but despite numerous policy statements going back at least 2 decades (the big ‘change’ was supposed to happen after the 2008 Olympics), very little has been done, it’s always been easier to open up the spending spigots and kick the can down the road. In particular, the funding model for local government – which has always been the big driver of growth – is now not fit for purpose and must be replaced by either a proper local taxation system or direct funding from Beijing. But that is easier said than done. There has to be a very significant transfer of wealth to ordinary citizens through higher wages and better social welfare provision in order to boost consumer spending (one of the few things orthodox and heterodox economists agree on when looking at China). And as for debt – in theory, this is a simple problem to address (i.e. monetize/forgive it in one form or another), but there appears to be an unwillingness to even discuss this option within high level circles in China.
The irony to me is that having studied the Japanese crash intensively, the Chinese may somehow manage to replicate exactly the mistakes the Japanese made. There appears to be a lot of pressure to go for yet more concrete pouring and refinancing of debt as a ‘solution’. This will risk deflation, zombification and/or a greater crisis further down the line.
While it can be argued that the current property/investment boom is not as bad in China as it was in Japan, in other respects the Chinese economy may be a lot weaker than Japan was at the time – for all its modernity, China is still essentially a poor country – significantly poorer than, for example, Russia or Turkey, and probably not even matching Mexico. What is unique about China is its enormous size, which allows it to mobilize resources and dominate economic sectors in a way small developing countries can’t. But then again, this has never helped India, which also has some very advanced technological sectors.
The other huge problem – ironic given demographic problems – is youth unemployment. This seems to be a characteristic of fast growing export-led economies once they rise above the sweatshop levels of development – both Japan and South Korea have had huge problems in keeping up employment levels even at times when their economies have been seen to be healthy when measured in GNP. In simple terms, I don’t think you can keep up a high level of employment if you insist on suppressing wages and consumer demand. But this is integral to an export/investment model of development.
If you want to understand what’s happening in China its important I think to forget the whole China vs US thing (the US has almost no direct or indirect influence on what is happening in China) and look at it as it is – a typical, if unprecedentedly large, example of a country pursuing very rapid growth using what used to be called the ‘American’ system (later refined by the Germans, South Koreans, Taiwanese and Japanese). Each of those economies have unique features, but the underlying advantages and disadvantages of combining high levels of internal wage/spending suppression in the domestic economy with an insistent on export and investment led growth all seem to lead in the same direction. The only question is whether they can achieve the transition to a more balanced economy (i.e. ROK and Taiwan or even Russia) or end up butting their heads against the ceiling Argentina or Brazil style, or perhaps end up in some sort of Japanese style limbo, albeit at a much lower level of development than Japan.
A few years ago, I would have been fairly confident that the CCP could pull it off, especially with someone as impressive as Xi at the helm. But more recently there are increasing signs of inept leadership, groupthink and poor decision making at higher levels of government in Beijing, going right to the top. There is a lot of rot among our leadership classes everywhere, not just in the west.
64 comments
Comments are closed.
Very good, thanks PK. Incidentally I remember – I think they were from you – comments to the effect of “China has a significant private debt problem” well before 2020.
I do wonder what, if any, historical experience China has with the concept of debt forgiveness, whether in the form of jubilee or anything else.
I was unaware until some Chinese fellow Covid realists explained to me that China seems to be as culturally hostile to the concept of welfare spending as the United States/Europe (or at least large and powerful factions of those regions) are. In that context it’s a minor miracle they were able to sustain their containment and elimination policy for as long as they did (and also because the central government delegated the spending for this policy to local governments – that is, currency users, not issuers – instead of paying for it themselves). Such a miserly spirit seems likely to be economically counterproductive, unless and until they can transcend that way of thinking.
Finally, and this will be old hat to most here, but the transition to the Infinite Maximum SARS policy will induce economic strains of its own (in the same way that climate, which PK alluded to, does). It’s clear that China’s economic problems precede and exist independently of the new disease, but it’s a real factor that isn’t going to make anything easier and could exacerbate existing problems; the most obvious one that PK touched on being youth unemployment because, even if the jobs are available, there will be a macroeconomically significant number of young (and older!) people who will simply not be physically able to work as much as they would like to (although I have no doubt that they will work themselves as hard as they possibly can, especially given the aforementioned relative lack of welfare/social safety net).
I always fear to thread into the area of ‘cultural factors’ as they are often just a way of covering up deeper issues or to indulge in some form of Orientalism. But its certainly true that there is a general Asian/Chinese hostility to the idea of giving people something for nothing. I’ve many times had conversations with Chinese friends here where they ask incredulously if its true that the poor people they see get handed out money by the government. Its simply unthinkable to them.
That’s not to say that the CCP doesn’t believe in looking after the population – but the overall emphasis is on providing a baseline of fundamental needs – shelter, food, jobs, education, health, rather than money. In this respect, China does pretty well (although its health system is an awful mess – they would do well to look across the Taiwan Strait to see how it should be done). One thing I’ve been impressed with recently is how general ‘quality of life’ issues have been seriously tackled around China. Most lower Tier Chinese cities are pretty horrible places – polluted, with grim architecture and murderous traffic – but there have been enormous improvements even within the last decade.
But it is interesting to see how cultural issues – if that’s what they are – could seriously impact policy right now. I’ve absolutely no idea if its true or not (so much commentary about what Xi wants or not is just guesswork or worse), but it is frustrating to see many seemingly simple policies not being activated – such as more generous direct payments to the poor – and I can only presume this comes down to a political/ideological reason. It also seems to be behind the remarkable reluctance of Beijing to inject cash directly into regional governments. Much of the thinking behind this seems to be the moral hazard fear – once you start on this you can’t stop. But ultimately this comes down to the repeated failure of Beijing to get to grips with the proper funding of local governments, who are the main drivers of expenditure around the country. I think the complete breakdown of the existing local government funding model (i.e. using rising property values to fund local infrastructure investments) is a far more serious issue than the housing price crash. But it is – in theory anyway – eminently fixable.
Now that you mention it, i seem to recall some tweets from Naomi Wu during one of the COVID lockdowns. They showed the local government having dropped off food supplies at apartment buildings and like for the residents to split among themselves.
I do wonder if that would be a preferred system to giving out a lump sum each month. In particular when that sum is means adjusted, and thus often end up locking people in a trap where if they start to work they end up losing money.
This is a problem with the United States. Sometimes a single dollar over the line means losing hundreds, even thousands, of dollars in support as there is also the cutoff of support if a certain, already limited amount of income and/or savings is acquired. I can add that the different programs have competing requirements.
This is aside from the inadequate amounts of funding, the growing corruption within local local and state governments, diversion of funds into other areas, having obscene “administrative” costs, and complex, difficult means testing.
This does cause a problem long term because having shipped much of the economy overseas, made getting an education in anything too expensive, and crushed income over the past two generations, it has made a joke of the idea that if one was honest, worked hard, got an education, or at least skills, then they would be successful, probably more so than their parents. The American Dream went from reality to a lie.
Unlike my Silent, Greatest, and Boomer ancestors who found what I just wrote true, every single generation after that has not. United States has been training generations of Americans that success is impossible. People learn by seeing what has happened in their lives. If you keep showing that honesty, education, and work, even competency means nothing, then people will act as if that is true. Often because that is increasingly the is true. Being corrupt, dishonest, backstabbing, and having connections is what is needed for “success.”
The Chinese do appear to have concerns about having an actual economy, but if they, like the United States has, make the rules for success, whatever that is, different than honesty, education, skills, and work, then people will not be honest or educated although they will work hard at what does appear to work.
When I built a project in China 10-12 years ago, my client and his friends all said that the 8% growth model of the economy was considered essential by the government. Without it, youth unemployment [driven by migration to the big cities] would rise significantly, and the only thing the government was worried about was a bunch of young people with nothing to do but demand a change of priorities.
I’m sure this was an oversimplification, but it’s held up for the last ten years . . . no matter what is happening in their economy, they keep adding fuel to the fire to keep people employed, because those young people are not going back home to live with their parents where they grew up. And, as PK notes, there is no safety net to sustain them through even a blip in the economy.
China has always kept a very tight grip on internal movements (the hukou system) which was very successful at preventing the social problems associated with rapid growth (i.e. slums). But it did complicate the allocation of workers around the country which is no doubt one reason why there has been a rapid growth in youth unemployment.
Japan and ROK in particular always maintained deliberately low productivity sectors (services/agriculture) to soak up lower skilled workers. China has never particularly had the need for that, although I suspect that local governments were very active in job creation schemes of one form or another if and when local problems arose. The problem now is that they don’t have the money for this. Add to this a somewhat lobsided gender ratio thanks to the one child policy (i.e. excess young males) and you have a potential problem with no easy solutions. While creating make-work jobs is straightforward, a lot of young Chinese were brought up with the assumption that they’d be much better off than their parents. I suspect it will be a very unpleasant surprise to many that this is not the future they anticipated.
Capital flight has got to be a factor as well, even if the CCP clamps down on egress points like foreign real-estate investment, then cryptocurrencies. The more authoritarian Xi gets, the more nervous people with savings will get. I would bet on gold being next, it’s easy to hide and Chinese gold imports overtook India’s a decade ago.
I suspect that most mobile capital in China is already ‘out’. For so many Chinese, their wealth is tied up in property in one way or another so its hard to move in significant amounts. And the clamp down on Hong Kong has made life very difficult for companies as its much harder now to use transfer pricing or other methods to move capital outside the system. To cash in assets like shares right now would likely mean a heavy loss, so even the pessimists within China (and there certainly plenty of those) are reluctant to take that hit.
The government itself doesn’t seem too worried about it at the moment as I’ve not heard of any tightening of the rules. Solely on anecdote, I haven’t heard any Chinese contacts complaining about the difficulty in getting money out compared to previous times when there were crackdowns. A friend has a business helping Mainlanders invest in property here in Ireland and she says business is brisk, with nobody having any issue with modest sums of cash. Although interestingly I’ve heard quite a few stories of UK based Chinese moving some resources to Ireland and Europe as a hedge against any problems there.
If the Chinese populace insists on a high savings rate and will not alter its behaviour to consume more Chinese output while simultaneously exports decline, the only solution to maintain employment is for the Chinese state itself to increase its own consumption. That’s if I have my sectoral balances understood correctly, mind you.
I was reading a day or so ago that the Chinese themselves were putting away more in savings as they recognize rough times ahead. Without some sort of social security net in place, they want to keep some leeway with how they can respond to any downturns. I’d be doing the same.
I might have commented a bit too early. It is not only in China this sort of thing is happening but in the EU as well. Bank deposits are dropping across the EU as customers are pulling their money out of their banks in order to find a better return for their money-
https://www.rt.com/business/582088-european-banks-customer-deposits-drop/
So who is in the worse economic position at the moment? China or the EU? More to the point, are all these stories about China right now just a way to distract from the EU’s problems? China having to reconfigure their economy is a massive problem but they have no choice as they know that they have a storm coming their way. The cause of the EU’s problems is another matter altogether.
The EU isn’t a single entity.
Saving rates, exports, etc. vary across countries.
Germany for example usually has a high savings rate and a trade surplus. This only works because the EU itself has a trade surplus and the rest of the EU have a trade deficit towards Germany (and lower saving rates, but depends on the country).
Not to say that the Euro isn’t fundamentally broken, because it is, but it’s a semi stable sort of broken. Despite the weakness in Germany, I don’t see it going into trade deficit any time soon.
The Chinese situation requires a much faster response especially since the US is trying to kill Chinese exports. They need domestic demand one way or the other.
The one obvious way for Beijing to directly and rapidly help consumption is to take a leaf out of US policy – using military expenditure as a shadow method of injecting cash into backward regions. This is not good news for China’s neighbours.
This was my question because in the last 10 years or so China seems to have created its own MIC. But does it actually impoverish the natural tendency to consume? (Instead of compensating for it.) What difference spending on the BRI v. the military? We know military spending has created a disgraceful welfare condition in this country because we can’t afford welfare when all the money gets spent on military and high tech industries and the result is living rough or in tent cities for at least a million people, and hand-to-mouth for another precarious 40 million of us. Private debt is just another result of misspent militarism. So question: How does a developed country maintain a healthy society, and now equally important also a clean environment – without excessive consumption? If the solution is as simple as effective planning by government, then where the hell is it? This needs a solution beyond stimulating domestic consumption which is becoming a dreadful problem all by itself, almost as awful as militarism.
I think one issue with infrastructure spending is that, quite simply, it doesn’t generate many direct jobs. It tends to be very capital intensive. A billion dollars on road or rail construction doesn’t produce a huge number of direct jobs – and not many indirect jobs wither if you already have enough roads and railways. If you want to create jobs directly, you need to do it through local expenditure – i.e. employ people directly to do all sorts of useful things in the community. The problem is that this is very administratively complex compared to just building a few new bridges.
I’m not aware of any studies on this, but my guess is that military expenditure in a country where nearly all weapons are built domestically is a very quick and efficient way of both getting a Keynesian boost and in directing money to weaker areas (in China, most military manufacturers are in the centre and west for strategic reasons, but this coincides with many of the less well-off areas. So I think it will be very tempting for Beijing to give the green light to whatever expenditure the generals want. But in the long term of course this results in an economy late the late Soviet Union – wonderful tanks, crappy cars.
Thanks for putting this up, I wasn’t expecting this!
Just to clarify the context of my comments – I’m not a China ‘expert’, but my background as a student in the 1980’s was mostly on development and regional economics – a very unfashionable area then as it was counter to the all-conquering victory of free market ideology. So from a general cultural interest in China as a teenager I’ve been several decades observing China’s development with a mixture of fascination, awe, and occasional horror.
Its unfortunate that so many observers of the Chinese economy look at it from the lens of either conventional market watching or one or other theoretical/ideological perspectives, ignoring that the growth model chosen by the CCP is standard issue Development Economics 101 for ‘how to go from poverty to upper-middle income’ status. There is no mystery about it, and so many of the features of China as it is now were entirely predictable as so many other countries have experienced exactly the same problems, albeit never at the sheer scale of China.
This isn’t to criticize the CCP for what they have done (and much of it is enormously impressive). They took the pragmatic short cut to rapid growth knowing full well that the model would have to change further down the line. The problem is that once you set an economy in one direction it can be enormously difficult to change course as you have built up a set of interest groups who are very happy the way things are. I think this is the situation China finds itself in right now.
This is the point where government should step in. Thanks for this analysis. It just makes me mad all over again because everybody drops the ball. So I won’t rave on.
Thank you for the kind comment.
I very much appreciate the thoughtful, tone of PK’s post.
Thank you.
But CCP is actually officially called CPC.
Very good post, though I had already gone through it in the comment section. Here PK summarizing several years of economic surveillance of China and prospects in short form does a “the luxe” job.
It is quite possible that after a very long period of growth and development the leadership is simply not able to change the chip. If this has worked for so long why won`t do so for the next decade? As PK, Setser, Pettis and others have stated repeatedly this will only make the adjustments more difficult and damaging and therefore will reduce the political willingness to do so. Further development cannot be based on bridges to nowhere.
In digging around for information about China lately, I’ve been impressed with their ability to change course on a dime. It is a truly bottom-up driven government, for starters, so phrases containing “authoritarian” are jarring to me. And finding un-spun data is very difficult. Take the “youth unemployment crisis” which may not actually be one: https://www.youtube.com/watch?v=AazuYgfyVf8 Pretty much their entire “youth” sector is in school still. They aren’t even looking for work until they’re out of that category, on the whole. The fact that their government system is wildly different from anywhere else is easy to miss.
“It is a truly bottom-up driven government”: um, like N Korea?
Couldn’t say. But China’s system is radically different from ours, and is far closer to true democracy than ours by orders of magnitude. Some quick pointers to it here: https://godfree.substack.com/p/chinese-democracy
That sentence explains a lot of the bellyaching, whining, and racist rhetoric coming out of US leadership.
They are frustrated they can’t turn China into another colony of the US, like they have done to the EU.
On The Duran a couple days ago, Jeffrey Sachs was talking about China’s economic crisis. He said a great deal of the crisis is the US running a similar playbook as it did against Japan starting in the mid to late 1980’s. Sachs says the US has been trying to choke off Chinese exports since 2016. I’d be interested in PK’s take on Sachs’ argument on The Duran.
I didn’t see that interview, but while China’s problems do to an extent mirror Japan’s, I see it as stemming from the model of development – I don’t think anything the US has done or can do as being particularly relevant. I think its a mistake to view what is happening in China as anything other than a Chinese phenomenon – what the US or anyone else does or thinks is very peripheral to the problems China faces.
The US is of course trying to stem China’s exports and has been for some time, but so is everyone else – as Keynes pointed out a long time ago countries that try to maintain artificially high export surpluses are inherently destabilizing to their partners, as they expect everyone else to run deficits. While Germans and Japanese, etc., tend to see export surpluses as a sign of inherent virtue (and to an extent, so do the Chinese), they are not good for anyone in the long term, including the exporting country – or to be precise, workers in the exporting country. Everyone wants to stem China’s exports whether because they are worried about their own exports (ROK, Japan, Germany, etc), or they want a slice of the rapid development pie (India, Indonesia, etc). Russia, as maybe the only true near-autarky among major powers, is the only country that can look on without being too bothered about the subject. So China is pushing a rock uphill if it thinks it can export its way out of trouble.
While Dr. Sachs is an expert on Russia and developing economies, he is not an expert on Japan. He actually unwittingly admitted it by saying he went in the tow of perceived Western experts like Ezra Vogel. That’s sort of like getting the World Bank tour. You see what you are supposed to see and are told what you are supposed to be told.
Japan is extremely hermetic and actually and consciously goes to some effort not to let gaijin see how it really operates. That preference is aided and abetted by how hard it is to become fluent in Japanese I would regular heard things that were widely known in Japan that even Westerners in Japan working for US companies did not know and often first page news stories that should have been of great interest to the US business press and Wall Street analysts that were not reported or otherwise noted.
If you look at Japan’s growth rates in the 1980s, you can see Sachs’ fundamental clam, that the 1985 Plaza Accord was a fatal blow to Japan, is simply false. You’ll see a blip and a reversion to trend. I was in Japan frequently in 1987-1989, in the domestic branches of Sumitomo Bank, which has aggressive revenue targets. I heard no one bitching about slowing growth.
And I also don’t see the US as engaged in a dastardly plot to hold down Japan. The US business press and even business schools as of the 1970s were resigned to US loss of manufacturing supremacy to Japan and Germany. That resignation paved the way for the offshoring policies of the 1990s and later.
What Sachs forgets is that US manufacturers, particularly automakers, were whipsawed when the US went from a very weak dollar environment in the 1970s through the end of the Volcker shock (1982) and then the dollar shot up fast and hard. US automakers lost huge market share in 24 months to the Japanese. They never got it back. Now they likely would have lost it eventually, but this was a severe dislocation.
And since the trigger had been a very sudden and large currency move, and the yen actually was undervalued (by how much is debatable), the Plaza Accord isn’t as much of an out of left field action as you might otherwise think.
Japan fell over when its monster real estate and merely awfully big stock market bubbles burst. Both had been impressively large as of 1985 and shot to the moon after that. I heard Westerners who should have known better say they would never go down, the capital flows were so large.
That WAS the US’ fault. The US forced an extremely rapid deregulation on Japanese banks, not to keep Japan down, but merely to open the market more to US investment banks.
But Japanese banks were extremely unsophisticated. They did no cash flow based lending or even cash flow analysis. They didn’t use NPV. They didn’t risk adjust. They didn’t even do asset-liability management. I wrote a primer for Sumitomo Bank, Japan’s supposedly best run bank, in the winter of 1985.
So they all loaned 100% on the value of urban Japanese real estate, which literally never traded, because reasons. They also went running into derivatives (including importantly their client) and all blew themselves up very quickly.
(“All models are wrong, some are useful”):
Can’t vouch for its veracity because I’m not expert in any way, but Richard Werner has his own theories about Japan’s stagnation which he outlined in “Princes Of The Yen”, which I haven’t seen mentioned here…
Yup – unfortunately, a lot of smart people these days are falling into the Dunning Kruger camp when asked to comment on topics just marginally outside their knowledge base (myself included).
You are right of course about the Plaza Accords, in my comment yesterday I was getting my facts mixed up, a big mistake when commenting on things I haven’t refreshed my reading on lately. Despite having read a lot on the 1989 crash in Japan, I’ve never really sorted out in my head the sequence of events.
Excellent post. I see so much that America is in decline because of excessive spending and not producing anything and importing too many goods. China is in decline because they save too much and produce too much for export and do not spend enough internally. I am a little confused on what works best since essentially a high savings rate is bad(China) and then consumer spending with high debt levels is bad(America) as well so what is the proper way to have an economy grow sustainably? It seems simple but I am sure the answer is not so easy. Sorry it is very confusing to follow and for me to understand.
Also the decline of either the US or China will be devastating to the world economy and specifically the poorer nations, right?
No/little debt financed consumption and savings that are proportional to the economy’s potential growth (maximum investment into productive growth without any speculation).
That part is pretty simple.
How to get there(and stay there) is the impossible question.
From my memory, everything my family owned in the 1960s was American made, everyone had a job that paid at least adequately, and savings, and education was essentially free. Add that the economy was varied enough that getting a job that suited you or that you could do, was doable. Also, the cost of living was low compared to wages. Finally, the country was an autarky. I am not seeing something like this anywhere in the world.
Even if success as measured by that American Dream was not attainable, a decent life was, which makes any personal problem smaller. It also made civic participation easier. I wonder if the destruction of that political economy for the current one was driven by the need of the ruling class to keep the population under control.
We should all acknowledge that the American-dream-paradigm created a frenzy of economic and social imbalance. We would be far more reliable logically to operate on a new platform, maybe America Reality. I don’t understand why it is so hard to do. Imo, American Reality is a good place to be, we’re learned volumes since WW2, science is streaking to the edge of the known universe, we have accepted our responsibility to the planet and all our fellow travelers, we have good ideas for keeping everything in balance and almost everyone is sick and tired of war. No?
Yes, I agree, but I am thinking of the fact that the country was an autarky with an essentially prosperous population. Today, we are neither and much of what is needed by anyone including food in many countries is shipped by gigantic ships across the ocean. If I want my car to keep running I need China or perhaps Japan.
Getting back to balance means reversing four or five centuries of colonialism as well as the re-industrialization of the United States after fifty years of de-industrialization. This is going to be a multi-generational project.
Best i can tell it is about money flows.
Keep in mind that in most nations, a consumer is also a worker. Thus you can model the basic flow as:
production > wage > consumption > production
But if you replace production with imports, where will the wages come from? Thus US households are getting more and more in debt (i think some recent articles talked about people using credit cards to buy groceries now).
In China’s case the disruption is that most production was being exported, but now the biggest importer of Chinese goods, USA, is clamping down on them. So China wants to boost internal consumption. But if most Chinese save rather than spend on consumption then the flow once more grinds to a halt.
Another, more philosophical, question is if economies can grow to infinity on a finite world. Or if say China and India growing has to be counterbalanced by shrinking in USA and EU.
I’ve learned to be very skeptical of Kremlinology, whether aimed at China or on Putin’s Russia, especially as in the West there’s a real incentive to always predict the worst.
To me, China’s situation is reminiscent of the “crisis of overproduction” that Marx and Engles highlighted as a tendency of capital. There’s too much stuff (commodities) and capacity (means of production) and not enough demand for it. It’s becoming more difficult to turn over capital. In the past, such crises were overcome by capital destruction, usually in the form of a recession/depression or, in the most severe cases, war/revolution.
Here’s some Engles:
“It is no longer able to turn all this mass of means of production into capital. They lie fallow, and for that very reason the industrial reserve army must also lie fallow. Means of production, means of subsistence, available labourers, all the elements of production and of general wealth, are present in abundance. But ‘abundance becomes the source of distress and want’, because it is the very thing that prevents the transformation of the means of production and subsistence into capital.”
IMO sometimes wars can cause overproduction, as seen after WW1. Once US industry had tooled up for war time production it needed to call on Bernays, and his nascent public relations service, to get Americans to consume more come peace time.
Thank you for reposting this important comment.
I have a question about wages.
China’s current economic model relies on suppressing wages but their wage rates are increasing relative to other countries. If China wants to transition to a consumption model then their industrial sector will have to compete with cheaper labor. I’ve always been led to believe that China is dominant in manpower hungry industrial sectors but is that dominance able to out compete lower wage alternatives?
China will also have to let it’s currency appreciate in a consumption driven model. That brings up another host of issues that also feed into their increases in wages relative to other countries.
If it is not able to compete with lower wage countries, how does China manage a recession with out a safety net and large % of unemployed young men with nothing to do?
I do not envision a period of Chinese aggression (American aggression is another story). China is dependent on globalization/America’s imperial system. BRICS is an attempt to reform that system not a revolution.
China is at the end of the energy system. I hope they understand that the US/India/Japan can choke China’s economy with out engaging with China’s navy/army.
So if there is no war, then what do you do with a lot of angry young men that apparently do not want to do manual labor.
I’m no expert on the wage market, but I think the core of the problem is that in an export led model you force your workers to compete with international rates, including of course countries that have cheaper labor, at least corrected for productivity rates (you can have high wages of course if its matched with high productivity). So the key driver for suppressing wages is the need to keep Chinese labor cheap in relative, not absolute terms, which means you are benchmarking yourself against the poorest countries with the most exploitative systems. If you developed a strong domestic market for products then there would be no need to compete in the same way – the constraint on higher wages would be inflation. This isn’t a problem unique to China – Japan and ROK have both struggled with this.
Now the reality in China is quite complex – high level engineers in Shanghai, for example, will earn pretty much the same as a western engineer. Airbus has stated that its cheaper to build their aircraft in France than in China, although there are obviously other cost factors at work. Plus there is the scale issue, in which China is unbeatable. If you want a smartphone factory up and running in 2 years with 10,000 mid level engineers and technicians working on site, there is nowhere else in the world to go.
But the problem as I see it for China is that in the absence of a strong domestic market, they have no choice but to export if they want growth, and this means reducing relative costs (not just labor). If you read official statements from Beijing, they want to do both – export heavily while boosting local consumption. But this is impossible – the policies needed are inherently contradictory for a large economy (you can argue that a small specialized economy like Singapore or Ireland don’t have the same constraints). For the last 3 decades China could balance the contradictions by maintaining a very high level of domestic infrastructure spending, including of course on houses. But investing in infrastructure has diminishing returns once you’ve built all the railways and roads and ports and houses that you actually need. There are some economists who argue otherwise, but I think there is a growing consensus within China that all the low hanging fruit in terms of investment has already gone.
It has to be said that far more countries have failed than succeeded in weaning themselves off a reliance on exports only as a source of employment and wealth growth. Japan and Germany have to an extent stagnated through their insistence on maintaining export surpluses, but at least they are stagnating at a relatively high level of development. Some small countries – like Singapore and Switzerland, have maintained high levels of wages with an export model, but mostly through a focus on very high levels of productivity in specific sectors, and this model probably can only work for small, relatively open economies.
wages are now lower in Mexico than China
One tactic that allows you to keep wages low, as Michael Hudson has mentioned here a few times with reference to why the US can never be competitive in many industrial sectors, is suppressing cost of living. If the state controls e.g. the cost of real estate, food, utilities and keeps these artificially low, wages can also be kept low relative to other countries and exports stay competitive. But you can’t do this AND use real estate as a growth mechanism, apart from any structural or administrative obstacles.
China has stopped being “cheap” for a very long time. See this interview by Tim Cook, https://www.inc.com/glenn-leibowitz/apple-ceo-tim-cook-this-is-number-1-reason-we-make-iphones-in-china-its-not-what-you-think.html. Manufacturing of high tech components requires skilled tool engineers, and the Chinese has millions of those, not something you can replicate overnight in other countries.
There’s this image going around that anything done in China can be done somewhere else very quickly in large scale. Wages aside, there’s also the infrastructure factor. The Chinese has the best infrastructure in the world.
There are a few other aspects of China’s situation that might be considered:
a. China has direct access to nearly all of the Asian market. It’s taken great big, highly effective steps to avoid becoming (very) resource-constrained. The BRI strategy was selected in order to extend the life-span of the export model, and BRI is just getting started
b. China has the option to _not_ empty the countryside any further, but to decentralize production (with the attendant efficiency impacts) in order to stem the inflow of (somewhat under-utilized) workers. Technology (enabler) and resource- and energy-limits (constraints) and social policy can be done quite differently now than the West did it 120 years ago. Things truly are different now.
China may be the first to implement a highly distributed industrial model, and opt for distributing both productive capacity and wealth-generating capacity instead of continuing to centralize it.
And this sort of distributed production would play very well indeed with China’s BRI trading partners, particularly in central Asia. So-called “pop-up” small-scale production systems would sell extremely well in the BRI interior.
Lastly, rather than view China’s cultural aversion to “giving something away for nothing” as a negative, I view that as a great strength. China could (re)distribute the _capacity_ to generate wealth instead of distributing printed money. One is way better than the other.
And thanks to PK for the excellent work, and to Yves for drawing attention to it.
Yes, Stopped me cold here. “Redistribute the capacity to generate wealth” and define wealth as inseparable from the health of the environment and society. Wealth and Health coming together full-circle.
Adam Tooze has chimed in on the discussion with a series:
https://adamtooze.substack.com/p/whither-china-part-i-regime-impasse
https://adamtooze.substack.com/p/chartbook-whither-china-part-ii-posen
https://adamtooze.substack.com/p/whither-china-part-iii-policy-hubris
Prof Hudson keeps arguing that the Chinese must start taxing the land for goverments’ revenue.
Also, the export oriented Germany is having troubles itself, of a bit different nature. But they do have solid safety nets build up. Which of course could slowly be dismantled if they keep going on the same direction they are heading now.
Apparently Russians are not complaining of the Chinese made cars that are now replacing western and German cars on their market. Never mind the EV cars…
Fresh from the press, an unlocked article from Peter Lee’s visit to China this August, and his impression on why the economy is going the way is going and what is the biggest worry there for their leadership:
https://www.patreon.com/posts/travelers-tales-88480944
I think it comes close to the arguments that prof Sachs was making on The Duran.
Heck, Chinese cars are doing inroads (heh) in Europe as well.
Keep seeing ads for brands i have not heard about before here in Norway almost monthly.
I’d agree entirely with Prof. Hudson of course that a property tax is the way to go for local government revenue. The problem is that even in the most authoritarian of States, it’s hard to see how you can implement a property tax when values (and hence peoples savings) are rapidly dropping. The thing that has always surprised me about China is just how vague and poorly designed the tax system has been. The constant growth for a couple of decades has made this a nettle they were loath to grasp. For now, I see no choice in the short to medium term but for Beijing to grasp the nettle and directly fund local governments. But there seems to be a strong ideological/institutional objection to this.
I’ve been vaguely wondering how muni bonds here in the US could avoid debt accumulation, and pay back in kind – defined as something other than money tokens, like a social credit system Or stg like a direct balance of value. Instead of socializing costs we would be socializing profits. Any privatizing of profits would be turned into a privatizing of debts payable to society and the environment.
Isn’t it hard to get people to pay taxes when you’re not providing any services in return?
I recall reading a paper some time ago (can’t find the link now, sorry) about difficulties in understanding how Chinese construction business operates. Apparently “construction rights” can be 25-30% of the value of the property in China, for example. Which means that when a constructor has managed to buy the rights, it’s pretty much all the proof the bank requests to finance the remaining 70%. And a low-performing loans are not a burden for a Chinese bank, since in the end it’s owned by the government and the main purpose is to finance, not make profit.
Anyhow, some years ago Valdai Club published a paper on the transformation of the Chinese economy where the writers claim that the 2008 global crisis caused China to begin a quick transfer from export-based to consumption-based. What we are now seeing is actually the side-effects of stimulus pumped into the Chinese economy to increase consumption: fast urbanization (and youth unemployment), household indebtedness, overproduction in construction.
The paper probably paints too planned picture of events when the government was merely reacting, but it still makes a pretty good case of the economic transition having started over a decade ago.
That Valdai report in my opinion is based on a fundamental confusion between consumption led growth and investment led growth – which is typical of most mainstream economics. All the figures I’ve seen (and yes, there is plenty of scope for argument due to the difficulty in interpreting data from China) is that following 2008 domestic growth in China has been almost entirely investment led – i.e. pouring concrete and building houses. The growth was almost entirely due to top down directions from Beijing to local governments (and banks) to spend money. Promoting consumption would have required very different policies – most obviously allowing the domestic currency to appreciate in value and allowing more consumer debt.
Is there not also another wrinkle related to local governments being funded almost completely by property taxes?
Not property taxes, but land sales. This is one of the biggest problems they will have to sort out – how to replace this funding source.
Thanks for the comments.
In the other article I was referring to, I recall the local government doesn’t sell the land, but the “building rights” on that land. That technically, when you buy an apartment in China, you also gain the partial ownership to those rights. I’m not sure I understood that correctly, though.
Some may disagree, but I think the legal distinction in China between ‘building rights’ and ‘ownership’ is largely pedantic (I can stand corrected on this, it’s not my area of expertise). It’s a little like the difference between freehold and having a long lease on a property – in practice, its ownership. In my experience, people in China consider themselves as ‘owning’ land or an apartment in more or less the same way as an American or European does, despite the very different legal and cultural context. I don’t think that in practice it makes a huge difference, including when it comes to borrowing money using the property as collateral.
To give an example, South Korea and Japan both have very similar landholding laws – both are largely derived from US practice, including their approach to zoning. But in ROK the government has far stronger powers of eminent domain (compulsory purchase). The result is very visible in how their cities grow (in Japan it’s mostly organic, in Korea its very much central government planner directed). But in legal/financial terms, Japanese and Korean homeowners don’t really think of their ‘ownership’ as being all that different.
Sorry, the above was meant to be a reply to Polar Socialist.
I’d add one thing to your first paragraph – the actual ownership of assets and debts within the Chinese system is pretty opaque to outsiders – which is part of the problem. Banks (and there are several different types of bank in China in terms of ownership), may well have thought that any loans were backstopped by the local government or Beijing – but certainly Beijing thinks otherwise. So yes, there were very loose rules on lending to developers – but the core question of who is ultimately responsible for any bad debt is quite an open question in China, which is of course why it will be devilishly difficult for Beijing to sort it all out, bar an all out ‘wipe the slate clean’ approach, which is so far not on the agenda.
Lack of jobs? Why not a focus on elder care, environmental remediation and micro grids? With Chinese EVs they will be needing a sustainable electricity grid. The obvious size difference between Cuba and China might make the Cuban focus on medicine for people less likely, but Cuba sends medical teams world wide. The infrastructure of “pouring concrete” etc. could be replaced by remediation teams.
MAybe!!! Or maybe not!!
The geopolical analysis needs to be also studied and if you ignore it you do get a proper picture!!
Am I right to summarize that it is debt and the potential for default and funding in general that is the worry here?
Most everything economists argue about seems to be, ultimately, funding.
Keynes said something like, Whatever a people determines to do, if they have the resources, they can.
It just may be that these funding issues will not matter in China.
Strictly speaking, debt is not a problem in China at all. Almost all the debt is internal, China (either the State or country as a whole) has minimal debts denominated in foreign currencies. So theoretically, all the debt within China could be wiped out with the stroke of a pen. In practice… well, it’s not so simple.
I would interpret debt in China as a symptom of the problem – which is essentially misallocation of capital and an unsustainable growth model which is leading to a loss of productivity and deflation.
There will be 1.2 billion climate refugees around 2050. How can a discussion of the Chinese, European, and American economies not mention the effects of heat and mass climate migrations? Climate change is compartmentalized and not a part of the discussion. This is a form of denial. Also, there is an assumption of the necessity of growth. The necessities for the well being of the population, unemployment, for example, are a byproduct of growth in a capitalist system. How to organize for some form of a steady state economy is left out of the discussion. I’m not quibbling here. I am trying to state what I see is the problem.