During the financial crisis, pronouncements by Nouriel Roubini would move markets. Even though he still commands attention, in a investment environment driven by blind faith in the munificence of central banks, being focused on the real economy isn’t as relevant as it once was. And Roubini may have erred in trying to maintain his high profile when the trajectory of the economy was hard to discern (recall the seemingly unending debates over V versus U versus W shaped recoveries? The net result is the new normal has been designated a recovery when it it looks more to be a sideways waffle).
By contrast, China has trends underway that simply cannot be sustained, but a command economy can keep that sort of thing going well past its sell by date. The biggest is the staggering dependence of its economy on investments. No major economy has had investment as a percent of GDP at 50% for a sustained period. This is a textbook case of Austrian malinvestment. We’ve catalogued some of it here. For instance:
Similarly, the expansion of debt is also proving less effective in generating GDP growth. From 2000 to 2008, it required $1.5 in debt to produce $1 of GDP. By contrast, credit efficiency in the US became poor right before our bubble imploded, with it taking $4 of credit to produce $1 of GDP. China now is even less efficient than the US in 2008, with it now taking $7 of credit to yield $1 of GDP increase.
And that’s before we get to Michael Pettis’ ongoing commentary about the dangers of China’s debt levels, or the ongoing sightings of bridges to nowhere and underutilized factories.
So Roubini’s call is interesting, in that he sees an ugly end in China as inevitable but not imminent. From Roubini via an e-mail alert:
I’m writing on the heels of two trips to China….My meetings deepened my own impression and RGE’s long-standing house view of a potentially destabilizing contradiction between short- and medium-term economic performance: The economy is overheating here and now, but I’m convinced that in the medium term China’s overinvestment will prove deflationary both domestically and globally. Once increasing fixed investment becomes impossible—most likely after 2013—China is poised for a sharp slowdown. Continuing down the investment-led growth path will exacerbate the visible glut of capacity in manufacturing, real estate and infrastructure. I think this dichotomy between the high-growth/inflation pressures of the next couple of years and growth hitting a brick wall in the second half of the quinquennium is far more important than the current focus on a “soft landing” amid double-digit growth. A number of local scholars close to policy circles agree that this is the biggest challenge of the next few years, as we’ve been saying for months.
Despite policy rhetoric about raising the consumption share in GDP, the path of least resistance is the status quo. The details of the new plan reveal continued reliance on investment, including public housing, to support growth, rather than a tax overhaul, substantial fiscal transfers, liberalization of the household registration system or an easing of financial repression.
No country can be productive enough to take 50% of GDP and reinvest it into new capital stock without eventually facing massive overcapacity and a staggering nonperforming loan problem. Most likely after 2013, China will suffer a hard landing. China needs to save less, reduce fixed investment, cut net exports as a share of GDP and boost consumption as a share of GDP.
China is rife with overinvestment in physical capital, infrastructure and property. To a visitor, this is evident in brand-new empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, massive new government buildings, ghost towns and brand new aluminum smelters kept closed to prevent global prices from plunging.
It will take two decades of reforms to change the incentive to overinvest. Traditional explanations of the high savings rate (lack of a social safety net, limited public services, aging of the population, underdevelopment of consumer finance, etc.) are only part of the puzzle—the rest is the household sector’s sub-50% share of GDP.
Several Chinese policies have led to a massive transfer of income from politically weak households to the politically powerful corporates: a weak currency makes imports expensive, low interest rates on deposits and low lending rates for corporates and developers amount to a tax on savings and labor repression has caused wages to grow much less than productivity.
To ease this repression of household income, China would need a more rapid appreciation of the exchange rate, a liberalization of interest rates and a much sharper increase in wage growth. More importantly, China would need to privatize its state-owned enterprises so that their profits become income for households and/or massively tax SOEs’ profits and then transfer those fiscal resources to the household sector.
It will be interesting to see whether Roubini is overcorrecting from his experience with the US housing/credit bubble, where he was so early to predict a bad end as to be a Cassandra.