By Martin Wolf
Published: September 21 2010 20:40
“In the case of China, there is a lack of balance, co-ordination and sustainability in economic development.”
Who dares to make such a downbeat assessment of the world’s most dynamic economy before a gathering of influential foreigners in the heart of China itself? The answer is Premier Wen Jiabao at last week’s “summer Davos” in Tianjin. He is right. When almost everybody believes China is invulnerable, what might go wrong? As Andy Grove of Intel said: “Only the paranoid survive.” Mr Wen is wise to be similarly cautious.
Yet, as Mr Wen also noted, “the past two years have seen China emerge as one of the first countries to achieve an economic rebound, and maintain steady and relatively fast economic development under extremely difficult and complex circumstances.” Mr Wen added: “We owe our achievements to the ... implementation of the stimulus package.” As a result, the economy grew by 9.1 per cent in 2009 and 11.1 per cent in the first half of 2010.
This success has followed three decades of very fast growth. At purchasing power parity, gross domestic product per head has risen almost tenfold since the “reform and opening up” began, under Deng Xiaoping, in 1978. It is a remarkable record, but not quite unprecedented. China’s rate of “catch-up” on the US is not so very different from that of Japan prior to the mid-1970s and South Korea’s between the early 1960s and the financial crisis in 1997.
What is different, however, is the scale of the country and its initial poverty. China’s GDP per head (at purchasing power parity) was a mere 4 per cent of US levels in 1978. Even now, it is less than a fifth. The latter was in the position of Japan in 1950 and of South Korea as long ago as 1978. If China were to achieve Japan’s relative GDP per head before growth slowed sharply, it would enjoy another 25 years of fast economic expansion, to emerge with much the world’s biggest economy.
What could stop the juggernaut? Some point to rapid monetary growth, credit bubbles, asset price overshoots and bad debts (see chart). But I agree with Jonathan Anderson of UBS, a respected analyst of the Chinese economy, that this concern is exaggerated. Credit growth is normalising already. Mr Wen argues that the capital adequacy ratio and non-performing loans ratio now stand at 11.1 per cent and 2.8 per cent, respectively, both in safe territory. More fundamentally, so long as the government remains solvent and growth is sustained, the financial sector should be unable to create an unmanageable crisis. A rapidly urbanising country with an economy expanding at 8-10 per cent a year will grow out of shocks, not least by absorbing excess capacity.
The most interestingly pessimistic view comes from Michael Pettis of Peking University’s Guanghua School of Management.* The characteristic of Chinese growth is that it is “unbalanced”, as Mr Wen notes: it is highly dependent on investment as a source of demand and driver of supply (see charts). It is, in a sense, the most “capitalist” economy ever.
To see charts click on: http://www.ft.com/cms/d53583c0-c5aa-11df-ab48-00144feab49a.jpg)
Thus, between 1997 and 2009, gross investment rose from 32 per cent to 46 per cent of GDP, while household consumption fell from 45 per cent of GDP to a mere 36 per cent. This must be the lowest share of consumption in any significant economy ever. In a country with hundreds of millions of poor people, it is even shocking. Meanwhile, the rising investment rate has been the main driver of growth. In the early 2000s, “total factor productivity” – increases in output per unit of input – were also important. But the contribution of higher efficiency has been waning.
This, Prof Pettis argues, is a “souped-up version” of the Asian development model we saw in Japan and South Korea in earlier decades. The characteristics of this production-oriented approach are: transfers from households to manufacturing, via low interest rates on savings, repressed wages and a depressed exchange rate; very high investment; rapid growth of exports; and high external surpluses. China is “Japan plus”: its investment rate is higher, trade surpluses larger, rate of consumption lower and exchange rate intervention bigger.
This has been an extraordinarily successful development model, but, notes Prof Pettis, it eventually runs into the constraints of “massive over-investment and misallocated capital”. He continues: “In every case I can think of it has been very difficult to change the growth model because too much of the economy depends on hidden subsidies.” Moreover, China’s scale will shift the price of imports, particularly raw materials, against it, so accelerating the decline in profits.
In China, a rising rate of investment is needed to maintain a given rate of economic growth. At some point, investment will stop rising and growth will slow. China will then face the Japanese challenge: how to sustain demand as the required rate of investment collapses. If, for example, the gross investment needed to sustain a 10 per cent rate of growth is 50 per cent of GDP, then the rate of investment required to sustain 6 per cent growth might be just 30 per cent of GDP. With its massive dependence on investment as a source of demand, any decline in expected growth threatens a huge recession.
One answer would be another government-driven investment surge, however low the returns. The more attractive answer is faster growth of consumption. There is evidence of that during the past two years. But, as Prof Pettis notes, for consumption to grow consistently faster than GDP, household disposable income must also do so. Yet if this is to happen, income must be shifted from the corporate sector. That implies a squeeze on profits, through higher interest rates, higher real wages or a higher exchange rate. But that increases the risk of an investment collapse, with dire consequences for demand. As Prof Pettis argues, in China “growth is high ... because consumption is low”. Rebalancing the economy towards household consumption could undermine the ability to sustain growth itself. If so, China is on an investment treadmill.
China’s is the most impressive “catch-up” economy in history. That is partly because it is so unbalanced. The longer rebalancing is postponed, the more painful the adjustment will be. The Chinese economy of two decades from now will have to be vastly less investment-driven than the one of today. How smoothly and how soon will it get there? These are huge questions.
* “Chinese consumption and the Japanese ‘sorpasso’”, mpettis.com.
Copyright The Financial Times Limited 2010.
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