He starts the article pointing out that many people have adopted a stand of there being a Beijing Consensus and the nearly four decades of Chinese growth is unprecedented in history. One can get a good understanding about the many growth miracle stories that didn't end well in the book 'Why Nations Fail' which in my opinion is a must read. It stresses on the importance of Institutions and incentives that are essential for a country to get into a virtuous cycle of development. Inclusive political and economic systems are needed for a country to get into this virtuous cycle. Without this a country might be able to sustain good economic growth for a seemingly large period only to ultimately collapse (USSR, Brazil, Mexico etc).
Michael Pettis who is also a fan of 'Why Nations Fail', stresses on the importance of Social Capital. He attributes high levels of social capital as the cause for development and describes high level of capital stock as a symptom of wealth and not the cause. This is especially relevant in Chinese case with its high level of investments on infrastructure.
Pettis divides Chinese growth into four stages as follows:
The First Liberalizing Period
This happened in the late 1970s and early 1980s and Deng Xiaoping played a major role in circumventing the elite resistance. The reforms were aimed at building social capital and it was made possible for a Chinese to produce and sell as individual and not just through the poorly managed and state controlled collectivist organizations. A limited number of farmers were allowed to keep whatever they produced above their quota which incentivized them to increase their productivity. Not surprisingly they were able to almost double their yield. The reforms increased the economic activity and generated tremendous wealth creation.
The Gershenkron Period
The economy ran into infrastructure and capacity constraints after the initial spurt in economic activity. This second phase addressed this issue by directing the domestic resources to fund an investment boom. China embarked on a program to resolve the problems identified by Alexander Gershenkron in 1950s and 60s as the things that constrain a backward economy: 1) Insufficient savings to fund the investments. This was resolved by constraining the domestic consumption and directing the savings towards investment. 2) Failure of private sector to engage in productive investments due to legal uncertainties and positive externalities which they themselves might not be able to take advantage of. It was natural for the state to step in identify where the investments should be directed to. This was welcomed by the elite/new elite and local governments since they will have much involvement in the activities of SoEs which directed this investment and growth and thus they became politically entrenched. Since the household income growth was constrained by keeping the currency from appreciating and not letting wages to increase by much, much of the wealth went to the top.
Investment Overshooting
In the previous period because of the low level of infrastructure from which China started, it was easier to identify where to direct investment to. Obviously the ICOR (Incremental Capital Output Ratio) began to increase over the years and the ability of investments to create real wealth reduced. Social Capital didn't keep pace with the physical capital because of the policy of investment led growth model favored the elites by giving them access to cheap land, capital and subsidies. So it largely remains an export driven economy which cannot primarily depend on its domestic consumption for growth yet. This was a problem leading up to the 2008 financial crisis and the fiscal stimulus after the crisis made it even worse since it unleashed another round of investment binge accompanied by debt. Many of these investments were badly directed (bullet trains anyone) and the real estate market in China is in the bubble category with its Ghost Cities and towns. China is in this phase right now and is trying to rebalance its economy from the investment driven growth phase to a consumption driven model.
The Second Liberalizing Period
China's current contribution of investments towards its GDP is around 50% and its ICOR has increased to above 6. This explains why its GDP has slowed down to around 7.5% right now. It is obvious that it has to increase the contribution of consumption which means that it has to do plenty of reforms. Many of these reforms should be aimed at undermining the elite rent capturing and will be met with great resistance. In the third plenum, many reforms were announced by President Xi Jinping and Premier Li Keqiang which aims at increasing the social capital. Those are; land reform, hukou reform, environmental regulations, interest rate liberalization, governance reforms, market pricing and elimination of subsidies and all them largely transfer wealth from state/elite to small and medium sized enterprises.
Conclusion
Michael Pettis paints a hopeful picture of Chinese government taking the right steps. But the problem is that, as he points out, the GDP growth rate will have to fall very low close to around 4% and anything above that means it is through investment overshooting accompanied by unsustainable debt levels. What he doesn't stress much is the lack of political freedom in China and how the people have come into some sort of a compromise where they barter their freedom for growth. If the economy slows to around 4%, which will qualify as a hard landing, it will be accompanied by job losses and pain which can cause political unrests. We also don't know whether the real estate bubble when it pops will have as big an impact that it had in US after the sub-prime crisis. I don't think any crash in China will have a systematic impact on the World Financial System but it will definitely impact the commodity prices (already we are seeing) and the commodity super-cycle that accompanied Chinese growth story will be well and truly over. This will have its impacts on many of the resource rich nations like Australia, countries in Africa and Middle East. It will also affect Germany because of its capital goods export to China.
Case for India: In the medium to long term, a Chinese crash will certainly favor India because of our import dependence on many of the commodities. With the right policies we might be able to even attract manufacturing jobs. I don't know whether we will face a Lehman moment with respect to Chinese crash, but a further slowdown there is is not going to help the world growth numbers which is already getting downgraded. The difference in policies in different parts of the globe (tightening in US, loosening in EU and Japan) might smother the propensity for a big crash but one can never be sure because a return of the Euro Crisis will add to the chaos. The problems with EU, China and Japan are kind of systemic under their existing order and it is always good to keep in mind Murphy's law. In my opinion a Chinese crash is a matter of when and not if. Being bearish on China was a contrarian view two years ago but now it is very mainstream.
References
http://blog.mpettis.com/2014/06/the-four-stages-of-chinese-growth/
No comments:
Post a Comment