After the Storm
China’s Bad Growth Bet
Nouriel Roubini
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LONDON – I recently took two trips to China just as the government launched its 12th Five-Year Plan to rebalance the country’s long-term growth model. My visits deepened my view that there is a potentially destabilizing contradiction between China’s short- and medium-term economic performance.
China’s economy is overheating now, but, over time, its current 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. Instead of focusing on securing a soft landing today, Chinese policymakers should be worrying about the brick wall that economic growth may hit in the second half of the quinquennium.
Despite the rhetoric of the new Five-Year Plan – which, like the previous one, aims to increase the share of consumption in GDP – the path of least resistance is the status quo. The new plan’s details reveal continued reliance on investment, including public housing, to support growth, rather than faster currency appreciation, substantial fiscal transfers to households, taxation and/or privatization of state-owned enterprises (SOEs), liberalization of the household registration (hukou) system, or an easing of financial repression.
China has grown for the last few decades on the back of export-led industrialization and a weak currency, which have resulted in high corporate and household savings rates and reliance on net exports and fixed investment (infrastructure, real estate, and industrial capacity for import-competing and export sectors). When net exports collapsed in 2008-2009 from 11% of GDP to 5%, China’s leader reacted by further increasing the fixed-investment share of GDP from 42% to 47%.
Thus, China did not suffer a severe recession – as occurred in Japan, Germany, and elsewhere in emerging Asia in 2009 – only because fixed investment exploded. And the fixed-investment share of GDP has increased further in 2010-2011, to almost 50%.
The problem, of course, is that no country can be productive enough to reinvest 50% of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.
Commercial and high-end residential investment has been excessive, automobile capacity has outstripped even the recent surge in sales, and overcapacity in steel, cement, and other manufacturing sectors is increasing further. In the short run, the investment boom will fuel inflation, owing to the highly resource-intensive character of growth. But overcapacity will lead inevitably to serious deflationary pressures, starting with the manufacturing and real-estate sectors.
Eventually, most likely after 2013, China will suffer a hard landing. All historical episodes of excessive investment – including East Asia in the 1990’s – have ended with a financial crisis and/or a long period of slow growth. To avoid this fate, China needs to save less, reduce fixed investment, cut net exports as a share of GDP, and boost the share of consumption.
The trouble is that the reasons the Chinese save so much and consume so little are structural. It will take two decades of reforms to change the incentive to overinvest.
Traditional explanations for 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. Chinese consumers do not have a greater propensity to save than Chinese in Hong Kong, Singapore, and Taiwan; they all save about 30% of disposable income. The big difference is that the share of China’s GDP going to the household sector is below 50%, leaving little for consumption.
Several Chinese policies have led to a massive transfer of income from politically weak households to politically powerful companies. A weak currency reduces household purchasing power by making imports expensive, thereby protecting import-competing SOEs and boosting exporters’ profits.
Low interest rates on deposits and low lending rates for firms and developers mean that the household sector’s massive savings receive negative rates of return, while the real cost of borrowing for SOEs is also negative. This creates a powerful incentive to overinvest and implies enormous redistribution from households to SOEs, most of which would be losing money if they had to borrow at market-equilibrium interest rates. Moreover, labor repression has caused wages to grow much more slowly than productivity.
To ease the constraints on household income, China needs more rapid exchange-rate appreciation, liberalization of interest rates, and a much sharper increase in wage growth. More importantly, China needs either to privatize its SOEs, so that their profits become income for households, or to tax their profits at a far higher rate and transfer the fiscal gains to households. Instead, on top of household savings, the savings – or retained earnings – of the corporate sector, mostly SOEs, tie up another 25% of GDP.
But boosting the share of income that goes to the household sector could be hugely disruptive, as it could bankrupt a large number of SOEs, export-oriented firms, and provincial governments, all of which are politically powerful. As a result, China will invest even more under the current Five-Year Plan.
Continuing down the investment-led growth path will exacerbate the visible glut of capacity in manufacturing, real estate, and infrastructure, and thus will intensify the coming economic slowdown once further fixed-investment growth becomes impossible. Until the change of political leadership in 2012-2013, China’s policymakers may be able to maintain high growth rates, but at a very high foreseeable cost.
Nouriel Roubini is Chairman of Roubini Global Economics (www.roubini.com), professor of Economics at the Stern School of Business at NYU and co-author of Crisis Economics, whose paperback edition is forthcoming this month.
Copyright: Project Syndicate, 2011.
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Blankfiend 08:12 15 Apr 11
Excellent article. Thank you Professor Roubini. This sounds like the type of explosive mix that could lead to civil unrest that would further exacerbate the "hard landing."
njweatherdon 04:45 16 Apr 11
It'd be interesting to see a sectoral and/or regional disaggregation of the share of fixed investment.
Not sure how much we can take data on that stuff seriously though.
Also, I think the 47% number can be considered as somewhat of an outlier because it, in part, reflects the stimulus. I wouldn't be surprised to see numbers more toward the 40% range soon enough, and probably declining slowly over the medium or long run. So the concern of approaching 50% is, perhaps not something that needs to be worried about.
In my opinion, given the plausible nature of the downside risks mentioned in the article though, I think they are definitely worthy of consideration even if there are likely more reasons to be optimistic.
SSSChambers 01:29 17 Apr 11
It seems to me that China can pursue their current path, albeit with increasing consumer spending, for a long time. Unlike other countries, they have 1.3 BILLION people to bring towards a middle class level.
sfeng 05:58 18 Apr 11
A typical view looking from West to East... The reform and the eventual rise of China is a gradual and complicated process. The consenus/harmony/gradual approach might be slow; but it provides the crucial stability required to change from a export and investment driven model to a more sustainable internal consumer driven model. I am optimistic on China in the long-run, but do understand the political and economical challenges faced by China. Understanding China, too optimistic or too pessimitic view could disappoint you. Again, I am optimitic on the GRADUAL rise of China. In such a proces, the symbiotic relationship between China and US is crucial and I trust the people in both countries to take a wiser road - a bi-polar or tri-polar system is more stable for the world.
PaulRepstock 03:48 23 Apr 11
Mr. Roubini like most economists seems to totally ignore the real world when modeling the future. Rather than worry about the economic effects of China's growth on our Western lives, we should be more concerned that those emerging countries with large populations might not have time to develope sufficiently robust infrastructure to protect their people from naturally occuring events. Had Japan's recent earthquake event struck China or India instead, the casualties would have been in the tens if not hundreds of millions, and the shock to the World's productive capacity would have been far greater and of longer duration.
As an aside; if one reads the second half of the article and substitutes US for China, in the description of the socio economic sypmptoms, the article still reads consistently?
All attempts and suggestions for macro management are skewed by self interest of the proponents of the schemes. As another poster suggested a gradualist approach is more reasonable. The landscape will probably find it's own level no matter what we do. There are factors historical and future which cannot be calculated. Whether it be OCPF or climate change the effects cannot be calculated at this time.
rebentisch 12:42 07 May 11
In the context of a hard landing we could also discuss options for a territorial disintegration of China.
fblancbrude 05:37 11 May 11
Prof Roubini is being bold by putting a date on China's day of reckoning... I wonder what makes him say that after 2013 some kind of threshold will have been reached for China.
The other important question is to know what a 'hard landing' might mean for China. In all likelihood it just means a new NPL crisis and recap programme of Chinese banks (with will only cost a fraction of the USD3Tr reserves).
What else is going to happen? 300m people are going to move to the city.
Structural change = economic growth
wiretap 11:27 11 May 11
The scenario laid out in this article hinges on the cost of financing the corporate sector rising. What is the scenario that will lead to rising interest rates?
tango9111 09:39 15 May 11
Has China overinvested in infrastrucutre? It would be interesting to know. If not, there may still be room to run and those investments might payoff in further economic growth rather than lead to stagnation.
Also it appears the Chinese government has already anticipated the need for more consumer spending. Will it take two generations? Seeing all of those Audis on Chinese roads and the huge number of young, smart Chinese coming of age, maybe a five year plan is not so far off.
libertastotus 07:34 07 Aug 11
China is lack of a commercial infrastucture to sustain vital across-the-board domestic consumption. In Bejing, the captital of the country, with a very dense population just like New York or London, in most of the areas you can't even find convenient stores to buy a bottle of water or soda. You can buy a bottle of water from small cigarette stands as there are plenty of them. However, you have very limited choices for a bottle of soft drink at a cigarette stand. That's the capital, the most developed city of the nation. I visited that city a number of times, and I walked around a lot. That's a personal experience. You want to buy electronic gagets in Beijing, go to this area called Zhongguancun. There are a number of huge buidlings that are termed as the mega malls of electronic goods. When you go inside, you realize on every floor there are dozens or even more a hundred small booths that sell similar items one next to the other. You don't know if a booth carries what you are looking for and there are no pricing labels on the any of the items on display. You start with one booth, ask for what you are looking for, find out about the pricing, bargain with the shop keeper, and you repeat those activities onto the next booth. It was not easy to shop in those mega malls. One time I was there to look for a power adator for the 220 volt wall outlets in China. It took me a good hour to finally find one. Domestic consumption? There is a long way to go.
ebrunar 02:31 15 Apr 11
If China's goal is to steer towards long-term, reasonable appreciation of the renminbi, wouldn't it make sense to try to build enough capacity to enable Chinese producers to keep their sales profitable by gains in volume, helping maintain the jobs picture in the reputedly inefficient State-controlled factories?
Whichever way it goes, I hope the people will only put up with this to a point and find ways to apply sufficient pressure in the system to at least improve the way the regime organizes the exploitation. The current tightening makes me nervous.