Interesting, but exceptionally vague counter-point to the received wisdom about China's rebalancing. The writer focuses too much on changing the financing model and not enough on the reform that will enable the capital markets to develop to the point where this will become possible.
Guest post: China rebalancing is a dangerous obsession – beyondbrics - Blogs - FT.com
Guest post: China rebalancing is a dangerous obsession
Jul 2, 2014 7:47am
by guest writer
64
By Qu Hongbin, Co-Head of Asian Economic Research, HSBC
For many, China’s growth model, which has delivered average annual GDP growth of 10 per cent over the past three decades, simply looks wrong: a national savings rate of around 50 per cent is unheard of in a large, modern economy.
A typical diagnosis states that China invests too much and consumes too little. The prescription is “rebalancing” – moving the economy away from investment towards consumption-led growth. However, a consumption-led growth model has little in theory or evidence to support it.
For developing economies (which China still is in per capita terms), the theory is quite clear: they should invest in building up their capital stock per worker. A higher savings rate will mean less consumption, but it funds greater investment too. That ultimately allows poorer countries to catch up to higher per-capital GDP levels faster.
Economists generally agree that sustained economic growth depends on supply-side fundamentals such as the stock of capital and technological innovation. Ultimately, it is productivity growth that drives GDP growth in the long run. There is little in the academic literature that suggests a causal link between higher consumption and higher growth rates.
Consumption-led growth models have also performed poorly in practice. In the 1970s and before economic reforms, China’s household consumption share of GDP was over 60% – higher than that of the US at the time. However, growth during the decade was significantly slower than what came after, when investment as share of GDP rose steadily.
Furthermore, a credit-driven consumption model is not only unsustainable, but the debilitating effects of consumers deleveraging from high levels of debt in a deflationary environment will make the recovery much more difficult. Of course, no country consumes nothing and saves everything for investment; it would be a bad idea even if it could as the investment would eventually run into diminishing returns.
The key debate then, is whether China has already reached the point where extra investment becomes over-investment. On a macro level, we think China’s capital stock per worker is still low and less likely to be subject to diminishing returns. China’s development into a modern economy is far from finished. Much more infrastructure investment is still needed to cope with the rapid pace of urbanisation and industrialisation.
While the recent infrastructure boom has boosted the country’s transport capacity, China’s railway network is still shorter than that of the US in the 19th century. There are no doubt plenty of examples of over-investment in certain sectors. But it does not mean one can draw a simple with the economy as a whole. There are still more useful infrastructure projects to be built before China is overrun by bridges to nowhere.
Critics would point to data showing the incremental capital-output ratio in China coming down substantially since the global financial crisis. But this mainly reflects a shift in the focus of investment away from say, toy factories, and toward subways, which are more capital-intensive and generate less of a boost to short-term output.
That would indeed pull down the short-term return on capital (which still remains high). However, it does not imply diminishing returns have set in because infrastructure investments generate significant spill-over effects through lifting the whole economy’s efficiency and labour productivity, which will boost return on capital in the future.
China’s problem is not that investment is too high, but that underdeveloped capital markets have meant investment has been funded through the wrong financing model. Too much has been funded by short-term bank lending, sometimes through non-transparent local government vehicles or other parts of the shadow banking system.
This creates a duration mismatch, as many of these projects have returns that accrue over a long period of time. The real rebalancing challenge is therefore more subtle. It involves changing the way investment is funded by improving credit supply through a more developed credit market, improving access for small and medium-sized enterprises, and expanding the local government bond market to fund long-term infrastructure investment.
This would be more efficient than having the government introduce further distortions by micro-managing the demand side. In the long term it is inevitable that the savings rate will fall due to demographics, but that makes it even more important for China to invest now. Otherwise, once the savings rate begins is natural decline, it becomes more difficult to fund investment.
Rebalancing through deliberately forcing down the savings rate would be more difficult and dangerous. Say the authorities tried to reduce the real interest rate to discourage saving. Without all manner of reforms to boost the social safety net, that could lead to even greater precautionary savings.
Consumption would fall, as would firms’ profits and government tax revenues, making it more difficult to finance the required safety net. Far better, we would argue, to target the distortions at source with structural reforms. The obsession with rebalancing China’s economy is instead leading to misguided policy recommendations that are too blunt, and which may carry unintended consequences.
This piece was written jointly by Qu Hongbin and John Zhu, HSBC’s Greater China Economist.
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This rambles a bit, but touches on some of the main themes of China's rebalancing: increase disposable income, stop with wasteful real estate development projects, price capital according to its risk, and develop the capital markets.
Piketty with Chinese Characteristics by Andrew Sheng
and Xiao Geng
- Project Syndicate
BUSINESS & FINANCE
ANDREW SHENG
Andrew Sheng, Distinguished Fellow of the Fung Global Institute and a member of the UNEP Advisory Council on Sustainable Finance, is a former chairman of the Hong Kong Securities and Futures Commission, and is currently an adjunct professor at Tsinghua University in Beijing. His latest book is From Asian to Global Financial Crisis.
XIAO GENG
Xiao Geng is Director of Research at the Fung Global Institute.
JUL 2, 2014
Piketty with Chinese Characteristics
HONG KONG – In his bestselling book
Capital in the Twenty-First Century, Thomas Piketty argues that capitalism aggravates inequality through several mechanisms, all of which are based on the notion that
r (the return on capital) falls less quickly than
g (growth in income). While debate about Piketty’s work has focused largely on the advanced economies, this fundamental concept fits China’s recent experience, and thus merits closer examination.
Of course, a large share of China’s population has gained from three decades of unprecedentedly rapid
GDP growth. The fixed-capital investments that have formed the basis of China’s growth model largely have benefited the entire economy; infrastructure improvements, for example, have enabled the rural poor to increase their productivity and incomes.
As
the investment rate rose to almost half of GDP,
the share of consumption fell to as little as a third. The government, recognizing the need to rebalance growth, began to raise the minimum wage in 2011 at nearly double the rate of real GDP growth, ensuring that the average household had more disposable income to spend.
But property prices have risen faster than wages and profits in manufacturing, causing the return on capital for a select few real-estate owners to grow faster than China’s GDP. The same group has also benefited from the leverage implied by strong credit growth. As a result, China’s top 1% income earners are
accumulating wealth significantly faster than their counterparts in the rest of the world – and far faster than the average Chinese.
In fact, while the rise of China and other emerging economies has reduced inequality among countries,
domestic inequality has risen almost everywhere. The Piketty framework highlights several drivers of this trend.
For starters, by lowering trade and investment barriers, globalization has created a sort of winner-take-all environment, in which the most technologically advanced actors have gained market share through economies of scale. In particular, as the global economy moves toward knowledge-based value creation, a few innovators in global branding, high-technology, and creative industries win big, with the global boom in tech stocks augmenting their gains.
The resulting concentration of revenue, wealth, and power undermines systemic stability by creating too-big-to-fail entities, while hampering smaller players’ ability to compete. The global financial system reinforces this concentration, with negative real interest rates promoting financial repression on household savings. Given that banks prefer lending to larger enterprises and borrowers with collateral, small and medium-size enterprises struggle to gain access to credit and capital.
Another problem is that the low interest rates generated by advanced-country central banks’ unconventional monetary policies have led to the “decapitalization” of long-term pension funds, thereby reducing the flow of retirement income into the economy. In many emerging economies, including China, widespread fear of insufficient retirement income is fueling high household saving rates.
Economists largely agree that this trend toward inequality is unsustainable, but they differ on how to curb it. Those on the right argue for more market-based innovation to create wealth, while those on the left argue for more state intervention.
In fact, both approaches have a role to play, particularly in China, where the government is pursuing a more market-oriented growth strategy but retains considerable control over many aspects of the economy. China needs to strike a balance between policy-supported stability and market-driven progress.
In particular, policy and institutional factors have led to the underpricing of key resources, generating significant risk. The vast workforce has driven down the price of labor, impeding the transition to a high-income, domestic-consumption-driven growth model. Similarly, failure to account for environmental externalities has contributed to the underpricing of natural resources like coal, fueling excessive resource consumption and creating a serious pollution problem.
Moreover, policies aimed at stabilizing the exchange rate and keeping interest rates low have caused capital and risk to become undervalued in large projects. And local governments’ effort to finance development by selling land to investors at artificially low prices has spurred massive investment in real-estate development, causing property prices to rise at unsustainably high rates. Given property’s role as the main form of collateral for bank loans, financial risk has risen sharply.
The government is now attempting to mitigate the risks that investors and local governments have assumed by allowing more interest- and exchange-rate flexibility. But the transition must be handled carefully to ensure that property prices do not plummet, which would increase the ratio of non-performing loans – and possibly even trigger a major financial crisis.
In order to ensure long-term social stability, China must promote inclusive wealth creation, for example, by establishing strong incentives for innovation. The rise of high-tech companies like Huawei, Tencent, and Alibaba is a step in the right direction, though the fact that the most successful Chinese tech companies are listed overseas, and are thus not available to mainland investors, is problematic. Regulations and exchange controls prevent the retail sector from benefiting from new wealth creation.
Another challenge lies in the decline in the Shanghai Stock Exchange Composite Index from its 2007 peak of 6,000 to around 2,000 today. With financial assets failing to bring adequate dividends or capital appreciation, many investors have switched to real estate as a hedge against inflation.
China’s leaders are already working to guide the transition to a growth model driven by domestic consumption and higher-value-added production. But the challenge is more complex than that. The new model – with the help of market forces, where and when appropriate – seeks to ensure that wealth is created sustainably and shared widely. To succeed would fulfill the Chinese Dream. Failure would mean that inequality would continue to fester worldwide.
Andrew Sheng
and Xiao Geng
apply to China Thomas Piketty's framework for understanding the country's rising income inequality.
- Project Syndicate
Read more at
Andrew Sheng
and Xiao Geng
apply to China Thomas Piketty's framework for understanding the country's rising income inequality.
- Project Syndicate
