Rogoff: "Is China Immune to Crisis?"

Kenneth Rogoff, writing for Project Syndicate, argues that if China’s stimulus succeeds, it will do so at the expense of intermediate-term growth. He echoes the widely-held view that China needs to move towards a paradigm that gives more weight to domestic consumption. The problem is, however, that a transition will be awkward and is likely to be forced on China (the low wages that are key to international competitiveness are an impediment to developing a large, more self-sustaining internal market sufficient to absorb much of the production now focused overseas).

From Project Syndicate:

Addressing the annual World Economic Forum in Davos, Switzerland, Chinese Premier Wen Jiabao explained his government’s plans to counter the global economic meltdown with public spending and loans.

He all but guaranteed that China’s annual growth would remain above 8 percent in 2009…

But does the Chinese government really have the tools needed to keep its economy so resilient? …

America’s deepening recession is slamming China’s export sector, just as it has everywhere else in Asia. The immediate problem is a credit crunch not so much in China as in the United States and Europe, where many small and medium-size importers cannot get the trade credits they need to buy inventory from abroad.

As a result, some once-booming Chinese coastal areas now look like ghost towns, as tens of thousands of laid-off workers have packed their bags and returned to the countryside.

Similarly, in Beijing’s Korean section, perhaps half of the 200,000-300,000 inhabitants ― mainly workers (and their families) who are paid by Korean companies that produce goods in China for export ― reportedly have gone home…

Many leading Chinese researchers are convinced that that the government will do whatever it takes to keep growth above 8 percent. But there is a catch. Even if successful in the short run, the huge shift toward government spending will almost certainly lead to significantly slower growth rates a few years down the road.

Simply put, it is far from clear that marginal infrastructure projects are worth building, given that China is already investing more than 45 percent of its income, much of it in infrastructure.

True, some of China’s fiscal stimulus effectively consists of loans to the private sector via the highly controlled banking sector. But is there any reason to believe that new loans will go to worthy projects rather than to politically connected borrowers?

In fact, China’s success so far has come from maintaining a balance between government and private sector expansion. Sharply raising the government’s already outsized profile in the economy will upset this delicate balance leading to slower growth in the future.

It would be preferable for China to find a way to substitute Chinese for U.S. private consumption demand, but the system seems unable to move quickly in this direction.

If government investment has to be the main vehicle, then it would be far better to build desperately needed schools and hospitals than “bridges to nowhere,” as Japan famously did when it went down a similar path in the 1990s.

Unfortunately, China’s local officials need to excel in the country’s “growth tournament” to get promoted. Schools and hospitals simply do not generate the kind of fast tax revenue and GDP growth needed to outperform political rivals.

Even prior to the onset of the global recession, there were strong reasons to doubt the sustainability of China’s growth paradigm. The environmental degradation is obvious even to casual observers.

And economists have started to calculate that if China were to continue its prodigious growth rate, it would soon occupy far too large a share of the global economy to maintain its recent export trajectory.

So a shift to greater domestic consumption was inevitable anyway. The global recession has simply brought that problem forward a few years…

One way or the other, the financial crisis is likely to slow medium-term Chinese growth significantly. But will its leaders succeed in stabilizing the situation in the near term?

I hope so, but I would be more convinced by a plan tilted more toward domestic private consumption, health, and education than to one based on the same growth strategy of the past 30 years.

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  1. ndk

    Incidentally, China has abruptly decided to begin importing a very large amount of commodities. It might be in response to necessity such as the drought or expended stockpiles, stronger economic growth, or simple stockpiling/diversification. I strongly suspect the latter, as it seems like precisely the decision to make after the actions of officials in the Obama administration.

    My Chinese friend volunteered that a lot of her friends, generally young and college-educated, are losing their jobs, or living in fear of it. She lives in Chengdu but studied in Beijing. It’s certainly a much more intense concern than I’d heard from her earlier.

  2. k

    Andy Xie sees glass half full:

    Driving the world
    by Andy Xie 2009-02-06

    The financial crisis presents an opportunity for China to seize the leadership baton for globalisation and become its centre for goods, services and capital, while catalysing a new China boom that could last a decade or longer. That boom could turn China into the world’s largest economy – and a developed country – within two decades.

    China has been a bottom feeder in the global economy. Keeping costs low and making labour-intensive products have brought it safety and growth. Australia, Brazil and Russia sell natural resources to China in return for cheap manufactured goods. Japan and Germany sell expensive cars and technology to China in exchange for cheap manufactured goods. And America just hands over dollars for goods and services, and gets them back by selling derivatives like collateralised debt obligations, backed by inflated US house values, to foreigners.

    The global economy has run like a motorcycle, with American consumption as one wheel and China’s savings as the other, with everyone else piled up on top. The sustainability of this world depended on foreigners believing in the Wall Street debt instruments that paid for America’s imports while keeping inflation at bay. Inflation came three years ago with surging oil prices. The tightening that accompanied it burst the US property bubble in 2006. It took another year for the subprime market, and still another for financial derivatives, to blow up. The resulting crisis has destroyed Wall Street’s credibility. The motorcycle economy has fallen over.

    The US now offers the world, in particular China, a plan for recovery: you buy my treasuries, Uncle Sam gives the proceeds to American people to spend, and your exports and your economies may recover. The recovery plan tries to put the motorcycle economy back on its wheels by replacing American households with the federal government.

    Accepting this offer is not in China’s best interests. First, the plan may bring modest growth for a few years but will be followed by another, bigger crisis centred on the US treasury market. Second, instead of taking America’s offer, China can start attracting investment as part of its trade-led development model. In short, it can start competing with the US for money rather than just rasing dollars by selling goods to the US.

    China has been attracting foreign capital for some time. But this has been mainly to improve its production capacity, especially in the export sector. The new strategy calls for foreign capital to fund China’s capital formation in anticipation of earning profits from richer Chinese consumers in the future. It would help China to shift its economy to consumption without sacrificing growth.

    China is in a good position to replace the US as the centre for globalisation: with little debt, enormous savings, and its sheer size, its growth potential is vast. Current per capita income of US$3,300 could be raised to US$10,000 within two decades through a combination of growth and currency appreciation. At the same time, gross domestic product could rise from today’s US$4.3 trillion to US$13 trillion in today’s dollar terms. Such an increase would offer plenty to investors who bet on China’s future. This is why China can succeed in changing its growth model.

    To engineer the transition, China must create a first-world environment for capital flow and pursue an aggressive urbanisation strategy to anchor domestic consumption. First, China should fix a date, preferably within five years, for floating the yuan; that is, forgoing accumulating foreign exchange reserves, and making the capital account freely convertible.

    Such a change would require the economy to modernise in many ways. As money could travel freely, only a first-world environment for investment would attract and keep money at home. The rule of law would need to be strengthened enormously to make the new system viable. A corollary is that arbitrary administrative power would have to be severely limited. Fixing a date for currency convertibility would be similar to joining the World Trade Organisation a decade ago: it would set in motion a new wave of reforms.

    Second, as China succeeds in attracting foreign money, it must have a strategy to turn it into efficient economic growth. Otherwise, the money would be used for blowing bubbles, which could bring down the country. The anchor for domestic demand must be urbanisation. To become a developed country in two decades, China must aim to increase its urbanisation to 75 per cent by then. Moreover, urbanisation must be viable in the long run; the system needs to change so that migrant workers become rooted in cities.

    China’s urbanisation strategy should focus on building 30 mega-cities of more than 20 million residents each. These cities would have the right to issue bonds to fund their development. Because they would have the size for economies of scale in building infrastructure, protecting the environment, and creating jobs, they would have tax revenues to pay off their bonds. When money was plentiful, they would have easy financing and could accelerate urbanisation. When money was scarce, they would face high funding costs and could slow down in response. Basically, China should turn its urbanisation into a sponge for global capital. Shifting the rural population into big cities is the only way for the nation to modernise.

    The global financial crisis is casting a shadow over globalisation. Developed economies may resort to protectionism to keep jobs at home, leading to a vicious cycle of recession and more protectionism. China is in a position to carry the baton for globalisation. This is a unique chance to become a developed nation in a generation.

  3. Anonymous

    @k regarding the article you posted.

    If they try this approach the velocity of their endeavor will carry extreme consequences to a landmass that is already presenting very unfriendly conditions to the human/animal/plant forms. These effects are already present and incressing through out the entire ecosystem at a rate not seen in human endevor/actions/outcomes/timelines.

    My concern is not if they can or can not pull it off, but the out comes of said actions in less than a few decades.

  4. wunsacon

    >> To engineer the transition, China must create a first-world environment for capital flow…
    >> …Basically, China should turn its urbanisation into a sponge for global capital…

    My translation: To engineer the transition, China must first create opportunities for foreign banksters to profit from it.

    But, of course!!! ;-)

  5. Richard Kline

    To the extent that China is presently moving into major commodity purchases, this is easily the most sensible macroeconomical action undertaken by any major economy in the present crisis. Commodities are as low as they are ever likely to be again, a much better time for a speculative play. They will be needed in China in due course, not least if their infrastructure-led stimulus plan is to work. They also are the only really good diversification play at the present, particularly if a major currency crisis is imminent (which is my view). Chinas has huge currency exposure, so this is the obvious endeavor. We see here the potential advantages of being a statist economy. Also, a mega-commodities bugy would be evidence that those directing China’s economic policy actually have something other than spinal fluid above the neck, not a view normally attributed to them in the Anglo-American MSM. Show me _anything_ attempted in either the US or the UK which seems as sensible.

    Rogoff is dubious of a ‘bridges to nowhere’ stimulus in China. If that is what they attempt, then he is right, yes. What they have proposed is a major build-up of their rail network among other things. This is exactly the right choice for China in any respect one could consider, and would have a significant multiplier on future growth if done well. I’m not going to detail this last; the benefits are obvious, and anyone not up to speed on this needs to get there before they feel in a position to weigh in on China’s economy and the minds behind its transformation. Regarding those hospitals and schools which Rogoff feels will not be built, again if that is the result then yes, he has a point. This is exactly where the central government can have a major impact, and look good too: local governments won’t build them, or will skim the contracts, but central government management of a ‘quota’ of construction is a prime chance for the CCP to look like they care and are in charge. Think that they are smart enough to know this, too? We’ll soon see.

    I’m not saying this because I love either the CCP—I assuredly do NOT—nor because I’m enamored of statist economies—*yuck* to *meh*. But the socio-political structure of the Chinese is a statist one: if the CCP didn’t exist, the equivalent would be generated to fulfill that role; er, that’s exactly what happened, actually, for anyone who skipped 20th Century China 505. And tell me what the Liberal Democrats in Nippon are other than the smiley face version? And the power elite in China and more generally in East Asia stay that way by keeping the little guy little. This is what Japan has done for five generations, and believe it that the Mainlanders are close students of that in their inner leadership colloquia. This runs _directly counter to the idea of building an empowered middle class in China_. Anyone opining on what China ‘should’ or ‘will’ do who does NOT grasp this quintessence of Chinese political economy is talking out of something other than their mouth, to me. Building up a consumption heavy domestic economy is not on for the Mainland power elite. First, the resource flow required for a First World level consumption would be prohibitively expensive. But second and far more important, it would be political suicide for the power elite: don’t think that they will ever do this voluntarily. Repression would be much, much preferred to keep rioting peasants in line than boosting consumption and generating a potential alternative power base. Modest consumption gains are another matter, but if attempted will, in my view, err on the under rather than the over. To the extent that a middle class develops in Mainland China, it will do so slowly, organically, and with NO help from the Center, in my view. Rogoff’s comments that China should boost domestic demand, then, are not ‘wrong,’ but they are textbook Western economics which do not engage with the realities of Chinas political economy, and as such tangential to the actual problem set of that country and its national economy. Who has power, how, and how will that be maintained? Answer that first in any question of China’s ‘economy’ economy.

    Regarding Xie’s piece, there are so many problems there I don’t know where to begin. And I generally like Xie’s commentary; he’s pretty plugged in and willing to take a firm position. I read this as his ‘If I were First Minister to the Emperor’ wish list, since China is in fact going to undertake major economic actions, and is in a position to, yes, profit greatly from this crisis if the make the ‘right’ moves. So perhaps he is speaking his peace to nudge what he can, or at least get on record with “coulda, woulda, shoulda.”

    Xie: “The rule of law would need to be strengthened enormously to make the new system viable.” Yes, which is EXACTLY why this will _NOT_ be done. To the extent to which laws become strong, the Center is weakened, as the ‘arbitrary exercise of power’ is essential to their position. I do not expect to ever, EVER see this done in a meaningful way (a major part of why I am no fan of the CCP, it is in their interest to remain above any law).

    Xie: “Second, as China succeeds in attracting foreign money, it must have a strategy to turn it into efficient economic growth.” Andy, buddy, how can you write this nonsense?; you’re smarter than that. (Could it be that you lunch and golf with those in China’s Near Abroad who want to free up their investments for untrammeled profit, hey?) Look, the Mainlanders did NOT open their economy to investment to make YOU and YOURS rich. But they did have a plan, and I know you understand this: Technology transfer is the name of the game. Capitalists think that everything’s about money; other kinds of political economists understand that the means of production come first, last, and always. China’s strategy of the last twenty years was NOT to attract ‘foreign investment;’ that was Mexico’s strategy, for instance, and look where it got them. (Chumped ‘n’ dumped, is where.) China already _had_ control of their economy and their currency; what they did not have was a banking system, and First World technological base. The macrostrategy of the Center was to compel offshore technology transfer for major investments onshore. They got this from Taiwan; that was the key to letting Taiwanese money in to make money for itself. That was the key with Korea; same thing. Let them gorge, so long as we get their means for ourselves. It took a lot of effort and arm-twisting, but that was much the what the Center got with investment from the EU onshore in China, technology transfer and on-site expertise to train local staff. The US mostly wouldn’t play, and mostly didn’t get in; our free choice. But don’t say that they Chinese don’t have a strategy: they do, it was a good one, it was the right one, and largely it has worked. Their were sideffects which aren’t pretty, but hey, that’s what complex systems entail. Now the strategy of _local_ powerbrokers in China, by contrast, was to get local investment to skim off a take and deal out goodies to local cronies. That’s what the property speculation game has been all about, and a lot of the sliver-margin export trade with no technology transfer. But this last _was not_ the strategy of the Center, and many commentators in the West do not seem to get this. I would think that Xie would and does get this, but . . . .

    Xie: “China’s urbanisation strategy should focus on building 30 mega-cities of more than 20 million residents each.” Oh dear gods, NO, what an awful idea. Major cities are colossally consumptive of resources, like cancerous leasions on the ol’ sphere. (Yes, they’re rockin’ good places to live if you have a little flash, but that’s not the point.) Building and maintaining developed urban areas holding 130M will be hugely expensive, and fundamentally unsustainable. And wrong-headed because China’s population is going to level off and drop back. One Child was a policy I cannot endorse, but it was effective, and artificially enforced gender imbalances also means that the male-biased populace will drop back even more than once child assumes since many won’t marry and of those few will reproduce. China’s population may not drop enormously, and it will continue to move toward cities, but the idea of through enormous resources at building up resources at just the point the populaton is going to cross a tipping point is, well the kinds of thing the European Big Scientists might imagine but that the Rest of the World should not succumb to, in my view.

    Xie: ” . . . China should fix a date, preferably within five years, for floating the yuan.” I claim no expertise in China or macroecomics, the above notwithstanding. I’m just a bloke who reads history, writes a bit of it, and keeps notes. So nobody should take investment advice from me: I operate on time frames of 250-10000 years, see. But I will tell you my view on when China will float the yuan more or less fully. That will be when China’s banking industry is strong enough to compete on level terms with the major financial institutions in the world economy. As of 2008, this was not the case; accordingly, the Center in China, with perfect sense, kept their banking industry behind a firewall which has required them controlling their currency. Americans can scream all they want over consequences from that they do not like, but it was, is, and will be irrational to expect the Chinese to simply be stupid about something so basic as this; that’s my view. Now their banking industry has frequently had little fires in the files behind that wall, but hey that’s what a statist economy is for, foam retardant and exemplary punishment, right? We talk, loosely, of ‘vendor financing’ from China on it’s export trade. When Mainland Chinese banks begin to _themselves_ finance China’s external trade, and are well-enough managed to turn a renminbi on such commerce, the yuan will be ready to float. Ten years, maybe, unless the West does as bad a job of coping with their banking collapse as they appear to be on course for, in which case more like seven. I do not expect any free float until then, because to float their currency with a weak banking system is simply gross stupidity, and the Chinese haven’t been showing too much of this over the last twenty years. Occasional stupidity, yes; gross stupidity . . . they leave that to the experts. We have lots of experts in America, yes: We lead the world in that capacity.

  6. k

    Richard, thanks for the point by point reading of Xie’s talking point. I learned a lot.

    A “statist economy” eh? That’s good.

  7. sinophile

    We are keen for China to “boost domestic consumption” but, if you multiply increased consumption by 1,300,000,000 people you accelerate global resource depletion and environmental degradation at an awesome rate.

    What the Chinese and the rest of us need to do is figure out how to survive peaceably in a steady-state economy–a paradigm shift which nobody in the West wants to contemplate.

  8. Anonymous

    So what I’m hearing is that America is the patsy ?

    The world has only one consumption machine and it just blew a head gasket. But it is a cardinal offense to suggest reciprocity.

    By dogmatic decree, the US has a spiritual duty to participate and even promote the decline of it’s own system in support of the statists’ way, because they won’t risk losing the right of the ‘arbitrary exercise of power’ that is essential to their position. ( and, in theory, enethma to ours)

    Slave ownership is the quintessential right of the ‘arbitrary exercise of power’ along with the right of accrual of others labor for the pupose of wealth and power concentration. What really is the difference between slavery and the statists way ?

    Somehow, turning Americans into slaves through labor arbitrage has gained economic traction again. At least we have the good breeding to set a minimum slave wage, although some argue it’s too high.

    Thanks to all for an interesting discussion.

  9. Anonymous

    The core problem with China that cannot be solved is that competition between local governments meant that there are far too many firms pursuing too few niches, ending with everyone losing money.


  10. Bill

    I have no training in economics or finance, but I’ve been reading a lot online lately.

    Thanks to all for a really dynamite discussion of this area which I know nothing about, now I can think about it with a little more knowledge.

  11. Anonymous

    (the word verification was ‘tratr’, which is what you get when you remove I/O from traitor – lots of seditious discussion, no throughput of action. Like most blog conversations)

    China will not be a US$ 13T economy in 20 years. Even if they were to quadruple their GDP in that time I doubt highly the rest of the world would be standing still. This implies no growth at all in the US or Eurozone for *** 20 years *** just so China can catch up and take the lead. We’ll have a world war to end all world wars by then if that happens.

  12. K Ackermann

    Note to China,

    Keep your political system. Free and fair elections requires sponsorship.

    Trust me; capitalism is incompatible with good governance. It becomes parasitic, but a capitalist parasite is certain to destroy the host.

    Best Wishes,
    United States

  13. halbhh

    China may be in rather more dire shape than most realize.

    China is the big export surplus nation, therefore China can and should really test Keynes now.

    Since many Chinese save in response to fear, increasing the Chinese social safety net sharply would be one good stimulus. I’m thinking of a version of social security, and also a single-payer state health insurance system.

    China should press the Keynes Test Button firmly, and hold it down….

  14. lineup32

    China and the U.S. have a bad marriage but neither one has an economic plan B for living without the other. The result will be a lower standard of living for both but neither can accept that reality.

  15. pepster

    Richard Kline said, “Technology transfer is the name of the game.”

    This is a valid point, and an astute observation. However, Jim Collins (I think it was in Good to Great) notes that technology itself does not do much. Rather, it is the selective use of technology for creative endeavors that propels companies and countries forward. So for me the question becomes how creatively can the Chinese utilize technology once they gain access to what they’re after.

    My opinion: not very much. I am in academia (biomedical and bioengineering research) and I base this opinion on literature that I have seen come out of China. In general, it is of much lower quality and creativity than that done in the US and Europe, and it’s not because they don’t have access to the same materials that we in the US have. They do; for example, reagents for organic synthesis and standard molecular biology techniques such as gene cloning and PCR are readily available everywhere. It’s because their research, i.e. what they’re doing with the technology, is not that interesting, creative, nor clever.

    To make clear my position, I am not saying that Chinese make poor researchers. Indeed, many of the best and brightest researchers are of Chinese descent. What I’m saying is that the US has a culture that fosters creativity that China does not have, and this more than the actual possession of any one technology is what’s important.

  16. pepster

    Xie: “Second, as China succeeds in attracting foreign money, it must have a strategy to turn it into efficient economic growth.”

    This comment makes sense to me. If China does NOT do this, it would likely mean that the foreigners’ return on investment isn’t very good. In that case, wouldn’t these foreign investments just go elsewhere?

  17. Tortoise

    “Madame Defarge Watch”. That’s great, Yves!

    Well, as Mel Brooks said, “It’s good to be the king.” Now we know that it is even better to be the CEO of Goldman. The royalty of our times…

  18. Anonymous

    China will be unable to make an abrupt turn without crashing. There are too many people, and the standards of living are too varied. It won’t work. They know it. That’s why they are not finding any solutions.

    As for the US, it must lower the cost of life of every American by making energy MUCH cheaper, and find ways to limit outsourcing (opening new economic sectors, making sure other countries don’t manipulate their currencies, etc.).

  19. purple

    To make clear my position, I am not saying that Chinese make poor researchers. Indeed, many of the best and brightest researchers are of Chinese descent. What I’m saying is that the US has a culture that fosters creativity that China does not have, and this more than the actual possession of any one technology is what’s important

    The U.S. poaches the best people from the rest of the world, because our wages higher, and we’re generally a more open society. Hence the term “brain-drain”.

  20. Anonymous

    Xie: “The rule of law would need to be strengthened enormously to make the new system viable.”

    This comment shows very clearly a weakness I see in most economic analysts. That is a lack of historical and political understanding. Their proficiency with numbers leads economists to be over confident with regards to political and social factors in economic development.

    For China to develop a strong rule of law would take a wrenching and profound transformation. Wishing doesn’t make it so. It would take decades, if not longer.

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