Video of my TV interview with CNC (Xinhua News Agency TV) on China's rise and its impact on APEC can be watched here.
Gavyn Davies has a long analysis of the sustainable speed of China's economic growth on his Financial Times blog. Below is the comment I wrote on it - the comment is rather self-contained so can be read as a stand alone. Normally, of course, I would like to reproduce both sides of the argument but I cannot do so without infringing the Financial Times copyright. Readers are therefore, of course, encouraged also to read Gavyn Davies own analysis which can be found here.
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Rather than taking 3rd party projections, which do not control China's economic policy, the starting point needs to be China's own stated goal. As set out in the latest 5 year economic programme this is to double GDP between 2010 and 2020 - average growth 7.2%.
So far since 2010 each year growth has exceeded this target. On the official target, total GDP growth 2010-2014 should be 32.1%. If a probably excessively conservative 7.3% growth in 2014 is assumed then actual growth 2010-2014 will be 36.1% - significantly above target. This means 6.7% average annual growth would have to be maintained until the end of the decade. If I were in the habit of making bets I would place a very significant sum of money on the fact China's target will be met, rather than the deceleration to 3.9% endorsed by Larry Summers, the Conference Board or 'bought' by George Magnus, to use his own phrase on a recent Twitter discussion (or the 3-4% projected by Michael Pettis).
One of the good things about this discussion, however, is that numbers are now used by serious participants instead of vague talk of 'slowdown' - if China's growth is 0.5% or 7.0% this is 'slowdown' but evidently the real meaning of the two numbers would be totally different.
I have set out at the fundamental factors which permit China to maintain such high growth rates in 'China's Economic Growth in the Light of the Findings of Modern Western Economic Research' which can be found here.
My own view is that China at present is making some policy mistakes which are knocking a bit, probably 0.5% - 1.0%, off the actual growth rate it could achieve. This would not be the first time such mistakes have been made, and in other periods its targets have been exceeded - naturally the targets are averages. But the present situation merely means China is coming down closer to its official growth rate rather than substantially exceeding it.
There is no indication China will not make its own target and every indication Larry Summers, the Conference Board and George Magnus will be wrong - although I much respect the fact they are engaging in serious projections which can be empirically tested, as opposed to meaningless rhetoric sometimes used in discussion on China.
Inbound investment into China continues to be the highest for any developing economy - US$101 billion in 2013 on UN data. But the pattern of investment in China is changing significantly as the country develops, and this trend will inevitably become more pronounced. China refusing to acknowledge and internalise that only 30% of the world’s population now lives in countries with a higher per capita GDP than China leads to confusion on the key issues in foreign investment.
In the first decades after the start of China's economic reforms in 1978, inward foreign direct investment (FDI) was primarily undertaken by overseas companies to create a base for exports. Although this was helpful in China's early stage of "reform and opening up," the investment was frequently very low value added. For example, a 2009 study found China received only 2 percent of worldwide wages paid for iPod production despite the fact that every iPod, at that time the world's most successful consumer product, was manufactured in China.
As recently as 2010, the majority of China's exports came from foreign-owned companies. Among large exporters, the role of foreign investment was even greater - of the top 200 exporting companies in 2009, 153 were foreign-funded. Only among small and medium size exporters were Chinese companies dominant and Alibaba's original success was creating the Internet systems that connect these Chinese companies to their foreign markets.
But as China's economy has developed, the reason for its attractiveness to foreign companies has radically changed. In comparative international terms, China is no longer a low-wage economy. On World Bank data, only 30 percent of the world's population now lives in countries with a higher per capita GDP than China, and wages will be approximately proportional to this. In Southeast Asia and South Asia, every developing country except Malaysia now has a lower per capita GDP than China.
For many foreign companies aiming at exporting, China's unrivalled skill in major manufacturing fields has become the country's main attraction. A U.S. study, with the self-explanatory title "Why Apple builds iPhones (and everything else) in China," spells this out clearly. The New York Times posed the question, "What does China have that America lacks?" The conclusion was:
"Quite a lot. China has more mid-level engineers, a more flexible workforce, and gigantic factories that can ramp up production at the drop of a hat. China also offers tech firms a one-stop solution. 'The entire supply chain is in China now,' a former high-ranking Apple executive tells The Times. 'You need a thousand rubber gaskets? That's the factory next door. You need a million screws? That factory is a block away. You need that screw made a little bit different? It will take three hours.'"
Indeed, the example of the iPhone, now the world's most successful consumer product, graphically shows how China's manufacturing capability saved what is now a triumph from a potential PR disaster. As the New York Times noted:
"A little over a month before the iPhone was scheduled to appear in stores, Mr. Jobs beckoned a handful of lieutenants into an office. For weeks, he had been carrying a prototype of the device in his pocket. Mr. Jobs angrily held up his iPhone, angling it so everyone could see the dozens of tiny scratches marring its plastic screen… People will carry this phone in their pocket, he said. … 'I won't sell a product that gets scratched,' he said tensely. The only solution was using unscratchable glass instead. 'I want a glass screen, and I want it perfect in six weeks.' After one executive left that meeting, he booked a flight to Shenzhen, China. If Mr. Jobs wanted perfect, there was nowhere else to go."
The result was that when the screens arrived: "the workers were assembling 10,000 iPhones a day within 96 hours. Another example: Apple had originally estimated that it would take nine months to hire the 8,700 qualified industrial engineers needed to oversee production of the iPhone; in China, it took 15 days."
Low wages are therefore no longer China's key attraction for foreign investors.
"Wages actually aren't that big a part of the cost of making consumer electronics… Paying American wages to build iPhones would add only about US$65 to the retail price of each handset, according to analysts' estimates. That's an amount Apple could likely afford. And in fact, China no longer offers rock-bottom wages. But when it did, it used that window 'to innovate the entire way supply chains work,' says Sarah Lacy at Pando Daily. China is now 'a place other countries can beat on sheer cost, but not on speed, flexibility, and know-how.'"
The second fundamental feature of the new situation for inward FDI is that since 2007, China has not only been an export base, but it has also been the world's most rapidly growing market in dollar terms as well as in percentage terms. This will only continue. This is a result of the fact that although the U.S. remains the world's largest economy, at market exchange rates, China's growth rate is almost three times that of the U.S. Consequently, as shown in the chart, in 2013 China's increase in GDP was US$1,038 billion compared to US$555 billion for the U.S., i.e. China's dollar GDP increased by almost twice as much as it did in the United States.
China's unparalleled market expansion presents decisive advantages for potential company growth. In stagnant or more slowly growing markets, such as the U.S. and Europe, to achieve rapid growth most companies have to increase market share. In China, in contrast, rapid growth can be achieved without gaining market share but simply through ongoing market expansion - an easier prospect. FDI is therefore increasingly taking advantage of China's domestic market, not for exports. A further result, consequently, is that FDI increasingly flows into the service sector, which primarily serves China's domestic market and not exports. In 2013, 52 percent of inward FDI went into China's service sector.
But if China's market expansion is the world's fastest, there is no doubt competition for companies engaged in FDI is becoming tougher in certain respects. In its earlier stages of development, China so badly needed FDI that it offered formal tax concessions and regulatory enforcement was sometimes lax. Tax concessions are already largely abolished, and lax enforcement is being tightened.
The latter includes dealing with criminality - in 2010 RTZ employees in China admitted taking kickbacks and recently GlaxoSmithKline was fined US$490 million after it was found to have bribed doctors to sell its drugs. Anti-competitive behavior is also being clamped down on. This year six infant milk powder companies were convicted of price fixing, and fined US$110 million, while 12 Japanese auto-parts makers were also fined US$200 million for the same offence.
Foreign companies investing in China continue to enjoy clear advantages in key sectors. These include in advanced technology industries, apart from defence - for example high end computer services and civil aircraft production; highly concentrated global industries dominated by global producers such as automobiles, and non-financial services in general - for example supermarkets and fast food chains. But in medium technology, or many rapidly growing industries, Chinese companies are increasingly tough competitors - Lenovo not only dominates China's domestic computer market but has become the number 1 PC producer globally, while China's smartphone manufacturers, such as Xiaomi, Lenovo and Huawei, are increasingly effective in domestic competition with Apple and Samsung.
Given the size and growth of China's market, inward FDI will remain at very high levels. But the days of China as a cheap labor export base are ended – because the majority of the world’s population is now at a lower level of economic development than China. Only by accurately analysing its real stage of development, and therefore its real position in the world economy, can China realistically assess its strengths and weaknesses in attracting foreign investment.
In a person modesty is admirable. But in serious economic matters neither boasting nor excessive modesty is a virtue – only realism. To navigate a ship must have an accurate chart – if it does not there is a danger it will hit a reef. The same applies not only to foreign investment but to China’s economic policy in general.
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The following article was originally published on 2 June 2014 and dealt with a resolution passed by the US House of Representatives. However its arguments clearly deal with the issue of human rights in general. For the reason's given in it, China's is easily the greatest contribution made to human rights by any country in the world.
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On May 28, the U.S. House of Representatives chose to debate a resolution expressing its concern over the issue of "human rights" in China. This makes it appropriate to make a comparison of the real records of the U.S. and China on human rights.
This is a vital issue as human well-being is certainly the sole goal of any correct policy -- including in that the right of each nation to pursue its national sovereignty and national culture, which is why China's "national revival" and overall human progress are inseparably linked.
Real human beings have an immense number of needs and desires ranging from basic ones, to have good health and enough to eat, through to the most complex -- the most advanced fields of human culture or science. Objectively only extremely developed societies, with enormous economic and social resources, can approximately meet all these needs.
Consequently the attempt to reduce "human rights" to a Western style political structure, as though having a "parliamentary" system were the most important question facing human beings, is ridiculous. The real issue was very well put by the BBC's correspondent in China, Humphrey Hawksley:
"I hear from an Iraqi wedding photographer who had lost so many friends and family members that he would gladly have exchanged his right to vote for running water, electricity and safety; from an Argentine shoe maker who bartered trainers for food because his economy had collapsed; and from the African cocoa farmer whose belief in the Western free market left him three times poorer now than he was thirty years ago."
The example of women in China and India can readily be taken to illustrate the real issues involved in human rights. A Chinese woman's life expectancy is 77 years and literacy among Chinese women over the age of 15 is 93 percent, an Indian woman has a life expectancy of 68 and literacy rate over the age of 15 is 66 percent. India may be a "parliamentary republic" but the human rights of a Chinese woman are (unfortunately)far superior to the human rights of a woman in India. Anyone who does not understand or admit that there are better human rights if a person lives nine years less or more and whether they are literate or illiterate is either out of touch with reality or a liar.
If the real meaning of the term "human rights" is used, it is evident that China has the best human rights record in the world -- and those words are carefully chosen. China has lifted more than 630 million people out of poverty -- more than the entire population of the European Union or the continent of Latin America, and almost twice the population of the U.S. China has brought social security protection to 820 million people, and health care to over a billion. China is responsible for 100 percent of the reduction of the number of people living in poverty in the world. No other country in the world has achievements remotely matching these for the real well-being of humanity.
What is particularly striking is the factual contrast between what China has achieved and the laughable claim of the U.S. to a superior "human rights" record. In the world outside China the number of people living in poverty in an economic system dominated by the U.S. has, according to international criteria defined by the World Bank, increased in the last 30 years. The United States has waged a series of aggressive wars in Iraq and Afghanistan in which hundreds of thousands of people were killed -- not to speak of its earlier war in Vietnam in which it killed 3 million people. Even leaving aside the economic realities, in the purely political sphere, since World War II the U.S. has, as the U.S. commentator William Blum noted:
• dropped bombs on the people of more than 30 countries;
• attempted to overthrow more than 50 foreign governments, most of which were democratically elected;
• attempted to assassinate more than 50 foreign leaders.
Furthermore, the facts establish clearly that the attacks on China's human rights record by the U.S.government, and those they support, are merely hypocrisy.
China openly states its foreign policy principle -- that each country has the right to choose its own form of government and whether it wants an absolute monarchy without political rights, a parliamentary republic, or socialism is not China's affair. The U.S., in contrast, in words claims the right to criticise other countries in the name of supposed "universal values" of Western forms of political rule.
But the reality is transparently different to this. A country such as Saudi Arabia, which is an absolute monarchy, in which political parties are banned, in which women are forbidden even to drive cars, is not subject to U.S. campaigns over "human rights." Nor is Bahrain, another absolute monarchy which serves as the base for the U.S. Fifth Fleet.
The U.S. involvement in events such as the military overthrow of Chile's president Allende is evident, and the U.S. has even formally admitted its role in the overthrow of the elected government of Mosaddegh in Iran.
In Russia in 1993 the U.S. government supported Yeltsin's attack with tanks on the Russian parliament, while they condemn as "anti-democratic" Putin, whom not only elections but every opinion poll shows to have the most popular support of any Russian leader in decades -- the difference between the two being that Yeltsin pursued a policy subordinate to the U.S. while Putin pursued a policy independent of it.
These facts establish beyond doubt that the problem for the U.S. government about China is not "human rights" -- if China were an authoritarian regime supporting the U.S. it would not be criticised. The real problem about China for U.S. neo-cons and their followers is that China's national revival makes it strong.
China's contribution to the real well being of humanity is not only greater than the United States but is unmatched by any other country in the world. Instead of complaining, the U.S. House of Representatives would be well advised to pass a resolution congratulating China for its unequalled contribution to human well-being in lifting over 600 million people out of poverty, establishing an enquiry to find out why U.S. supported economic policies in the rest of the world have made no such contribution to human rights, and publicly apologising for the hundreds of thousands of people it has killed in its wars -- including the thousands of ordinary U.S. soldiers who died in them.
Only when it does that will the U.S. House of Representatives begin to understand the real issues involved in human rights for real people of the real world.
August 22, 2014 is the 110th anniversary of the birth of Deng Xiaoping. Numerous achievements would ensure Deng Xiaoping a major position in China's history – his role in shaping the People's Republic of China, his steadfastness during persecution in the Cultural Revolution, his extraordinarily balanced attitude even after return to power towards the development and recent history of China, his all-round role after 1978 in leading the country. But one ensures him a position among a tiny handful of people at the peak not only of Chinese but of world history. This was China's extraordinary economic achievement after reforms began in 1978, and the decisive role this played not only in the improvement of the living standards of Chinese people but the country's national rejuvenation. So great was the impact of this that it may objectively be said to have altered the situation not only of China but of the world.
China's economic performance after the beginning of its 1978 reforms simply exceeded the experience of any other country in human history. To give only a partial list:
• China achieved the most rapid growth in a major economy in world history.
• China experienced the fastest growth of living standards of any major economy.
• China lifted 620 million people out of internationally defined poverty.
• Measured in internationally comparable prices, adjusted for inflation, the greatest increase in economic output in a single year in any country outside China was the U.S. in 1999, when it added US$567 billion, whereas in 2010 China added US$1,126 billion – twice as much.
• During the beginning of China's rapid growth, 22 percent of the world's population was within its borders – seven times that of United States at the beginning of its own fast economic development.
Wholly implausibly, it is sometimes argued that this success was merely due to "pragmatism" and achieved without overall economic theories, concepts, or a leadership really understanding the subject (particularly with no knowledge of U.S. academic economics!). If true, then the study of economics should immediately be abandoned – if the greatest economic success in world history can be achieved without any understanding of the subject, then it is evidently of no practical value whatever.
In reality this argument is entirely specious. Deng Xiaoping's approach to economic policy was certainly highly practical regarding application – the famous "it doesn't matter if a cat is black or white provided it catches mice." But it was extremely theoretical regarding foundations – as shown clearly in such works as In Everything We Do We Must Proceed from the Realities of the Primary Stage of Socialism, We Are Undertaking An Entirely New Endeavour, and Adhere to the Principle to Each According to his Work. Deng Xiaoping's outstanding practical success was guided by a clearly defined theoretical underpinning, which can be understood particularly clearly in its historical context and in comparison with Western and other economists.
As is generally known, after 1949 the newly created People's Republic of China constructed an economy, fundamental elements of which were drawn from the Soviet Union. It is important to understand that there was nothing irrational in this – the USSR, up to that time, had the world's most rapidly growing economy.
Indeed, the immediate post-1929 success of the USSR was of extraordinary dimensions. During 1929-39 the USSR achieved 6 percent annual GDP growth, which until then was by far the fastest ever achieved by a major economy, and almost twice the historical growth rate of the United States. Despite colossal destruction in World War II, by 1949 the USSR had already regained its prewar production level.
The elements which produced such historically unprecedented economic growth were clear. From 1929, Stalin, with the First Five Year Plan, launched the USSR on an economic policy never previously attempted in any country – construction of a national basically self-enclosed administered economy. Resources were not allocated by price but by material quantities – a steel factory did not buy iron ore on the market but had it allocated by administrative decision. Foreign trade was minimized. State ownership was applied even to small scale private enterprises such as restaurants. Farmers' small holdings were eliminated and agriculture organized into large scale collective farms.
Despite verbal claims that this policy was "Marxist," Stalin's economic structure was in fact radically at variance with that of Marx himself. To use the Marxist terminology common to both China and the USSR, Soviet economic policy in 1929, in a single step, replaced economic regulation by prices (exchange value) by allocation by material use (use value).
Marx had written a socialist state would: "wrest, by degree, all capital from the bourgeoisie, to centralize all instruments of production in the hands of the state... and to increase the total productive forces as rapidly as possible." In writing "by degree" Marx clearly envisaged a period during which state owned and private property would both exist. Instead, in the USSR in 1929 essentially all property was taken into the state sector.
The very word "socialism" is derived from "socialized" (i.e. large scale) production – not small scale peasant output. However in the USSR, after 1929, even small scale peasant plots were taken into state ownership – prior to their administrative elimination. However, simultaneously with suppression of small scale private output, the advantages of very large scale production were eliminated by the nationally self-enclosed character of the USSR's economy – a U.S. aircraft manufacturer like Boeing sold into the world market, but a Soviet manufacturer such as Ilyushin could produce aircraft only for the far smaller Soviet economy.
Soviet economists who pointed out these issues were executed by Stalin for doing so, but in any case such criticism appeared "theoretical quibbles" compared to proven Soviet economic success.
After 1945 this dynamic changed. In 1929 the global economy had been collapsing into "autarchic" states or empires. The United States, the British Empire, Japan and Nazi Germany, were cut off from each other by tariff walls. The international monetary system, the Gold Standard, collapsed without replacement. Amid such global economic chaos, the autarchic socialist USSR far outperformed autarchic capitalist economies.
But following World War II, the integrated world economy was gradually rebuilt. A new international payments system, the dollar standard, was created. Tariffs were reduced. The Soviet economy was small compared to this new world economy, and could not be integrated into it without relaxation of its planning system – as global economic fluctuations could not be planned for. Collectivized Soviet agriculture was unproductive and the USSR's consumer goods of low quality, due to Stalin's insistence on overwhelming priority to heavy industry – in Stalin's words: "What does a fast rate of development of industry involve? It involves the maximum capital investment in industry." By the 1970s Soviet economic growth, while more rapid than the United States, was far slower than Japan or South Korea – which were selling into the world market.
But, if the USSR's economy was heading to crisis, the free market system, its only existing alternative, was by the 1970s showing its own difficulties. After the 1973 "oil price crisis," most developed capitalist economies decelerated dramatically. The United States both slowed and from the early 1980s began the huge debt accumulation which eventually culminated in the 2008 international financial crisis. When the free market model was applied to the former USSR, from 1992 onwards, it led to the greatest economic collapse in a major economy in peacetime in history – Russia's GDP fell by 30 percent.
Confronted with decisive problems in both dominant economic models, instead of remaining trapped within one or the other, Deng Xiaoping embarked on a policy never previously seen – creation of what is now referred to in China as a "socialist market economy."
In one sense, Deng Xiaoping went from the USSR's post-1929 model "back to Marx." Underlying Deng Xiaoping's analysis from 1978, frequently in its literal wording, was Marx's famous "Critique of the Gotha Programme" – his most extensive commentary on the construction of a socialist society.
To see this close relation here for example is Marx's analysis: "What we are dealing with… is a communist society, not as it has developed on its own foundations, but… just as it emerges from capitalist society." For a person in such a society: "The same amount of labor which he has given to society in one form, he receives back in another." But: "In a higher phase of communist society… after the productive forces have also increased… society inscribe on its banners: From each according to his abilities, to each according to his needs!"
Deng Xiaoping's own post-1978 formulation is almost word for word Marx's: "A Communist society is one in which… there is great material abundance, and the principle of from each according to their ability, to each according to his needs, is applied. It is impossible to apply that principle without overwhelming material wealth. But in the present period in China, before the accumulation of such wealth, the principle was to each according to their labor/work: ‘We must adhere to this socialist principle which calls for distribution according to the quantity and quality of an individual's work." Deng's fundamental characterization was: "China is in the primary stage of socialism. Socialism itself is the first stage of communism, and here in China we are still in the primary stage of socialism – that is, the underdeveloped stage. In everything we do we must proceed from this reality, and all planning must be consistent with it."
But while in one sense Deng Xiaoping "returned to Marx," he necessarily had to resolve many problems of a modern economy Marx never envisaged. Purely theoretically, a number of these had been analyzed by Keynes in the 1930s. Keynes' fundamental conclusion was that investment played the determining role in the economy, "the fluctuations of output… depend almost entirely on the amount of current investment" (Keynes conclusion has since been comprehensively confirmed by statistics). As, in a modern economy, investment is financed by borrowing, Keynes advocated very low interest rates to incentivize investment. But Keynes judged these alone would be insufficient to stably maintain an adequate investment level. It was therefore necessary for the state to play a direct role in setting the level of investment: "I am… skeptical of the success of a merely monetary policy directed towards influencing the rate of interest… I expect to see the state… taking an ever greater responsibility for directly organizing investment." Keynes noted: "I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands."
But if the "the current volume of investment" were to be set, Keynes realized this meant a large state investment role: "I conceive… that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment."
Keynes noted such a "somewhat comprehensive socialization of investment" did not mean eliminating the private sector, but socialized state investment operating together with a private sector: "This need not exclude all manner of compromises and devices by which public authority will co-operate with private initiative… The central controls necessary to ensure full employment will, of course, involve a large extension of the traditional functions of government." Keynes, consequently, envisaged an economy in which a private sector existed but in which the state sector was sufficiently dominant to set overall investment levels.
But Keynes' analysis remained purely theoretical. It could not be implemented in the West for an insurmountable reason – which is why the West's "Keynesianism" bears little relation to Keynes' own writings! Capital investment is "the means of production." If the most basic investment decisions were not taken by private capital, it would no longer be a capitalist society. Keynes had developed an incisive theoretical analysis, but which could not be implemented in the society in which he lived.
Problems which were insurmountable for Keynes were, however, no problem for Deng Xiaoping – as he did not intend to create a capitalist society! To be clear, there is no evidence Deng Xiaoping's economic concepts were directly influenced by Keynes. But ideas Deng Xiaoping was entirely familiar with from Marx led to the same economic structure as Keynes. The state would retain ownership of large scale (i.e. socialized) economic sectors, thereby giving it the ability to regulate the investment level, while smaller scale economic sectors (non-socialized production) could be released to the private or non-state sector. The state therefore did not need to own the overall economy, just to own enough to set the overall investment level.
This is evidently the policy applied in China from 1978 by the replacement of the rural People's Communes created in the 1950s (collectivized agriculture) with small scale based farming (the "household responsibility system"). Then the policy known as Zhuada Fangxiao ("keep the large, let go the small") could be embarked on – maintaining large state firms within the state sector and releasing small ones to the non-state/private sector.
Therefore, although a vibrant private sector was created, the state sector was still large enough to set the overall investment level – i.e. the state sector remained dominant. As the Wall Street Journal summarized: "Most economies can pull two levers to bolster growth – fiscal and monetary. China has a third option … accelerate the flow of investment projects." An economic structure envisaged only in theory by Keynes was realized in practice by Deng Xiaoping.
Deng Xiaoping's economic structure simultaneously solved the problem of diverting resources from heavy industry and creating an abundant supply of consumer products. As the state owned heavy industry, prices in this sector could be controlled, while simultaneously those in agriculture and light consumer industry were liberalized. Relative prices therefore rose in agriculture and consumer industries, resources flowed into these sectors and their output soared. Simultaneously the urban population was protected against initial negative pressures on living standards by these price rises by subsidies financed by reducing China's armaments expenditure. The extraordinarily rapid growth this structure produced created large scale savings which, in a virtuous circle, could then finance the building of heavy industry on a new basis.
Simultaneously with reintroducing small scale "non-socialized" production, China's economy pursued international "opening up," allowing it to participate in the largest scale production of all – for the global market.
Therefore, far from Deng Xiaoping's economic policies being purely pragmatic, they flowed in an integrated fashion from underlying theoretical principles through to the solving of eminently practical issues. It was this which produced by far the greatest economic growth and social advancement seen in any country in world history.
This integrated character of Deng Xiaoping's economic system also explains why any diversion from it necessarily leads to economic problems. Any return to an administered economy leads to inability to take advantage of small-scale production and to integrate with, and take advantage of, a world economic market. Any system in which private enterprise is dominant loses the ability of the state to set the investment level, and thereby recreates the crises which both Keynes and Deng Xiaoping had successfully solved how to tackle. In short, no other figure in history has ever combined such deep economic thinking with such practically successful economic policy as Deng Xiaoping.
Deng Xiaoping was above all a great leader of the Chinese people. Through pursuit of his country's national revival, lifting over 620 million people out of poverty, he also made an unparalleled contribution to humanity's overall well-being.
But if that were not enough, Deng Xiaoping had another achievement. By far the greatest economist of the 20th century was not Keynes, Hayek or Friedman but Deng Xiaoping.
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This article originally appeared on China.org.cn on 22 August 2014.
Earlier this year sections of the Western media tried to spin a story that the world economy was experiencing 'severe slowdown in China' and 'strong recovery in the U.S.' – China's economy was allegedly in trouble and the U.S.'s doing well.
Now that the actual data is in for the first half of the year, it shows that the opposite was true. China's economic growth rate was 7.5% in the year to the second quarter of 2014, and the U.S.'s economic growth rate was 2.4% - China's economy grew more than three times as fast as that of the U.S.
Still more significantly for the U.S., its own statistical agencies and the IMF have officially revised their projections for long term US growth down – both organizations now estimate it at only 2%. The Economist, somewhat cruelly, put a cartoon of the US as a tortoise on its front cover, stating bluntly that U.S. 'long term growth has slowed.'
My calculations for the U.S. economy are marginally more optimistic. Over the last 20 years, U.S. average annual growth was 2.4%, and there is no short term reason why it should slow. But this is just a minor detail, since either estimate means the US will remain on a path of 2-3% annual growth.
What are the comparative prospects for China's economy – not over the next few months, but over the longer term, say to 2020? Answering this requires going beyond immediate news events and short term fluctuations, to the fundamental factors determining China's economic development.
Right at the beginning, it should be clarified that the medium/long term aim of China's policy is not to maximize GDP growth. This is explicit; indeed, it has become commonplace in China recently to say that what matters is not the quantity of growth, but its quality.
But unless it is specified what the criteria for 'quality' are and how 'quality' is to be measured, this becomes an empty, clichéd phrase, of the type China's President Xi Jinping stressed must be avoided. The only correct measure of 'quality' can be the overall well-being and national security of China's population, summarized by China's goal of 'comprehensive national renewal.'
This correctly contextualizes economic growth. Economic growth is not an end in itself, but is an absolutely indispensable means to achieve the desired ends. International comparisons show more than 80% of consumption growth, and over 70% of life expectancy extension – the latter reflecting factors such as health care and environmental quality – is the result of economic growth.
For those at the bottom of the income ladder, economic growth is particularly crucial. The Oxford Poverty and Human Development Initiative recently studied every country in the world's correlation between GDP per person and the Multidimensional Poverty Index (MPI), which considers ten indicators including nutrition, child mortality, and years of schooling. An extraordinarily close correlation was found – as The Economist magazine noted: 'Economic growth may thus not only be the best way to overcome extreme poverty, but also to reduce terrible non-economic social ailments as well.'
Since the attainment of a high standard of living – which requires high consumption, good environment, quality health care, and poverty elimination – is certainly at the top of the priority list if China is to maintain rapid overall progress, sustained high economic growth is indispensable. Fortunately, examination of economic fundamentals shows that, provided no major policy mistakes are made, China will continue to outperform all other major economies for a prolonged period.
Any economy's growth is necessarily determined by two simple ratios. The first is the percentage of the economy that is invested. Modern economic research shows that 57% of growth in an advanced economy is due to capital investment, 32% to increases in labour, and only 11% due to productivity increases (technically known as Total Factor Productivity – TFP).
Developing economies, such as China, at present have the advantage that they can apply technologies from more advanced economies without having to pay the research costs of developing them – a benefit known as 'catch-up.' In developing Asian economies, for example, 22% of growth is due to productivity increases compared to only 11% in developed economies, as the chart below shows.
But the advantage of being able to borrow technology without paying development costs disappears as an economy becomes more advanced. Therefore, the role played by productivity growth falls as an economy moves to higher income levels, while the role played by capital investment increases, as is also shown in the chart above. The percentage of growth accounted for by productivity declines from 19-22% in developing economies to 11% in advanced ones.
By 2020 China will be on the verge of becoming a 'high income' economy according to World Bank criteria. As China is no longer exempt from the economic growth rules that apply to any other country, its growth strategy must therefore assume that as it becomes more developed, its growth will become more and more dependent on capital investment and less dependent on productivity increases.
China's advantage in meeting this challenge is that its investment level, 47% of GDP, is the highest of any major economy, providing a solid basis for long term growth. Maintaining such a high level of investment is the first essential for China's rapid growth, while reduction in investment would affect growth negatively.
The second key ratio determining economic growth is 'how much bang you get for a buck' from investment. Technically this is known as ICOR (incremental capital output ratio): what percentage of GDP has to be invested to generate 1% GDP growth.
So far China's situation is also satisfactory in this respect. Taking the average for the latest three years for which there is data in order to avoid distortions caused by short term fluctuations, China invested 5.1% of GDP for each 1% rise in economic growth, whereas the U.S. had to invest 7.9% – China's investment was therefore about 50% more efficient that the U.S's investment. But China's investment efficiency has fallen – the gap used to be bigger. It is also striking factually that as China’s state investment has been held back, and therefore private investment has risen as a percentage of total investment, China’ ICOR has worsened – that is its overall efficiency of investment has declined.
A key reason is the slowdown in China's industrial growth. Productivity increases in services are much slower than in industry in all countries. But in the last three years China's industrial growth has significantly decelerated to around 9% a year, as shown in the following chart.
It is too early in China's development for it to shift from a manufacturing to a service-based economy. By comparison, South Korea is still an economy dominated by manufacturing, but China's per capita GDP is only one quarter to one third of South Korea's, depending on the measure used. A premature shift from industry to services would therefore lead to a significant decline in China's economic efficiency.
So far the problem is not serious – 9% industrial growth is sufficient to achieve China's 7.5% GDP growth target. But any further industrial deceleration would be damaging, as productivity growth in services cannot substitute for productivity growth in the manufacturing industry.
Maintaining the competitiveness of China's industry will therefore be the key to maintaining China's overall economic efficiency and growth in the coming years.
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This is an update and expanded version of an article originally published at China.org.cn.
Chinese President Xi Jinping's recent visit to Latin America illustrates that from both the economic and political viewpoint the relation between China and Latin America is increasingly becoming one of the world’s most important. Although Xi Jinping specifically used the phrase "community of shared destiny" to describe China's relations with Brazil, the term clearly applies to China’s conception of the relations between itself and the Latin American continent as a whole.
Economically a specific basis creating the basis for this relation is that China and Latin America are now regions of the developing world at similar stages of development. Adjusting for different price levels, calculating in World Bank parity purchasing powers (PPPs), Latin America's per capita GDP in 2013 was slightly under US$15,000 and China's slightly under US$12,000. Both were substantially higher than South Asia's US$5,000 or sub-Saharan Africa's US$3,400.
That China and Latin America are both at significantly higher levels of economic development than other major regions of the developing world means they have expanding and substantial areas for trade and cooperation. This also helps explain why trade between China and Latin America as a whole is almost exactly in balance – evidently substantially limiting any trade frictions.
Naturally, within that overall framework, individual issues in trade between China and Latin America remain. Manufacturing exports from China to Latin America are much more developed than those in the opposite direction. China's rapid growth in the last decade played a major role in helping most Latin American countries develop, by creating high demand and high prices for their energy and other commodity exports, but over the longer run Latin America will want to develop its own manufacturing exports to China. China's purchase of US$3.2bn of regional range aircraft from Brazil's Embraer, announced during Xi Jinping's visit, is an example of a trend with which Latin America will be concerned. Furthermore, China's relations with Latin America interrelate with a key strategic question for that continent's own development – Latin American economic integration.
China's economy is much larger than any individual Latin American countries – giving China a much larger market than theirs, and therefore creating the potential for huge developments in economies of scale and geographical specialization in different economic sectors. Measured at current exchange rates, China's GDP in 2013 was US$9.2 trillion compared to US$2.2 trillion for Brazil – Latin America's largest single economy.
This means that the question of Latin American integration is linked with its relation to China. For Latin America to develop relations firmly based on equality with China the continent as a whole has to relate to it, while China’s trade would clearly benefit from the much greater size of market and economic dynamism Latin American economic integration would create.
Simple numbers dictate this reality. China has approximately twice Latin America's population, and its economy is approximately twice as large as Latin America's, no matter how measured – in current exchange rates Latin America's GDP is US$5.6 trillion and China's US$9.2 trillion, and in PPPs China's GDP is US$16.2 trillion and Latin America's US$8.5 trillion.
If relations are only between China and one Latin American country, it is therefore objectively difficult to keep them balanced. But greater Latin American integration fits with China's own strengths. A large part of China's extraordinary economic development, an average 9% a year economic growth for over 35 years, is due to huge infrastructure investment. From 1992-2011 China spent an average 8.5% of GDP a year on infrastructure.
China has already promoted infrastructure projects as a key way of ensuring Asia's economic integration. Similarly Latin America's economic integration cannot be achieved without large scale infrastructure links. China's huge financial resources – the world's largest foreign exchange reserves and an economy generating over $4 trillion a year for capital investment compared to only $2 trillion in the United States – makes it the world's strongest economy to aid and participate in such development. China's infrastructure capabilities reach far beyond finance – its sale of ultra-high voltage transmission lines to Brazil, for example, is already important in aiding developing the hydro-electric power potential of the Amazon. Discussions between Brazil, Peru and China, during Xi Jinping's visit, on the development of a transcontinental railway indicate the scope of what is possible. On a smaller scale China is lending US$2.1bn to Argentina for railway development, and US$4.7bn for dam and power construction.
This interlinks with the considerable significance for Latin America of the announcement, at their recent summit, by Brazil, Russia, India, China and South Africa (BRICS) of the establishment of the US$50bn BRICS development bank and the US$100bn BRICS contingency fund. In terms of international finance, previously U.S. dominance of the IMF resulted in a historical record of that organization not being used in a genuinely multilateral way, as a means to allow developing economies to expand their economies, and overcome short term economic problems, but instead to impose policies which served U.S. financial interests and blocked economic growth of countries receiving loans – as writers such as Joseph Stiglitz have shown in detail. Latin American countries, as well as those in Asia, experienced this.
Despite U.S. government proposals to reform the IMF to better reflect the weight of developing economies, made during the international financial crisis, and which would have ameliorated this problem, the U.S. Congress has not passed the necessary legislation to achieve this. The BRICS countries were therefore able to agree to establish a lending mechanism which helps partially circumvent the U.S. veto in the IMF. While only an initial step China’s great financial fire power makes it the core of a trend that is likely to increasingly weaken U.S. dominance of international financial flows.
China's loan and aid policy, which is therefore likely to be influential in the new BRICS institutions, has radically differed in approach from the IMF. China has not required from those receiving loans or aid domestic economic policy conditions – China merely self-evidently required that its loans had to be repaid, receiving in a number of cases guarantees not only in cash but in commodities. But China did not specify what domestic policies should be pursued to ensure loan repayment but left this to the country concerned – a different approach to the IMF.
The BRICS development bank and contingency fund is therefore potentially significant not only for long term growth but for allowing Latin America to avoid experiences of the type seen in the continent's "lost decade" of the 1980s, when severely contractionary economic policies were imposed as part of the "Washington Consensus." In addition to the long term development from the BRICS bank, the sums available from the contingency fund will help countries avoid being forced into adopting unsuitable or damaging economic policies due to short term financial difficulties.
If the advantages of this for Latin America are evident, what are the advantages for China – because to be stable and long term any relationship has to be win-win? The answer is not only in immediate reciprocal trade and investment but the security in supply and markets Latin America can help bring to China.
China is sufficiently strong militarily that not even the most extreme U.S. neo-cons advocate a war with it. But China is conscious it is dependent on extremely internationalized sources of supply and markets – China has already overtaken the United States as the world's largest goods trading nation. Therefore, if any country wished to weaken China, it can attempt this by cutting off sources of supply or access to markets. For example, the sanctions implemented by the United States against Iran can directly put pressure on China's economy. Expanding China’s relations with Latin America allows China to diversify both its sources of supply and its markets – contributing to its economic security.
For these reasons Xi Jinping’s emphasis on the importance of China’s and Latin America’s links, its ‘shared destiny’ is unlikely to have been merely a rhetorical flourish for his hosts. It corresponded to the objective interests of both China and Latin America
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An earlier version of this article was published at China.org.cn .
Inaccurate articles sometimes appear claiming China faces a "severe debt crisis." Factually these are easily refuted. Changyong Rhee, the IMF's Asia and Pacific Department director, pointed out that China's national and local government debt is only 53% of its GDP, compared to U.S. government debt which is roughly as big as GDP, or in Japan where government debt is 240% GDP. Foreign debt is 9% of China's GDP – insignificant set against the world's largest foreign exchange reserves.
Factually, it is therefore unsurprising that China's predicted "Lehman" or "Minsky" moment, a financial collapse, invariably fails to occur. But there is another, even more fundamental, reason why China's economy does not suffer severe financial crises of the type that struck the Western economies in 2008 or wracked the Eurozone. As this illustrates a way that China's economic structure is superior to the West's, it is worth analyzing.
Starting with fundamentals, the way the argument is constructed that China faces a "serious debt crisis" violates the most elementary accounting rule – more precisely that of double entry book keeping, which was invented in Italy "merely" eight centuries ago! This is that for every debit entry there has to be a credit one, and vice versa. Discussion of only of one side of a balance sheet without the other is financial nonsense. Claims, such as in the Financial Times, that the big story of 2014 is "the black cloud of debt hanging over China" are financially meaningless given they do not discuss assets to be set against debt.
To illustrate this elementary accounting principle, take a simple example. A company borrows $100 million at 5% interest, uses it to build houses, and sells them at 15% profit. To declare "there is a crisis – the company has a $100 million debt" is evidently nonsense. The company has debts of $100 million but assets of $115 million. It can repay $105 million and make $10 million profit – there is no "debt crisis" whatever. That its assets are greater than its debt illustrates why it is financially illiterate to discuss only debt without assets. A "balance sheet" is called that because it has two sides, not one.
Apply this to China and the West's financial systems. Evidently no financial problem exists in either if a borrower makes a profit on a loan – they repay it. A problem only exists if the borrower does not make sufficient money to repay the debt.
If the borrower is a small or medium one, again there is no difference between Western and Chinese financial systems. In both cases the borrower partially or fully defaults and, if necessary, goes bankrupt.
Specific criticisms can be made, which this author would tend to agree with, that in the West's system companies are sometimes too easily allowed to use bankruptcy to escape debts, and China has propped up some companies that would have been better allowed to go bankrupt. But these are detailed points, not affecting the essence of the matter. China is also now taking a more robust line in forcing into default small and medium borrowers that cannot repay loans – recently Shanghai Chaori Solar Energy Science and Technology defaulted without a bail out.
But, by definition, individual bankruptcies by small and medium companies do not affect the financial system's viability – they are a normal part of market functioning. The key difference between China's and the Western financial system comes with debts by large institutions – "system making" ones to use technical economic terms. Here Western and China's systems differ – and China's is superior.
First take Western government debt. As Western governments ideologically oppose state investment, Western state borrowing is overwhelmingly used not to finance investment but consumption – via social security payments, unemployment pay etc. For example, in the United States at the depth of the post 2008 Great Recession, annual government borrowing was 13.6 percent of GDP but state investment was only 4.5 percent – borrowing overwhelmingly financed consumption. As Western government debt primarily finances consumption it therefore creates no lasting asset. That is why in the West it is not wholly misleading to look at state borrowing purely from the debt point of view – even if it is wrong conceptually.
China is different. The bulk of borrowing, particularly by local government, is for investment, primarily in infrastructure. Borrowing therefore creates lasting assets – roads, subways, housing etc. Assets in turn create revenue streams directly, indirectly, or both. Direct revenues are fares, rents, tolls, etc. Indirect revenues are generated as infrastructure investment aids economic growth, yielding taxes, and has well-known effects in raising land values – land sales being one of Chinese local government's biggest sources of income.
As China's government debt is used for investment, not consumption, analysis not financially offsetting debt by assets created by them is not merely wrong formally but is therefore a serious factual mistake. Similarly, company borrowing is primarily used for investment, i.e. asset creation.
This leads to a final difference between China's and the West's financial system. In both Western and China's financial systems, if the value of an asset created by borrowing equals at least the value of the debt, there is evidently no problem. The difference between the two comes with bad investments – where the value of the asset created does not equal the borrowing.
A major financial crisis occurs when there are large scale bad investments by "system making" institutions, those that are "too big to fail" – this need not be a single bad investment but can be very large numbers of small bad investments, as with the U.S. sub-prime mortgage crisis. In these cases, in both the West and China, only the state has the resources to solve the problem. But the way the state intervenes is entirely different in China and in the West.
In the West, the financial system is fragmented – individual institutions are financially separate. As there is no unified financial system, the necessary transfer of resources from the state, to prevent collapse of "system making" institutions, is therefore external and chaotic. For example, following Lehman's collapse, essentially every private Western bank had to be salvaged by government subsidies, direct nationalization etc. The same occurred with GM and Chrysler. In Greece, the EU and IMF ordered partial bond defaults, bailout packages etc. The transfer of resources from the state, and in some cases private bond holders, was via chaotic "crisis" means – the "Lehman moment."
Basic laws of economics cannot be avoided, so if in China a substantial number of bad loans occur, as with banks in the 1990s, the state also has to transfer resources. But in China the core of the financial system is not fragmented, but is a single integrated whole constituting central government, local governments, state banks, and large state owned companies. Resources are therefore not transferred by chaotic crisis, as in the West, but within this integrated financial system. China's financial system could be conceptualized by the analogy of a single person transferring money from one bank account to another – for example from the central government to bail out local governments. Or, if you want to put it more popularly, it is as though money is transferred from one pocket to another.
A transfer of resources from the state therefore takes place in China, as in the West, but in an orderly and not a chaotic fashion. That is why China never has a "Lehman moment" or a "Minsky moment," a large scale financial crisis – the superiority of China's financial system to the West precludes it happening.
To avoid misunderstandings, this does not mean that if large scale bad investments are made in China this does not create problems. If, for example, a bad railway investment is made which fails to generate adequate users, the resources transferred within the system to bail it out means these resources are not available to build a railway which is required. But the problem therefore not does appear in the form of systemic financial crisis, which does not occur for reasons outlined, but in the form of the economy's overall investment efficiency declining as resources are sucked into inefficient ventures at the expense of efficient ones.
The data on this latter process is clear. Every major economy suffered a decline in investment efficiency as a result of the international financial crisis. Taking the five years after the financial crisis began, the percentage of GDP that had to be invested in China for its economy to grow by 1% rose from 3.4% to 4.9% – China's investment efficiency worsened under the impact of the global financial crisis. But in the United States the percentage of GDP that had to be invested for the economy to grow by 1% rose from 8.1% to 33.1%! In other words, China came through the negative consequences of the international financial crisis much more successfully than the United States.
Because they ignore elementary accounting rules, those writing that China will suffer a severe "debt crisis" are writing financial fairy stories – which is why, as with all such tales, they never actually occur.
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The publication of the latest US GDP data casts a clear light on the false claim the US economy is recovering strongly and China faces 'crisis'. The data shows that in the last year, from the 1st quarter of 2013 to 1st quarter 2014, China's economy grew by 7.4% and the US economy by 1.5% – see Figure 1. Even given the effect of the bad weather on the US economy in the 1st quarter, the much greater growth impetus on China than the US is clear.
Taking the six year period, 1st quarter 2008 to 1st quarter 2014, as shown in Figure 2, the US economy grew by 7.1% and China’s economy by 63.0% – that is China’s economy grew almost nine times as fast as the US. In short all the claims of ‘China crisis, US strong recovery’ have no contact with the facts.
TV interview with me on China CCTV News about Chinese Prime Minister's visit to the UK - particular focus on internationalisation of RMB http://english.cntv.cn/2014/06/20/VIDE1403256725540259.shtml
RMB internationalization is one of the most important questions for China’s economy. But it is also one where developments will go more slowly than media speculation imagines, due to the real factors affecting it.
An exaggerated picture on RMB internationalization is presented when percentage growth figures are used as these are calculated starting from very low levels. For example, the proportion of RMB payments carried out in the United States in April 2014 rose by 100 percent compared to a year earlier, which sounds spectacular – except that the rise was only to 0.04 percent of all worldwide currency transactions. In April 2014 the RMB accounted for only 1.4 percent of international payments.
Taking China’s strongest area internationally, by the end of 2013, 8.7 percent of world trade was RMB denominated, but around 80 percent of this was with Hong Kong. The dollar’s global share was 81 percent. The European Central Bank states that by the second quarter of 2013 only 0.3 percent of international bonds were in RMB. By the beginning of 2014, 60 percent of foreign exchange reserves were in dollars, 25 percent in Euros and only 0.01 percent in RMB.
These numbers are so low that there is room for huge percentage increases, yielding profitable business for individual financial institutions, without the RMB’s peripheral position in global finance altering.
Beyond these extremely low numbers, there are fundamental structural reasons why the RMB will not play a central role in global finance in any near time frame, and the dollar will remain dominant for a prolonged period.
Only two global currency systems have existed in the last 300 years. In 1717 the pound was linked to gold, establishing the international gold standard. This system lasted for 200 years – its collapse can be taken as either 1914, when it was temporarily suspended, or 1931 when the pound formally broke its previous parity with gold. The second global system, a de facto dollar standard, has lasted for almost seven decades since 1945. The interregnum between the two, 1931-45, accompanied the most catastrophic crisis in world economic history.
There is therefore a prolonged lag between the economic rise and fall of states and changes in international monetary systems. The UK fell behind the United States as the world’s largest market economy in the 1870s, but Britain maintained global monetary dominance for half a century. There was a seventy year lag between the United States, becoming the world’s largest economy and the dollar becoming the dominant international currency.
This extreme “rigidity” in international payments structures flows from the fundamental character of a market system. An efficient market can only operate if there is a single measure of prices – if there were different prices in different parts of the market uncontrollable arbitrage and/or fragmentation would destroy it. Gold provided a single measure for international markets, then the dollar did. The only period in which there was no single price measure, 1931-45, could only exist because the world economy was disastrously fragmented – and the accompanying results, the Great Depression and World War II, were catastrophic.
A necessary consequence of the existence of only a single price standard is that, to allow its functioning, substantial international holdings of whatever is the price unit must exist – large gold holdings under the gold standard, and large dollar holdings under the dollar standard. The scale of these reserves then becomes a powerful factor maintaining the dominance of that monetary unit.
This is why periodic predictions, ignoring economic fundamentals, that the dollar is about to be replaced or challenged by some other unit invariably turn out to be false. For example, the prediction was made that the Euro could replace the dollar. The reality, as the statistics show, is that the dollar continues to dominate international payments.
What are the consequences of these fundamental economic realities for RMB internationalization? The RMB can certainly become a minor international currency, but it cannot challenge the dollar’s dominance. That could only occur if the “dollar system,” as a global price unit, were replaced by an “RMB system” – which would require a revolution in the global economy, and is unrealistic in the coming period.
This, in turn, has major consequences for any liberalization of China’s capital account. As it is impossible, for a prolonged period, to replace the dollar as the dominant international currency, and therefore the dollar remains the dominant unit people wish to hold, the inevitable result of global capital account liberalization since the 1970s was not a multilateral flow between currencies but merely a net inflow into dollars. This strengthened the dollar’s international position, allowing the U.S. to finance its huge balance of payments deficits.
Countries which ignored these economic fundamentals, and mistakenly believed international capital account liberalization was a multilateral system, rather than one to allow funds to flow into dollars, were hit by economic crisis. For example, South East Asian countries, which had mistakenly imagined that they could benefit from capital account liberalization, were taught a devastating lesson in the crisis of 1997 that the only large scale net flows which the global payments system permits are into the dollar.
This current international monetary system is certainly unjust. Gold was produced internationally, therefore could not be controlled by a single country, and was a multilateral unit against which all currencies were measured. In contrast the “dollar standard” means one country’s currency is the unit in which all others are measured, giving the United States a type of “monetary monopoly” – with many consequent advantages in the international monetary system. But there is nothing that can be done about this until another unit can replace the dollar as setting international prices. Until then international crises, even those originating in the United States, as in 2008, do not weaken the dollar’s position. As Eswar Prasad comprehensively documented in The Dollar Trap: “Global financial crisis has strengthened the dollar’s prominence in global finance.”
Because the inevitable factual content of the international monetary system is to allow flows into the dollar, capital account liberalization, which would be required for full internationalization of the RMB, has become an extremely destabilizing economic force. Joseph Stilitz, Nobel Prize winner in economics, concluded, reviewing the history of financial crises:
“Capital account liberalization was the single most important factor leading to the crisis. I have come to this conclusion not just by carefully looking at what happened in the [Asian] region, but by looking at what happened in the almost one hundred other economic crises of the last quarter century… capital account liberalization represents risk without a reward.”
“Risk without reward” is a necessary consequence of the structure of the international monetary system, and capital account liberalization, as simply creating a flow into dollars. Large scale RMB “internationalization,” which would require liberalization of China’s capital account, would therefore lead to a large outflow of China’s capital into the United States and dollar assets to the detriment of investment in China. For this reason, as leading Chinese economist Yu Yongding put it:
“China has to maintain its capital controls in the foreseeable future. If China were to lose control over its cross-border capital flows it could lead to panic and so capital outflows would turn into an avalanche and eventually bring down the whole financial system.”
China therefore can, undoubtedly, develop limited RMB internationalization within a global monetary system continuing to be dominated by the dollar – particularly for trade. But any idea that the RMB can challenge the dollar’s position, or escape the dangers of liberalization of the capital account, is an illusion and at worst could seriously damage China’s economy.
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This article originally appeared at China.org.cn.
China is by now strong enough to deal with any external threat to its development. Only major internal errors can block its progress. One well known such threat is any attempt to return to an administered, as opposed to a ‘socialist market’, economy. However negative financial events – increases in interbank lending rates, falls in share prices, much higher bond yields than in other major economies, falls in manufacturing and service sector PMIs - highlight another danger, that of ‘market romanticism’ as opposed to ‘market realism’. This consists of verbally adhering to a ‘market economy’ but in fact not understanding what a market economy is. Put formally, market romanticism is simply the economics of neo-liberalism.
Various negative trends which have shown themselves in China’s economy in the immediate last period in reality have a clear and simple market origin. As shown in the chart China’s total savings rate has significantly fallen from 53.2% of GDP in 2009 to 51.4% of GDP in 2012 – it is important to note that total savings are not only those of households but also company savings and the ‘negative savings’ of the government budget deficit. Total savings data is not yet published for 2013 but there is no indirect data, in particular for company profits, showing a major recovery in savings rates.
This decline in China’s savings rate has as consequences rising interest rates, a decline in investment, and therefore economic slowdown – tendencies at present expressing themselves.
Interest rates are the price of capital and express the balance between capital supply (savings) and demand for capital (investment). As savings rates have significantly fallen one of two things must occur – or both. Either interest rates must rise, as the supply of capital has fallen relative to demand, or investment, the demand for capital, must decline.
As frequently occurs, both trends are taking place in China. Demand for capital, that is investment, is slowing – a trend augmented by rising interest rates. Taking a three year moving average, to eliminate effects of purely short term fluctuations, the chart below shows that by 2012 the real inflation adjusted growth rate of China’s fixed investment fell to the lowest since 2001 at 9.9%.
Inflation adjusted data for investment in 2013 is not yet published, but current price data shows the annual increase in fixed asset investment fell from 21.2% in January 2013 to only 19.9% in the latest available data. As there has been no corresponding fall in inflation it is almost certain that the real rate of increase of fixed investment fell further in 2013.
Simultaneously with falling investment China’s interest rates have risen. This was partially disguised in 2012 as inflation was declining – therefore real interest rates could rise without the headline grabbing nominal rate increasing. But as China’s inflation ceased falling in 2013 nominal rates began to rise significantly.
The result is that not only have China’s interest rates risen in absolute terms, as shown in both bond and interbank lending markets, but they have particularly risen relative to the global benchmark US rates – US savings levels, in contrast to China, have been rising for the last four years. At the beginning of 2008 the yield on China’s 10 year government bond yields was only 0.5% higher than the US, whereas by the 2nd week in January 2014 it was 1.9% higher. The sharp spikes in interbank interest rates last summer, and again late last year, were manifestations of the same process of rising interest rates.
With China’s growth rates falling, and interest rates rising, the recent fall in the share market was logical.
A slowing rate of investment and rising interest rates necessarily produces slows economic growth and therefore more slowly rising living standards – as the rate of increase of GDP is overwhelmingly the most important source of rising consumption. China’s GDP growth fell from 9.3% in 2011 to 7.7% in 2012, and its growth rate of consumption fell in parallel from 10.7% to 8.4%. Again inflation adjusted data for 2013 is not yet available, but without adjusting for inflation the rate of increase of retail sales fell from 14.9% in November 2012 to 13.7% in the same month in 2013. As in the same period the rate of increase of the CPI rose from 2.0% to 3.0% almost certainly the growth rate of consumption was falling.
These problems were accurately predicted in advance. A falling savings rate is merely another way of saying that the percentage of consumption in the economy is rising – that is ‘consumption led growth’ is occurring. But predictably such a rise in the percentage of consumption in the economy is making the situation worse not better.
Understanding how a market economy works equally shows the only way to strategically overcome these problems. That as a country becomes more economically advanced capital investment plays a larger role in its growth is both confirmed by modern econometrics and predicted by the great economists from Adam Smith onwards – in an advanced economy investment’s role is six times as important as productivity increases in economic growth, with 57% of growth coming from investment, and only 9% from productivity improvements. But without foreign borrowing investment requires exactly equivalent domestic saving.
The only strategic way to deal with present economic problems is therefore to raise the savings rate again –which will simultaneously allow a faster growth rate of investment and, by increasing the supply of capital, allow interest rates to fall, thereby lessening problems in the interbank and bond markets. As the largest contributor to savings comes from companies, this therefore requires increasing company profitability and limiting the diversion of company profits to consumption (via excessive dividend payment or other means).
The factual arithmetic of a market economy therefore requires understands that maintaining a high level of savings and investment is the single biggest challenging facing China’s development and all policies, including in finance, must therefore be aimed at sustaining it.
‘Market romanticism’, because it does not understand the facts of a market economy, wrongly believes productivity increases, achieved via tinkering with markets, can compensate for a fall in China’s savings and investment rates. It is ‘penny wise and pound foolish’ - concentrating on hoped for efficiency improvements which even if they were successful could not compensate for falls in savings and investment.
‘Market realism’ and ‘market romanticism’ are therefore clashing in the present economic situation in China. ‘Market realism’ concentrates on the key fact of the necessity to maintain the high savings and investment rates – increased market efficiency is useful but cannot compensate for problems in these more fundamental economic factors. ‘Market romanticism’ wrongly believes that increased efficiency in markets can compensate for declines in the savings rate or even advocates policies which would reduce the savings level further.
But as is said in the West ‘facts are stubborn things.’ Carrying out policies of ‘market romanticism’ necessarily produces financial and economic problems.
Developing a ‘socialist market economy’ is the way forward for China, and return to an administered economy would be disastrous. But as recent negative financial trends confirm it is necessary to reject the myths of ‘market romanticism’ to develop such an economy.
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An edited version of this article appeared originally in Chinese in a series of discussion articles on the market economy on Sina Finance.
The announcement of the relaxation of China's one child policy created great discussion in China and internationally. But its significance was widely misunderstood. Contrary to myth, the increase in China's labor supply plays little role in China's rapid economic growth. In reality, 96 percent of China's economic growth comes from factors other than a rising labour supply. Therefore, there is no reason why China's economy should slow significantly because China's working age population stopped growing in 2012. The mistaken view, sometimes expressed, that China will grow old before it becomes rich is therefore the reverse of the reality: China will grow rich before it grows old. To demonstrate clearly why, first the facts will be stated and then their implications analysed.
A worker of a company processes galvanized products in Qingdao, east China's Shandong Province,[Xinhua/Yu Fangping]
Even an elementary back of an envelope calculation shows why increases in China's working age population have made only a relatively small contribution to China's economic growth. Indeed, this is so immediately clear it is somewhat of a puzzle that the myth ever existed in some quarters that China's growth depended essentially on increases in labor and therefore China's economic growth faces a serious "demographic challenge" due to the end of the increase in the working age population.
From the beginning of reform in 1978 up to 2012, the average annual increase in China's population aged 15-64, the international definition of working age, was 1.7 percent. Over the same period the annual average increase in China's GDP was 10.2 percent -- almost six times as fast. The increase in China's working age population was therefore only 17 percent of the rate of increase of China's GDP -- showing clearly that the rate of growth of population could not possibly explain, or be the main reason for, China's rapid economic growth.
Looking at the trends in more detail shows still more clearly that population trends did not determine China's economic trajectory. Taking five year moving averages for changes in working age population and GDP, to remove the effects of short term fluctuations, China's average annual growth rate of working age population was 2.8 percent in 1983, five years after the beginning of reform. By 2000 this had fallen to 1.6 percent, and by 2012 it was only 0.6 percent. The growth rate of China's working age population was therefore consistently falling.
But China's GDP growth showed the exact opposite trend. Annual average GDP growth rate was 8.1 percent in 1983, 8.6 percent by 2000, and 9.3 percent by 2012. Therefore while the growth rate of China's population was falling its economy was accelerating! This shows clearly changes in China's labor supply were not the prime cause of its economic growth.
Making exact calculations shows the situation even more graphically. It might be naively imagined that as China's working age population grew at 17 percent of the rate of its GDP increase therefore increases in labour accounted for 17 percent, which is under one fifth, of the increase in China's economic growth. This contribution would already seem surprisingly small for those who believe increases in working age population was a major factor in China's economic development, that China's growth rate must therefore now necessarily fall sharply, and China will "grow old before it grows rich." But in reality even 17 percent is a great exaggeration of how much increase in the labor supply contributed to China's growth.
The reason for this is that the increase in the amount of time actually worked grows more slowly than the increase in the working age population. This is because the period of time spent in education rather than work tends to increase, vacations tend to get longer reducing the number of days worked, and other factors.
To show the effect of this, the chart shows the sources of China's GDP growth in 1990-2010 -- the latter being to the latest date for which international comparisons are available. As can be seen, 64 percent of China's growth was due to investment increases, 30 percent to increases in productivity, and only 6 percent to increases in labor. China's rapid economic growth was therefore overwhelmingly driven by increases in investment and increases in productivity with increases in the labour supply playing only an extremely small role. Given its growth rate, eliminating the entire increase in labor into China's economy would have taken only half a percent from China's GDP growth.
But even that 6 percent number slightly exaggerates the role of increases in labor supply in China's economic growth! Increase in labor contribution to economic growth take place due to two processes. The first is a rise in the number of hours worked as the workforce gets bigger (the increase in labor quantity). The second is the improvement in skills and education -- a skilled worker creates more value than an unskilled one (the increase in labor quality).
The increase in China's labor quality is 2 percent per year, in line with the average for developing countries. This has a modest scope to increase with higher expenditure on education and skills -- the average increase in labor quality in a developed economy is 3 percent a year. Only 4 percent of China's GDP growth comes from increases in the quantity of labor, which are affected by demographics.
In short, increases in China's labor supply, due to expansion of the working age population, accounted for only 4 percent of China's total GDP growth -- less than half a percentage point of annual GDP growth!
Claims by those such as that by Financial Times writer David Pilling that "the song of China's miracle has a three-word refrain: Just add people" are therefore absolute nonsense. Only 4 percent of China's growth came from "adding people" and 96 percent came from factors other than "adding people!"
This does not mean no economic problems are created by China's aging population. But these come from a completely different route than shortage of labor. The real economic difficulty China faces with regard to population is that people in work can save, while those not working, because they are too young or too old, generally do not save. The decline of the percentage of China's population in work therefore tends to lower China's household savings rate. As investment necessarily has to be financed by savings, this puts downward pressure on China's investment rate, and as investment is the main source of economic growth not only in China but in most economies this could lower China's economic growth. While the decline in China's working age population does not pose a risk of significant economic slowdown due to lack of labor, it could cause a problem due to fall in savings.
But fortunately households are only one of three sources of savings. Of the other two, government savings are small in almost all countries, and usually negative. But company profits are the biggest source of saving in China. If savings via company profits were to increase, this can compensate for any decline in household savings due to the fall in the percentage of the population which is working.
Maintaining high growth in China therefore depends more on maintaining company profitability than it does on population. A decline in company profitability is a much more serious threat to China's growth than any demographic factor. A rise in company profitability, through its effect in raising company savings, would be a far more powerful factor in maintaining China's economic growth than relaxing the one child policy.
In summary, the claim that China faces a significant slowing of its economy due to population factors, and therefore China will "grow old before it grows rich," is a typical example of myths created by engaging in woolly rhetoric without using numbers. Increases in labor supply play such a small role in China's economic growth that the end of the rise in the working age population will have only a very small effect in reducing China's growth rate. It is what happens to China's productivity, and above all its investment, that overwhelmingly will determine its economic growth and therefore its prosperity. Provided the correct policies are pursued, China will certainly become rich before it becomes old.
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In 2010 Professor Danny Quah, of the London School of Economics, noted: 'In the last 3 decades, China alone has lifted more people out of extreme poverty than the rest of the world combined. Indeed, China’s ($1/day) poverty reduction of 627 million from 1981 to 2005 exceeds the total global economy’s decline in its extremely poor from 1.9 billion to 1.4 billion over the same period.' The aim of this article is to analyse the situation taking data published three years after Quah's analysis; look at the trends not only of extreme poverty, which the World Bank calculates using expenditure of $1.25 a day or less; examine a slightly wider poverty definition ($2 a day expenditure), and compare the trends in other regions of the world economy.
The conclusion is simple. Quah's conclusion still holds. China is responsible for 100% of the reduction in the number of people living in poverty in the world. This finding is the necessary backdrop to any serious and informed discussion of the role of China in the world economy and its contribution to human rights.
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There are many remarkable economic statistics about China.
Nevertheless, impressive as such statistics are, from the point of view of human welfare it is another number which dwarfs all others: the contribution of China to the reduction of human poverty not only within its own borders but in its impact on the world. The astonishing fact remains that China has been responsible for the entire reduction in the number of people living in absolute poverty in the world!
To show this the table below gives the number of those in China and the world living on expenditure less than the two standard measures used by the World Bank to measure poverty. These are the criteria for extreme poverty, expenditure of less than $1.25 a day ($37.5 a month) and those living in poverty – expenditure of $2 day ($60 a month). Charts showing the trends are at the end of the article.
In 1981, on World Bank data 972 million people in China were living on an expenditure of less than $37.50 a month. By 2008 this had been reduced to 173 million, by 2009 it fell to 157 million. Consequently 662 million people were lifted out of extreme poverty in China in the twenty seven years up to 2008 and 678 million by 2009.
In contrast the number of people living in such extreme poverty outside China increased by 50 million between 1981 and 2008 – the number of people emerging from poverty was less than the population increase. This was due to the rise in the numbe of people living in extreme poverty in sub-Saharan Africa. China was consequently responsible for 100% of the world’s reduction of the number of people living in extreme poverty.
Analysing those living on $2 a day ($60 a month), still a very low figure, the trend was even more striking. The number of people in China living on an expenditure of this figure or less fell from 972 million in 1981, to 395 million in 2008, to 362 million in 2009. The number living on expenditure of $60 a month or less in China fell by 577 million by 2008, and by 610 million by 2009.
In contrast the number of those living at this level of poverty in the world outside China rose from 1,548 million in 1981 to 2,057 million in 2008 – an increase of 509 million. Again, China accounted for the entire reduction in the number of people in the world living at this level of poverty.
It is therefore almost impossible to exaggerate what a contribution not only to its own people but to the welfare of the whole of humanity China’s economic progress has made. Without China there would have been literally no reduction in the number of world’s people living in poverty.
The gigantic impact of this on human well-being is not only in its direct effect on personal income and expenditures. It is also in its indirect consequences for human welfare. To take simple examples
The direct and indirect effect of bringing people out of poverty is also the greatest contribution that can be made to human rights, The reality is that China’s bringing over 600 million out of poverty means no other country in the world remotely matches China’s contribution to human wellbeing and real human rights.
Quah, D. (2010, May). 'The Shifting Distribution of Global Economic Activity'.Retrieved January 2, 2012, from London School of Economics: econ.lse.ac.uk/~dquah/p/2010.05-Shifting_Distribution_GEA-DQ.pdf
China has the world’s fastest growth of consumption while its population lives significantly longer than would be expected from China’s level of economic development. These facts clearly establish China has easily the world’s fastest rise in living standards.
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One of the strangest claims about China that sometimes appears in the media is that it has a slow growth of consumption and living standards. In reality China has the fastest growth of consumption of any country in the world – whether this is measured only by household consumption or includes government consumption on areas vital for quality of life such as education and health. Furthermore, indicators show that compared to other countries, China's quality of life is better than would be expected from its present stage of economic development.
First the facts regarding these issues will be established and then they will be analyzed.
Table 1 shows the growth rates of consumption, both total and household, for the G7 and BRIC economies. These economies are selected for comparison as, given China's size, the appropriate comparison is with major economies – not Caribbean islands or African states. Nevertheless including small economies would make no difference – China would still be seen to have the world's fastest consumption growth rate.
The fundamental period of comparison used is from 1978, the beginning of China's economic reform, to 2011 – the latest date for which figures are available for all countries. However, as data is not available for Russia before 1990, a comparison for 1990-2011 is also given.
The pattern is clear. China's average annual increase in total consumption was 7.9 percent in 1978-2011 and 8.5 percent in 1990-2011. The increase in household consumption in the same periods was 7.7 percent and 8.1 percent. China's are easily the world's highest rates of growth of both household and total consumption.
By comparison, India, ranking second after China, has an annual rate of total consumption increase in the same periods of 5.4 percent and 5.9 percent and its rates of increase of household consumption are 5.2 percent and 5.9 percent.
The U.S., by comparison, had an annual growth rate of total consumption of 2.7 percent in 1978-2011 and 2.5 percent in 1990-2011. U.S. growth rates of household consumption are 2.9 percent and 2.8 percent in the same periods. China's consumption growth rate was therefore almost three times as fast as the U.S.
It is obvious that such a rise in consumption – an increase in quantity and quality of food, housing, holidays, phones, cars, furniture, health care etc. – is a decisive factor in determining any country's living standards. China's rapidly growing numbers of smartphones, cars, internet users, those taking foreign holidays etc. reflect its rising living standards. However some people attempt to claim, entirely falsely, that China's dramatic increases in consumption may be offset by other factors – for example weaknesses in health care, deterioration in the environment etc.
Fortunately, this can be tested objectively. Life expectancy, as is well known, is a very sensitive indicator of overall living conditions. As well as most people having a direct goal of living longer, length of life also summarizes the combined impact of health, environment, consumption and other factors on human well-being.
As people in China live significantly longer than would be expected given its economic development level any claim China’s rapid rise in consumption is more than offset in terms of rising living standards by health, environmental or other considerations is false. The evidence is clear that environmental, health and other factors affecting health quality are superior in China than would be expected for its level of economic development.
None of this is grounds for complacency. What have been analyzed here are growth rates, not absolute levels. China’s life expectancy (73.5 years) is still significantly behind the US (78.6 years) let alone Italy (82.1 years) or Japan (82.6 years). China must still undergo a prolonged period of economic growth before it achieves the highest levels of developed economies.
Nevertheless China is developing from a situation where in 1949 it was one of the world’s least developed countries. It is therefore ridiculous utopianism, which in practice would lead to the wrong policies, to believe China can in one step achieve the highest levels of the most advanced economies. The relevant question is whether China is developing living standards and consumption more rapidly than other economies, in which case it is catching up with them, or whether it is developing more slowly than other countries – in which case it is falling behind.
But given that China has the world’s fastest growth of consumption, why is the totally erroneous statement made that China underdevelops consumption? Such claims commit the elementary mistake of confusing China’s growth rate of consumption, the world’s highest, with the percentage of consumption in GDP – which is low in China. But for change in the population’s living standards what counts is how fast their consumption is growing, not the percentage of consumption in GDP – for example the percentage of consumption in GDP of the Democratic Republic of the Congo is an extremely high 89% but it is the world’s poorest country for which data exists!
The conclusion is therefore absolutely clear. China has by far the fastest growth rate of consumption in the world, together with life expectancy significantly above that which would be expected given its level of economic development. China, in short, has easily the world’s fastest rise of living standards.
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The period since the international financial crisis began has for the first time in over a century seen the US displaced as the world’s largest industrial producer – this position has now been taken by China. It has also witnessed the greatest shift in the balance of global industrial production in such a short period in world economic history. In 2010 China’s industrial output exceeded the US marginally but this has now been consolidated into a more than 20% lead with the gap still widening further.
In 2007, on UN data, China’s total industrial production was only 62% of the US level. By 2011, the latest available comparable statistics, China’s industrial output had risen to 120% of the US level. China’s industrial production in 2011 was $2.9 trillion compared to $2.4 trillion in the US – this data is shown in Figure 1.
When the comparable data is released for 2012, China’s lead will have increased substantially– between December 2011 and December 2012 China’s industrial output increased by 10.3% whereas US industrial production increased by only 2.7%. Calculations based on estimates in the CIA's World Factbook indicate in 2012 the value of China's industrial production was $3.7 trillion compared to $2.9 trillion for the US – which would mean China's industrial production was 126% of the US level.
Taking only manufacturing - that is excluding mining, electricity, gas and water production - in 2007 China’s output was 62% of the US level, by 2011 it was 123%. Again the gap has widened in 2012 and 2013.
No other country’s industrial production now even approaches China - in 2011 China’s industrial output was 235% of Japan’s and 346% of Germany’s.
World Bank data, using a slightly different calculation of value added in industry, confirms the shift. On World Bank data China’s industrial production in 2007 was only 60% of the US level, whereas by 2011 it was 121%.
Therefore in only a six year period China has moved from its industrial production being less than two thirds of the US to overtaking the US by a substantial margin. If China was the ‘workshop of the world’ before the international financial crisis it is far more so now
The trends producing such dramatic shifts in such a short period are shown in Figure 2. In six years China’s industrial output almost doubled while industrial production in the US, Europe and Japan has not even regained pre-crisis levels. To give precise statistics, between July 2007 and July 2013 China’s industrial production increased by 97% while US industrial output declined by 1%. Industrial production data for July is not yet available for the EU and Japan, but between June 2007 and June 2013 EU industrial output fell by 9% and Japan’s by 17%.
It is this enormous rise in China’s output which also drove the much discussed global shift in industrial production in favor of developing countries - in the six year period to June 2013, the latest date for which combined data is available, industrial production in advanced economies fell by 7% while output in developing economies rose by 65%.
As is clear from Figure 3, China accounted for the overwhelming bulk of the increase in the developing economies. Industrial production in Latin America rose by 5%, in Africa and the Middle East by 6%, and in Eastern Europe by 10%. But China’s industrial production in this period rose by 100% - industrial output in developing Asia as a whole rose by 65%, but the majority of this was accounted for by China.
Such a rise in China’s industrial production has consequences spreading far beyond industry itself. Industry has easily the most rapid increase in productivity of any economic sector – notably compared to services. The decline of industrial production in the EU and Japan, and relative stagnation in the US, means China is cutting the productivity gap between itself and the advanced economies. This is crucial for progress in raising China’s relative GDP per capita and living standards.
This rising productivity also explains why China’s exports have been able to maintain their competitiveness despite substantial increases in the exchange rate of China’s currency the RMB. On Bank for International Settlements data, the RMB’s nominal exchange rate rose by 25% between July 2007 and July 2013. But China’s real effective exchange rate, that is taking into account the combined effect of the nominal exchange rate and inflation, rose by 31% But despite this major currency revaluation China’s exports continued to exceed its imports.
The ability of China to successfully absorb such high increases in its exchange rate, due to high levels of industrial productivity increases, directly translates into relatively lower prices for imports and improved relative living standards for China’s population.
This data also settles the dispute between who believed there was a major industrial revival in the US, such as the Boston Consulting Group, and Goldman Sachs and other analysts who correctly concluded no such major revival has occurred. Those in China, such as Lang Xianping, who wrote that a great US industrial revival was taking place and China’s industry was in crisis look foolish in the light of data showing China’s industrial output doubled in a period when US industrial production did not grow at all. The only reason US industrial performance does not appear very weak, with negative net growth over a six year period, is because of the even worse performance of a major decline in industrial output in the other advanced economic centers – the EU and Japan.
It is naturally important not to exaggerate this scale of advance by China in industrial production. China’s industrial output is now considerably larger in value terms than the US, but the United States retains a substantial technological lead which it will take China a considerable period to catch up with. Due to a long period of globalization and consolidation by US companies, both processes which are only at early stages in China, US manufacturing firms are still four times the size of China’s in terms of overall global revenue– although between 2007 and 2013 Chinese manufacturing firms overtook Germany to become the third largest manufacturing companies of any country.
The scale of these changes in world industrial production also make clear that in comparison to developments in China gas and oil ‘fracking’ in the US, which have attracted widespread media attention, is merely a statistical sideshow – as already noted overall US industrial production has not even recovered to pre-crisis levels.
For the first time for over a century the US has been definitively replaced as the world’s largest industrial producer. Such a once in a century shift can literally only be described as historic.
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An earlier version of this article appeared at China.org.cn
Publication of US 2nd quarter GDP data, following that for China, makes it possible to accurately compare the recent performance of the world's two largest economies. The results are extremely striking as they show that in the last year the slowdown in the U.S. economy has been far more serious than in China. Consequently the data shows that while both economies are being adversely affected by current negative trends in the world economy, China is dealing with these more successfully than the U.S. Intense media discussion in China about its ‘slowdown’ is therefore misplaced unless equivalent attention is paid to understanding why the US economic slowdown is much worse than China’s.
To accurately establish the facts, it should be noted China and the U.S. publish their economic data in slightly different forms. It is therefore necessary to ensure that like is compared with like. The U.S. emphasizes annualized change in GDP in the latest quarter compared to the previous one; for the newest data this means it takes the growth between the 1st and 2nd quarters of 2013 and basically multiplies it by four. China emphasizes the growth between the 2nd quarter of 2013 and the same quarter in 2012.
Both methods have advantages and disadvantages. Quarter by quarter comparisons depend on seasonal adjustments being accurate, which is not always the case, while year by year comparisons are less sensitive in registering short term shifts.
But in the present case the conclusion is not fundamentally changed whichever method is used. If the method emphasized by China is used, then, as shown in Figure 1, in the 2nd quarter of 2013 China's GDP grew by 7.5% compared to a year earlier, while U.S. GDP grew by 1.4%. This means that China's economy grew at over 500% of the rate of the U.S. economy. Using the method preferred by the U.S. China's annualized GDP growth in the 2nd quarter was 6.8% and the U.S.'s was 1.7%, which means that China's economy grew at 400% of the rate of the U.S. economy.
Due to the difficulties of making accurate seasonable adjustments in both China and the U.S., the author would emphasize the year on year comparison; but whichever method is preferred China's economy was growing at 4-5 times the speed of the U.S. economy.
If the whole period since the international financial crisis began is taken then the disparity in growth between China and the U.S. is even more striking. In the five years up to the 2nd quarter of 2013 China's GDP grew by 50.7% and U.S. GDP by 4.5% (Figure 2). China's GDP grew more than ten times as rapidly as the U.S.
Turning to the most recent period, it is widely understood that since the beginning of the international financial crisis, China's economy has far outperformed the U.S., even if the dimensions of this are not clearly grasped. What is not so often understood is what has happened during the last year. During that period the economies of both China and the U.S. slowed, indicating the negative trends in the international economic situation. But the U.S. slowed far more than China.
China's year on year GDP growth fell from 7.6% in the 2nd quarter of 2012 to 7.5% in the same quarter of 2013 - a decline of 0.1%, or a 1.3% deceleration from the initial growth rate. However the year on year growth rate of the U.S. in the same period fell from 2.8% to 1.4% - that is by 1.4% or by 50% of the initial growth rate (Figure 3). Consequently China's growth fell marginally but the U.S.'s growth rate halved.
Furthermore, as the Financial Times correctly pointed out in its editorial on the latest U.S. data, U.S. economic growth has been particularly depressed in the last nine months. In that total period the U.S. economy grew by only 0.7%, or an annualized rate of under 1%. In the same period China's economy grew by 5.3%, or an annualized rate of slightly over 7%. Therefore if over the entire course of last year China's economy has been growing at 4-5 times the speed of the U.S. economy, in the last nine months China's economy has been growing at 7 times the speed of the U.S.
This does not mean that the US cannot partially recover from its extremely depressed 1.4% annual growth rate in the last year – the 10 year moving average of US annual growth is 1.8% and its 20 year annual moving average is 2.5%. But even recovery to these rates would leave the US growing at only one third of the rate of China.
The latest data therefore shows that the global economic discussion about the present world economic situation is not about China's "slowdown" and U.S. "recovery". It is "why is China coming so much more successfully through an adverse global economic situation than the U.S.?" And "why has the U.S. economy slowed so much more dramatically than China's in the last year?
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An earlier version of this article appeared at China.org.cn.
I greatly admire and avidly read Gavyn Davies blog, but his latest comments on China, unusually, lack precise numbers which therefore creates some ambiguities which can give unnecessary credibility to wrong analysis. Putting in precise numbers should bring clarity.
China's government has spelt out officially its precise growth target. That is to increase GDP by 100% in 2010-2020 – about four times the prospective growth rate of the US in the same period.
Given China’s cumulative growth in 2010-2012 (17.8%) this means China has to hit a 6.9% average growth rate for the rest of the decade to achieve its target. As all this is unambiguously spelt out the relevant yardstick is whether China will achieve this.
It is a wholly spurious method, not used by Gavyn but used by others, to invent some target China never set and then claim there is a ‘crisis’ because China has ‘failed’ to achieve a target it never put forward! There is no indication China is falling below its projected growth target - China’s growth this year will clearly be above the target rate.
If Gavyn, or anyone else, wants to say argue there is a serious crisis in China, they have to claim growth will fall below the average 6.9% rate – some people do of course, so we will examine that below.
As for the efficacy of the 2008 stimulus programme it can be seen in two sets of figures. In the five years between the 1st quarter of 2008 and the 1st quarter of 2013 China’s GDP grew by 51.8% and the US by 3.5% - the EU and Japan contracted. This is shown in Figure 1.
To remove any claim of possible distortion caused by the depth of the US recession in 2007-2009, in the year to the 1st quarter of 2013 China’s economy grew by 7.7% and the US economy by 1.6% - that is China’s economy grew 6.1% faster than the US economy, or at 480% of the US growth rate. This is shown in Figure 2.
The argument that China is suffering from economic ‘crisis’ on anything like the scale of the US, Europe or Japan, for example because of its recent liquidity problems, is rather like the spurious argument that really the flu is the same as polio because they are both illnesses!
As for the suggestion that Michael Pettis has been proved right I am afraid that although he edits his blog very fairly his predictions on China are extremely inaccurate. In 2009 he insisted: ‘'I continue to stand by my comment last year... that the US would be the first major economy out of the crisis and China one of the last.' This statement is entirely inaccurate – as the more than 50% growth in China and less than 4% in the US since the beginning of the financial crisis shows. His new thesis is that: ‘'I still maintain that average growth in this decade will barely break 3%.' The projection of 3% growth is itself entirely inaccurate but given China’s existing growth this means that for the rest of the decade it would have to grow at 1.6%!!! The reason for such inaccurate predictions is that Michael Pettis makes, as shown in his book The Great Rebalancing, one of the oldest errors in economics – underconsumptionism, that is the confusion of demand (consumption plus investment) with consumption. He himself lists in the opening pages a whole series of underconsumptionist authors.
Coming back to Gavyn’s blog, China’s growth rate continues to be above the target it has set itself of 100% GDP growth in a 10 year period. That will be about 4 times US GDP growth in the same period. China will overtake the US to become the largest economy in the world in approximately 5 years. The rest of the world would be highly delighted to have such a ‘crisis'.
I actually sort of assume Gavyn doesn’t disagree with those numbers? If I am wrong, and he does then of course it would clarify the debate, if he gave his own. But indicating numbers is the best way to clarify the discussion. My projection is simple – China will hit its 100% GDP growth target over a 10 year period.
In June, China suffered its worst liquidity crisis in over a decade. Some sections of the U.K. and U.S. media exploded with wild comparisons to the US financial crisis in 2008.
Such comparisons were nonsense, however, based on an elementary economic mistake. The U.S. did not suffer a liquidity crisis in 2008. It faced an insolvency crisis. The former is a shortage of means to meet immediate payments; the latter occurs when banks' liabilities exceed their capital. In 2013, Chinese financial institutions faced liquidity problems, but not a single major institution failed. Numerous U.S. financial institutions collapsed in 2008. Comparing the two events is rather like claiming that the flu and the bubonic plague are equally serious, since both are illnesses!
But not being the bubonic plague doesn't mean that in its own terms flu is not unpleasant, or that it doesn't have side effects that last for some time. Therefore, it is important to analyze the crisis' causes in order to determine whether similar events will recur. While the exact form of crisis was not predictable - it never is - both Chinese economists and the present author predicted why there would be problems for the Chinese economy. Now that June's symptoms have been somewhat ameliorated, whether a similar crisis emerges in the future depends on whether the key mistake that led to the present one is resolved.
The key symptom of June's crisis was a spike in interbank lending rates to a 13 percent peak. Willingness to pay this indicated that financial institutions urgently needed cash. Analyzing the links between the underlying disease and the symptoms shows why.
The core problem that led to the liquidity crisis was advocacy that China abandon the policies which for 35 years have made it the world's most rapidly growing economy, in favor of something termed "consumer led growth," a theory that boosting consumer demand will lead companies to a more rapid increase in production of consumer goods and a more rapid rise in living standards. Unfortunately, this theory factually doesn't take into account that investment is the main source of economic growth, and conceptually it doesn't understand what a market economy actually is.
A market economy necessarily can only be "profit led growth." Output does not increase due to "demand," but only because of profit. Failure to understand this pushed the economy towards the liquidity crisis via its key policy proposal that the percentage of consumption in China's GDP be increased, and to pay for these purchases the percentage of wages in GDP should increase.
Increasing the percentage of wages in the GDP necessarily means reducing the percentage of profits. Therefore the theory of "consumer led growth" in reality advocated that a profits squeeze should be applied to companies via wages growing more rapidly than GDP. Regrettably, in the first part of 2013, this policy was pursued, with China's consumption rising significantly more rapidly than its investment, an indication wages were rising more rapidly than GDP. This produced the only possible consequence in a market economy: a chain reaction leading to crisis, which duly broke out in June in credit markets
Wages rising more rapidly than GDP squeezed company profits. By May 2013, the overall profit increase by companies listed on China's A-share market was zero percent - they were falling in inflation-adjusted terms. Consequently, both private and state-owned companies starting reining in investments. In the first five months of 2013, growth in fixed assets investment was 0.2 percent lower than growth in the first four months, and private investment growth was 0.1 percent less than it had been a year before.
This, in turn, led to economic slowdown. GDP growth fell from 7.9 percent in the last quarter of 2012 to 7.7 percent in the first quarter of 2013, placing greater pressure on profits. Profits were then squeezed further by the rise in the RMB exchange rate, which created difficulties for China's exporters.
This inevitably affected credit markets. With profit growth slowing, and in some cases, becoming negative, companies needed credits to plug holes in cash flows. Simultaneously, as companies were using cash to plug payment holes and not to invest, credit became less effective at stimulating growth. Given that profits were squeezed in most sectors, companies diverted what resources they could into markets which were more profitable - most notably, real estate, fuelling price increases in this sector. The pressure on company profitability therefore expressed itself via ballooning demand for credit, ineffectualness of credit in accelerating growth and excess upward pressure on real estate prices.
To attempt to stop ballooning credit, the Central Bank tightened liquidity. But this tackled symptoms, not the disease - rather like treating chicken pox by pressing on the spots. The disease was therefore not cured. Indeed the situation worsened as companies' cash flows were now squeezed from two directions - from the fundamental processes described above and by the Central Bank's liquidity tightening. If this dual pressure had continued, there would have been a financial collapse. Therefore, the Central Bank had to alter course and inject credits.
By supplying liquidity, the Central Bank took pressure off companies from one side, thereby overcoming the immediate crisis. But the underlying cause of the problem will not be overcome until the company profits squeeze is fully reversed.
Finally, while a crisis would have occurred anyway, it was worsened by the incomplete structure of China's banking system. China, like every country, must possess a core of system making banks that are "too big to fail." Such huge banks will never be adequately responsive to small companies' needs, however. In the U.K., which has a private dominated banking system, there are endless complaints by smaller companies about large banks! China has not yet created an adequate system of "small enough to fail" banks, which are responsive to smaller companies, around its large core lenders. Instead, an insufficiently regulated shadow banking system developed.
But the same fundamental factors that made it possible to accurately predict rapid growth of China's economy for 35 years show it is relatively easy for China to overcome these problems, as they are self-inflicted policy problems, not objective constraints.
In 2012, under the influence of the World Bank report on China, similar policies were pursued in the first half of the year. They also led to a growth slowdown. When this policy was reversed in mid-2012, with an investment stimulus, growth accelerated from 7.4 percent to 7.9 percent. In 2013, unfortunately, the wrong policy was pursued for longer and therefore led to June's crisis.
Lin Yifu, former senior vice president of the World Bank, recently stated: "Those who advocate that China's economy should rely on consumption are, in fact, pushing the country into a crisis." Regrettably, June's events confirmed these words.
Large forces in China are working against the errors that led to the June crisis. Companies do not want profits pressured. Slower economic growth will lead to less rapid increase in living standards, creating dissatisfaction among consumers. As June's events in China's financial market were a liquidity crisis, not one of solvency, and China's banks remain highly profitable with assets far outweighing liabilities, no systemic damage has been done to China's banking system. June's events simply demonstrated that even in a country with China's very strong macroeconomic fundamentals, an incoherent theory can wreak havoc. A non-sequitur like "consumer led growth," which necessarily applies a profit squeeze to companies, inevitably leads to economic crisis.
June's credit market explosions were simply the market economy reminding everyone that, within it, there can never be "consumer led growth." Only "profit led growth" is possible.
Hopefully the appropriate lessons have been drawn.
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An earlier version of this article appeared at China.org.cn.
China's economic achievement is so enormous, indeed literally without parallel in human history, that it is sometimes difficult for people to take in its scale. A country which in 1978, when "reform and opening up" was launched, was one of the poorest in the world, has now reached a point where it has a higher GDP per capita than the countries containing the majority of the world's population. Only 30 per cent of the world's population now lives in countries with higher per capita GDP than China.
To give absolutely precise numbers, drawing on the newly published data for the world economy in 2012 released by the IMF, the chart shows that by 2012, only 30.2 per cent of the world's population lived in countries with a higher GDP per capita than China, while 50.2 per cent lived in countries with a lower one. China itself constituted 19.6 per cent of the world's population at this time.
China is, therefore, now in the top half of the world as far as economic development is concerned, and to avoid any suggestions of exaggeration, it should be made clear that these comparisons are at the current market exchange rate measures usually used in China – although calculations in parity purchasing powers (PPPs), which are the measure preferred by the majority of Western economists, makes no significant difference to the result.
The chart also illustrates China's extraordinary progress. In 1978, when "reform and opening up" began, only 0.5 per cent of the global population lived in countries with a lower GDP per capita than China, while 73.5 per cent lived in countries with a higher GDP per capita. The transition to a situation where China has overtaken the majority of the world's population in per capita GDP is the greatest economic transformation in human history, both in terms of the short time frame required and number of people affected.
Given that the data clearly shows China has progressed into the top half of the world economy in terms of economic development, why do some persist with misrepresenting China as being "in the middle" or even more misleadingly dubbing it a "poor" country by international standards?
Such misrepresentations make elementary statistical errors which are familiar to those who analyse income distribution data. For example the following argument is sometimes presented: The IMF World Economic Outlook database gives GDP per capita statistics for 188 countries with China ranking 94th – therefore China is "in the middle". Another sometimes-cited statistic compares China to the world average – in 2012 China's GDP per capita was 59 per cent of this average figure – making China appear a "poor" country.
The problem with this "list" method is that it does not take population into account. For example, the Caribbean state St Kitts and Nevis, population 57,000, has a higher GDP per capita than China while India, population 1.223 billion, has a lower one. To say China is "between the two", as though St Kitts and Nevis and India represent equivalent weights in the world economy, is playing games with words rather than carrying out serious analysis. This elementary statistical rule is particularly relevant given that the number of developed economies with small populations is disproportionately large. The population of countries must therefore be taken into account when calculating China's real relative position in the world economy.
The second mistake, comparing China to the "average", makes an error so well known in income distribution statistics that it is somewhat surprising anyone gives it any credence, let alone continues to propose it.
Statisticians know that averages, technically speaking the "mean", can be disproportionately affected by small numbers of extreme values. It is well known that this applies to incomes within countries as small numbers of billionaires artificially raise average incomes in a way that misrepresents the real situation.
This statistical distortion is clear from international data. Average world GDP per capita, that is world GDP divided by the number of people, is slightly more than $10,000 per year. But only 29.9 per cent of the world's population lives in countries with GDP per capita above that level while 70.1 per cent live in countries below it. Something with only 29.9 per cent above and 70.1 per cent below is not most people's idea of an average!
What most people understand by an average, the mid-point, is, in proper statistical terms, not the average but the median. Reputable studies on income distribution, therefore, almost invariably use the median, not averages, to avoid this distorting effect of small numbers of extreme values. Using the statistically misleading average, instead of the mid-point, bizarrely transforms the real situation – that China now has a GDP per capita above that of the majority of the world's population – into giving the impression that China is a poor country!
There are three main reasons why it is important to accurately present China's level of development.
First, policy must be based on accurate analysis – in serious matters there is no virtue in either optimism or pessimism, only in realism. As the famous Chinese phrase tells us, it is better to seek truth from facts.
Second, accurate presentation is necessary to clearly understand the real economic challenges China faces. For example China's GDP per capita is now higher than all developing South and South East Asian countries except Malaysia – clarifying why any competitive strategy for China based on low wages is unviable.
Third, China's position in the top half of the world in terms of GDP per capita makes clear its technological level – China's economy is now dominated by medium, not low, technology.
Does an accurate presentation of China's real level of development endanger its international legal status as a developing economy? The World Bank has not yet published new criteria for the GDP per capita necessary to qualify as an "advanced" economy, but the 2011 criteria and statistical data is available and it tells us that the answer to the question is "no". To classify as "high income", an economy must have an annual GDP per capita of slightly more than $12,000. Only 16 per cent of the world's population lives in such economies. It will take 10-15 years for China to achieve "high income" status – although when it does this will more than double the number of people living in such economies.
Achieving the "Chinese dream" requires that the present reality is accurately understood. China has entered the top half of the world's level of economic development. Only 30 per cent of the world's population lives in countries with a higher GDP per capita than China. That is the accurate analysis of China's relative position in the world economy. To achieve the "Chinese dream" requires eliminating not only any exaggerated bombast but also any systematic underestimation
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The international financial crisis brought about a radical change in the structure of international industrial competition, and China is winning this new contest. That is the only conclusion that can be drawn from the pattern of industrial expansion and contraction in the major industrial centres in the five years since the beginning of the international financial crisis in 2008.
As taking comparisons only for single years can obscure this fundamental trend, Figure 1 shows the changes in industrial output during the entire last five year period in the world’s four major industrial centres – China, the U.S., the European Union (EU) and Japan. The pattern is clear and striking.
China’s industrial production therefore increased by over three quarters during a period when U.S. industrial production stagnated and EU and Japanese industrial production significantly declined. That is a conclusive victory by China in this competitive struggle.
Extending the comparison to other developing economies, there is no individual industrial centre matching the four major global ones. Figure 2 therefore shows aggregated data for developing economic regions. As statistics for all developing economies are not available for February 2013, the period January 2008 to January 2013 is considered. Data for China is also shown. As no separate China data was published for January, due to the Spring Festival holiday, China’s January data is taken as the mid-point between December and the combined January-February statistics.
Again the pattern is clear over the five year period.
China was therefore successful in industrial competition not only with developed but with developing economies. As the increase in China’s industrial production was over 75%, and it was already one of the world’s main industrial centres, this constitutes a major shift in the balance of world industrial production in China’s favour.
What conclusions follow from these developments?
First, the claim of some Chinese commentators that there is a great revival of U.S. industry and China is lagging behind is factual nonsense. Not only has China’s industrial growth far outperformed that of the U.S., but U.S. industrial production has not even yet recovered to pre-financial crisis levels. Their arguments, based on citing purely individual examples such as that Apple will manufacture a few Macs in the U.S., are based on one of the most elementary and worst forms of statistical distortion – citing individual anecdotes and not overall trends.
Second, these differences in development have long-term consequences spreading to outside industries. Productivity increases in the industrial sector are much greater than in non-industrial sectors. Therefore China’s success in industrial competition raises its overall rate of productivity growth relative to less successful competitors.
These factual trends do not mean China will not face major future challenges within the industrial sector. China has already successfully shifted the centre of gravity of industrial production from low technology products (textiles, toys etc.) into medium technology (construction equipment, smartphones, personal computers, ships etc.). But China’s transition to very high technology industrial production still lies ahead – outside non-market sectors such as military and space production.
But it is not abnormal that China’s industry is currently dominated by medium, not yet high, technology production. China’s GDP per capita is approximately that of Japan in 1966 or South Korea in 1988. At those times Japan and South Korea had successfully made the transition from agricultural and low value added industrial economies to dominance through medium technology sectors – ship building, steel etc. Today China globally dominates the same industries. But at that time the period of domination of Japan and South Korea by high technology product innovation – Sony’s PlayStation and Walkman, Samsung’s high-end televisions and mobile phones – lay 10-15 years ahead.
As Lin Yifu, former chief economist and senior vice president of the World Bank rightly stresses, it is impossible for an economy to develop market sectors greatly out of line with its overall level of development. The full transition of China’s industry to dominance by high technology production lies a decade ahead. The key fact at present is that comparison of trends in the major industrial centers shows that in the intensified global competition created by the international financial crisis China is clearly winning.
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China’s National People’s Congress (NPC) has set a 7.5% official GDP growth target for this year. Lin Yifu, former Senior Vice-President and Chief Economist of the World Bank, and one of China’s most important economists, predicts that China can maintain 8% annual growth for 20 years. A key question is evidently whether such targets are realistic. Can China maintain this type of growth rate?
The immediate negative factors are evident. The international context for China’s economy this year is bad. The Eurozone economy is shrinking, Japan is stagnant and US growth is anemic. A 16% fall in world commodity prices since their peak has led to slower growth in major developing economies such as Brazil.
China’s policy makers initially underestimated the problems in the advanced economies. Adjusted for inflation, imports by developed economies have not regained pre-financial crisis levels. China therefore did not achieve its 2012 target of a 10% trade increase – the ctual rise was 6.2%. The lower 8% trade growth target set for 2013 is more realistic if still challenging. All major motors for growth will therefore have to come from China’s domestic economy.
In terms of strengthening China’s relative international economic position, and maintaining its ranking as the world’s most rapidly growing market, all this makes no difference. China is the world’s most open major economy, so it cannot cut itself off from international trends. China’s growth rate inevitably goes up or down with global economic fluctuations – the constant is that China strongly outperforms these trends.
To give more precise numbers, a rule of thumb of over 20 years, which successfully passed the test of events, is that China grows on average at whatever the advanced economies expand at plus 6% - the greater outperformance during the financial crisis was untypical. Developed economies this year will probably grow at around 1.5-2.0%, implying China will grow at 7.5-8.0% - in line with official forecasts. This is consistent with the official target of doubling the size of China’s economy between 2010 and 2020.
But for estimating expansion of China’s market, and growth of living standards, the absolute rate at which China’s economy develops is obviously key. It is therefore worth looking beyond short term ups and downs to the fundamental factors determining how fast an economy grows. This makes clear why China will achieve its 7.5-8% growth target. It also eliminates ‘manic-depressive’ analyses of China’s economy – periodic oscillating predictions of ‘hard landing’ and ‘rampant growth’ which appear in some parts of the media.
The current infatuation with examining consumption in China’s GDP is misleading in terms of analysing its economic performance. A country’s consumption growth is overwhelmingly determined by its GDP growth – internationally 87% of consumption increase is determined by the latter. If China’s GDP grows rapidly consumption will grow rapidly. If China’s GDP growth slows its consumption, over anything other than the very short term, will be lower than its potential with high GDP growth.
Every economy’s growth, including China’s, is necessarily determined by two key parameters: how much it invests and how efficiently that investment creates growth. Taking the five year average for 2006-2011, the latest internationally comparable data, China’s fixed investment was 43.1% of GDP, and it invested 4.1% of GDP for its economy to grow by a percentage point. Consequently, as a matter of simple arithmetic, China’s economy grew at an annual average 10.5%.
The lower the percentage of GDP invested for any given economic growth the more efficient that investment is. Furthermore, contrary to some myths, China’s investment is extremely efficient by international standards as the Table shows. For example in 2006-2011 China needed to invest 4.1% of GDP to grow by 1% whereas the US invested 24.3% - China’s investment was six times as efficient in generating GDP growth as the US. Even before the international financial crisis the US invested 7.0% of GDP to grow by 1% compared to China’s 3.4%. These key numbers determine how fast China’s economy grows.
If China’s economy is to slow, as some critics argue, then it is necessary one or both of these key parameters changes. Either China’s percentage of investment in GDP must fall or the efficiency of its investment in generating GDP growth must decline – there are no other choices.
Taking first investment efficiency, the Table shows that almost all economies were negatively affected by the international financial crisis. China was no exception – the percentage of GDP which had to be invested for its economy to grow by a percentage point rising from 3.4% to 4.1%. But this deterioration was less than for most countries – the US figure rose from 7.0% to 24.3%, Germany’s from 8.2% to 18.4%.
China’s investment efficiency would have to fall greatly not to achieve its 7.5% growth target. If China’s recent investment level was maintained then the percentage of GDP it needs to invest to grow by a percentage point would have to rise to over 5.7% before China failed to hit its growth rate target. Maintaining China’s efficiency of investment is therefore a constant challenge for the government, but China has a considerable safety margin in setting its target growth. The government’s entire focus is on maintaining the efficiency of investment, not reducing it.
The other possibility for slowing China’s economy would be a sharp reduction in the percentage of investment in GDP. There are certainly some in China advocating reducing the level of investment in GDP, but not by nearly enough to prevent China hitting its growth targets. At its present level of investment efficiency China’s GDP growth rate falls by 1% for each 4.1% reduction in the percentage of fixed investment in GDP. But in the last 5 years China’s annual GDP growth averaged 10.5%. To reduce China’s GDP growth below 7.5% requires a fall in the percentage of investment of GDP of 10%. No serious figure in China, as opposed to a few Western analysts, advocates this. A fall in investment share of 2-4% of GDP, the type of figure sometimes advocated, would only slow China’s economic growth by 0.5-1.0%.
Therefore international economic headwinds are negative. But in both the efficiency of its investment and the percentage of investment in GDP China has considerable safety margins for achieving its growth targets - unless the administration makes very large errors the growth targets will therefore be met. Indeed, looking at these margins of manoeuvre, Lin Yifu’s 8% is perhaps more realistic that the government’s 7.5% - administrations always like to announce they have exceeded targets.
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This article is slightly edited for an international audience from one which originally appeared in Shanghai Daily.
The US magazine Worth published a report with its analysis of who were the 100 most powerful people in global finance. Four were from China - Shang Fulin, Chair of China Banking Regulatory Commission; Zhou Xiaochuan, Governor of the People's Bank of China; Lou Jiwei, Chair and CEO of China Investment Corporation and Jiang Jianqing, Chair of the Industrial and Commercial Bank of China (ICBC). They were respectively ranked 14th, 15th, 27th and 31st.
That only four of China’s top financial figures were included in the list in fact showed how much understanding of the power of China’s financial and banking system still lags behind its reality. There are exceptions – for example Bloomberg journalists Henry Sanderson and Michael Forsythe in their recent book China’s Superbank simply stated that Chen Yuan, chair of China Development Bank, was ‘the world’s most powerful banker.’ But in banking it would seem Deng Xiaoping’s famous advice that China should ‘hide brilliance, cherish obscurity’ is alive and well.
This is a serious error, as will rapidly become apparent. To grasp the underlying dynamic of the global financial industry it should be grasped that it is a mistake to understand the strength of China’s economy by statistics such as that China produces as much steel as the next 38 countries combined, more cement than the rest of the world put together, that it is the world’s largest market for TVs, refrigerators, mobile phones, cars, or that it has more than twice as many internet users as the US. These figures are impressive but far from illustrating the real core of China’s economic power. The real center of China’s economic strength, which determines both its domestic and global expansion, is unparalleled financial strength.
China has yet to overtake the US in GDP but the annual sum of China’s finance available for global or domestic investment, that is its savings, are already twice those of the US. As Figure 1 shows China’s savings in 2011, the last year for which there are comprehensive figures, were $3.6 trillion compared to $1.8 trillion in the US.
But savings are the ‘raw material’ of the financial system. It is this huge flow passing through China’s banking system which is making China the world’s ‘financial superpower’. China’s $3.3 trillion foreign exchange reserves, easily the world’s largest, are a powerful adjunct but it is the year after year generation of domestic finance on a scale which has no international parallel which is the unmatched core of China’s economic strength.
To see the dynamic this is creating in the global finance industry it is useful to give a comparison of the main indices for China’s and the US’s banks – 2013’s figures, when they are published, will further reinforce these trends.
US banks reporting in 2012 were still ahead of China’s on revenue - $550 billion compared to $404 billion, and on assets - $10,079 billion compared to $9,895 billion. But on profits China’s banks had already overtaken their US competitors - $105 billion compared to $68 billion. China’s banks also held the lead in stock market valuation - $992 billion to $847 billion.
At the beginning of 2013, by market capitalization both China (ICBC, China Construction Bank, Agricultural Bank of China, Bank of China), and the US (Wells Fargo, J.P. Morgan Chase, Citigroup, Bank of America) had four out of the world’s top ten banks by market capitalization. But the total valuation of the Chinese banks was $706 billion compared to the US $620 billion. China’s ICBC is the world’s largest bank by both profit and capitalization.
In other financial fields - insurance, mortgage lenders, credit cards etc - the US still maintains a lead over China. But in core banking strength there is already essentially no difference between China and the US.
But by every indicator the rate of growth of China’s banks is many times higher than US competitors. By revenue China’s banks were 16% as large as US banks in 2007, by 2012 they were 74% as large. By assets the corresponding figures were 30% and 98%, by market valuation 43% and 117%, and by profit 17% and 155%. China’s far more rapid buildup of domestic finance means that the balance will progressively and rapidly move in favor of its institutions. It is therefore only a short period of time before China’s overtake US banks on all measures. China’s underlying financial strength is relatively rapidly being transformed into institutional strength in its banking system.
Where US banks traditionally held a strong lead over China is that China’s were essentially domestic banks but US banks operated globally. This, however, is beginning to change as China’s banks ‘go global’.
First to globalize were China’s official development banks. In 2005-2011 China Development Bank and Export-Import Bank of China (Exim Bank) provided over $75bn in loan commitments to Latin America. In 2010 their $37bn commitment was more than the World Bank, Inter-American Development Bank and United States Export-Import Bank combined. In Africa China’s Exim Bank has lent more than the World Bank every year since 2005 – its loans in 2011 being $15 billion.
But now globalization of China’s commercial banks is proceeding rapidly. By the beginning of 2013 ICBC operated in 39 countries with overseas assets of $170bn – a 30% increase on 2011. The stability, and state guarantee, of China’s banks, is attractive compared to the continual structurally determined scandals in US and European competitors - making it clear it is the time taken to develop the necessary management skills that is now the primary difficulty in expanding China’s banks overseas operations. In such a vital international financial center as the Middle East, the focus of global oil money, the rate of expansion of ICBC’s assets in 2012 was 29% to $4 billion while profits rose by 69%.
China’s banks have so far concentrated on developing countries, which are growing more rapidly than developed ones. Key acquisitions, for example, were ICBCs purchase of a 20% stake in Standard Bank, South Africa and Africa’s largest bank. The advantage of the combination of Standard Bank’s local knowledge throughout Africa, and ICBC’s huge financial firepower, is evident. ICBC’s shareholding in South Africa Standard Bank also made it easy to purchase Standard Bank’s Argentinian subsidiary – consolidating ICBC’s position in Latin America.
This initial concentration on developing economies resembles the ‘countryside surrounds the cities’ strategy of China’s telecoms giant Huawei and other Chinese industrial companies. But China’s banks financial strength gives them the opportunity to directly expand operations in developed economies. Bank of China and ICBC are now active in New York’s property market, while last year ICBC carried out China’s first takeover of a US bank with Bank of East Asia. The international expansion of RMB operations, with the world’s largest foreign exchange dealing center London trying to compete as an offshore operator with Hong Kong and Singapore, centrally involves China’s banks.
Globalization of China’s banks cannot be instantaneous. But the problems involved are time in acquiring permits, training management, creating infrastructure etc not fundamental financial strength. Overcoming these difficulties, given the unparalled financial muscle that can be applied, is simply a matter of time.
How should the situation be summarized? It is sometimes assumed manufacturing is China’s strongest industry. This is a mistake. China is the world’s largest manufacturer, and largest manufacturing exporter. But a substantial part of China’s manufacturing output, and half its exports, are still by foreign companies. It will take significant time to build the power of China’s own manufacturing companies. But the foundations of China’s own banks are already those of an emerging financial superpower. It is only a matter of time, a rather short one, before that translates itself into an equivalent strength of China’s global finance companies.
Within a decade a list of the 100 most influential people in world finance will not contain four from China. It is likely to be dominated by figures from China.
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An edited version of this article appeared in China Daily.US.
In the 4th quarter of 2012 China’s economy speeded up, with GDP growth rising to 7.9%. For 2012 as a whole China’s GDP rose by 7.8%. Internationally this contrasted sharply with the EU and Japan, both of which have passed into new downturns, and the US where economic growth in 2012 was 2.2% - anaemic compared to previous recoveries. China’s industrial production in the year to December rose by 10.3% - compared to 2.9% in the US. China’s annual economic expansion now exceeds the US in dollar as well as percentage terms – China’s GDP in 2012 rose by $982 billion compared to $600 billion for the US.
The scale of changes in the world economy involved can be seen even more clearly if the period since the international financial crisis began is taken. Peak US GDP prior to the financial crisis was in the fourth quarter of 2007. Since then China’s GDP has grown by 52.5%. But in the 4th quarter of 2012 US GDP was only 2.4% above its pre-crisis level.
In the last five years China’s economy has therefore grown more than twenty times as fast as the US while the economies of the EU and Japan have shrunk. In current dollar prices China’s GDP has risen by $4.7 trillion and the US by $1.65 trillion.
In industrial production, the most internationally traded sector, and the one with the fastest productivity growth, the change in the last five years is even more dramatic. On the latest available data EU industrial production is 12% below its pre-crisis peak and Japan’s 22% below. In the US, despite unsubstantiated talk of ‘industrial revival’, in December US industrial output was still over 2% below its peak of more than five years previously. In the five years up to December 2012 US industrial production had fallen by 3%, but China’s industrial production had risen by 80%.
These huge economic shifts pose two questions entering 2013. This year can China maintain the pickup in economic momentum that was clear in the fourth quarter of 2012? Can China maintain this over the medium/longer term with the consequences for further changes in the structure of the world economy flowing from this? Examining the economic processes unfolding at the beginning of 2013 gives the answer ‘yes’ to both questions – and for the same reason.
Turning back to short terms trends, undoubtedly at the beginning of 2012 China's economic policy makers had underestimated the difficulties in the developed economies. China's official prediction of a 10% export increase in 2012 could not be achieved without significant growth in developed markets. This did not materialize and exports rose only 7.9%.
As external demand was overestimated there was a delay in launching a program to stimulate domestic demand. Therefore China’s economy slowed. By May 2012 annual fixed asset investment growth had fallen to 20.1%, the lowest for a decade. In August the yearly increase in industrial production declined to 8.9%. In the same month the annual increase in industrial company profit fell to 6.2%.
However, by mid-2012 policy was adjusted appropriately. In late May Premier Wen Jiabao announced an infrastructure centred investment program that grew to $157 billion. Theoretical support to this new stimulus was given by former World Bank Chief Economist and Vice President Lin Yifu - who has now returned to Beijing to be a major influence in China’s economic policy making.
The correctness of these policies was rapidly shown. By December the investment decline reversed, with the annual increase in fixed asset investment rising to 20.6%, and industrial output growth accelerating to 10.3%. Industrial company profits grew – rising to a 22.8% annual increase in November. These trends underlay the GDP growth increase from 7.4% in the third quarter to the fourth quarter’s 7.9%.
In a perfect world doubtless China would have launched its domestic stimulus a few months earlier. But in economics it is impossible, due to the enormous number of variables involved, to make precisely accurate projections, only orders of magnitude can be accurately predicted. In particular policy makers had to take into account that China’s population is extremely inflation adverse. If export demand had been at the level expected, launching a domestic stimulus would have threatened economic overheating with inflationary dangers. In the grand economic scheme of things, with China’s GDP rising at 7.8%, the US at 2.2%, and the EU and Japan not at all, a few months delay is virtually neither here nor there.
Nevertheless there exists a small industry of those claiming China is ‘soon’ to suffer deep economic crisis – the ‘soon’ merely progressively moving forward in time when it doesn’t materialize. A few examples will give the flavor of the genre:
The fact that such predictions are regularly refuted by events does not stop them being put forward. A slight delay in China launching a domestic stimulus in 2012 therefore created a frenzy of speculation in such circles regarding a ‘hard landing’ or ‘crash’ in China’s economy – which as always failed to materialize and instead, as already noted, China’s economy accelerated.
A new ‘theory’ therefore had to be put invented of why China’s economy will substantially slow – that China’s government is allegedly sacrificing the long term interest of its economy for a short term ‘fix’. According to one formulation of this, by Jamil Anderlini and Simon Rabinovitch in the Financial Times: ‘China went into reverse in the second half of 2012 in its efforts to rebalance its economy… Though steady, consumption took a back seat to capital spending as a driver of growth.’
Unfortunately this line of argument makes as little sense as, and will be therefore be just as refuted by events as, the numerous others.
First, taking the long run, modern econometrics shows clearly that as an economy develops it becomes more dependent on investment for growth, not less. As China moves from a developing to a developed economy investment would be expected to play a greater role in its growth.
Second Lin Yifu has rightly stressed that the industrial upgrading of an economy consists of it moving from labor intensive to increasingly investment intensive industries. This is precisely the path China is following with its exports increasingly switching from labour intensive products such as textiles and toys into more capital intensive ones such as ships, construction equipment, smartphones and cars.
Finally, in the purely short term, the present global economy conforms to economic theory showing that investment fluctuates more than consumption, and it is investment downturns which therefore create economic recessions. The latest data shows in developed economies fixed investment is nearly 10% below its peak and has been declining since the first quarter of 2012. China’s ability to counter such threats by an investment stimulus program is therefore a sign of the strength of its economy, not a weakness. It is this ability to control and raise investment which determined that China’s economy continued to grow rapidly, while the sharp decline of investment in the developed economies led to their stagnation or renewed recession.
Consequently, rather than China’s government’s policies sacrificing the long term strength of the economy to short term expedients, the stimulus launched from summer 2012 integrates both short and long term considerations in economic development. This is why the majority of predictions for growth in China’s economy in 2013, from both Chinese and the majority of international experts, are for a further speed up in GDP growth to more than 8% - the World Bank’s 8.4% being fairly typical.
The main dangers to China’s growth in 2013 are therefore not domestic but those from external weakness in developed economies. The latest prediction by the World Bank for growth in 2013 is 1.9% in the US, 0.8% in Japan and -0.1% in the Euro Area. For this reason the World Bank’s overall projection for global growth is a low 2.4% in 2013.
Naturally China, as the world’s second largest economy, and the world’s largest goods exporter, cannot isolate itself from world economic trends. If the world economy slows in 2013 China is likely to slow, and if the world economy accelerates China’s economy is likely to speed up. But whatever the short term ups and downs China will continue to enjoy its 6-7% growth lead over the developed economies.
In regard to the medium term a major turning point in world history is being approached. The IMF projects that, in comparable price levels, that is parity purchasing powers, China will overtake the US to become the world’s largest economy in 2017. At market prices China will overtake the US to become the world’s largest economy a few years later. Exactly when the latter transition will take place depends on the assumption on exchange rates, with 2019-20 being the most central date. To be safe it may be said China will become the world’s largest economy ‘within 10 years’. Given the short time scale, unless China’s economy slows very drastically and very quickly this transition is inevitable.
No one alive has ever lived in a world in which the US was not the largest economy – it gained that position in approximately 1870. It is, among other reasons, because it is mentally difficult for humans to adjust to the new and never experienced that constant theories are put forward that China’s economy must be about the slow substantially. But, for the reasons already outlined, China will maintain its rapid economic growth. That is 2013’s realistic economic perspective.
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An earlier shorter version of this article appeared in China Daily.