Michael Pettis: Falling US Consumption to Lower Chinese Growth to 5-7%

In a Financial Times comment. Michael Pettis gives a well-reasoned and glum forecast for Chinese growth, namely, that it is unlikely to exceed 5% to 7% over the next few years. The reason he sets forth is that China was able to show growth rates in excess of domestic consumption growth thanks to US exports. But US consumers will be consuming at lower levels for the next few years, As Pettis explains, the implication for China is that its overall growth rate will fall below its domestic consumption growth rate.

Now 5% to 7% growth may not sound shabby at all to American, but things look very different from China. Anything below 8% will be inadequate to absorb expected increases in the workforce. The government’s authority has rested upon its ability to deliver rapid enough growth, and that has also helped to paper over tensions between coastal cities, which have seen great gains, and the hinterlands, where progress has been much slower.

Marc Faber has said that the economic reports coming out of China are greatly exaggerated and he pegs growth now at a mere 2%.

From the Financial Times:

For 20 years, and especially in the past decade, rapidly rising debt has allowed America’s consumption growth to exceed economic growth, with a concomitant rise in the country’s trade deficit. One consequence of this too-rapid growth in American consumption has been that the non-US global economy was able to grow faster than non-US global consumption. This was especially true for Asia, the main beneficiary of the US consumption boom, and for China in particular.

While Chinese consumption was growing at an impressive 9 per cent a year over the past few years, Chinese gross domestic product growth substantially outpaced it, clocking in at 10 per cent to 13 per cent annually. China was able to do this in large part because as it poured resources and cheap financing into manufacturing, and in so doing produced many more goods than Chinese households and businesses were able to consume….

But everything has changed….US debt levels will decline over the next several years……American consumption will grow substantially slower than the US economy, and so the trade deficit will decline. For the rest of the world, even ignoring the possibility of a decline in global investment, a contraction in the US trade deficit will bring with it a period in which economic growth will be less than consumption growth…..

If the Chinese economy was the biggest beneficiary of excess US consumption growth, it is likely also to be the biggest victim of a rising US savings rate. For now, China has been able to avoid the brunt of this reversal. Although Chinese exports have dropped, imports have declined even faster, so that China’s GDP continues to grow faster than its consumption, and China’s savings level, which is the inverse of consumption, continues to rise. But this has come at the expense of an unsustainable squeeze on China’s export competitors.

Eventually, and maybe this is already happening, the decline in the US trade deficit must result in a decline in China’s ability to export the difference between its growth in production and consumption. When this happens, China’s economy will grow more slowly than Chinese consumption, just as the opposite is happening in the US. Put another way, rather than act as the lower constraint for GDP growth, as it has for the past two decades, growth in Chinese consumption will become the upper constraint. At the same time, for the next several years Chinese consumption will necessarily rises as a share of GDP, just as US consumption must decline as a share of US GDP.

If Chinese consumption growth is able to continue at 9 per cent annually, the implications are that China’s GDP growth will fall from the heady 10-13 per cent levels of the past few years to something approaching 6-8 per cent, depending on the speed of the US adjustment and the share of the adjustment absorbed by China’s trade competitors. But there are reasons to doubt the ability of Chinese consumption to grow so quickly.

First, in an environment of much slower Chinese economic growth, it would not be surprising if consumption growth rates also declined. Just as rapidly rising income fed rapidly rising consumption on the way up, a sharp slowdown in income growth should cause consumption growth also to slow. Second, and more importantly, China’s fiscal stimulus consists mainly of a massive expansion in bank lending, which is almost certain to lead to a sharp rise in bad loans. Resolving these, which China will have to do in the next few years, will probably require the same policies used to resolve the banking crisis of the late 1990s, which will inevitably constrain consumption growth.

For now, an extraordinary but inefficient expansion in new bank lending has powered the Chinese economy into growth rates that many thought unlikely even six months ago. But rapidly rising bank lending, especially if misallocated to nearly the same extent as in previous loan surges, cannot be a long-term solution for slowing Chinese growth.

Over the next five years or more Chinese economic growth will necessarily be lower than growth in Chinese consumption. The massive but unsustainable investment in infrastructure and new production facilities that characterises the Chinese fiscal stimulus package will not be able to change this fact. From its dizzying heights during the past two decades, the world needs to prepare itself for a decade during which, if all goes well, China grows at a still respectable but much lower rate of 5-7 per cent. If the current fiscal stimulus package retards China’s adjustment process, as many analysts argue that it does, growth rates may be much lower.

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  1. Purple

    Given China's weak private domestic consumption numbers, which fell dramatically as a proportion of GDP over the last decade, this should not be surprising.

  2. moslof

    Fiscal conservatism is a hallmark of a sinking social mood. Like the "two steps forward one step back" saying, it seems natural to pull back or consolidate. The only problem is debt amounting to 4 times GDP will not be serviced as we point fingers and blame.
    Why isn't there anything in this blog about Wells Fargo selling $600M of MBS last week for 35 cents on the dollar. Will that news bring a dose of reality to the "rally" phase we are experiencing?

  3. Lorenzo

    Interesting, but a somewhat one-sided argument on Chinese growth rates. Yes, mathematically, ceteris paribus, sounds right, but the facts on the ground point to a different potential. As Purple mentions, consumption numbers as a percentage of GDP fell significantly over the past decade. A significant reason behind that was a reduction in the social safety net which led to a rise in the savings rate to buffer against illness or unemployment. Now, the Politburo is re-introducing 'welfare' measures specifically to encourage a fall in saving (and rise in consumption). Taken together with financial reform (underway) there is good reason to believe that, mathematically, domestic consumption will rise much faster than GDP allowing growth rates to return to above 8%.

  4. Bill

    I like Lorenzo's post.
    I have no clue where the growth rates of Chinese GDP and consumption will end up. But I would say that now is a perfect time for them to introduce or expand a program like Social Security. It's a very effective way to increase consumption.

  5. "DoctoRx"

    Americans should be rooting for China to grow slowly or not at all.

    When the world's most populous country becomes the world's leading economy, we'll increasingly be sending them manufactured goods in return for their promises to pay.

    And the balance of power in all other ways will inexorably shift in ways we won't like.

    Blame it on Nixon . . .

  6. Anonymous

    Improving the social saftey net in China has become such a standard response to any discussion of Chinese savings that I think it has become true simply because everyone knows that it is true. But, aside from the fact that it will take years to be fixed and even more years before it becomes credible enough to affect household consumption, where is the evidence that countries with strong social safety nets have high consumption and those with weak social safety nets have low consumption? It seems to me that industrial- and trade-related poicies that boost production and constrain consumption might have more to do with high savings than lack of good medical care. At any rate Pettis has talekd about this a lot and he may be onto something.

  7. Zee

    Social polarization in China is immense. Did you hear about the 30,000 stell workers that killed the politburo boss.

    “The income gap in China is significant. It reflects several issues. One of them is the unreasonable economic structure, i.e., the incomplete market structure. The Chinese government monopolizes the banks, energy, and so forth, in the market and causes a deformity of the market. These industries earn more because the state protects and monopolizes them. There is no transparency.”


    The average disposable income of Chinese urban dwellers is about US$1,350 annually, growing at between 10-20% each year. In rural areas, it is about a third of that figure. It will be a long while before it is possible to reach the US$5,000 figure, the point at which discretionary spending is said to take off.

    Hard to envision a one-party dictatorship allowing the buying power of the masses to rise up to that of the developed countries. The PPC would lose their power base as the masses would have a much stronger political voice in such a scenario.

  8. Balmain Bear

    I like Michael Pettis' stuff but there is a larger macro story that suggests much stronger growth for China.

    China is still in the stage of "catching up" to the intensive use of capital per-person apparent in developed economies through unleashing the market reforms of a modern industrial economy. This embeds a deep momentum in their growth.

    Last year China suffered a real estate bust, stock market bust, export collapse and unemployment shock more or less simultaneously. Yet here it is no more than one year later clattering along at such a pace that monetary authorities are hitting the brakes on lending (whatever the growth rate really is).

    Sure they've got overcapacity along with everyone else. And they're going to have a wave of dud loans in 18 months. But as Japan proved in the mid twentieth century, it takes something calamitous to knock these free-market developmental economies off track.

    None of that does much to help debt-crippled Western economies, although it might cushion the blow if they have commodities.


  9. bb

    with monthy wages averaging around $200 and non existent social safety net, how far can consumption grow? i think it is at its peak level anyways. rising wages and social benefits can increase it, bu they will hurt relative export competitiveness. remember that those migrant workers are in direct competition with vietnamese, philipinians, and cambodians for really low paying jobs.
    add to this what i consider the boiling eisaster of this year's $1.2 trillion credit infusion and anyone can conclude the banking sector will be the first beneficiary of any 'social safety net' policies. command economies suck, believe me, i have seen a few from inside.

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