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China, me old China

January 20th, 2009

This is a long overdue post, promised as a thankyou to my old friend Martin Ellison who managed the transfer of the blog from the old, slow and unreliable shared server to the new accelerated server a few months back. Anyone who has noticed the difference is welcome to add their thanks in comments.

As a return in kind, I promised a post on any selected topic within reason, and Martin asked about the Chinese economy, a subject on which I’ve regularly promised myself I will get up to date. So, here goes.

To start with some numbers, according to the not very reliable official statistics the Chinese economy (really, the market part of the economy, excluding lots of near-subsistence agriculture) has been growing at around 10 per cent per year. That corresponds, very roughly, to input growth of 6 per cent (a weighted average of a market labour force growing at maybe 3 per cent a year and a capital stock growing at 10 per cent or more thanks to incredibly high savings) and total factor productivity growth of 4 per cent).

If you accept these numbers, then, just to absorb the growth in the labour force, with no further capital deepening, the economy needs to grow at 7 per cent a year. This rate is slowing as the easy opportunities for productivity growth are exhausted and as the supply of reasonably employable entrants to the market diminishes. But it’s not going to drop fast.

The problem is that, with exports falling off a cliff, it’s going to be very hard to maintain growth unless Chinese households suddenly stop saving and start consuming. No doubt this will happen in the end, but the process will certainly be painful.

The likelihood of a severe economic slowdown will pose big problems for the political system. In a Western democracy, the immediate reaction to a severe economic shock is typically to throw out the incumbent government. Even if the other side does no better, the easy availability of an alternative government reduces pressure for revolutionary change. There’s no obvious analog in the Chinese context. Perhaps some minister or group of ministers can be made to take the fall, but it’s unclear that anything that would be perceived as a change of government is feasible.

Turning to the substance of policy, it’s obvious that the existing system has produced big changes in policy, but much less clear (to me) how these are brought about. In the present crisis, for example, the government might seek to accelerate the winding down of state enterprises to save money, or alternatively might reverse this process to save jobs. I don’t know the advocates of the alternative strategies resolve their differences in cases like this. Perhaps others could comment.

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  1. plaasmatron
    January 20th, 2009 at 22:12 | #1

    Traveling through China a decade ago, what struck me was the unswerving respect for Mao. Despite his later faults, he is perceived as having returned China to the Chinese, out of the hands of the colonialist cronies, the Guomindang. Communism was always a banner defining what they were not, rather than what they wanted, and came with financial and military aid to-boot. When Deng switched courses, the people followed. 30 years of astounding success, partially earned and partially good timing associated with coinciding with the biggest debt expansion in history, has kept the critics quiet. Soon the enormous (ca. 500 million) poverty stricken masses will start to question if the current leaders really know what they are doing. Combine this with bleedingly obvious corruption at the local level of government and a sickening acceptance of brutality in everyday life; I expect major unrest in the later part of this year coinciding with the onset of colder weather.

  2. Hermit
    January 21st, 2009 at 09:08 | #2

    The problems of growth dependence were anticipated decades ago by economists such as Hermann Daly. Now we see it unfold. Even in Australia’s resources sector there seemed to be an understanding that it couldn’t go on forever. I’d liken it to an aircraft that must have forward speed to keep it aloft so that it doesn’t fall to earth. On a more positive note there will be a slowdown in China’s gargantuan greenhouse emissions. Some of Australia’s rich mineral deposits will be conserved for future generations. Let’s hope what emerges is more sustainable.

  3. Sam
    January 21st, 2009 at 09:29 | #3

    Hi John. Thanks for the post. Just wondering what your/others opinion/s are on how to approach official Chinese statistics. You say, “…according to the not very reliable official statistics the Chinese economy…”. This reminds me of comments by a Professor from my studies in the US. He was a former state department employee in HK, China and Taiwan and had jobs up to deputy Ambassador and argued that while the statistics got better in more recent time, they’ve historically been absolute rubbish. I remember that he used to enjoy telling the story of playing golf with the then head of the reserve bank in China who said he had no idea what the real inflation rate was (because of incomplete and inaccurate data collection) and that the main consideration when they reported the official inflation and growth rates was political.

    While these sorts of problems with historical Chinese data seem to be well known (as I assume your above quote alludes to), I still see people regularly trotting out these statistics without any real compunction. How do economists/others try and get around this problem? The only response I’ve heard on this came from an investment banker I talked to while I was visiting Deutschebank’s HQ in Frankfurt a few years ago. He said that they didn’t really have a good way of doing it but tried to use data that could be validated by other countries (e.g. import/exports) to get a better idea of the robustness of the official Chinese data. But this approach still seems to be very limited? Thanks!

  4. January 21st, 2009 at 14:46 | #4

    Dear John,
    I’ve been interested in the China question for years, after reading a book with a seemingly rude title “Lords of the Rim”. Great book, anyway told of the expansion of Chinese capitalism across the Pacific Rim after fleeing the Communist acquisition of assets, and argues the author, their toil injected huge amounts of resourcefulness and wealth into the East Asian economies, while taking a hands off approach totheir politics. Indonesia, Thailand, Malaysia and even Australia and the West Coast of the US. Anyway, something that Deng and later Chinese Government’s move into capitalism, the policy has been has been to try and entice these people back home.
    Now that the Chinese Government has become the crux of our economic fortunes (while only taking 20% of our exports… ok I suppose that’s a lot) it has risen front and centre to our perspective.
    The growth rates, which have been made easier to obtain coming from nothing, zero, zilch – had to slow down sooner or later.
    I guess what I wanted to know from your good self is what you thought about the amount of US foreign reserve they hold, and what that means for their economy? Does it mean that the got jipped with the fall in the value of the US economy?
    And what next for these two?

  5. Nick K
    January 21st, 2009 at 15:12 | #5

    It seems obvious to me that China cannot sustain its current growth rates for that much longer into the future, for a few reasons:
    - slowing world growth will reduce export revenues
    - the one-child policy means that before long China will be dealing with rising costs of aging populations and fewer workers

    It is worth remembering that it wasn’t that long ago that many commentators were claiming that Japan would become the world’s leading economy. Now such a claim is so ridiculous that one would be laughed out of the building for making it.

    It is very easy to be dazzled by the latest economic success story, only to find that each ‘miracle’ economy comes up against limits to growth.

  6. BilB
    January 21st, 2009 at 16:15 | #6

    Thanks Martin Ellison,

    JQ’s site is a fresh breeze campared to how it was. Great work.

  7. stephen
    January 21st, 2009 at 16:24 | #7

    China will undoubtedly slow in line with the rest of the world, as markets for key exports contract. However there are some factors that suggest a pretty high positive growth rate will continue (albeit at less than double-digit rates). First, the movement from rural to urban areas that has driven a lot of economic expansion particularly in some of the coastal provinces – notably Guandong – that looks set to continue. Second, the new Chinese middle class which has stimulated domestic demand. Third, massive investment in skills formation will ensure productivity growth. According to UNESCO China now has more than twice as many university graduates p.a. than the USA and there has been extensive investment in skills in many other areas as well.

    Nick in the comments thread suggests that the one child policy will mean China will suffer problems of an aging population and fewer workers. He may be right in the long run; but there is for the foreseeable future no workforce shortage, as the move from rural subsistence to higher paid urban work is an ongoing source of labour. It is also arguable that the one child policy is one of the reasons for development of a more prosperous and better educated middle class.

    So will China be subject to unrest? Clearly the leadership has been worried about it for a while – seen in the continual emphasis in Hu Jintao and other leaders’ speeches on the importance of a harmonious society. Governance problems like corruption are genuinely of concern to the government and it’s trying to deal with them. (if you’ve firsthand experience in China, feel free to debate whether or not its making headway)

    In the short term, the prospects of a slowdown will mean opportunities for poorer Chinese to relocate to a factory job may be postponed; that a number of factory workers will lose their jobs – but unlikely permanently; and that some businesses will go under. Will this be blamed on the current government, or will it be seen (much like the perception of the Rudd government here) as being driven by global factors and primarily the US mortgage collapse? My perception is that its more likely to be the latter, especially given the relish that State media take in reporting on US misfortunes. This suggests that in the short term there is likely to be unhappiness, but not intense discontent with government that might lead to a buildup of pressures for revolutionary change.

    What’s more worrying longer term are ethnic tensions, regional tensions, and the harm that climate change is likely to inflict on both agriculture and living conditions. Subjects for debate another day.

  8. January 21st, 2009 at 18:31 | #8

    No one has yet mentioned another slow burning problem that is definitely on its way: the huge disproportion of men to women. According to the New Republic last year (http://tinyurl.com/6lflbo):

    “After almost 30 years of the [one child] policy, China now has the largest gender imbalance in the world, with 37 million more men than women and almost 20 percent more newborn boys than girls nationwide.

    By the time these newborns reach puberty, war games may seem like a quaint relic. In the 2020s, Chinese Academy of Social Sciences researcher Zheng Zhenzhen, estimates in a People’s Daily interview that 10 percent of Chinese men will be unable to find wives, which could have a huge impact on Chinese society.”

    Indeed, and none of the consequences are likely to be good.

  9. gerard
    January 21st, 2009 at 19:08 | #9

    the Chinese government needs to restore public healthcare and education. the main reason that Chinese people prefer to save rather than consume is that their social welfare system is so minimal. A serious illness in China can cost several years worth of wages, so you have no choice but to save.

  10. Nick K
    January 21st, 2009 at 21:24 | #10

    Stephen says “It is also arguable that the one child policy is one of the reasons for development of a more prosperous and better educated middle class.”

    That may well be true. It is normally the case that falling birthrates actually contribute towards economic growth in the short-term. That is because people don’t have to spend as much time looking after children, and can therefore spend more time in the workforce, running businesses etc.

    The problem is that this growth is invariably unsustainable. Because any country that has low birthrates will sooner or later have to deal with the problems of an aging population and too few younger workers to keep things going. The bottom line is that if you fail to reproduce the human capital, you will have to pay a price down the track.

  11. Nick K
    January 21st, 2009 at 21:35 | #11

    Gerard @ 9, it’s funny you should mention this. A lot of free market think tanks like the CIS and IPA have for some time been making the point that the growth of the welfare state has a negative effect on national savings. Yet these arguments have generally been ignored by most of the commentariat, especially in the context of the current debate about excessive levels of personal debt and inadequate savings.

    I’m glad that you have brought this point up. It will help move the debate forward.

  12. gerard
    January 21st, 2009 at 21:37 | #12

    there are costs of supporting a large retired population, but even worse are the costs of supporting (and educating) huge numbers of children, which is the common situation in most developing countries.

  13. gerard
    January 21st, 2009 at 21:54 | #13

    11, I’m not sure what debate that is – although I imagine that the CIS and IPA regard China’s perverted healthcare system as something good and would like to import it here.

  14. Nick K
    January 21st, 2009 at 21:57 | #14

    Gerard, if you want to look further into demographic issues I suggest you read some works by Phillip Longman. Moreover, Longman writes from a non-ideological perspective. He tends to blame both free markets and state intervention in equal doses.

    Elderly people actually consume more resources than children, so the cost of supporting an aging population is greater.

    Moreover, the costs of raising children are an investment in the future human capital. The costs of supporting elderly people don’t have the same impact on increasing future human capital.

  15. January 21st, 2009 at 22:12 | #15

    steve from brisbane quoted “By the time these newborns reach puberty, war games may seem like a quaint relic. In the 2020s, Chinese Academy of Social Sciences researcher Zheng Zhenzhen, estimates in a People’s Daily interview that 10 percent of Chinese men will be unable to find wives, which could have a huge impact on Chinese society.”

    Historically, that sort of thing leads to war because from a certain perspective that’s a win-win: either you get your Sabine women or you get rid of your surplus males. (Ancient Rome isn’t the only precedent.)

  16. conrad
    January 22nd, 2009 at 06:58 | #16

    “Elderly people actually consume more resources than children, so the cost of supporting an aging population is greater. ”
    .
    All of this might well be true of rich countries like Australia, but is it true of places where the average life expectancy is 70, there is little in the way of pensions or other government subsidies and grandparents often end up in child-care roles?

  17. Nick K
    January 22nd, 2009 at 12:34 | #17

    Conrad, it may be true that it costs less to support elderly people in poor countries than in wealthier countries.

    But the same is also true of children. It costs far less to raise children in poor countries, because children start working at a younger age and spend less time in formal education.

    Moreover, in more traditional societies children are more likely to work in small family concerns. This means that parents capture a larger proportion of the labour market contributions of the next generation. Whereas in more advanced economies, children end up working for other larger businesses. So parents capture less of the benefits.

    Another point is that in countries with substantial social security systems those who fail to produce children can end up relying on other people’s children to support them in their old age. So more of the benefits of raising the next generation are socialised, rather than being captured by those who produce more children.

  18. gerard
    January 22nd, 2009 at 12:39 | #18

    Yes Nick, I was more thinking about places like Nigeria and Saudi Arabia where it is not uncommon for women to have seven children. China was the same a two generations back. The costs to a poor society of supporting this huge number of young people is enormous, resulting in most of them ending up with little education and few prospects of employment. When high-birthrate, low-income countries cannot afford to invest in their younger generation they are actually making a negative investment in long term social dysfunction.

    (I shudder to think what Gaza will be like in 20 years, when it has 2.5 million instead of 1.5 million people).

  19. Martin
    January 22nd, 2009 at 13:12 | #19

    JQ, thanks for this.

    I should say that all I did was move the data across to the new server; the speed-up was all the result of the faster server.

  20. carbonsink
    January 23rd, 2009 at 06:45 | #20

    Kohler on China today: Broken China

    China’s economy is clearly slowing rapidly. On some measures it is going backwards – for example, electricity production is falling; so is steel production and motor vehicle production.

    Citigroup’s Shanghai-based economist, Ken Peng, estimates that after seasonal adjustment, China’s real GDP growth in the December quarter was -0.3 per cent annualised – the first contraction in at least 16 years

    This is not a “growth recession”, its a recession recession.

  21. jquiggin
    January 23rd, 2009 at 09:33 | #21

    Martin, it doesn’t sound like much, but it was more than I could manage, and I’m by no means a total computer illiterate. Thanks again.

  22. carbonsink
    January 27th, 2009 at 14:49 | #22

    This chart found on Brad Setser’s blog suggests that Chinese growth was negative in Q4 2008.

    Stephen Green of Standard Chartered has constructed an indicator of Chinese economic activity that isn’t based on the government’s reported GDP data. It suggests a far bigger fall in Chinese output than in 1998.*

    Chinese output shrank in the fourth quarter. The first quarter isn’t going to be any better

    Where are you Ian Gould?

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