Monday, November 29, 2010

A silver lining in the global outlook?

David Leonhart has an extensive article in the New York Times about how China may move from a country driven by infrastructure and capital goods growth engines to a consumer led growth. It's well worth the read and puts into perspective many of the points that experienced China watchers have talked about. Consider, for example, on what he says about the scale of the infrastructure and capital goods growth story:
China now spends about 50 percent of its gross domestic product on a broad category economists call investment — roads, bridges, trains, ports, technology, factories and office buildings. That is the highest share in recorded history. During their great booms in the 1960s and ’70s, Japan and South Korea never topped 40 percent. China itself was spending 35 percent only a decade ago.
But that growth path may be reaching its limits:

Perhaps the most telling sign that China’s economic model is reaching its limits is a decline in its efficiency. To maintain 10 percent annual economic growth, it has had to invest more and more in roads, buildings and the like. In other words, the return on its investments has begun to fall, which is never a good sign. “We’ve got a problem,” Guo, the bank chairman, told me. “We realize this kind of growth is not sustainable. It’s not the kind of problem like a financial crisis. But if such inefficiencies accumulate for quite a long time, you reach the point where, suddenly, maybe things burst.”
I have cautioned, as have many others, about about pushing China too hard on the currency question. The Chinese are afraid of political and civil unrest. Leonhard puts this fear into perspective:
One businessman told me he knew that most outsiders thought of China as a top-down, centralized country. “But China is a collection of special interests,” he said, “like the U.S.” Leaders understand that suppressing labor unrest may help economic growth in the short term by holding down wages and thus the price of exports. But many also know that economic discontent risks political instability of the kind that in the last century alone toppled an emperor and Chiang Kai-shek, led to the chaos of the Cultural Revolution and threatened the current regime in Tiananmen Square.

More balanced global growth?
Analyst like Stephen Roach of Morgan Stanley has warned for years about the risks of uneven global growth. Put simply, Americans consume too much and the Chinese consume too little. Indeed, the main planks of China's latest five year plan is to encourage more domestic consumer spending and to migrate up to the value-added ladder to more design oriented growth.

Liu He, a vice minister at the central government’s Office of the Central Leading Group on Financial and Economic Affairs, recently commented in a Caixin inteview on the five-year plan to be launched in 2011 [emphasis added]:
The most obvious and most prominent consideration for the 12th Five-Year Plan is, where will the global market go in the future? And an important question is, how do we create a large domestic market?
He went on:
In the past, what was proposed was transforming the economic growth model. Transforming the economic growth model means increasing efficiency, which involves Paul M. Romer’s New Growth theory, which is to improve total factor productivity and the knowledge content of growth. Transforming the economic growth model is really improving the efficiency of supply.

The transformation of economic development proposed by the 17th National People’s Congress mainly implies three things. The first is the transformation of the aggregate demand structure, which means shifting from economic growth that relies on exports and investment to a model of balanced consumption, exports and investment.

The second is transforming the supply structure from a model of growth driven by secondary industry to a model of balanced growth driven by primary, secondary and tertiary industries, with the service industry in particular playing a larger role.  
Third is the transformation of factor inputs, from quantitative expansion to comprehensive growth relying on knowledge, technology, management, etc.
Michael Pettis agrees. He believes that such a transformation in the character of Chinese growth would mean a Chinese growth slowdown, but its global effects could be relatively benign:
If China indeed experiences a rapid slowdown in GDP growth, the impact on the rest of the world may be far less than we expect. The real key is the evolution of the Chinese trade surplus. If it contracts, it will provide an expansionary boost to the rest of the world, not a contractionary one.

Of course that doesn’t mean that the world will grow quickly. My expectation is that global demand growth over the next several years is likely to be anemic with or without China. But it does man that a slowdown in Chinese growth might not be the disaster for the world that many believe.
Also a rapid slowdown in Chinese growth does not mean a social or political disaster domestically It depends on how serious China is about rebalancing its economy. If policymakers are willing to force up interest rates and wages, most of the adjustment pain will be borne by SOEs and the state sector, not by the household sector. In that case we might see a slowdown in Chinese consumption growth, but one not nearly as severe as the slowdown in Chinese GDP growth. Since the Chinese, like everyone else, probably measures their well-being in terms of purchasing power per capita, rather than GDP per capita, a sharp slowdown might not be nearly as painful as we assume.
If China were to gradually achieve more balanced growth in the next decade, then this could indeed be a silver lining for the outlook in the decade ahead.

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