Brad Setser Begs to Differ With Nouriel Roubini on China

Brad Setser and Nouriel Roubini have collaborated in research and publishing on currencies but since are working independently. Roubini issues a grim outlook for China (“Roubini Foresees Chinese Hard Landing“). A cornerstone of Roubini’s analysis was that China was export-dependent and exports are falling fast:

Note that China is an economy is structurally dependent on exports: net exports (or the trade balance surplus) are close to 12% of GDP (up from 2% earlier in the decade) and exports represent about 40% of GDP. Real investment in China is about 45% of GDP and, leaving aside the part of this investment that is housing and infrastructure spending, about half of this capex spending goes towards the production of new capital goods that produces more exportable goods. So, with the sum of exports and investment representing about 80% of GDP, most of Chinese aggregate demand depends on its ability to sustain an export based economic growth.

The trouble –however – is that the main outlet of Chinese exports – the U.S. consumer – is now collapsing for the first time in two decades.

Setser characteristically is more measured, and (while not naming Roubini) takes issue with the notion that China is as beholden to exports as Roubini maintains (note he clearly regards net rather than gross exports as the relevant metric):

There has long been a rather sterile – at least in my view – debate over how much exports contributed to China’s recent growth. It has long been clear that:

a) Most of China’s growth didn’t come from exports. It couldn’t. Net exports almost never generate 10% growth on their own.

b) The absolute size of the contribution of net exports to China’s growth was large. In 2005, 2006 and 2007 net exports added between 2 and 3 percentage points to China’s growth. When net exports added close to 3 percentage points to the United States growth in the second quarter, no one argued that the contribution to US growth from net exports was small.

….The World Bank expects that net exports will contribute around one and a half (1.5) percentage points to China’s growth. Real export growth topped real import growth – though both slowed. 1.5% percentage points from net exports isn’t bad. It is more than the US had gotten on average over the last seven quarters. Indeed, it is not all that different from the average contribution net exports have made to US growth in 2008.

The Chinese exporters who were doing well just weren’t as vocal as the textile and toy producers who weren’t. They also tend to be more capital-intensive and thus employ fewer people.

And despite all the (true) talk about the difficulties some Chinese exporters now face, net exports almost certainly contributed positive to China’s growth in the third quarter. Real export growth in the third quarter (on a y/y basis) still exceeded real import growth. That is why China’s nominal trade surplus was basically flat during the first three quarters of 2008 even though China was paying way more for its commodity imports.

The sharp contraction in US consumption, the rise in the yuan v the euro, Europe’s own slowdown and the latest data from China suggests that real Chinese exports could soon fall. If net exports are contributing to growth, it will be from a fall in imports, not a rise in exports. That is sure to slow China’s growth.

Absent the close to 3% contribution from net exports in the boom years, China’s growth would have been a (respectable) 9% rather than above 11%. With a negative 3% contribution to growth during the boom (as is often the case), growth would have been close to 6%. And if net exports turn negative now China’s growth clearly would slow sharply.

But the real key to forecasting China’s future growth consequently is determining whether domestic consumption and above all investment will continue to grow strongly in the absence of strong export demand. Remember, over the past few years both domestic investment and exports increased rapidly. If they fall together as well, Chinese growth will slow quite significantly.

And unfortunately the latest indicators seem to suggest that they are correlated; consequently domestic demand may fall along with exports.

That isn’t good for anyone.

The (likely) fall in construction is particularly worrisome. China’s new capital intensive export sectors haven’t been huge job generators. Building buildings by contrast employs lots of people – including a lot of migrants from rural areas.

Chinese policy makers recognize that China’s economy is slowing. They are trying to stimulate the economy in a host of ways. Loan limits have been lifted (and amusingly, their presence was only formally acknowledged when they were lifted). New infrastructure projects have been announced. Useful (though tardy) steps are being taken to improve China’s social safety net. It just isn’t clear if they will be powerful enough to offset a smaller contribution from net exports and a (likely) slowdown in investment.

I should note that China is also taking steps to promote exports, notably by increasing its export rebates. That is far less helpful to the global economy.

If the signs from China continue to point to a sharp slowdown, all the large parts of the global economy may enter into a slump at the same time. That isn’t good.

A final point: it is often argued that China needs rapid growth in order to generate jobs, and consequently 6-8% growth doesn’t cut it. That is only partially true. A lot depends on the composition of growth. Recent Chinese growth has been capital not job intensive, so very rapid growth hasn’t translated into rapid job growth. If China shifted the basis of its growth, it might be able to generate more jobs even if the overall pace of growth changes. The risk though is that China won’t change the basis of its growth – so slower growth will mean fewer jobs. But we shouldn’t lose sight of the fact that it is unusual for a country growing at 5-6% not to be able to generate strong job growth.

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  1. Richard Kline

    Setser has the numbers, and I assuredly do not; that said, I have had the same non-quantitative view to which he puts a context. The salience of export industries in China’s development of the last dozen years is much over-stated, very much over-stated in most American perspectives. The great bulk of China’s development has in fact been domestic. There is certainly a ripple effect in domestic secondary spending from the export profits of onshore concerns, and I’m not sure that that is captured in Setser’s basic framework, but it would not seriously alter the conclusions he advances even so. How China makes it through the global downturn will depend very much on how they stimulate and/or support domestic demand and domestic growth. Chinese actions to let marginal toy producers close down while also making current proposals to build out their rail system now show that China’s economic planners understand their situation very well.

  2. Bob_in_MA

    Richard Kline: The great bulk of China’s development has in fact been domestic.

    Frankly, I don’t see how anyone draw a clear line between what development was purely domestic, what was export led and what was export fed (dependent on the business of exporters.)

    The question seems to be whether the figure of 40% of GDP being exports is as enormously significant as it sounds. The focus on net exports seems to imply that imports for consumption are also high.

    But why are the Chinese sitting on $2T in reserves if their economy wasn’t so dependent on export growth?

    I think the Chinese faced a crossroads a few years ago. Allow significant appreciation of the Yuan to dampen inflation and increase domestic consumption at the expense of export growth, or take the path they have.

    Now, massive over-capacity is going to become evident throughout the emerging markets. China will have to make a much harder choice, whether to spend some of their dollar reserves on stimulating the domestic economy, raising the Yuan and harming exports even more.

    Roubini’s position seems almost commonsensical to me.

  3. Viv

    Again how accurate are the GDP figures? We just don’t know!

    If china needs 8% growth just to maintain stability well thats just plain ridiculous! 8% growth compounded for 50 years would mean that the Chinese economy will be 47 times greater than it is today!

    IMO China will go into a long and deep slump. There is no way they are escaping.

  4. doc holiday


    That is a great balance between two viewpoints! Dipping into a basket of economist worms and pulling out two or even three examples is probably going to be helpful in finding better averaged and weighted material. I think triangulating off Roubini and Sester is a great start, but they both seem to be connected to things like The Peterson Institute for International Economics.

    I think your opinion in all this search is very important and effective, because this type of clarity from you is not divisive or just a matter of baiting people with polarity and diversity, and thus this contrast you can help provide, is part of shaping and engineering consensus opinion. Keep up the fine work ol’ boy, and don’t let The LHC interfere with the signal-to-noise stuff!

    Amen and out…. hope that made sense, but what does these days?

  5. Cool Head

    You’ve hit the nail right on the head. Overcapacity! This is what one sees if one visits any place in China, esp the big cities. Huge airports, with multiple gates–but only one flight a day at an airport near Xuzhou, the simply HUGE Pudong airport of Shanghai the great highways that go nowhere in particular. Massive overcapacity. The fixed costs alone would drag the govts budgets down anyday when new investments stop coming in–something like a ponzi scheme.

  6. reader shopping at 'low end' stores

    Brad Setser probably doesn’t shop at Walmart, LNT, BestBuy, 99 cents stores, or other “low end” stores. I am frequently amazed that just about everything I looked at are has the “Made in China” label…including food.

  7. reader shopping at 'low end' stores

    Brad Setser probably doesn’t shop at Walmart, LNT, BestBuy, 99 cents stores, or other “low end” stores. I am frequently amazed that just about everything I looked at are has the “Made in China” label…including food.

  8. Anonymous

    Growth may not be DIRECTLY linked to “NX”, but JOBS are. If jobs fall due to slumping NX or even slumping gross exports, less income will be created for household consumption… Roubini is correct.

    Pascal B, Montreal

  9. Anonymous

    Setser’s comments are right on. I agree with him on just about every point.

    If you look at net exports from “Asia” (as opposed to just China) over the last 5 years, you’d see China’s gross export growth has really come at the expense of export growth from other Asian exporters. China has been importing near-finished products from other Asian economies, adding a little value, and then re-exporting. So, looking at net exports is undoubtedly the right metric.

    As far as China’s “over-capacity” goes… as someone who’s traveled to China on an annual basis for almost two decades, as someone who landed in the Pudong and Beijing capital airports within the first few weeks of their opening, as someone who has driven on many of these expressways within the first 6 months of their opening… there is limited over-capacity here.

    China’s making up for about 200 years of under-investment in infrastructure. No matter what metric you look at, China has unbelievable latent potential. The Pudong airport filled up within a few years, requiring the construction of a second (and I believe third in planning) runway. Beijing is the same story.

    That’s not to say there aren’t bubbles out there, especially in residential construction, and possibly in second/third-tier cities. But don’t confuse new construction with bubbles or over-capacity. Much of coastal China will gobble up every inch of new infrastructure within the next 3-5 years.

  10. Anonymous

    I think the big question has always been will china crash/hard landing or comfortably slowed down.

    I for on don’t think China will crash land.

    1. most of it’s industry and economy are not highly integrated. So even entire sector going down might not crash another sector readily as in advance nation.

    2. most of China’s economy are low tech manufacturing, people can simply go back to the village and wait out the recession. It will increase the under employed. (This compared to laid off auto worker in the US. They are screwed)

    3. Authoritarian government is very effective at mobilizing national resources/infrastructure building when the order come down. So reaction time might be shorter when it come to keynesian pumping. ON top of that China is on infrastructure building stage anyway.

    4. price of fuel and industrial feed are down. This might reverse some effect from last subsidy deletion.

    I wouldn’t want to be in chinese textile, toy or food for export industry. But anything on domestic and regional trade (Taiwan, Asean) probably would only slow down instead of crashing.

    btw, asean so far seems to be holding nicely.

  11. doc holiday

    It may be worth keeping an eye on short term treasuries (again).

    FYI: 3-Month Treasury Bill: Secondary Market Rate

    2008-09-17 Value = 0.03

    2008-10-06 Value = 0.26

    However, go back to this story from a year ago for perspective and a glimpse as to what LHC distortion looks like:

    U.S. Three-Month Treasury Bill Yield Falls Most Since Oct. 1989…EzoY& refer=home

    – U.S. three-month bill yields fell the most since October 1989 as investors sought out the safety of government debt amid a flight from risky assets.

    The yield on the three-month Treasury bill fell 0.61 percentage point to 4.025 percent, the lowest since 2005 and the biggest single-day decline since Oct. 13, 1989.

    The tumble in yields came after Merrill Lynch & Co. lowered its rating on Countrywide Financial Corp….

    For historical trends go here:…2/data/ DTB3.txt

  12. zezowaty Zorro

    Brad Setser got strong point. There is a huge difference between net export and gross export, the same as between gross value and net value. As it happens Setser clearly shows, that more than half if not 3/4 of 40% GDP gross export is import cost (material etc.) and therefore net export made in China accounts for 10% of GDP, so compounded with central currency regime and comfortable savings cushion they are in no way heading toward a hard landing, as US of A is: no cushion, cosmic debt, oversupply, slumping demand.

  13. Anonymous

    Roubini is correct that the gross export is related to jobs. When you keep a constant net export, lower gross export means fewer jobs. That cannot be good.

    But Sester correctly mentioned that most of export value are actually import value. It means that those jobs added a little value then re-export to US or EU.

    Thus, when US and EU have a crisis and demand falls, those very low-value-added low paid jobs will difinitely lose. The people would possibly go back to the countryside…if the CCP can maintain the stable situation during this process. Those people will wait for another boom time to come out and work again…

  14. Bob_in_MA

    I think the point about necessary job growth is that there are essentially 20million+ new workers each year because of working age population growth. These weren’t all farmers moving to the city, they are twenty-somethings looking for a job.

  15. Anonymous

    anonymous — i think the right concept is value added in the export sector, or exports net of related components imports. That isn’t 40% — but it is close to 20% in my viww. More importantly, my strong view as that the value added in china’s export sector is rising — largely b/c electronics component production shifted to china. you see this after 2004 — rises in china’s exports to the US and Europe were no longer associated with rising chinese imports from the rest of asia.

    the reference to net exports in my post is reference to the net contribution of exports to annual GDP growth — which has been quite large absolutely over the past few years in china even if hasn’t accounted for the majority of China’s GDP growth.

    Yves — I wasn’t really arguing against Nouriel so much as against the Economists’ argument that exports have played no role in Chnia’s GDP growth (in which case, there is no reason to worry — china can plug along just fine, as it doesn’t rely on international banks for financing/ benefits from lower commodity prices). My main different with Nouriel is one of tone rather than substance — he wants to fit China’s slump into his global hard landing meme; i preferred to steer clear of the term hard landing.


  16. Anonymous

    China could have been a huge experiment in “sustainable development”. Their populace had the discipline to endure slow, thoughtful, change. But no. The same scumbags responsible for the coming mad max scenario in the US decided to finance China’s metamorphosis into a huge slave plantation gulag pumping unnecessary plastic crap into containers bound for Seattle and Long Beach. Now what? Who’s gonna finance our next bubble? Saudi Arabia? Hell, they should be demanding payment for oil in gold.

  17. Juan

    Brad states: “If China shifted the basis of its growth, it might be able to generate more jobs even if the overall pace of growth changes.”

    which, given the transnational restructuring of E. Asia, seriously begs questions of control and whether that nation can reverse its capital deepening, export hub course without greatly destabilizing the region and beyond. Of course, should this global recession be sufficiently intense and prolonged, the party-state may have little option,,,how could it ever have imagined otherwise.

    East Asia specialist Martin Hart-Landsberg and economist Paul Burkett’s 2006 paper China and the Dynamics of Transnational Accumulation: Causes and Consequences (PDF) provides some insight and yes, Richard, data into what has been a decidedly beyond-national development process.

    Roubini is closer to correct.

  18. Anonymous

    Has Setser or anyone on this board actually visited the countryside in China?

    There’s a simple reason why none of the migrant workers want to go back to the countrywide.

    There’s no friggin food there! As in starvation level no food, not go back and go onto food stamps US style the cupboards are bare.

    Also don’t forget much of the better farm-land was in the South which has now been turned into factories.

    Petty crime and social unrest is skyrocketing in the cities due to lack of work and lack of social services.

    The CCP is extremely aware of the issues with lack of basic services, high cost of basic necessities and how easily things can spiral out of control.

    The Chinese can simmer for a long time, but when they blow it can be very bad and very bloody.

  19. russell1200

    The last few recessions within the US have been relatively lighter because much of our industrial capacity was swapped out for service industries so that the old inventory overcapacity issues were dampened.

    The percentage swings in output for primary producers is proportionally large as an economy moves through its business cycles/bubbles.

    Construction is a poster boy industry for illiquid supply meeting liquid demand, with even small downward swings in demand causing huge shake ups within the industry. It of course is also an industry where the inventory part of the business cycle can hit hard.

    To the extent that both the industrial and construction portions of China’s economy make up a large portion of their economy, you would expect to see some very deep swings regardless of where the drop in demand comes from.

  20. larryang

    What kind of effect would China liberalizing their household registration system have on residential construction?

  21. Anonymous

    It’s worth considering that ALL problems of underemployment and attendant social unrest can be readily solved by simply paying unemployed workers with freshly printed yuan to dig holes in the ground and then fill them back up again. When faced with deflation, a government can pursue policy like this with impunity. So I wouldn’t bet on a social explosion in China anytime soon, unless you are certain that the Chinese leadership is ideologically opposed to this sort of crude Keynesianism.

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