Let me say up front that I’m a long term China bull. The production base that China has seized in the past decade is the stuff of super powers. Sure, China faces a much more difficult political economy at home than other super powers before it, and that may lead to a more troubled and shorter reign at the top, but becoming the industrial powerhouse of the world is a pre-requisite for sovereign super power and China is building it.
But that does not mean Australia will benefit in the future as it has done for past ten years. Indeed, the minds that I respect most are becoming very worried about Australia’s relationship with China in the medium term. Some of that concern goes mainstream this morning at the AFR, driven largely by Chris Richardson of Deloitte. There are two articles, one op-ed and one report. From the op-ed:
China wanted to slow: it has relied on cheap credit and galloping property and construction sectors for too long.
…punting on China to achieve yet another round of “stronger for longer” has been the safest bet of the past decade, and the Chinese authorities are already on the job.
Yet there’s more bad news already unleashed in China than many Australians have yet recognised. There is a huge underlying demand for new urban housing as people flock from the country to the city to live.
Even so, the pace of apartment building in China in recent years outpaced the enormous need for it, leaving many apartments empty: the only argument is whether the overhang of empty apartments measures “just” 10 million new homes or as much as 60 million.
Besides, although China’s slowdown is unlikely to be permanent, its economy has to stop being as reliant on infrastructure, factories and exports, and start to drive its growth from families and retail spending instead. That isn’t happening yet, and may well prove a messy gear change when it does arrive – leaving growth permanently below the souped up gains of the past decade.
As usual the AFR focusses on the political angle of Richardson’s argument, bewailing another blow to the ever-delayed Budget surplus. But the importance of Richardson’s argument is the medium and long term, not this year’s tax take. As Michael Pettis argued last week at MB:
Now for the first time I think maybe the long-awaited Chinese rebalancing may have finally started.
Of course the process will not be easy. Debt levels have risen so quickly that unless many years of overinvestment are quickly reversed China will face debt problems, and maybe even a debt crisis. The sooner China starts the rebalancing process, in other words, the less painful it will be, but one way or the other it is going to be painful and there are many in China who are going to argue that the rebalancing process must be postponed. With China’s consumption share of GDP at barely more than half the global average, and with the highest investment rate in the world, rebalancing will require determined effort.
The key to raising the consumption share of growth, as I have discussed many times, is to get household income to rise from its unprecedentedly low share of GDP. This requires that among other things China increase wages, revalue the renminbi and, most importantly, reduce the enormous financial repression tax that households implicitly pay to borrowers in the form of artificially low interest rates.
But these measures will necessarily slow growth. The financial repression tax, especially, is both the major cause of China’s economic imbalance and the major source of China’s spectacular growth, even though in recent years much of this growth has been generated by unnecessary and wasted investment. Forcing up the real interest rate is the most important step Beijing can take to redress the domestic imbalances and to reduce wasteful spending.
What is so interesting about this argument is that Pettis himself is not at all bearish. Nor should he be. If managed right, it means a reasonably smooth internal transition from fixed-asset driven growth to consumption led growth, which relies upon the fact that even if GDP drops to 3%:
…household income continues growing at 5-6%, this is far from being socially disruptive. Households don’t care what GDP growth is, they care about the growth in their spending power.
Moreover, the incumbent superpower, the United States, would also benefit. A rapidly rising Chinese consumer creates greater net international demand and the US is well positioned to grow its consumer exports to China.
So international politics benefits too.
There is an irresistible logic in this course for the Chinese economy. The only real question is when? How will Chinese leadership juggle it and will the transition be delayed by the interests that are adversely affected by it? But even that question is no longer so vague. Whether Pettis is right that it has begun already, it’s going to happen in the next few years, as Richardson describes.
For Australia, the lesson is simple. Healing Chinese imbalances is bad for Australia’s chosen reliance upon a small set of building block commodities. China will prosper but we will face our reckoning.