Financial Times
Is China’s period of relatively rapid economic growth over? That was the focus of last week’s column. The answer, I argued, was that the country still has the potential to reach the living standards of the world’s richest countries because it is relatively poor.
But that doesn’t mean you will. It faces major obstacles to continuing its success. In this column, I address one of the most important obstacles: “underconsumption.”
The last two decades should have eliminated the view that economies naturally gravitate toward full employment. On the contrary, an excessive tendency to save can lead to a chronic demand deficit, which must be compensated for by an expansionary monetary and fiscal policy. Although these “solutions” can cause other problems.
Analysis of the global financial crisis from 2007 to 2009 in my book “The Shifts and the Shocks” [As mudanças e os choques] was largely based on this point. I also pointed out that excess savings played a central role in Japan’s loss of economic standing. Germany’s excess savings played a central role in the eurozone crisis.
China’s story is similar but on a larger scale. Gross national saving peaked at 52% of GDP in 2008. In 2019, preCovid, it was still at 44%. Before 2008, almost 20% of these huge savings flowed into China’s current account surplus.
After the crisis, these surpluses became politically and economically unacceptable. The alternative ultimately was an even larger investment, much of it in real estate. Gross investment increased from 40% to 46% of GDP from 2007 to 2012.
However, this increase in investment was accompanied by a sharp decline in the growth rate. This combination can be indicated by changes in the “incremental rate of capital production” the relationship between investment and growth rate. This value has increased significantly, from a low of 3 in 2007 to a preCovid high of 7 in 2019. This indicates a sharp decline in investment returns. Meanwhile, as I mentioned last week, the debttoGDP ratio has skyrocketed, making the financial situation even more fragile.
Back in 2007, thenPrime Minister Wen Jiabao warned that the Chinese economy was “unstable, unbalanced, uncoordinated and unsustainable.” Was he right? Michael Pettis of Peking University’s Guanghua School of Management has made the same argument in detail several times.
It is impossible to know when unsustainable processes will come to an end. But they will arrive. As the late Herb Stein told us, “If something can’t last forever, it will stop.” It appears that the unbalanced economy is now being disrupted by a major real estate collapse.
According to UBS, new home construction starts in July were 65% below levels seen in the second half of 2020. Home sales and construction are also expected to stabilize at 5060% of the peak reached in 202021. With real estate accounting for about 25% of China’s economy, this suggests continued weakness in demand and therefore something similar to Japan’s future.
The danger is not a major financial crisis: China is a creditor country; their debts are predominantly in their own currency; And your government owns all the major banks. A policy of financial repression would work very well.
The danger lies rather in chronically weak demand. In today’s global environment, it will be impossible to generate a large export boom or sustained current account surpluses. The investment rate is already spectacularly high while growth is slowing. Even higher nonreal estate investments cannot be justified.
The obvious alternatives are greater public and private consumption. However, given the financial difficulties of local governments, the former will require an increase in central government spending. In the second, a shift in income distribution towards families will be required. Neither option seems likely. The central government seems too timid to take such drastic measures.
The fundamental reality of the Chinese economy is that household consumption only accounts for about 40% of GDP. Yes, this is partly due to the savings rate of private households, which averaged around 35% of disposable household income in the years before Corona.
However, this is all the more true since the disposable income of private households only accounts for around 60% of GDP. The other 40% is allocated to other institutions, i.e. government agencies, stateowned companies and private companies. The savings rate of these companies was apparently around 60% of total income. This puts the muchvaunted savings rate of private households in the shadows.
China is indeed hypercapitalist. A large part of the national income goes to the capital controllers and is saved by them. This worked well during the previous hypergrowth phase.
But the savings are now too great to be used productively. Income must now be accumulated by those who spend it. This would lead to higher consumption growth in the medium term and higher consumption levels in the long term, thereby creating a solid base of domestic demand for future expansions. However, this requires a redistribution of income and wealth to ordinary people and a significant shift in the focus of public spending. Early restructuring of outstanding debts will also be necessary.
This appears to be a pivotal moment in China’s modern economic history. If the government realizes that the old model of high savings and high investment is broken, it can generate adequate growth with a more balanced, consumptionoriented economy.
A savings rate of, say, 3035% of GDP would be sufficient. But achieving such a thing requires revolutionary changes to income distribution and government priorities. That would be good for China. The country can avoid Japan’s trap. But will it do it?