Today Martin Wolf of the FT joins the growing ranks of China skeptics. It is interesting to contrast his views with those of Glenn Stevens, enunciated in his speech yesterday. According to Wolf:
Until 1990, Japan was the most successful large economy in the world. Almost nobody predicted what would happen to it in the succeeding decades. Today, people are yet more in awe of the achievements of China. Is it conceivable that this colossus could learn that spectacular success is a precursor of surprising failure? The answer is: yes.
Japan’s gross domestic product per head (at purchasing power parity) jumped from a fifth of US levels in 1950 to 90 per cent in 1990. But this spectacular convergence went into reverse: by 2010, Japan’s GDP per head had fallen to 76 per cent of US levels. China’s GDP per head jumped from 3 per cent of US levels in 1978, when Deng Xiaoping’s “reform and opening up” began, to a fifth of US levels today. Is this going to continue as spectacularly over the next few decades or could China, too, surprise on the downside?
Versus Stevens:
change in global relative prices. Let me be clear here: there is a cyclical dimension to the China story, and it is important that we remember that. But there is also a structural dimension. And the associated change in relative prices constitutes a force for significant structural change in the economy. I think we have all only begun to grasp its implications relatively recently.
Versus Wolf:
It is easy to make the optimistic case. First, China has a proved record of success, with an average rate of economic growth of 10 per cent between 1979 and 2010. Second, China is a long way from the living standards of the high-income countries. Relative to the US, its GDP per head is where Japan’s was in 1950, before a quarter century of further rapid growth. If China matched Japan’s performance, its GDP per head would be 70 per cent of US levels by 2035 and its economy would be bigger than those of the US and European Union, combined.
Such arguments rest on two features of China’s situation. The first is that it is a middle-income country. Economists increasingly recognise a “middle-income trap”. Thus, sustaining rapid increases in productivity and managing huge structural shifts as the economy becomes more sophisticated is hard. Japan, South Korea, Taiwan, Hong Kong and Singapore are almost the only economies to have managed this feat over the past 60 years.
Happily, China has close cultural and economic similarities with these east Asian successes. Unhappily, China shares with these economies a model of investment-led growth that is both a strength and a weakness. Moreover, China’s version of this model is extreme. For this reason, it is arguable that the model will cause difficulties even before it did in the arguably less distorted case of Japan.
Versus Stevens:
For a long time, the world price of foodstuffs and raw materials tended to decline relative to the prices of manufactures, services and assets. But for some years now the prices of things that are grown, dug up or otherwise extracted have been rising relative to those other prices. This is mainly due to trends in global demand. At any point in time for a particular product we can appeal to supply-side issues – a drought, a flood or a mine or well closure, or some geo political event that is seen as pushing up prices. But stepping back, the main supply problem is really that there has simply been more demand than suppliers were prepared or able to meet at the old prices.
Versus Wolf:
…Investment has indeed grown far faster than GDP. From 2000 to 2010, growth of gross fixed investment averaged 13.3 per cent, while growth of private consumption averaged 7.8 per cent. Over the same period the share of private consumption in GDP collapsed from 46 per cent to a mere 34 per cent, while the share of fixed investment rose from 34 per cent to 46 per cent. (See charts.)
Versus Stevens:
It is worth noting in this connection that many commentators have for years been calling on policymakers in the emerging world to adopt growth strategies that rely more on domestic demand and less on exports to major countries. This is happening. It carries the implication though that, first, more of the marginal global spending dollar is going to products that are steel-, energy- and protein-intensive for the emerging world’s consumers and less on other things like, say, luxury property in western countries.
Versus Wolf:
If this pattern of growth is to reverse, as the government wishes, the growth of investment must fall well below that of GDP. This is what happened in Japan in the 1990s, with dire results. The thesis advanced by Prof Pettis is that a forced investment strategy will normally end with such a bump. The question is when. In China, it might be earlier in the growth process than in Japan because investment is so high. Much of the investment now undertaken would be unprofitable without the artificial support provided, he argues. One indicator, he suggests, is rapid growth of credit. George Magnus of UBS also noted in the FT of May 3 2011 that the credit-intensity of Chinese growth has increased sharply. This, too, is reminiscent of Japan as late as the 1980s, when the attempt to sustain growth in investment-led domestic demand led to a ruinous credit expansion.
As growth slows, the demand for investment is sure to shrink. At growth of 7 per cent, the needed rate of investment could fall by up to 15 per cent of GDP. But the attempt to shift income to households could force a yet bigger decline. From being an growth engine, investment could become a source of stagnation.
Versus Stevens:
…more of the marginal production of the world economy has to be in those raw material intensive products – and in the raw materials themselves – and less in the production of the other things. Ultimately there will be enough steel, energy, food and so on to meet demand – supply is responding. But considerable adjustment is needed to get there (and Australia is a very prominent part of that adjustment).
Both seem to have faith in capitalist growth models but different ones. Wolf argues from the principles of efficient Western capital utilisation and Stevens from the Eastern version of centralised capital allocation, at least for fixed assets. Interestingly, both of these currently have question marks over them. You decide.
