Three
years ago, when I predicted that China’s GDP growth could slow to as low as 3% within
five years (Here A and Part B), few agreed. Even
if more people start to accept the reality of China’s slowdown today, most
still expect a growth rate around 7%. Explaining why I made my predictions could
help clarify unnecessary confusions in this debate, which also illustrates the
fundamental economic problems that China needs to resolve to achieve more
balanced growth. Maybe surprising to many, six charts, which I have used in
many talks in the last couple of years, are sufficient to make my point.
Chart
1
Chart
1 shows how urgent it is for China to rebalance from the current export and
investment driven growth model. It plots the investment and savings of China as
a percentage of GDP. Before proceeding, let’s introduce a national accounting identity:
Saving minus investment equals current account balances. Chart 1 shows that around
2007 savings exceeded 50% of GDP and dwarfed investment by about 10% of GDP,
which was the root cause of China’s annual trade surplus of about 10% of GDP. This
external imbalance was large in magnitude given the already large size of
Chinese economy and led to significant frictions between China and its trading
partners. After 2008, China’s external imbalance shrank significantly as a
percentage of GDP, due to dramatically increased investment as shown in Chart 1,
as savings stayed at the pre-2008 levels. So the conclusion by many experts
that China has successfully adjusted its external imbalances is a misperception.
In reality, China merely disguised its imbalanced growth with a surge in
investment that most, including its own premiers, now realize as unsustainable.
However, if China reduces its wasteful investment without an even faster drop
in savings rate, the external imbalances will increase again as a percentage of
a Chinese economy. This will become
unbearable to its trading partners who are now in recession or slow recovery, especially
given that the same percentage of GDP as current account surplus now means a much
larger U.S. dollar amount (Chinese GDP has grown by about 80% percent in U.S.
dollar term since 2007). So China is between a rock (continued wasteful
investment) and a hard place (a looming trade war). It is urgent for China to
reduce its saving rate because history shows that trade wars between those
controlling supplies and those controlling markets generally end in the victory
of the later. Note that no country in peacetime has achieved the same saving or
investment level as China for a sustained period of time. Chinese saving and
investment rates are much higher than, for example, Germany, other East Asian
countries, or other Confucian culture countries, suggesting that their
commonality with China cannot explain China’s extremely high savings rates.
Chart
2A
Chart
2B
Chart
2 uses a simulation to show how long and difficult it will be for China to
rebalance to a more consumption driven growth model. Note another national
accounting identity: GDP is the sum of consumption, investment, government
spending, and net export. For simplicity, Chart 2 assumes that China will grow
its consumption and government spending at the same rate as the last decade (about
8% and 9%, respectively) and that its net export stays as the same percentage
of GDP. It also assumes that government spending will stay constant as a
percentage of GDP once reaching 19%, the average of OECD countries. For
consumption to grow from the current 34% of GDP to 50% in 10 years, a still low
but more reasonable level, Chart 2A shows that annual investment growth needs
to drop to -3% and China’s average GDP growth will drop to about 4% over this
period. In comparison, OECD countries have a consumption level of 63%. For
consumption to grow from the current 34% of GDP to 50% in 20 years, Chart 2B
shows that annual investment growth needs to drop to 2% and China’s average GDP
growth will drop to about 6% over this period. Throwing in some volatility in
the transition, it is not inconceivable to have GDP growth less than 4% in some
of the years. So securing 7.5% growth in the next decade is a false hope, and the
rebalance will take a much longer time than many have hoped. Note that Chart 2
makes very generous assumptions that ensure little changes in Chinese people’s
satisfaction; there is little chance for revolution or social chaos if
households can afford to grow consumption as in the last decade. However, an
obvious challenge is for China to obtain enough resources to grow consumption
after having spent so much resource on wasteful investment, which we will
discuss in later paragraphs.
Chart
3
So
for China to rebalance, Charts 1 and 2 suggest that China has to reduce savings
and increase consumption. For savings, people tend to focus on household
savings, whereas the reality is that China has to reduce savings of all sectors
of economy; Chart 3 shows that savings of all sectors increased substantially
in the last decade.
Chart
4
Chart
4 explains that part of the savings in Chinese economy other than those of
households is due to the structural subsidies to them from households. China
has taxed households to subsidize exporters through undervalued exchange rates,
anyone who invests through negative real interest rates, banks through
financial repression, producers through underpaid workers, and SOEs through
monopoly rents from a vertical structure in which SOEs occupied upstream
industries and gathered monopoly rents from downstream producers who buy inputs
from them, SOE through main board stock market, non-SOEs through enterprise
board, and other entities such as railway, roads, and infrastructure through
different financial markets to exploit investors in those markets. For example,
the goal of Chinese stock markets has always been to help SOE finance and help
government organize resources for investment, and has never been making money
for its invesotrs. Households also saved more in anticipation of the inelastic
obligations such as retirement, health care, and the education of offspring,
which is also one reason for reduced consumption.
Chart
5
For
reduced consumption as a percentage of GDP, Chart 5 shows that the main reason
is likely reduced labor income. It shows that the dramatic declines of consumption
and labor income as a percentage of GDP come hand in hand, which confirms the simple
truth: earn less, spend less.
Chart
6
Thus,
for China to rebalance, Chart 6 shows that it has to stop, and more
importantly, reverse the transfers from households. It needs to let market
determine exchange rate so that households do not need to subsidize exporters. It
needs to let market determine interest rates so that banks and anyone who
invests are not subsidized anymore. It needs to raise workers’ pay. It needs to
privatize SOEs, especially the upstream ones collecting monopoly rents. It
needs to reform the markets to make them a channel for investor to obtain
returns on their capital. This should reduce China’s saving rate. To get funds
to sustain fast consumption, the options are growing less abundant given that
China has made lots of wasteful investment and that China’s government debt is
a few times greater when considering the debt of entities such as local
governments. Cutting the transfers from households should increase labor
incomes. Land reforms should provide a one-time cash transfer to farmers and
should encounter less political resistance. A more politically difficult yet likely
necessary option is to privatize monopolistic SOEs and use the funds for free
education, Social Security, and health care, which should help reverse the
transfer from households.
Further,
the per capita income in China is still low and Chinese still far from the
technology frontier. This means that China still has a lot of potential to grow
but it does not guarantee high growth by itself. To dramatically release the
productivity of Chinese people, Chinese government needs to cut government
interference permeating every corner of the economy. Chinese government needs
to let Chinese people have the freedom to pursue their own ambitions and facilitate
their achievements. Chinese government also needs to provide much better
services such as education and health care to traditionally underprivileged
groups such as farmers and lower income households to exploit their human
resource to a greater extent. Low hanging fruits are almost gone and harder
parts of the incomplete reform has yet to start. However, if successful, China can
avoid sharply increased internal social tensions and external trade frictions, and
eventually enjoy more balanced economic growth.
No comments:
Post a Comment