Chinese Economy Going With Tried and True

Martin Wolf has a good piece in the FT about the need for tackling the world's imbalances and thus, changing the structure of the Chinamerican economy. An excerpt:

Much of the extraordinary increase in China’s aggregate savings is the result of rising corporate profits (see chart). It would surely be possible to tax and then spend a part of these huge corporate savings. The government could also borrow more: at the 3.6 per cent of GDP forecast by the IMF this year, its deficit remains decidedly modest. It is also hard to believe that a country such as China should be saving half of its GDP or running current account surpluses of close to 10 per cent of GDP.

Exactly, China can spend much more on policies that are consumption promoting, such as in housing, education and medical welfare. Many developing countries cannot spend in this manner due to some form of the poverty trap - low capital per person and inability to borrow to raise the level of capital. But not China, which has more capital than domestic demand AND the ability to use deficit spending [to boost consumption/welfare]. But as it stands, we're seeing the tried and true formula of increased investment rather than consumption spending, as you see in the following chart. We also have myriad anecdotal evidence that newly extended credit is indeed going into infrastructure and other government favored investment projects. This is awful news for badly needed structural reform.

However, to play devil's advocate, I'll name a few reasons China's presumably astute economic planners might be justified in their conservatism. The first is that the actual level of government debt might be twice the official statistic. Local governments in China, typically barred from issuing debt, have turned to other channels such as commercial legal entities. One report estimated local government debt at around RMB 4 trillion. But even adding SOE and other implicit obligations, China's overall debt level would be much higher but still low compared to many other economies. This brings us to a second and related government worry. One reason China's debt level is relatively low is the low liabilities promised by the government to its citizens. As China's populations ages, even modest expansion of the social welfare net would incur large potential liabilities. And a third argument is that China's bureaucracy is simply not fast moving enough to be able to accommodate a large expansion in social spending without waste and corruption. Not just China --- think of all the FEMA trailer and payment scandals following Hurricane Katrina.

Similarly, while the international monetary system is indeed defective, this is hardly the sole reason for the world’s vast accumulations of foreign currency reserves. Another is over-reliance on export-led growth. Nevertheless, Governor Zhou is correct that part of the long-term solution of the crisis is a system of reserve creation which allows emerging economies to run current account deficits safely. Issuance of SDRs is a way of achieving this goal, without changing the fundamental character of the global system.

China is seeking to engage the US. That is itself enormously important. However self-seeking its motivation, that is a necessary condition for serious discussion of global reforms. Yet China must also understand an essential point: the world cannot safely absorb the current account surpluses it is likely to generate under its current development path. A country as large as China cannot hope to rely on such large current account surpluses as a source of demand. Spending at home must still rise sharply and sustainably, relative to growth of potential output. It is as simple – and difficult – as that.

The reason this is a critical issue, says Wolf, is that

Fiscal deficits are now generally far bigger in countries with structural current account deficits than in those with current account surpluses. This is because the latter can import a substantial part of the stimulus introduced by the former. The Organisation for Economic Co-operation and Development forecasts a jump in US public debt of almost 40 per cent of gross domestic product over three years (see chart). It is quite likely, therefore, that the next crisis will be triggered by what markets see as excessive fiscal debt in countries with large structural current account deficits, notably the US.

As Michael Pettis and others consistently point out, on a macroeconomic levels, global accounts must balance. China has a lot to do with cleaning up these imbalances. I hope to see them move much more quickly to deal with it.