Friday, April 18, 2014
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China’s Struggle to Slow

BEIJING – At the opening of the annual session of China’s parliament, the National People’s Congress (NPC), Premier Wen Jiabao announced that the government’s target for annual economic growth in 2012 was 7.5%. With the global economy still struggling to recover, Wen’s announcement of such a significant dip in China’s growth rate naturally sparked widespread concern around the world.

But it is important to note that Wen was expressing a policy rather than forecasting performance. The purpose of targeting a lower growth rate, he explained, is “to guide people in all sectors to focus their work on accelerating the transformation of the pattern of economic development and making economic development more sustainable and efficient.”

Fixed-asset investment is the most important engine of China’s growth. As a developing country with annual per capita income of less than $5,000, there is still significant room for China to increase its capital stock. But the growth rate of investment is too high. The issue is not whether China needs more investment, but whether China’s absorption capacity can continue to accommodate the rapid investment growth of the past decade.

In this sense, the investment rate, which in China approaches 50% of GDP and is rising, can be regarded as a measure of the stress that fixed investment places on the economy. It is not entirely an exaggeration to say that the economy’s capacity for investment growth has reached its limit.

The recent high-speed rail debacle is a case in point. In 2003, China built its first high-speed-rail project. As a key component of the RMB4 trillion ($630 billion) stimulus package introduced during the 2008-2009 global financial crisis, investment in high-speed-rail construction increased by leaps and bounds. By the end of 2010, China’s operational high-speed-rail network surpassed 8,000 kilometers, with an additional 17,000 kilometers under construction. By contrast, all Western countries combined took a half-century to build a total of 6,500 kilometers. Built in such haste, catastrophe was almost inevitable.

Investment growth that surpasses an economy’s absorption capacity will lead to a rapid deterioration in the efficiency of investment, which in turn will harm long-term growth prospects. Evidence of this in China today is all too prevalent. To reverse this trend, some respite in investment growth is not only necessary, but also inevitable in a profit-driven economy.

While China’s investment rate should be brought down to a sustainable level, an equally, if not more, important challenge is to adjust the structure of investment. For many years, the single most important category of investment in China has been real-estate development, which accounts for roughly 10% of GDP and a quarter of total investment. But resources need to be allocated to projects that build up human capital, provide public goods, and foster creativity and innovation. Adjusting the investment structure, however, will inevitably cause investment growth to decelerate, at least in the transitional period, thus leading to a slowdown in overall GDP growth.

International trade has played a pivotal role in China’s economic development over the past 30 years. However, the global market is no longer able to absorb China’s massive exports, not to mention the immediate impact of economic malaise in Europe and the United States on export demand. Moreover, rising labor costs and a stronger renminbi will also undermine China’s export sector, causing GDP growth to slow this year.

Few would argue against China’s need for slower but better growth. The problem is that if China wishes to lower the GDP growth rate to 7.5% in 2012, from 9.2% in 2011, without worsening the growth pattern by raising the high investment rate even further, the annual growth rate of investment must be equal to or less than 7.5%.

A back-of-the-envelope calculation suffices to show that, unless the government is prepared to tolerate a further increase in the investment rate, achieving a GDP growth target of 7.5% implies a significant fall in the growth rate of investment. To compensate for the negative impact on GDP growth, and with export growth constrained by weak global demand, consumption must rise even more sharply, which is hard to imagine. In other words, lowering the GDP growth rate to 7.5% without making China’s growth pattern even more irrational is an impossible mission.

So a more likely growth scenario for 2012 is that China’s growth will be lower than in 2011, but still significantly higher than 7.5%. Correspondingly, its investment-driven growth pattern will be strengthened further, though at a slowing pace. Otherwise, a policy-induced hard landing would be difficult to avoid.

Indeed, how to achieve a more moderate growth rate without causing a hard landing is one of the most severe challenges confronting the Chinese government. A hard landing is simply not an option.

With the country’s fiscal position still positive, it is difficult to image that the Chinese leadership would be so headstrong about “accelerating the transformation of the pattern of economic development” as to risk such an outcome. Even if it is, GDP-obsessed and debt-ridden local governments are likely to strive to achieve the highest possible growth rates for themselves, while paying lip service to Wen’s call for a slowdown. That is why, despite the official target, most Chinese economists still bet on a growth rate well above 8% for 2012.

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  1. CommentedJonathan Lam

    Gamesmith94134: Dr. Doom Warns Wall Street and Washington---- Heed Karl Marx's Warning!

    Mr. Gert van Vugt,

    You make the best description on the theory on the economical growth Paradigm that the economic change seems like Malthusian’s diminishing return, and I agree. However, Mr. Roubini makes his point on the social disruption reverse itself through the diminishing demand. If we can put away the elements like the Ponzi scheme and benefactors in social caused deficiency or defects to growth. Corruption by capitalism and the dependency by socialism among societies both caused failure in the economical and societal development.

    Perhaps, we focus on the circuitry on the accumulation of wealth and consumable wealth that runs the economy. It seems both the capitalism and socialism ran short and proven wrong in the economical model or social model that became self-destructive; eventually, the economy runs from diminishing demand to diminishing return, or vice versa. So, if we use the living standard as the equilibrium position to the supply line of the circuitry of wealth balanced by both of the diminishing return and diminishing demand.

    How about I call my paradigm on the wealth circuitry in economical and social growth that supports and balances both accumulated wealth and consumable wealth; and it created a “Z” shaped development running both on the diminishing demand and diminishing return; which is based on the assumption, the route above the standard of living equal in length with the one below the standard of living is in agreement of its living standard to sustain a viable growth, which contains;

    • The base line as the diminishing return where the societies kept peace with its populace that consumable wealth that cause economical displacement like with its negative growth or no growth; it provides entitlement or social programs with non-productive individual citizens for example, 27% of its population on welfare with add-on with subsidies to sustain a standard of living.

    • The top line as the diminishing demand that ended with accumulated wealth favors of concentrated wealth owned by individuals that ended with profitless, 1% holds 27% of the global or national wealth, plus those with extra wealth is not in production yields to no growth.

    • And the diagonal line that connected to both ends is the support of the price and value in the middle is the standard of living which contains the most of the productive individuals who is moving up and down the ladder of growth.

    If more of the wealth accumulated than the wealth consumed, then it causes saturation of the wealth. The diminishing demand under the standard of living agreement made the demand idle because of the shortage of consumption. In the process, the standard of living will go down to meet its demand after the deflationary measure to make it consumable. In reverse, the wealth consumed is over the wealth accumulated, as it is less profitable. Then, it triggers the inflationary measures to aggregate demand to accumulate more wealth in its diminishing return mode; eventually it will balance itself again with the agreement of the standard living with a viable growth.

    It is not the supply and demand. It is rather the circuitry of wealth under the spells of the lower living standard that diminishing demand is being part of the deflationary measure. If the accumulated wealth became saturated, then it means the lower living standard that made the demand finite like lesser demand in loan of dollars in ECB.
    I am certain I am not being introspective; I may twist the theory a little; but the proof of the lower living standard in Europe made it plausible.

    May the Buddha bless you?

    Gamesmsith94134: Free-Trade Blinders


    “The experiment is based on somewhat of a false premise, because it speaks to an American audience where the lower class is currently the one facing the most challenges from free trade.”

    Since I do not have the figures to knick around, and I would explain Dani Rodrik’s experiment for its natural scientific reasoning like ones I wrote above my paradigm on the wealth circuitry in economical and social growth that supports and balances both accumulated wealth and consumable wealth; and it created a “Z” shaped financial development running both on the diminishing demand and diminishing return; which is based on the assumption, the route above the standard of living equal in length with the one below the standard of living is in agreement of its living standard to sustain a viable growth; and Societal changes due to the democracy on globalization. In assimilation, the shift of wealth circuitry make the redistribution of wealth from the developed nations, like US, EU, to the emerging market nations like China, India or Brazil. It would show how the wealth circuitry globally settling the living standard inequality to balance itself through the diminishing return as in welfare states or communistic position, and the diminishing demand as in capitalistic position when each maximized it top or bottom setting to its extreme. Since the ladder of growth with those defined the value and price expanded and extended its living standards in either ways, it develops a newer term of demand or supply to shift the advancement of living standard after inflation or deflation.

    Perhaps, it is observable that American turned welfare state that its economy turn anemic with some 1% loaded with wealth and 99% struggle to strive above the living standard that held itself to a diminishing demand. In reverse, the diminishing return states like communistic China benefits its labors after the globalization; their living standard rose after 20% increased salary and so is the demands of goods internally and externally. Now, Asian purchased 50% of the luxury good EU produced. Then, it is how the Capitalist turns communist, and communist turns capitalist; as much of the inequality of the living standard of the two combined to merge, the expansion of the global economy may reverse itself that a cycle of accumulated wealth circuitry is completed and the standard of living is moving with the strength of the frequency of the flow of wealth that is kept in it wealth accumulated circuitry in a long run. Perhaps, it is not “The question of who wins and who loses is always important, but it's not always the educated and wealthy who win in free trade and it's not always the poor who lose in free trade. All those manufacturing jobs going overseas?” as you said when these inequality living standard make the world goes around with globalization and free trade.

    In conclusion, there are deficiencies of both capitalism and communism in handling the accumulated wealth because of the agency and structure in societal developments due to a fact of the productivity model that each bounded to a death end for either a diminishing return or diminishing demand. We may always laugh at the communists for it insufficient supply; but if we understand better of our recession to depression for its lack of demand too. It is not the dogma that kept its economy stood still, but the accumulated wealth makes the world goes around. Perhaps, democracy and free trade is the motion of the cash flows in politics for its populace and they do affect nations of wealth globally. To-day, topsy-turvy is the diminishing return and diminishing demand are marginally reversing themselves when the all living standard merging themselves in creating the globalization and democracy setting in motion to make fee trade in balancing the outcome. When I ask why should US dominate the higher profitable in trading the high tech if it aborts its blue collars workers, or did it turn itself into welfare state by giving the rich ones another break? If US is not attempt to make its appropriate living standard for its people in lesser welfare state, the globalization and democracy will downgrade its status as developed nation to underdeveloped whether it will sustain its free trade environment or not. God bless America.

    “But democracies owe themselves a proper debate, so that they make such choices consciously and deliberately. Fetishizing globalization simply because it expands the economic pie is the surest way to delegitimize it in the long run.” Said Dani Rodrik.

    And, may the Buddha bless you too?