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Michael Pettis: Forget the Plenum

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Yves here. Pettis highlights the difficulties of restructuring the Chinese economy to feature more small business lending and consumption and calls them “political.” I’m not sure I agree fully. While withdrawing the heroin from current favored sectors is difficult both practically and politically (you will gore a lot of powerful oxen), I believe he misses the issues on the other side of the ledger, that of increasing consumption and smaller commercial lending. Fostering more consumption isn’t just a matter of creating better social safety nets (although that is a critical component); it also depends on having retail infrastructure and larger average home sizes. For instance, one of the not-often-enough recognized constraints to increasing consumption in Japan it its bubble years was the small size of Japanese homes and apartments. They simply could not own all that much stuff.

On the small business side, that too requires the building of infrastructure and skills. I’ve remarked in passing elsewhere that one of the reasons we don’t see more small business lending despite the Fed’s fond hopes that pushing on a string will work is that the overwhelming majority of banks no longer do small business lending. (The bigger issue is lack of loan demand, but we’ll put that aside for now). 30 years ago, every large bank had a year or two-long credit officer training program. They’d then cut their teeth working on large corporate loans and some would eventually wind up doing middle market lending or managing branches, which meant they’d approve small business loans. That type of officer has almost entirely died out. Except at small banks, branches sell products and loans are scored against templates set at high levels in the bank. Character-based lending and the use of knowledge of the local market have gone out the window. But Chinese banks need to build the skills that have been largely thrown out the window in the US, and then train staff and build the needed systems and oversight. That’s infrastructure that takes time and effort to construct.

Cross posted from MacroBusiness

Exclusively from Michael Pettis’ newsletter:

While the whole world speculates ceaselessly on what to expect from the Third Plenum… I am going to avoid the subject almost altogether. I am not doing so because the Plenum doesn’t matter, but rather because to me the only interesting questions are political, and these questions will almost certainly not be addressed publicly. Although we may disagree violently about the specifics, the timing, and the sequencing of reforms, most economists basically understand what China must do. It must regain control of credit by reducing investment misallocation, and as it does so it must increase the role of household consumption and investment in small and medium enterprises in driving demand.

This is above all, however, a political problem, not an economic one. Instead of directing unlimited amounts of very cheap credit and other economic resources to approved borrowers and powerful entities, in other words, we must now direct them to small businesses and ordinary households.

The past two years have seen a surprising amount of turmoil at the highest levels of the Chinese political establishment. The arrest last year and conviction this year of Bo Xilai, scion of one of China’s most powerful political families and a high flyer for whom no office seemed out of reach, was only the most spectacular episode in a series of events that have seen political alliances re-shuffled, powerful business and political leaders arrested, factional disputes magnified, and an explosion of rumors of more to come. After twenty years of what seemed, on the surface at least, remarkable cohesion within China’s political elite, events of the past two years have come as a great surprise to many.

And yet the historical precedents suggest that none of this should have surprised us. After nearly thirty years of spectacular economic growth and impressive social and political advances, China has exhausted the growth model that had once served it so well. It now suffers from many of the internal imbalances that were the near-automatic and easily predictable consequences of the policies associated with the growth model it had pursued, and policymakers in Beijing are very aware of the urgent need to adopt a new set of policies that will allow China both to rebalance the economy so as to protect itself from the consequences of soaring debt and to lay the foundations for another thirty years of solid economic growth and social and political advancement.

China is not the first country to have experienced a long period of miraculous growth. But, as University of Chicago’s Robert implied in his Warholian quip about growth miracles (“in the future every country will grow rapidly for fifteen years”), the most difficult part of growth miracles has not been the growth miracle itself but rather the subsequent adjustment. Consider the most notable examples: the United States in the 1920s, Germany in the 1930s, the Soviet Union from the late 1940s to the early 1960s, Brazil from the late 1950s to the late 1970s, Japan in the 1980s, and many others…they were not always resolved successfully.

In some cases, for example that of the United States and perhaps Brazil and South Korea, the adjustment was brutally difficult but the institutions that evolved during the adjustment period laid the groundwork for many more years of growth and stability (and a shift from military authoritarianism to a robust democracy in the latter two cases). In other cases, for example that of the Soviet Union, the adjustment period was long and protracted, and because during the adjustment period the country was unable to develop the right set of institutional reforms, it eventually collapsed into the kind of chaos from which it is still struggling to emerge. In still other cases, for example Japan, the adjustment seemed to leave the country locked into stagnation.

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  1. vlade

    Another issue is that the spending patterns are very much generational. That is, once a generation is “locked” in a spending patter (say having to save pennies for Depression ones, or to be able to spend left right and centre for 2005 folks), it’s very hard to change, and usually comes only with their children (who talk about the folly of their parents…) [although it’s “easier” to go to saving, because it’s hard to spend money if you have no money no credit, but more moeny and credit makes it easier to save money)
    So even if you start doing things for lower-middle class Chinese, it will take 5-10 years before you get a society that is comfortable with spending instead of saving.

    1. NotSoSure

      As a Chinese, I have to disagree with your statement. Chinese people have always been very comfortable with conspicuous consumption. Heck, otherwise we wouldn’t be getting stories of Chinese tourists mopping up luxury goods overseas.

  2. E.L. Beck

    But do small living spaces stop accumulation? Hoarding behavior suggests otherwise: Watch a couple of episodes of those clean-up-the-clutter-and-do-a-home-makeover shows for anecdotal evidence to the contrary.

    1. susan the other

      About accumulating stuff and human nature. I watched my mother go thru this. For 4 decades she bought lots of stuff and then one day when she was about my age now she stopped accumulating stuff. She stopped caring about all the stuff she had. She just wanted to give it all away. The same thing has happened to me. Two summers ago I sent a budget rental truck stuffed to the top off to good will and whoever wanted it. I didn’t even have the patience for a garage sale. I thought I was crazy because I thought my mother was crazy. And maybe so. But now I think we are crazy in this very way. Thanks to Merle Haggard. He did an NPR interview in which he talked about waking up one day and no longer wanting to do all the stuff he used to like to do; and that he had no control over this emotion. A part of him was just suddenly not there. Trust me, this happens. So small housing and less accumulation would probably be a good thing. And if we as a society no longer need to hoard in case bad things happen because we have a humane social system, then why accumulate? We should accumulate things like knowledge and service which do not require as much environmental destruction. Even tho’ I gave away half of my stuff, I have never been more curious.

    2. Yves Smith Post author

      You don’t understand how small Japanese apartments are. I was given the great honor of visiting the apartment of a senior managing director of Sumitomo Bank. It was in prime location, in a complex that had lawns and trees, a huge luxury in Tokyo, and inside the Otemachi line (Hiroo Garden Hills).

      I was told it had 3 bedrooms, which meant they must have been tatami mat size. 900 square feet max total, maybe more like 800 sq. feet. One not large combo living/dining room. A galley kitchen in which only one person could work. I assume one bathroom. It might have had room for a hot tub.

      Market value in 1987? $5 million. No typos in any of the figures.

  3. Edward Lambert

    When I was studying medicine, I had a teacher who had worked setting up blood banks from throughout Asia and India. He said that China was the most difficult country because the people simply did not want to give their blood to other people. He could not explain why.
    From this… I would say that China will find it absolutely impossible to pay the workers substantially more over time. There will be huge resistance to giving higher wages to workers, as if they were somehow giving their own blood. The workers are not appreciated as human beings as one in the West might see it.

  4. mary

    Further to Edward Lambert’s remarks: Apparently Israelis and Jewish people in general will not donate viable organs and/or other body parts for transplant upon death… what does it all mean?

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