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.

Comments
6
jaques666
July 8, 2013 at 14:38

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 12:36

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.

Thomas Patterson
July 7, 2013 at 21:25

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. 

Lifei Long
July 6, 2013 at 16:46

Time will Tell…and numbers will Swell.

Gaurav Tripathi
July 5, 2013 at 21:55

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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