China’s Great Rebalancing Act

China’s Great Rebalancing Act

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The rebalancing of China’s economy could well be one of the most profound stories of the early 21st century. If the rebalancing efforts fail, the significance will be much greater. After years of false starts, it appears that this epic process may finally be getting underway in earnest. At the very least, China’s leaders are making the right noises.

In China’s context, rebalancing implies the complicated and difficult process of lowering investment levels, increasing household consumption, reducing the role of the state sector, and significantly altering the way credit is allocated. Complicating this mission is an environmental crisis, the weak global economic backdrop, serious inequality within the population, widespread corruption, a tough real estate market, and the growing mountain of debt in China’s sprawling, distorted financial system. Despite these challenges, the rebalancing process must be undertaken soon if China is to achieve sustainable growth in the future, allowing it to continue its re-emergence onto the global stage and deliver on the ever-increasing economic expectations of its people.

Two key factors jump out as one considers how this process must proceed. First and foremost, strong political resolve will be vital for successful rebalancing. Moreover, there will be unexpected negative consequences that will cause various players to adjust their expectations and behavior in reaction to the changes that emerge. Knowing when to counteract these negative shocks and when to let them run their course will be an unenviable and delicate balancing act unto itself.

Recent events have illustrated potential and inevitable difficulties in this ongoing process. A cash crunch in China’s interbank markets caused a mild panic as well as several failed debt auctions (including by the Ministry of Finance and the Agricultural Development Bank of China). Growth rates and other data are worsening, prompting downgrades to growth forecasts and even a sovereign debt downgrade by Fitchearlier this year.

Although growth has moderated from the double-digit highs of the previous decade, even maintaining more comfortable high single-digit GDP figures is proving increasingly tough, despite credit growth spiraling at more than 30 percent per year since the global financial crisis. As the limits of over-investment and overcapacity are reached, a rebalancing is ever more urgent. The alternative is a larger debt crisis and collapse in growth down the line.

In order to rebalance away from inefficient and increasingly wealth destroying investment-driven growth, China’s consumption rates must grow faster than GDP for many years, as has long been argued by Peking University’s Michael Pettis. The difficulty is that China’s economic and financial system is heavily skewed towards supporting production and investment at the expense of consumption and household income.

This distortion is based on the provision of subsidized credit to often-inefficient firms through financial repression, an undervalued currency that helps exporters at the expense of everyone else, the transfer of wealth from households to companies through inadequately compensated land seizures (the source of much unrest at the local level), and wage growth significantly lagging productivity levels.

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20
Oro Invictus
July 12, 2013 at 00:02

@ Dewey Last [formerly But....]

It's hardly conjecture; what has happened to every other society, human or animal, which has grown to require more than it can obtain? Can you show me even one example where one of the things I mentioned does not occur in such a scenario?

I realize some people are uncomfortable speaking of such matters as dire as these; there are only too many who keep spouting on about “the fall of the PRC”, but this is one of those occasions where things are that dire and it doesn’t just apply to the PRC. Unless drastic measures are taken to ensure more sustainable lifestyles and industry (or some massive, utterly unheard of technological advances takes place), India, Russia, Japan, the US, Europe, even Canada are looking at similar issues further down the road.

I really do hope I’m wrong about this, more than you know, but ecological and human history has given me every reason to believe that I’m correct.

Dewey Last [formerly But....]
July 11, 2013 at 17:02

@Oro Invictus

"While the specifics of what will occur to the PRC if it continues with this “rebalancing” are difficult to predict exactly, you’re almost certainly looking at massive destitution, stagnation, conflict (internecine or otherwise), and/or disintegration."

Pure conjecture. 

 

jaques666
July 11, 2013 at 01:03

I wasn't being snarky. I was actually supporting the point. Albeit in a slightly humorous way.

jaques666
July 11, 2013 at 01:02

It is a relief that finally people are getting shaken out of the the mindless optimism about China. Sure, it's still big, sure it's still important, but it is in no way destined to take over the world.  Books such as Susan Shirk's Fragile Superpower etc

9 dashes,,4 dishes - 1 soup
July 10, 2013 at 14:10

I’m not as bearish on the PRC economy are many are. Nobody ever knows what China’s numbers really are. Beijing doesn’t even know. And the same money gurus who tell us the sky is falling today were telling us all to invest in China two years ago.

China was and remains a sucker’s bet for foreigners. Stay away. But a lot of Chinese will still make money riding the wave up or down.

I am not optimistic about the PRC in general. War is near, or it is already here. But I think the CPC will be able to paper over these economic problems a while longer.

Look at how old Chinese are getting. Compare that age to India, Vietnam, Cambodia or the Philippines. That’s China’s future – old age.

JohnX
July 10, 2013 at 07:12

Dont be snarky Jaque, Apple made a good point.

 

Its not normal to read words in only Capitals unless its only one sentence.

Example:

BIG BOYS LIKE BIG BOATS, BECAUSE THEY HAVE SMALL WHALES.

Its designed to catch ones attention and shout it out.

Another point to consider is to break a statement down into paragraphs at thier largest as a large block of text with no gaps does act like the person is afraid that if he doesn't keep talking then some one else will interrupt him/her and steal her/his thunder.

 

If one has a good point, then people will accept it regardless of how many words were used.

Example:

Sticking a chopstick up your nose means that no one will ever want to swap chopsticks with you again.

Oro Invictus
July 10, 2013 at 05:10

Can the CPC manage a rebalancing of the PRC economy towards one driven by a highly urbanized and consuming population? Perhaps. However, if they do, they’ve basically ensured the PRC’s ruin.

When considering urbanization and consumption, there are several schools of thought, which can be generalized into two major schools: Capital (Economic) and (Pure) Economic. The Capital school of thought inherently views urbanization and consumption as good things: An urbanized population consumes more, which means more industry and trade activity is required to provide said resources for consumption, thus increasing capital economic activity as a whole. Effectively, for capital economists, productivity is the sole concern; it is simply a case of “The candle that burns twice as bright is preferable to the other”.

However, the Economic school of thought works from a larger scope, and thus views urbanization and consumption good only if they can be sustained; theirs is policy that “The candle that burns twice as bright lasts half as long”. An urbanized population, especially an “artificially” urbanized population, consumes more because it is less resource efficient; to use an analogy, even if a Smartcar and a Humvee have the same engine and/or are travelling at the same speed, the engine of the Humvee has to work a hell of a lot harder to keep it moving than that of the Smartcar.  This, in turn, has two primary implications, the first being that said urbanized and consuming population is producing a great deal more waste, which not only can harm the economy from health effects, but also consumes resources (either by requiring resources for disposal or contaminating resources and preventing their usage); sticking with the previous analogy, if the Humvee and the Smartcar are both travelling down extremely long, narrow, and poorly ventilated tunnels, the air in the Humvee’s tunnel will become hazardous from the exhaust long before that of the Smartcar’s (which is an especially big deal if the Humvee hasn’t left the tunnel yet). The second issue is that there is no such thing as unlimited resources, thus an urbanized and high consuming population is more likely to (and, indeed, almost always does) overdraw resources faster than they can be replenished, something which becomes exponentially worse the more dense and the larger the scale of the urbanization; ending this car analogy, if the Humvee and Smartcar both start with the same amount of fuel, the Smartcar will get much farther off of its supply and is more likely to reach another gas station than the Humvee.

Now (aside from, perhaps, the above being an unintended advert for Smartcars) it should be plain why, unlike most things various people say will “inevitably destroy the PRC”, this current “rebalancing” is actually so pernicious. The PRC’s environment is already rapidly degrading and the amount of resources available to the PRC is similarly decreasing, if not yet in rate than in absolute reserves (which is further made worse due to said pollution). If the PRC begins consuming as much as the CPC intends it to, it will effectively render the environment(s) there and globally irreversibly damaged and, by *any* ecologist’s or general economist’s judgement, be unsustainable in terms of resources required. This isn’t even considering the sociological aspects of such events, as such wide-scale shifts will only worsen economic inequality, social stress and discord, and life satisfaction.

While the specifics of what will occur to the PRC if it continues with this “rebalancing” are difficult to predict exactly, you’re almost certainly looking at massive destitution, stagnation, conflict (internecine or otherwise), and/or disintegration. We have seen it only too many times in nature and in human history, the best example of the latter, perhaps, being the Rapa-Nui of Easter Island in their numerous population crashes. Despite this, it seems the CPC is intent on rendering the PRC into little more than another monument to human greed and short-sightedness, a marker raised atop destitution and ruin bearing the words “Quod erat demonstrandum”.

jaques666
July 9, 2013 at 12:00

what's that applesauce? I can't hear you!

Alfred M
July 9, 2013 at 11:37

Haha. Yeah! Why doesn't he chew on your "anecdotal" data point!? Even if it was real data, how would retail sales be a full indicator of consumption? Also, considering that REAL data investment growth levels (data) have been running HIGHER than your anecdotal retail sales "data point", then what exactly do you think it means? You don't need to be a mathmatician to realise that investment would still be running ridiculously high, and climbing faster than consumption.

applesauce
July 9, 2013 at 04:22

shouting on the internet doesnt make your arguement better, in fact it makes it worst and many ppl will simply disregards your points

Radwulf
July 8, 2013 at 23:50

Retail sales have been very high in China for literally decades, yet consumption as a share of the economy has still fallen.  Michael Pettis has covered this.  If I remember correctly, the reason is due to Chinese retail sales data including government spending as well as only considering shipping of stock from manufacturers to retailers but not those actually sold to customers (ie. inventory increases).

jaques666
July 8, 2013 at 23:08

Interesting. Where do you get the 18% increase in retail sales statistic from?  I would worry that government spending being equated to consumption kind of misses the point in a country with China economic structure. The stats from the government show IndP and FAI still growing faster than GDP. They need to grow slower than GDP.

Vish
July 8, 2013 at 20:47

I believe, what the authors missed out was the change in the composition of gdp in the year 2012. After a very long time, I believe since 1993, consumption had a higher share than investment. Consumption of both private consumers and government is on the rise – one anecdotal data is the increase in retail spending, growing at 18%, as compared to 8% for gdp plus 2% inflation. This retail spending is the private consumer spending – this is one data point that Michael pettis can chew on. He has been a china bear for too long and now it looks desperate on his part to come up with the nth reason for china failing.

jaques666
July 8, 2013 at 19:48

It depends if you are talking in absolute or relative terms. In proportional terms, then Investment, Consumption, Net Exports and Government Spending (consumption) must add up to 100% of GDP. If investment falls absolutely and GDP falls, then the leftover GDP will have a higher consumption share by definition.  If Investment falls and consumption rises both absolutely, then you could theoretically rebalance at higher growth rates. However as is mentioned in the article, many of the systems that boost investment ALSO suppress consumption. In this situation, it is very hard to change both at the same time. Lower growth is the only option

jaques666
July 8, 2013 at 18:26

This is definitely correct that it is a political issue really. The economics of the situation are actually quite clear…China can’t go on running such high investment levels without inevitable waste showing up as bad debts (even if the country and banking system keeps hiding them). Covering it up doesn’t change the fact that China is destroying wealth by over-investing. China’s GDP is probably already overstated by quite a degree due to NPLs not being acknowledged and written down properly.

Chickens always come home to roost in the end.

PAUL
July 8, 2013 at 12:24

TRANSITION WILL NOT BE SMOOTH AS IT NEVER IS. IT WILL BE A ROUGH LANDING. THE ONLY QUESTION IS HOW HARD WILL IT BE.IT INVOLVES TRANSITION OF THE ECONOMY FROM A INVESTEMENT/EXPORT BASED TO A HYBRID OF A INVESTMENT AND A CONSUMPTION BASED. IT WILL ALSO INVOLVE TRANSITION OF SOME ECONOMIC AND POLITICAL POWER FROM THE COMMUNIST PARTY TO THE PEOPLE.

PAUL
July 8, 2013 at 12:24

REBALANCING WILL BE DIFFICULT FOR CHINA. REBALANCE INVOLVES GIVING MORE MONEY AND POWER TO THE CONSUMERS/PEOPLE WHICH WILL COME AT THE EXPENSE OF THE CHINESE STATE/COMMUNIST PARTY WHICH IS USE TO CONTROL THE PURSE AND THE POWER COMPLETELY. THIS WILL LEAD TO SOME CHAOS AS IT WILL LEAD TO DECREASE GROWTH, INCREASING PRICES, INCREASED UMEMPLOYMENT AND A CERTAIN DEGREE OF HARDSHIP. CHINESE FOREIGN EXCHANGE RESERVES ARE THE BUFFER THEY CAN USE TO SPEND IN PROVIDING THE SAFETY NET WHICH MAY PREVENT A HARD LANDING.

Lifei Long
July 7, 2013 at 09:52

Time will Tell…and numbers will Swell.

Thomas Patterson
July 6, 2013 at 09:52

Gaurav, your error is in misinterpreting "drop in investment" as a currency value rather than as a percentage of a whole. The drop in investment refers to a drop in investment as a percentage of GDP, not as a currency value. Investment and consumption are two sides of a coin, rather like saving and spending. If you spend more of the money you make this month rather than putting it in the bank, you will naturally have less money to put in the bank. By the same logic, if investment decreases as a percentage of GDP, consumption absolutely must rise as a percentage of GDP. This is why a rise in consumption will probably lead to falling GDP. Investment in roads and bridges and factories contributes relatively more to GDP than consumption of goods and services. But more consumption will yield a more sustainble result. Therein lies the dilemma for a country that is addicted to growth.

Gaurav Tripathi
July 5, 2013 at 18:16

What are the main reasons , that inspite of "unbalanced, uncoordinated, and unsustainable" economy, Chinese still clinch growth of double or high single digit from decade (s). I don't understand why anyone thinks a big drop in investment in China will be accompanied by increased consumption. It didnt work out that way in Ireland or Spain. Consumers lose confidence when an 'economic miracle' narrative evaporates, surely the last thing they are likely to do is pump up their consumption. Can the 'good economics lead to good politics'?

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