Rebalancing and long term growth

As analysts and official entities like the World Bank continue to downgrade their forecasts for medium-term growth in China, physician I have been asked increasingly often for the reasons I believe that 3-4% average annual growth rates is likely to be the upper limit for China during the adjustment period. In this blog entry I want to explain how I arrived at my numbers. The analysis is fairly straightforward and those looking for a very complex econometric model are likely to be disappointed, but I have always believed that, unlike physics or cooking, anything in economics that cannot be easily explained to an educated layman with 9th-grade algebra and a little bit of calculus is likely to be useless (and if he knows some probability theory, the most beautiful branch of math in my opinion, he is able to soar).

Before beginning I should make two points. First, for many years I assumed that the “adjustment” period would begin shortly after the beginning of the administration of President Xi Jinping and Premier Li Keqiang, that is, from 2013 or 2014, and would run through the presumed end of their term in 2023.

In fact I may have been overly pessimistic. It now seems to me that China actually began adjusting economically, although in a very limited way, in 2012, when we first started to see growth slow as Beijing became increasingly worried about the astonishing increase in de??bt. This probably occurred because the big wage increases in 2010-11, which were counterbalanced by the sharp drop in real interest rates during that period, were finally able to take effect in 2012 when real interest rates rose sharply once again. Of course whether the adjustment begins in 2012, 2013, or 2014 probably doesn’t matter much to the analysis, but it is good news, I think, that it may have started earlier than I originally expected.

There is, by the way, nothing especially important about ten years except that it is a round number. If China adjusts much more aggressively than I expect, the adjustment period could easily occur within less than ten years, although this is unlikely to be the case because it will be politically difficult to pull off.

On the other hand, if the adjustment period is much longer than ten years, perhaps because the relationship between investment growth and consumption growth is highly positive, or because political opposition is fiercer than expected, growth rates might be a little higher on average in the first few years but the period of stagnant growth would last longer than ten years and there would be a much higher risk of an economic collapse.

As for the second point, I don’t really think of my numbers as being growth predictions. In fact more generally I do not like to make predictions and frankly have no idea of how to go about doing so, especially if it is likely to involve the complex econometric models.

What I prefer to do, and find more useful at least for my way of thinking, is to try develop an understanding of the overall system under clearly specified (I hope) assumptions, and then work through the logic of the system to see what the various outcomes can be. In other words I am not trying to predict what will happen but simply to list the various scenarios that are consistent with the model and to state explicitly what are the assumptions needed for those scenarios to occur. If the assumptions are plausible, then so is the scenario. If not, then they are not.

As I see it, 3-4% is what it takes for my arithmetic to work within plausible scenarios. It is, in other words, the upper limit of the average growth rate that allows me to work out arithmetically the growth in debt, consumption, investment and GDP needed for the amount of economic adjustment that will rebalance the economy by the minimal acceptable amount, without making some fairly implausible assumptions.

This means that depending on how aggressive Beijing is during the reform process, China’s actual growth might be higher if Beijing engineers a much more aggressive program than I think plausible of transferring resources from the state sector to the household sector, thereby forcing up the household income and household consumption shares of GDP. It will be lower if there are more adverse shocks to trade or the financial sector, or if political opposition to the reforms is fiercer than expected. In other words I really think of 3-4% average annual growth as the plausible upper limit of GDP growth, assuming no massive privatization program.

Let me state my assumptions. As everyone now recognizes, rebalancing in China requires that consumption grow significantly as a share of GDP over the next decade or more. China currently reports household consumption as representing about 35% of GDP, which is an almost surreally low number. By how much would consumption have to rise for meaningful rebalancing to have occurred?

Before answering, how meaningful is this 35% number? A number of analysts have regularly argued that the official data seriously understates both income and consumption in China, and so China’s real household consumption is much higher. This may well be true, but I think there are at least three counterarguments. First, while it is true that some consumption is not included in the official data, at the same time there is quite a lot in there that should not count as consumption, or at least not for the purposes of understanding the rebalancing process.

For example three of the fastest growing consumption categories year after year are gold and jewelry, household furnishings, and household appliances. I would argue that all of these should really count as investment, and certainly the latter two will drop dramatically as investment, especially in real estate, drops (and the former will probably drop as the financial repression tax is eliminated). As a rule any item of consumption the demand for which is highly correlated to investment should be treated as investment for our purposes, not consumption. So when analysts point out that a lot of consumption is paid for by businesses on behalf of employees, and so does not show up as consumption in the data, they are right. But they are also largely irrelevant. The consumption that we care about is consumption unrelated to investment, because it is this consumption that must rise as investment drops.

Second, if both consumption and income are understated, as they may well be, this does not necessarily mean that the consumption share of GDP is more than 35%. This would only be the case if the ratio of hidden consumption to hidden income is greater than 35%.

If most of the hidden consumption and income belong to the rich or very rich, as is commonly assumed, it may well be that the true ratio is lower, not higher, than 35%. Many analysts are muddled about the differences between absolute consumption levels and the consumption ratio, and so they believe that if they can show that consumption is higher than claimed by the National Bureau of Statistics, the imbalance is less of a problem. It isn’t. What matters is the consumption share of all that is produced, and if both GDP and total consumption are higher than the official numbers, China’s imbalance is not necessarily better. It may even be worse, and it is the imbalance that matters to China’s growth prospects.

Finally we are not talking about small imbalances here. The reported consumption share of GDP is astonishingly low, perhaps the lowest ever recorded, and so the error in the data would have to be enormous for it to matter to the rebalancing debate. Even if it turns out that 20% of Chinese consumption, and none of its income, were hidden and unrecorded in the NBS data, China would still easily have the lowest consumption rate of any major economy in the world.

What is the right level of consumption and investment?

Globally, consumption represents a fairly stable 65% of GDP. Over the past decade this average has encompassed a group of high-consuming countries, such as the United States and peripheral Europe, whose average consumption exceeded 70% of GDP, as well as a group of low-consuming countries, mainly in Asia, whose average consumption, excluding China, ranged from 50% to 58% of GDP.

This distribution of over- and under-consumption should change in the next few years. It is unlikely that the high-consuming countries will be able to maintain their excess levels of consumption for the rest of this decade, and indeed their consumption rates have already come down substantially, with more probably to come. Peripheral Europe is in crisis, and the United States is taking steps to raise its savings rate so as to reduce its current account deficit. Japan, although already a relatively low-consuming country, is also likely to try to increase its savings rate so that its massive debt can be funded by patient domestic savers, rather than by impatient foreigners.

This means that the rest of the low-consuming countries are also unlikely to be able to keep their consumption levels as low as they have in the past. A world with low-consuming countries requires high-consuming countries in order to balance.

If global consumption drops in the high consuming countries, with no corresponding rise in the low-consuming countries, it is unlikely that investment will rise quickly enough to replace it (why invest if no one is going to buy the output?), and so the global economy must respond with enough of a contraction in GDP to maintain consumption at roughly 65%. The great consumption and savings imbalances of the past that led to the current crisis, in other words, have to adjust. This means that if there are no longer large economies consuming 70% of more of their national income, the world is unlikely to be able easily to accommodate large economies consuming just 50–58% of their national incomes.

Let us assume, nonetheless, that the world can accommodate a minimal amount of Chinese rebalancing. Within a decade Chinese household consumption, according to this assumption, will rise to no more than 50% of GDP, as difficult as it will be for the world to accept such low consumption from its second-largest economy. This will mean that China still produces far more than it absorbs – especially if investment growth were to come down sharply, and it would mean that the rest of the world would be forced to absorb excess Chinese production without resorting to trade intervention.

For the sake of completion let us make a second assumption that, because the world is unable to accommodate such a low consumption level for the world’s second largest economy, global pressure forces an even more dramatic change in Chinese household consumption so that it rises to 55% of GDP, instead of 50% as in our first assumption, in ten years. Both of these assumptions can be modeled in a way that combines consumption and GDP growth to arrive at the desired outcomes, and I will ignore the possibility that if the world forces China to raise its consumption rate to 55% in ten years, this will probably happen through negative growth and trade disputes, thus making all my numbers overly optimistic.

So much for our assumptions about the consumption rate – the second set of assumptions involves investment. Currently China has the highest investment share of GDP in the world, with investment comprising 46% of GDP or more, depending on how it is calculated. A 2012 IMF paper that I have cited in earlier issues of this newsletter shows investment as high as 49% of GDP, and it calculates excess investment, i.e. the spread between actual investment levels and the level predicted by an historical model, which began growing around the year 2000, as being 5-10 percentage points.

What is the appropriate level for a country like China? A number of studies have examined other high-investment developing countries during their growth miracle stages, and for most of these countries investment peaked out briefly at 35-40% of GDP (in Malaysia, Thailand and Singapore investment did at one point exceed 40%, but in each case only for a very brief period). In emerging markets investment is typically around 30% of GDP.

How should China compare to these countries? Some analysts argue that China, a very poor country, suffers from a capital stock that is too low, and so the optimal investment level should be much higher. This reasoning, I hope I was able to show in my June blog entry, is based on a fallacy. The optimal amount of investment for any country depends not on how far it is from the capital frontier but rather on its level of social capital, and this implies that very poor countries should optimally have lower levels of capital stock per capita than richer countries.

China’s capital stock per capita, for example, is higher than that of Mexico, and much higher than that of Russia and Brazil, three other large developing countries that are substantially richer than China and whose workers are more productive. When analysts say that China’s capital stock is relatively low, they are completely befuddled. It is low compared to the richest and most productive countries in the world, as it should be, but it is high compared to other developing countries, and even compared to developing countries with much higher levels of productivity

Because investment shares in other developing countries peaked out at 35-40%, some analysts argue that this is the appropriate level of investment for China. There are of course a number of problems with this argument but two stand out especially. First, the countries for which investment peaked out at 35-40% of GDP nearly all had subsequent periods of very difficult adjustment, with burgeoning growth in debt and either sharp economic contraction or many years of very slow growth, during which periods the investment share of GDP dropped substantially.

It is not at all clear, in other words, that for these countries 35-40% was the optimal investment share of GDP. This was probably already too much investment because in many if not most cases it was subsequently followed by many years of low or even negative growth, probably as the economy was forced to grind its way through the debt associated with the excess investment. The optimal level, in other words, was probably much closer to 30%.

Second, even if 35-40% was somehow the optimal level for China all along, investment in China has substantially exceeded this level for many years, so it seems obvious that an appropriate adjustment should mean not that investment drops from 46% of GDP to 35-40%, but rather that is drops to something well below 35% for many years before returning to the “optimal” level. This, I think, is just common sense.

Making the implicit explicit

So I assume that investment must drop as a share of GDP. One way or another, either because Beijing forces changes in the growth model, or because Beijing does nothing and allows debt to build to the point where debt capacity constraints are breached, after which investment collapses automatically and the investment share of GDP will drop substantially.

How long will it take? I am going to assume Beijing has ten years to bring investment levels down to the new “optimal” level just to make my calculations easier, but as in the case of taking ten years for consumption to adjust, I think this is an heroic and frankly implausible assumption. Debt levels are simply too high in China for it to continue this level of investment growth for so many more years.

To repeat the exercise, then, let me make two separate assumptions – that investment will drop to 40% of GDP in ten years and that investment will drop to 35% of GDP in ten years. In either case I will assume that investment is currently 46% of GDP, although it is probably closer to 49%.

It turns out that it is fairly simple arithmetic to work out the implications of each of these assumptions relative to GDP growth. Rather than start with growth assumptions in consumption and investment and use these to determine what the corresponding GDP growth rate is likely to be, I thought it would be more useful if I reverse the process and simply assume a bunch of GDP growth rates ranging from -2% to +10%. These are the different average GDP growth rates possible under different scenarios for the next ten years.

We will assume two sets of adjustments for investment and consumption. The “easier” adjustment scenarios have household consumption growing from 35% of GDP to 50% of GDP, while investment declines from 46% of GDP to 40% of GDP. The “tougher” adjustment scenarios have household consumption growing from 35% of GDP to 55% of GDP, while investment declines from 46% of GDP to 35% of GDP.

The table below lists the consumption and investment growth rates needed for rebalancing to take place at each of the highlighted GDP growth rates.

Table:GDP, consumption, and investment growth in a rebalancing China


Assumed GDP growth rate

Consumption growth as the consumption share rises from 35% to 50%

Consumption growth as the consumption share rises from 35% to 55%

Growth in investment as the investment share drops from 46% to 40%

Growth in investment as the investment share drops from 46% to 35%




































To read the table, let us start by assuming, as an example, that we believe the average GDP growth rate over the ten-year period will be 6%. For China to do a minimal amount of rebalancing that gets consumption to 50% of GDP and investment to 40% of GDP, we can quickly figure out what the corresponding growth rates of consumption and investment must be. Consumption must grow by 9.9% a year and investment must grow by 4.5% a year to get us there.

Notice the reason why I do it this way rather than the “normal” way most other economists would. Instead of estimating what I expect the growth rates in consumption and investment will be, and then calculating the implicit GDP growth rate from those numbers, I start with an assumed GDP growth rate and then calculate what the implicit growth rates in consumption and investment must be in order for rebalancing to take place. I am not making predictions, in other words. I am simply working out logically what any GDP growth rate must imply in terms of consumption and investment growth rates in order for China to rebalance.

This allows me to make statements like this: If you think that China’s GDP will grow by 7% a year over the next decade, and if you expect a minimal amount of rebalancing, then you are implicitly predicting that consumption will grow by 10-11% a year for ten years and that investment will grow by 4-5.5%. If you believe these two implicit predictions are plausible, then your 7% prediction is also plausible.

Trade is a residual

Notice of course that for the changes to work we are implicitly assuming that the GDP share of the sum of other consumption (government and business) and the current account surplus changes automatically to allow the equation to work. So if consumption rises from 35% of GDP to 50% of GDP, for example, while investment falls from 46% of GDP to 40% of GDP, the other sources of demand (mainly other consumption and the current account) must have reduced their share of GDP from 19% to 10%. This probably means a sharp contraction in the country’s current account surplus and perhaps even a current account deficit.

I want to state again that these numbers are not predictions. They are simply the arithmetically necessary growth rates that are consistent with our assumptions. To return to the interpretation of the table, let us assume again that China does the minimal amount of rebalancing so that in ten years household consumption is 50% of GDP and investment is 40% of GDP, what are the investment and consumption growth rates consistent with, say, 6% GDP growth, and are they plausible?

It turns out that average GDP growth rates of 6% require, as an arithmetical necessity, that household consumption grow by 9.9% a year over the next ten years and that investment grow by 4.5%, after many years of high double digit growth and more recently growth in the low double digits. Is this plausible?

I would argue that positive investment growth rates for another ten years are highly likely to result in our reaching debt capacity constraints well before the end of the decade, so I am skeptical about the investment implications of this scenario. By the way some analysts have mischievously pointed to the very poor construction quality in China to argue that investment growth rates have to stay high just in order to account for higher-than-estimated depreciation costs, and that this suggests that China can grow faster than what we might otherwise assume.

This of course is nonsense. The fact that buildings and infrastructure are poorly constructed means that China is worse off, not better off, and the investment projects will ultimately be required to generate sufficient returns to pay off even more debt than originally estimated. Because it is debt capacity constraints that constrain investment, anything that creates debt without creating additional productivity to service the debt cannot possibly be a solution. Higher-than-expected depreciation increases debt relative to debt-servicing capacity.

I would also argue, more importantly, that if annual investment growth drops to 4.5%, and GDP growth to 6%, it will be very difficult, without significant and politically painful transfers from the state sector to the household sector, for consumption to grow at anywhere close to 9.9% a year for ten years. Consumption growth is, after all, positively correlated with investment growth, especially in the internal provinces upon which a lot of useless investment has been lavished.

In order to get Chinese households to increase their consumption by nearly 10% every year, I would argue that household income would have to grow at that rate, which means that wages, interest rates, and the value of the renminbi should in the aggregate increase rapidly to get consumption to rise fast enough, and of course since it is precisely low wage growth, low interest rates, and an undervalued currency that goose GDP growth, reversing them is not consistent with high GDP growth.

Can consumption grow at close to 10% for ten years while household income grows much more slowly? Yes, of course it can, if the household savings rate declines, but as China’s economy slows and as concerns about debt rise, it seems to me a tad optimistic to assume that the household savings rate will decline sharply. Rising income and rising uncertainty both suggest that we should expect higher, not lower, household savings rates, which in turn imply that household income must grow faster, not slower, than household consumption.

All of this suggest to me that while 6% GDP growth for the next ten years might not be impossible, it is extremely unlikely because it requires what are to me implausible assumptions about the ability to maintain and increase already-high levels of investment without increasing the debt burden unsustainably and about the rise in the growth rate of household income as both GDP and investment growth drop sharply. This is why even 6% annual GDP growth rates, which are still lower than most current growth projections for China, are implausibly high, in my opinion.

What about if you believe that reducing investment is a much more urgent priority than raising consumption? In that case you might argue that China can grow at 6% while the household consumption share of GDP rises to 50% and the investment share of GDP declines to 35%.

In that case you are implicitly assuming that household consumption will grow on average by 9.9% a year for ten years while investment grows by 3.1% a year. Is this possible? Of course it is. Is it plausible? Again, only if you believe that investment growth can drop sharply while the growth in household consumption rises to nearly 10% a year for ten years.

So what is plausible? My working assumption, which I acknowledge is probably still optimistic, is that somehow or the other Beijing can keep household consumption growing at around 7-8% a year, even with a sharp decline in the investment growth rate and with the pressing need to clean up the banking system (and remember that traditionally, in China and elsewhere, cleaning up the banking system always means finding ways of getting the household sector to pay for the losses).

I know many consider assumption this to be a little optimistic, but if Beijing is worried about the social implications of adjustment, this is probably the target it will need to meet, and Beijing can do so even with much slower GDP growth if the leadership implements mechanisms that transfer wealth from the state sector to the household sector. I discuss why this is the right growth rate for to target in more detail in a recent piece published on the Carnegie Endowment website and in an OpEd piece in the Financial Times.

The table above shows that if China is to do the minimal amount of rebalancing, which requires that the world accommodate for another ten years large Chinese trade surpluses, and that debt can continue to grow – quickly but at a lower rate than in the past – for another ten years without pushing China up against its debt capacity constraints, 7-8% growth in household consumption is consistent with roughly 3-4% growth in GDP. It is also consistent with more or less no growth in investment, which would after ten years bring the investment level down to 35% of GDP.

These numbers are, I think, plausible if still a little optimistic. This is something, in other words, that I think Beijing can reasonably pull off – if it is able to manage political opposition from the domestic elite – because they can transfer resources from the state sector to the household sector at a pace necessary to keep the growth rate of household income and household consumption fairly high. However GDP growth rates significantly above 3-4%, I would argue, require assumptions that are unlikely to be met unless Beijing is able radically to transform its attitude to state ownership and the power of the elite, and so embark on a major transfer of assets from the state to the household sector.

This is why I have argued since 2009 that that 3-4% average GDP growth for a decade is likely to be the upper limit once Beijing seriously begins to rebalance the Chinese economy, and if the administration of President Xi and Premier Li is able to pull this off, it would be a huge accomplishment. China would rebalance substantially, the problem of debt would have been managed relatively well, and the income of average Chinese households will have nearly doubled over the decade. The key assumption, of course, is that in the face of a sharp drop in investment, Beijing is nonetheless able to maintain current high levels of consumption growth.

Before closing it is worth pointing out that many analysts have told me that they do not think it is possible for household income growth to exceed GDP growth for many years. But why not? After all state income growth exceeded household income growth for many years, and if Beijing reverses the mechanism that accomplished this – albeit with political difficulty – it can reverse the relative growth rates. More importantly, Japan did just this after 1990, when GDP grew by around 0.5% annually but household income and household consumption grew by between 1% and 2%. The US did this too in the early 1930s when, if I remember correctly, household income and household consumption dropped by a lot less than GDP (around 35%) and investment (around 90%).

But notice these two examples. One occurred under conditions of no growth and the other under conditions of negative growth. Severely unbalanced systems always rebalance in the end, but the process of rebalancing is rarely easy.


This is an abbreviated version of the newsletter that went out four weeks ago.  Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at [email protected], stating your affiliation, please.  Investors who want to buy a subscription should write to me, also at that address.


 Add your comment
  1. Hi Michael,

    I have just finished reading your latest book and I would like to say thanks for giving the us such a useful framework for understanding the important overarching principles that govern the world economy. I think you have things pretty well sewen up with your savings model. But I am not that widely read. I only read what I can understand and make sense to me.

    I have also just finished reading the Battle of Bretton woods by Ben Stein. Reading your book first and in particular assimilating the accounting identities you introduced in chapter two was really helpful to understanding
    Ben’s book. Btw I recommend it to other Blog readers as a very useful insight as to how things happen at the highest levels. And what can go wrong.

  2. Provide a model, Michael. Because at the very moment I could debunk your article with ease.

    • Before you ask: Of course I cannot debunk 90% of your article, because it´s true. But the core question about China´s growth rate is unconvincing since Bo Xilai could pull a rebalance with high growth rates off in Chongqing.

      I mean.. if there is at least one proven case against the motion, you won´t be able to say that China´s way is predetermined. China´s growth rates will only go down, if its elites decide that it would be better so – for whatever reason.

      • Perhaps not with as much ease as you imagine, Jamba. Let me see if I understand you. You are arguing that Pettis’s claim that China can only achieve high levels of growth at the cost of even higher credit growth is easily refuted by citing Bo Xilai’s growth policies in Chongqing, right? If so, I suggest you find a better argument. Chongqing under Bo followed one of the most ruinous debt policies in China and it’s debt levels are among the highest of any major municipality in the country (except perhaps Tianjin, which is on the verge of bankruptcy). This really is a rather strange form of “debunking”.

        • I wrote that I cannot debunk 90% of his article, because it´s true.

          But the core question about future China´s growth rate is unconvincing. Michael came to conclusion that China won´t be able to rebalance accompanied with higher debt levels. Why? Because higher debt is unsustainable in the long run.

          And here´s the flaw:

          Chongqing however rebalanced accompanied with higher debt and high growth rates – and still grows with high growth rates.

          Shouldn´t something bad happen in the meantime? Michael wrote that the investment cost of Chongqing was spread through the national banking system. However the NPL rate of the local branches of the Chinese state-owned banks in Chongqing doesn´t significantly differ from the rest of the counry.

          So what actually prevents China from accompanying its transition with debt in the short/mid-term?

          Therefore I think that low growth rates during the transition time are a choice not a necessity. And if Michael wants to make a better argument (maybe he is still right after all), he should present a model for his conclusions.

          • One key flaw you’re making: believing the growth rates as being what the Chinese government puts them out as. The reality is this, we can’t trust the Chinese government’s data, period. They’re not growing at 7%+ this year when the SHIBOR curves have been inverted for most of this year.

            The growth that China’s experienced has been driven by a massive expansion of the Chinese banking system(which has expanded by around 50% of GDP over the last 3 years). This is the equivalent of the US lending $20 trillion through the US banking system over the past 3 years. If the US had that kind of expansion of its banking system, I’d bet you that we’d have 10% NGDP growth easily.

          • Has Chongqing rebalanced in the span of a year? WSJ says in 2012 that Chongqing’s FAI rate was over 80%. That’s like off the charts absurd.


          • A model? What do you mean by that, Jamba? He has presented one of the clearest and consistent models of the Chinese economy of anyone I know, and the way its works is pretty explicitly laid out in almost all of his posts on China.
            Why do you say that Chongqing has rebalanced? It seems to me that it has actually gone almost exactly in reverse, as Barbara and Andao have pointed out.
            Also you say “However the NPL rate of the local branches of the Chinese state-owned banks in Chongqing doesn´t significantly differ from the rest of the country.” Where did you find the per branch breakdown? More usefully, because Chinese banks probably underreport NPLs very significantly, and because most of the lending is to government entities, which won’t show up as NPLs because of their guarantee, why would you say that a similar NPL number proves that Chongqing has rebalanced?
            I think if you want to see some evidence rebalancing, you wouldn’t look at Chongqing at all. Maybe Wenzhou, or areas in Zhejiang or Guangdong, might show better evidence of partial rebalancing. Does anyone know what the debt and GDP numbers look like in these areas? Clearly they cannot be as distorted as those of Chongqing, but do they in any way support the idea that China can grow without debt?

      • Ha ha you are too polite, Barbara. I think there are better words to describe Jamba’s argument than “strange”.

    • The purpose of models most of the time is to obfuscate reality, not to enlighten. I appreciate Michael’s use of clearly written logic and simple arithmetic.

      • illumined, I couldn’t agree with you more. I think economists who present intuitive arguments and explain their thinking in a logical fashion are far more insightful than economists who base their forecasts on some black box model that simple regurgitates historical trends back at us. Michael has been correct in predicting much slower growth in China for some time while most were clinging to “the trend is your friend” approach to forecasting Chinese growth.

    • What’s stopping you?

      • 1. I think it´s morally wrong to write too much here. I mean.. this is Michael´s blog after all. It must really suck that a random person appears out of nowhere and occupy his place. He surely already hates me.

        2. I have the feeling that Michael isn´t the only one, who thinks that I´m an annoying blabber and should shut the fuck up. There are some pundits from foreign policy and other areas of economic policy, who really really don´t like me much either. I don´t want to push my luck too far out.

  3. Oh and congratulations on your excellent piece in today’s Financial Times, which for those who haven’t read it, can be found here:

  4. Hi Michael,

    I have just finished reading your latest book and I would like to say thanks for giving the us such a useful framework for understanding the important overarching principles that govern the world economy. I think you have things pretty well sewen up with your savings model. But I am not that widely read. I only read what I can understand and make sense to me.

    I have also just finished reading the Battle of Bretton woods by Ben Stein. Reading your book first and in particular assimilating the accounting identities you introduced in chapter one was really helpful to understanding
    Ben’s book. Btw I recommend it to other Blog readers as a very useful insight as to how things happen at the highest levels. And what can go wrong.

  5. Prof. Pettis

    What will happen to inflation if the consumption was to grow at 9-10%?
    Many more balanced economies struggle with inflation even during normal growth.

  6. Have just finished your recent book, and agree completely with most of your arguments.
    But you write above:

    “This is something, in other words, that I think Beijing can reasonably pull off – if it is able to manage political opposition from the domestic elite … [However growth much above 3-4% would require assumptions] unlikely to be met unless Beijing is able radically to transform its attitude to state ownership and the power of the elite …”

    About ten years ago Brad Setser had a blog on which he was writing that he expected the leadership to make various necessary changes that would obviously be in the interests of the nation as a whole. I commented that those changes wouldn’t be made, as they would not be in the interests of the elite. And they weren’t (at least to anything like the degree required).

    As you noted in your book, the trillions of dollars China has accumulated in foreign exchange reserves represent huge unrealized losses which were sustained when they bought the dollars, and which continue to increase with every dollar they buy at exchange rates not reflecting the true relative value. Would not the adjustments you argue are required result force the realization and revelation of those losses? From whose paper wealth would the losses be subtracted? Is there any cohort other than the elite that possesses sufficient paper wealth to cover them. Are those unrealized losses not in fact a substantial fraction of the elite’s ‘wealth’ (which is therefore substantially an illusion)?

    If the elite block the changes you advocate, what will be the result?

    • That’s not a problem because US dollar reserve is hedged by the gold reserve, which increases in value as dollar falls.

      • GoldBugs and Lew Rockwell fans, please do not obfuscate matters, there is no such Gold Standard, or hedging that matters, hasn’t been a gold Standard since early 1970”s, and never will; never can be a Gold Standard again. The GCC dropped their consideration of a Gold backed regional currency because their Current Account Surpluses, at the time, in mid-2000’s, would eat up the entire historical supply of Gold in one year. So please, abandon this funda-MENTAL-ist perspective.

        Likely your a Ron Paul, audit the FED fan as well, now that the FED is 5 times the size of its previous size, when Ron Paul was wanting to Audit the FED, speaking to young -bow-tied (Tucker Carlson-ite) Republicans in the early 2000’s. The only thing that is happening, is the global economy is more stable, asset values more near to previous levels, debtors in the advanced world more balanced having de-leveraged a considerable amount of debt, and the FED returning interest to the Treasury at historical levels. Proving, against the Lew Rockwell, Goldbug, and conspiratorial theorists perspectives, and many others in the financial community, that developing countries have done the global economy no favor by engineering current account surpluses outsized relative to their import cover needs, which have risen from 3 to 6 months, by IMF fiat likely, merely to rationalize the very large excesses of central bank financial engineers in the developing world.

        • “GoldBugs and Lew Rockwell fans, please do not obfuscate matters, there is no such Gold Standard, or hedging that matters, hasn’t been a gold Standard since early 1970”s, and never will; never can be a Gold Standard again. ”

          Um, we haven’t been on a gold standard since 1914. What we were on in the 20’s and again under Bretton Woods were gold exchange standards. That’s a very important distinction because it removed the automatic balancing mechanism of the classic gold standard, allowing nations to game the system with undervalued currencies and credit expansions. Of course it also ends up making the resulting bubbles that much bigger, like the Roaring 20’s and the Roaring 2000’s.

          “The GCC dropped their consideration of a Gold backed regional currency because their Current Account Surpluses, at the time, in mid-2000′s, would eat up the entire historical supply of Gold in one year. So please, abandon this funda-MENTAL-ist perspective.”

          A return to the gold standard or something rule based would have to take into account the obscene amount of money printed in the past 100 years. It’s no accident that the dollar has lost more than 90% of its purchasing power in the past century. Ironically it was Keynes himself that said debauching the currency in this manner is a bad thing.

          “The only thing that is happening, is the global economy is more stable, asset values more near to previous levels, debtors in the advanced world more balanced having de-leveraged a considerable amount of debt, and the FED returning interest to the Treasury at historical levels. ”

          1.) The world economy is more stable? Really? Discretionary monetary policy under Greenspan and Bernanke has led to multiple bubbles, each one getting bigger. We’re currently in the latest Federal Reserve induced bubble and some how I don’t see the fallout being any less severe than it was in 2007.

          2.) Asset values were at previous levels because they were highly inflated by a bubble. Therefore it stands to reason that we’re in yet another bubble. This is not a good thing. If anything it shows the danger of discretionary monetary policy.

          3.) As far I can tell the Fed interest rate suppression continues as before, and just recently they said they would continue until unemployment officially gets to 6.5%. If interest rates are starting to rise it certainly isn’t intentional on their part, it’s because they are starting to lose control. I wouldn’t be surprised if they came out with a more aggressive money printing scheme in the not too distant future.

          • Glad to have brought the Libertarians out of the closet………….
            “haven’t been on a gold standard”
            Nitpicking, …..afterwards, agree, and support until, “roaring”……then am not sure how we get the “automatic balancing system” you desire, again. Nor that present course is disastrous in respect to that fact. Have you read:
            “return to the gold standard or something rule based”
            You didn’t address the GCC findings, as stated,……. too much common confusion/delusion has driven Gold to untenable heights after the IMF released a vast amount, and essentially created a market.
            Many people adjacent to your seeming perspective are entirely confused of the efficacy, and potential uses, thus this need be defined more clearly.
            Yes, and at one time it took 8 or 6 dollars to buy a GBP. So, the Rogoff and Reinhart paper clearly showed, I believe I am citing correctly, how even metals were debased, with some containing less than 5% silver or Gold, why the old Dubliners rendition of the Irish Folk Song, “All for me Grog”, discusses the use of “spending all me tin”, not silver, or gold, but tin, as coinage was debased no less, actually, far more commonly. But your “rule based”, then see “the future of global cooperation” link above. And, also, I should think, that all the people, around the globe should make the same, that we should have non-property owning democracies, and in three years we will be able to shift to a model of Natural capitalism. I should think it, but only to my detriment for muddling my clarity. Much less, should I bind my perspectives to my desires, and should’s, where many a philosopher will tell you that it might be better that should be taken out of the language, as it assumes the better in discussion, without necessarily delineating the path is clear or possible. Again the “Future of global Cooperation”.
            “money printed in the past 100 years……………(to) …………… lost more than 90% of its purchasing power”
            China’s currency lost more than 80% in 1994 alone, so?
            Look at the amount of money printed in China just since 2008, equal (above) to the entire US commercial banking Sector, more than 14 trillion USD to last year. And your point is?
            Look at how the globally economy has expanded since Reagan, and when the bulk of this vast printing has taken place, or since Nixon moved us off the “Gold (Exchange) Standard”.

            “The only thing that is happening, is the global economy is more stable, asset values more near to previous levels, debtors in the advanced world more balanced having de-leveraged a considerable amount of debt, and the FED returning interest to the Treasury at historical levels. ”

            1.) The world economy is more stable? Really? Discretionary monetary policy under Greenspan and Bernanke has led to multiple bubbles, each one getting bigger. We’re currently in the latest Federal Reserve induced bubble and some how I don’t see the fallout being any less severe than it was in 2007.

            I am not sure that we are in a bubble, but that those who missed the previous have repositioned themselves to see such. I think we are in a stabilizing moment in the global system.
            As to Bubbles, personally, I superficially agree, but try not to assume too much.
            I was concerned of the Bubble, Housing Bubble before they blew. Similarly as I believe will happen in China (but that is much more exacerbated).
            Such is merely illustrative of returning to different stasis as happens in any complex adaptive system after a new force, of such power, as the 2008 global financial crisis was, is introduced into the system (the force of a crisis and the resultant impacts and interactions that occur upon, and with, other elements as actions and reactions). Do not confuse one (aspect/impact/interaction/ephemeral element) of the “system” with the totality of such, or the compounded energy of other elements, whose energy is able to be expended in the system, nor with the power of the total number of elements/impacts/interactions within the C.A.S. that influence the C.A.S.

            As to global system “more stable”, today. Yes, that it would have been without policy action, could have been without the policy action that was implemented.
            This is something that cannot be easily proven and is actually much more difficult to be disproven.
            But, yes private debt in the US has declined, there has been a fair amount of deleveraging.
            Housing prices have stabilized and modest growth is seen in the sector. With housing not very different from their long-term, non-“anomaly 2000’s”, trend.
            Many economies around the world didn’t deflate terribly, demand didn’t contract even more, asset values haven’t tanked as much as they could have tanked. Essentially, recent crisis policy action averted my 2007 fears of a great depression. You should understand, I come to my review of these matters, as one must, with much more than a mere finance/bank/monetary perspective. There is more to our global society than can be found within these narrow frames.
            Non-oil commodities have normalized lower than previous trend, commodity producers have had time to re-evaluate their long-term projections, investments, debt profiles and we didn’t see commodities fall off a cliff exaggerating negative (depression exacerbation) trends in the economy.
            Rational product producers, in the face of contracting global demand, have had the ability to rationalize their investments, cut costs, stockpile cash, re-finance their debt obligations and re-evaluate their investment decisions. If some of the story, of parts of the world economy having delinked, before, during, the global crisis, along with the flimsy rise of the global middle class component did drive some illogical recent investment flows.
            Unemployment is improving. Investment is slowly returning in areas of the economy where it hadn’t been expected.
            SWF’s stabilize
            BOP dynamics lessened and stabilized (there will always be examples that do not prove the rule)
            As to currencies, your use of the Brazil Real is curious, have you looked to historical charts. (or read of politico’s discussing “currency wars”). For example, if the QE can be linked to currencies rising or falling, and hot money as some are hoping again to revive in the dialogue, have you tracked QE to Emerging Market FDI inflows, or rather Portfolio inflows, and does this gel with expected movements in Currencies that Float. I haven’t seen evidence of this. I have heard it bandied about, especially by those on the Libertarian Wing of the Economic camp.
            Your point 2 is taken, discretionary monetary policy can be dangerous. Which also means it cannot. So, then leads to necessary or unnecessary. Perhaps, previously detrimental, and now necessary, rather than the same, different. With different impacts and interactions within the CAS.
            More people on Earth, Longer Lives, New technologies, Changes Abound, yet the purchasing power of a single notational unit of currency shouldn’t?
            Point 3
            Losing control…More Aggressive…..
            Where did they state that QE would last forever. This is important as Blinder states, as relates to forward Guidance and Greater Transparency in Central Bank actions in influencing investor and market sentiment as a stabilizing force in the economy.
            More aggressive. If necessary. I would even vote for the Fed holding all US Financial Assets upon which foreign central Banks receive dividends and Interest. Why should they engineer their economies, cycle unnecessary (as has been shown by the FED QE exercises) liquidity back into the US economy, then requiring the US taxpayer to pay interest on amounts over Import Cover, when the FED returns the interest it receives over the cost of operations to the US Treasury.

          • to read, Euro not QE….

            Csteven, this is a good article you posted. You might recall Mr. Pettis has been arguing that if Southern Europe pursued austerity policies while Germany did nothing to stimulate domestic demand the large German trade surpluses would be forced on the rest of the world.

            For the sake of the global economy, I only hope Germany comes to its senses after Merkel and the Christian Democrats get the September 22 elections behind them.

          • QE doesn’t push long-end rates down. It pushes them up. Every single time QE took place, long-end yields went up and stayed elevated until the programs were discontinued. The scary part is that the guys at the Fed think QE pushes long-end yields down, which is rather scary.

        • “global economy is more stable”

          If you ignore the fact that so far in 2013, the Brazilian real has declined 12.66% and the Argentine peso 12.59%. India’s rupee has dropped 13.25%. The Turkish lira is down 10.26%, the Indonesia rupiah 11.44%, the Malaysian ringgit 7.35%, and the Thai baht 3.96%. The South African rand has lost 17.28% and the Russian ruble 7.51%.

          10-year Treasury yield close to 3% signals the beginning of the collapse of US bond bubble.

        • Also

          “One of the most important impetuses to the rise of financialization was the end of the post-World War Two Bretton Woods system of fixed international exchange rates and the dollar peg to gold in August 1971.”

    • Assuming the elites prevent any meaningful reforms we have several examples of other countries that were in similar situations.

      1.) China could end up in an indefinite stagnation. This is Japan today, after their bubble burst they fell in love with bailouts and Keynesian stimulus to paper over their problems instead of enacting meaningful reforms and allowing liquidations.

      2.) China could start a war. This was more or less what happened in Argentina in the Falklands. In order to distract the populace from a flagging economy the military regime tried to play the nationalist card and take over the Falklands to show how strong they were. It might have worked, but Thatcher wasn’t willing to feed British citizens to a dictatorship. With militant nationalism running hot in China, they could also end up inadvertently causing a shooting war simply because they can’t back down in a crisis or else they would be viewed as “weak”.

      3.) China could “turtle” and cut itself off from the world. This option actually comes from China’s own history. One of the Ming emperors decided to deliberately isolate China from the rest of the world and burned Zheng He’s grand exploration fleet. This policy lasted all the way through to the end of the empire under the guise of the Chinese being the master race. I strongly suspect that the Qing elites viewed science and technology as being a threat to the status quo, so they fought to keep China backward for the sake of their own power. We also see this today with North Korea, so there is plenty of precedent for it.

      No matter which scenario plays out, it will end very badly for China.

  7. Michael –

    Overall a good and reasonable prediction based upon simple mathematics and some basic economic assumptions. As a quarterly visitor to China (mostly the Shanghai area) for the last 10 years my growth predictions would be very similar to yours, but based on somewhat different intuitive and anecdotal premises.

    First – The size of China’s economy is beginning to hit the mathematical limits of compounding. A perpetual 10% increase of a larger and larger GDP is a mathematical impossibility.

    Second – Going forward, Central Planning will prove to be more of a hindrance than a benefit. It will be very difficult for a centrally planned economy to effectively micro manage the huge number of market decisions required to redirect growth from investment to consumption.

    – The majority of decisions made by the Central Committee over the last 15 years have been beneficial to economic growth. However many of the decisions were easy choices; build an infrastructure, develop energy and basic manufacturing industries etc. Picking the low hanging fruit so to speak. On my quarterly visits since 2010/2011, it has become increasingly obvious that new infrastructure investments have a much lower marginal value.
    – Members of the Central Committee have become enormously rich over this period on infrastructure projects and GSE’s. It seems somewhat doubtful that these same influential party members are going to take away the punch bowl until debt burdens imposed by reckless investments result in some sort of economic crises.

    Third – Chinese products are no longer inexpensive. Lower end products are being out-sourced to Indochina and manufacturing for higher end products are beginning to be repatriated closer to the end market. In our case, we have opened a second contract manufacturing facility in Mexico and costs are fairly equal. A large increase in demand for Chinese goods in the West is unlikely.

    Fourth – Expect some political instability from the interior regions of China. When the promised increased living standards experienced in the coastal regions does not materialize in the interior, there will be political repercussions.

    Fifth – China’s overall economic policy appears to be patterned after the mercantilist policies adapted by the US in the first half of the 20th century, Japan in the 80’s, and currently Germany in the EU. The eventual unwinding this policy will likely result in much slower economic growth rates going forward.

    I think your 3-4% prediction is spot on.

  8. Even 3%-4% might be too much because now we have another factor, the stagnation and shrinkage of the workforce, same as in Japan in the 90’s, and growth certanily will be more difficult under this cenario as shown for Portugal: Is Portugal Facing a “Shortage Of Japanese”?
    The same is affecting Spain, Greece and Italy at the moment, but for China the problem is that it might get ol before it gets rich…

  9. Michael would you be able to add to your chart the impact of changes to China’s BoT?

  10. How does the hukou system and any reform to the system affect household income? The rural population does not have access to government assistance which certainly affects their level of household income (in a negative way). The level of education services could have generational affects on income level, and taxes will also have long-term and short-term consequences.

    Perhaps this next comment is more in-line with your previous post (Urbanization Fallacy), but what are the consequences of hukou system reform on bringing the 250 million rural Chinese into the cities? Aren’t most of these 250 million already in urban regions, or at least working in the cities? It seems like just reclassifying these people could put a lot of strain on the local governments – as the hukou system has been the foundation of the command economy.

  11. This is, again, an excellent overview of the challenges China is facing after decades of strong growth and developm ent. Your approach is more convincing to me than analyses based on econometric modelling which are based on assumptioms that require faith. Those models may have some utility to build scenarios but reality is another thing and the assumptioms that one makes may easily turn unrealistic.

    There are so many factors that may alter the assumptioms that using any model to predict future outcomes is nosensical as you point out. For instance, within your adjustment framework, any assumption made in husehold income growth, consumptiom and investment may be altered by factors that aren’t under the control of Premier Li Keqiang or other political leaders. For instance, you have mentioned befor that a slowdown in investment in China would most probably have great impact in the price of certain commodities as copper. I also thing that a sustained increase in household spending, given the size of China would also have an impact in other commodities such as agricultural porducts or oil. Those impacts could lead to shocks in those markets that could reshape the targets of the political leaders and the whole rebalancing process.

    Again, your post is illuminating and gives ample room for discussions and arguments. Nice job Mr Pettis.

  12. Michael, I would not be so quick to dismiss household appliances and furnishings as components of consumption. While consumption that could represent perennial expenditures would be desirable, we cannot presume we know how rising consumption should manifest itself. China as almost all developing (and some developed) countries has spent much of it’s new wealth on better housing. This has the inevitable effect of sales of appliances and furnishings.

    I do understand you have based this on overbuilding in housing stock. This is very true. This is also true of the U.S. in the 2000s. Many people confused buying bigger houses, filling them with furniture and appliances for investments, but some of them genuinely wanted to live in bigger and nicer houses. If I had to guess, consumers in both China and the U.S. will eventually shift their discretionary spending on housing and all its accoutrements to things such as tech gadgets, gourmet food, travel, healthcare, elderly care and so on. However recently, I have seen people here in the U.S. also decide to spend money on home improvements and remodeling because it makes them happy. Beyond some new paint and some inexpensive purchases at an estate sale, I myself do not consider this a good expenditure, but who am I to decide what represents appropriate consumption and what is not.

    That is a conundrum of the free market. People will always spend money on things they don’t really need. Perhaps even what many of us here would consider stupid things. Before the recession, I would lament on all the stupid crap (much of it made in China and Asia incidentally) lower income people would buy at Walmart and Target. All this stuff was considered consumption in our economic figures, but some might call it waste. Anectodally, I can tell you now there is less of this stuff being sold here in the U.S. I also can’t tell you how many gift shops (selling chachkis, figurines and other unnecessary items) have closed during the recession, but it has been a dramatic amount.

  13. Michael, Thanks for doing the math. The part i am struggling with is how income is going to be transferred to households. That is a sea change that i can’t see happening. Let’s assume you raise wages by 10% annually. You stress the debt servicing capabilities of the SOEs which put more pressures on NPL totals at the banks. Those companies could not compete in the export sector.

    I am not even sure if you transferred SOE equity shares to the lao bai xing in the form of some massive privatization that this would result in true spendable income being put into the hands of the masses. Aside from the banks who pay dividends to service the legacy AMC debts, there are few SOEs that pay meaningful dividends.

    • You can also look at the legacy problems of Russian privatization. The attempt to give everyone shares in SOEs still led to the oligarchs getting controlling stakes. Maybe a more tapered privatization would prevent this form happening.

      • Hua Qiao,

        ” Aside from the banks who pay dividends to service the legacy AMC debts”

        Could you please elaborate on that?

        BTW, Correct me if I’m wrong, but even if salaries do not rise, as long as GDP “”Growth”” drops, the household share would rise proportionally and thus the economy would rebalance, right?

        • @John

          The four SOE Banks pay dividends to owners and the largest owner is Huijin, the government entity that owns majority shares in both the 4 banks and also the AMCs. These funds are used to, among other things, service the det on the original bonds that the AMCs issued to the banks in exchange for purchasing the bad loans (at full face value).

          There are not a lot of other SOEs that pay dividends. In fact that was one of the directives recently by the regime…to goad SOEs to pay dividends.

          • Hua Qiao, does Huijin funnel these funds to the MOF which then stands by its guarantees on both the principal and interest on the bonds. I don’t think the share of dividends can account for the pay down in the outstanding bond values that has occured between 2010 and now.

            The MOF is bringing in other funds.

  14. This is an interesting book written in China in 2009………..

  15. whoops, on China above

  16. I hope Professor Pettis will refute Yukong Huang’s recent article in the Financial Times. I think I would be better to reserve my thoughts and read Arthur Lewis. I do hope Michael will respond to such a thought provoking article.


    • I should imagine that Michael will state what he has several times about the 7% growth rate that Huang sees as necessary, that it would require continued increases in components of GDP at levels that are unimaginable where the utility of investment lessens as investment grows at high rates due to eventual debt capacity constraints. Further that growth is largely, as savings, in the hands of the least productive components of society. Huang sees the current situation as not an outlier in the economic development of industrializing nations, but rather standard.

      His argument in discussing urbanization is mostly off-based. He does not index his Far West urbanization only from 90’s to size of economy, base b4 industrialization to present (but assumes it enough to drive). Nor does he even entertain that components of this industrialization, which is now merely an urbanization process, have been wasted on unnecessary projects.

      This in a country, where 2900 of 3200 (roughly, conservative to moderate estimate for sake of objectivity) of the companies on the stock market are run by the family of former and present high-party officials. Where similar statistics can be found in the rolls of HNI in the country, where promotion is based on achieving growth targets at the provinvincal level, where so much of the party is located (more than 95%, 99% of the party is at the province level).

      So, due to the nationalistic, xenophobic, and victimization memes that have been promulgated, especially after ’89, I understand that the former World Bank Director for China would hold such a perspective, as he has with his other work over the years, but China impacts the trajectory of the entire world with its policies, and need be a more cooperative and considerate member of the global economy.

      See: China Competing against itself and driving up the cost of commodities and how that has impacted the opportunity horizons of non-commodity based emerging economies globally.

      See All Aspects of the Chinese Economy as Arms of the State, and how weight they have done in creating savings, accelerating money growth, and with a plethora of investment, production and export (incentives/subsidies/rebates/cheap capital) affect investment and production (systems/platforms/chains) globally. Impacting nations from SEA to LA to AU and further afield.

      See Top-Down and Bottom Up “give and take” mechanisms within the governance structures (political, governmental, financial, social, civic, educational) and how this perverts incentives vis a vis promotion, growth, graft and maintenance of status quo.

      Urbanization, from the 1990’s at least through 2010, from my recollections had slowed to a pace of 1% annually, where most urbanization took place in the 1980’s if I am not correct.

      What we have is a story, perhaps bought, perhaps promulgated by those similarly inclined as Huang, telling a story of urbanization on the backs of floating migrants.

      I lived in a particular developing country. Where the low one month salary in a factory in a city would equal the per capita income of a rural resident annually. Around the corner from my house there were two chamber-maids. .They came into the city togethor, shared a single live in job caring for babies; probably made the equivalent of working in a factory. That pay, they split as they were afraid to come alone so there employer accepted both for the same pay (the developing world can be a dangerous place for a country girl all alone). After several years, 3 or 4, they will turn around and go home, and another member of their extended family will go into the city, or a pair. This is the lot of the migrant worker, as is my experience in adjacent developing economies. The sad thing is, how governance structures, and bottom-up, top-down governance, give and take mechanisms, are so deined at present, the ability of that great impact (temporarily receiving 12 times the rural income each year) is nullified by ripping people off their land, forcing them into “more urban” settings, and depriving them, a bit too hastily, of being able to leverage their urban savings into rural enterprises.

      Now the situation in China (one-child, recent wage increases) might be different, but I suggest, not too much so. It is a shame that the focus on SOE’s snuffed out the original developer of China, village based enterprises. Will the likes of Huang not see past well-staffed conferences, with projectors and great meals (photo-ops, tea ceremonies.and whiskey).

      As to Go West skewing Chinese Data, simple, percentage of people, percentage of investment, percentage of national GDP, then ask yourself, is western urbanization able to move the entire Chinese population where most of the people are seaboard and by far the largest percentage of the Chinese population would fit into an area east of the Mississippi in the US.

      • last comment
        last paragraph

        “move the entire Chinese population where most people” should read
        “move the entire Chinese GDP where most people”

  17. I like you analysis. By stating your assumption & having a model that give the changes in average growth rate, you has a system where those who disagree with you assumption can change the numbers to see how their assumptions would make a difference.

    I do see one main issue, being trade. Right now 19% (or 16% using the unofficial investment no.) goes to net exports. China’s rise have made a huge imbalance for the world because it’s net export is now bigger than the Total GDP of Mexico, South Korea, Spain or maybe Australia between 11-15 of the worlds GDP. You have this number shrinking down to 10% but that is still a massive amount that for an economy that will still be growing faster than the world. This is a relative new factor. China next exports are now similar to its total GDP 10 year ago.

    I think your model would benefit from a similar framework of world growth( which has a much narrower growth range) how much excess exports it would need to absorb for China to make it shift. This is especially important since China will still be investing in excess infrastructure much of which is used to manufacture trade goods.

    • Slotowner

      That is the beauty of Michael’s argumentation, it is able to be wielded, rather than merely dogmatic, ideological, interest or perspective based.


      your assertion to net exports is incorrect, the countries you mention, each, is far larger than china’s net exports, even than its net exports in 2007-8. (on any measure of GDP)

      Actually more than 60 countries have GDP’s larger than China’s Net Exports, including Slovakia, which has a population of 5.4 million people situated on 49,000 square kilometers.

      If merely thinking Exports, than 7 countries have GDP’s larger than China’s exports (on nominal terms).

      Actually, if china can set the path toward rebalancing, it wouldn’t be growing faster than the world.
      China’s Exports are larger than its Nominal GDP of ten years ago, which is why too many of its numbers are suspect (relationship between asset growth, M2 growth, growth in Asset Valuations vis a vis increasing Loans and Debt, etc).

      Absorbing others exports……China’s economy will become more mature and stabilize were it to structurally rebalance, others would benefit from being able to export, perhaps, Chinese companies would benefit from needing to respond to the desires and needs of consumers within their market, and other developing nations would benefit from no having the structural impediments to their own growth, and evolution of their own industrialization, the challenge, that China an imbalanced China ultimately presents to other developing countries hoping to industrialize (non-commodity producing emerging economies, but even commodity exporting emerging economies who want to be more than raw material providers to an imbalanced system). Commodity production requires large capital investment, high technology, machinery, equipment, but requires little input of labor, few jobs, so they can only be a small part of the mix when an economy develops. Even Indonesia, which has a diverse array of commodities, that they produce for domestic use and export, natural resource extraction doesn’t even equal the economy of Jakarta and is but 15% of Java’s economy alone.

    • Slotowner:

      Each of your perspectives are wrong…..
      using 2012 numbers….

      China’s total Exports (not net) do not equal either 11 or 15% of the world GDP….
      China’s current total exports wouldn’t have equalled 11 or 15% of Global GDP in 1980.
      It’s current Net Exports, assuming your 11 or 15% of global gdp in 1940 (even in nominal terms). ……………..
      Current Gross Exports might equal 11 to 15% of China’s current GDP, but its Net Exports would equal roughly 3% of China’s Current GDP. (Although I suspect it’s current GDP to be over-estimated.
      World GDP is 72 trillion (
      China’s Gross Exports are 1.9 trillion (

      So Gross Exports would be less than 3% more likely 2.5% of Global GDP.
      Now its net exports would be under 300 Billion USD in 2012….
      But, Mexico, South Korea, Spain, Australia all have economies far larger than China’s Net Exports…the smallest of the countries you listed is at least 3.5, closer to 4, times China’s (Exports minus Imports), it’s Balance of Trade. Of course each of those countries have far larger per capita GDP’s on Nominal or PPP than China and have economies whose trade is far less tied to commodities or dependent upon Multi-National Supply Chains for their export and import numbers (intermediate goods used in the making of final goods sold, more normally into the countries you mention due to higher per capita GDP). One exception, Mexico’s per capita GDP might be hovering around CHina’s due to the mass explosion in investment these last few years, but was less than 66% a few years ago and is a more stable and realistic number due to that.

      Your point of total exports, I think you mean, being close to its total GDP but 10 years ago is not something to commend or laud, rather it points to excess, instability and potential for serious economic distress if imbalances are not taken more seriously.

      Outside of growth, even though your numbers are outlandish, even the lower bounds illustrate that the world has absorbed too much of China’s exports to present. Mostly, this, when coupled to exorbitant prices for commodities, has seriously imbalanced the global economy, and the development trajectories of other emerging economies globally.

  18. Tocqueville and China’s political predicament: Tocqueville teaches chinese leaders that the only way to prevent revolution is resist reform

  19. Will “new urbanization” create Brazilian-style slums in chinese cities?

  20. The following is my comment on the site:
    Comments on Pettis “Why China faces four per cent growth: Pt. 2”, 14/09/2013,
    I made a comment on Friday and now Pettis’ second half is out so I would make a little more.

    Firstly, are the two examples of painful adjustment that Pettis used, namely the US in the 1930s and Japan in the 1990s applicable to China at all? The 1930s was or was in the wake of the great depression world wide but particularly in the US following the stock market crash in 1929 and the 1990s for Japan were the first of Japan’s two lost decades following the burst of its financial bubbles. Further, both countries at the respective times were at world economic frontier with one of the highest income in the world. Is China in those situations? No, any person with a common sense would understand China isn’t. China is only probably about 20% of the per capita income of that of either the US or Japan. China may have some bubbles, but definitely not as severe as to hurt its real economy. There is plenty room for positive growth and the degree of uncertainties on its growth is not as high as those in the economic frontier given the room to further catch up. By any measure, China would not allow bubbles to burst to such a damage degree.

    Secondly, as long as China’s saving rate is high to sustain its investment and net export, there is no need to artificially to adjust its domestic consumption at a damaging speed. Its financial market and hosing market are unlikely to depress its economy, given its huge foreign reserves and high savings.

    Thirdly, Pettis has a automatic adjustment factor, that is, the net export and government consumption. Contrary to Pettis assumption, this factor can accommodate a higher savings/low consumption and high investment if and when needed.

    So, Pettis is wrong in his conclusion that China is facing a decade of 3-4% growth.

    Further, Pettis got the cause effect wrong. The painful adjustments in the US in the 1930s and in Japan in the 1990s were the results of low economic growth. During the relevant periods, their investments fell and their consumptions didn’t grow. It’s not the adjustments that caused low growths. Rather, it’s the low growth that caused painful adjustments.

    China won’t have that painful adjustment and as a result there won’t be automatic low growth flowing from that painful adjustment. And if there is no low growth, there won’t be painful adjustment in consumption and investment.

    China’s new leadership government has already stated that it will sustain reasonable growth in the process of economic adjustment. It seems its limit of low growth is likely to 7.5% and it is unlikely to allow growth below that for any long period.

    The argument of a decade low growth of 3-4% for China is fanciful and delusional to the extreme.

    All the scenarios Pettis listed in the table is real growth rate and no inflation is included. In all likelihood, inflation in China is likely to be between 3-4% a year on average for the next decade or so, as indicated by the current 3.6% target for a real GDP growth target of 7.5% for this year.

    If inflation is included I would assume that China can maintain 8-9% real GDP growth that means nominal growth will be around 12-13% or more higher. For a nominal growth of 12% a year, according to the Pettis table (by extension, roughly 2% higher for all variables), the investment growth can be as high as 9-10.5% a year and consumption growth 16-18%.

    Would be that healthy economically? I don’t see a problem with that. Of course, there is no need to adjust between investment and saving/consumption as rapidly as Pettis argues and a longer adjustment, possibly 20 years or more is more likely given that consumption growth is that high and people would still have enough incentives to maintain high savings. Most people would be happy with that outcome.

    • Pettis may be wrong, but almost certainly not for the reason you say, Lintong, because it isn’t clear from your comment that you understand any of his arguments at all. What surprises me most is your wonderfully credulous claim that because the government says it doesn’t want growth to fall below 7.5%, growth must stay above 7.5%. Do you really believe this?
      And you think it won’t be a problem for consumption to grow at 14-15% a year? But didn’t the government want consumption to grow faster than GDP for the past seven years, and haven’t they failed in accomplishing this? Why do you believe that the consumption growth rate will suddenly double?

    • Your “rebuttal” is full of conclusions. I do not see economic logic.

      • Unless of course the accusation of “delusional” (in the view of the rabidly pro-government nationalists all skeptics are delusional, criminal, or conspiratorial, or all three) is an attempt at economic logic, as in: “The argument of a decade low growth of 3-4% for China is fanciful and delusional to the extreme.”
        Since Pettis sets out his argument in a very clear and logical fashion, it seems to me that even if someone like Feng were to disagree with it, he should not find it delusional. It would simply be that his assumptions are wrong, and nowhere does Feng show where and why he disagrees with the assumptions Pettis lists.

      • JohnWax’s analysis seems pretty clear to me…..
        Further, Lintong’s discussion is rather confused….

        Let’s face it, the stimulus of 2009 was a shot in the dark, not foreseeing the problems in EU or the length of this depression, caused by the Global System, Impacts and Interactions within it, not least the run up of all indicators and flows in the middle part of the past decade…….

        be they financial flows, portfolio, hot money, commodity pricing, energy pricing, acquisition of reserves, growth rates….
        It should be clear to any that the shifting toward investment in the construction of GDP from early in the last decade, belied weakness in the Chinese economy, that has only been extended by the following factors:

        untenable increases in investment as a percentage of GDP
        Government Ownership of Most Companies in the Stock Market
        Government Cycling of Savings to Chinese Corporates through Lending and Money Printing
        Corporate s Comprising Ever Higher levels of Chinese Savings (thus government Savings) through control of Chinese Corporate s (and Banks) through Party Mechanisms
        Now, lack of demand, because of pushing the envelope while backtracking on commitments as everyone understood and accommodated China as if the rest of the world were Chamberlain on these matters
        The Stimulus hoped to see China through until demand returned in the areas of the world where demand existed, extended downturns/slowdown has altered the mental horizons of those who formerly consumed excessively
        (I always thought it strange (perhaps hubris-ic) that China was arguing for Austerity in the areas of the world that were driving demand for Chinese (Supply Chain) Final Goods. Perhaps it was part of the story to deflect sharing blame for the crisis; as if, the true genesis for the crisis is found in each of the drivers of the overly rapidly rising trends that were witnessed globally and are merely due to Lehman-esque excess, which is wrong as history has clearly shown if pundits have failed to catch up with reality Such excess is exactly why I had predicted the crisis well prior to its occurrence. (which, I realize is easy to say, which is why I had been, previously, reluctant to say it).
        But strange nonetheless, because austerity and arguing against the profligacy of some in the global economy belied the primacy of China as an actor in the downturn, a driver of the trends that led to an implosion (cycling excess credit into US markets to prop up consumer demand), while also still relying on conceptions of such demand returning to rationalize excessively high levels of domestic investment, which will likely be foolhardy.I should imagine the Chinese leadership are far more cognizant, than recent commentators on this blog, about the dire predicaments that are at hand. Further, the utility of public relation overtures, despite the utility of soft power, are highly misplaced in respect to these matters and what is in China’s interest. I should imagine you had better read Michael more carefully, and hedge your investments.

        Should China’s leaders be able to guide to a better trajectory, they will thank themselves and find a more understanding global community. If they cannot, than Japans Lost Decade may have simply predated a lost several for China considering the excesses. I tend to view Michael rather optimistic in his perspectives; at least diplomatic.

  21. Prof. Pettis can you talk a bit more about privatization in the future? One imbalance in China is the state owning too many “things”. If more “things” are in private hands, more economically rational decisions would be made, promoting stability in the Western sense. China’s efficiency can also improve. What is the likelihood of some large privatization exercise? If this is done via sales, I guess the private sector cannot afford to buy up any significant amount of government-owned assets? Also too fast a speed of selling public sector “things” may depress the securities markets too drastically, leading to other problems? Thank you.

  22. …if he knows some probability theory, the most beautiful branch of math in my opinion, he is able to soar)…

    …develop an understanding of the overall system under clearly specified (I hope) assumptions, and then work through the logic of the system to see what the various outcomes can be. In other words … simply to list the various scenarios that are consistent with the model…

    Amen to orthogonal models (don’t expect anyone to really grasp the distinction in your point though):

    …The consumption that we care about is consumption unrelated to investment, because it is this consumption that must rise as investment drops…

    …This would only be the case if the ratio of hidden consumption to hidden income is greater than 35%.

    If most of the hidden consumption and income belong to the rich or very rich, as is commonly assumed, it may well be that the true ratio is lower, not higher, than 35%…

    Coup de Pettis, merci beaucoup!

    …so the global economy must respond with enough of a contraction in GDP to maintain consumption at roughly 65%…

    And the high-consumption companies are a greater share of global GDP, thus expect a massive implosion of global GDP ahead, which will mean the high-end 3-4% growth target for China is impossible.

    …if the world forces China to raise its consumption rate to 55% in ten years, this will probably happen through negative growth and trade disputes, thus making all my numbers overly optimistic…

    Yup, it ain’t gonna b purty bro.

    -2% GDP collapse

    2.5% Consumption slight growth

    -4.6% Investment collapse

    Now you are being more realistic.


  23. Professor Pettis,

    I’ve long been an admirer of your blog but have never felt compelled to post here before.
    I have generally been supportive of your basic premise (as I understand it) but lately been
    somewhat disturbed by a hypothetical situation which I will try to relate (its a bit convoluted).
    As with most things Economic, it begins with Say’s Law which you briefly mentioned in the post before last.

    1. Say’s Law seems to be widely (mis) interpreted as the dictum that “supply creates its own demand”
    and widely used to support the urbanization model. I’ve heard it more accurately expressed as the
    something along the lines of the income generated by the production of goods and services is identical
    to income necessary to buy all the goods and services produced- which seems pretty hard to deny. However,
    it seems that for goods and services to produce this income they actually have to be sold to someone.
    A product produced but not sold may result in the payment of wages, rents etc but since it is unsold
    those payments must come from somewhere (negative profit for the entrepreneur, lost bank income etc.)
    In this case, incomes from the production of goods and services are not identical to everything producers decide to produce
    but rather to everything purchased- which seems obvious enough. This seems like an important distinction and not just in China

    2. One obvious reason for goods and services left unsold would be poor marketing/management (generally outside the purview
    of positive Economics but undeniably a factor in some cases). Others would include inconsistency of interest rates, government
    policy and many more but poor management is the one I want to concentrate on for now. Essentially though, it seems demand is dependent on both income
    and reasonable goods to purchase with this income and it unreasonable to assume that some free market karmic force assures us that as
    long as we are producing goods and services that these goods and services will satisfy consumer demand fully and consistently.

    3. Now on to China, we hear almost ad nauseum about the “heroic” Chinese savings rate. The sources I read generally attribute this to culture traditions (apparently no other culture has a tradition of saving like this) or to the lack of a social security system (often exaggerated). But, I have noticed I personally, and many of my associates, (should mention here that I live in China) save around 75% of my income here and this,
    in my case, cannot be contributed to cultural factors (German-Irish so the two should balance out) also from California, if anything my historical savings
    rate has been whatever the opposite of “heroic” is. I am living in a second tier city now and I should note that my savings rate is higher than it was in
    Beijing (though it was still abnormally high there), Yeah, I know sample size of one here, but my point is that when I try to explain why I am saving so much
    it all comes down to one thing- there really isn’t much I want to buy here. The quality of goods and retail service, in other words, is insufficient to get me to buy.
    The only reason I save is because i don’t want to consume. I have lived in many countries and this has only been a factor in China.

    4. The upshot of all this, I guess, is that if we live in the real world we have to accept a) the strong possibility that poor business management can lead to a situation where
    a rise in income does not necessarily lead to an increase in consumer demand and b) a good deal of the extraordinarily high Chinese savings rate can be attributed to cultural
    traditions and lack of social security. Too many other countries share these factors but save far less. When you throw in negative interest rates as a disincentive then I think
    we have to admit the possibility that poor management/marketing of goods and services is responsible for a significant portion of the savings rate in China.

    5. So, if all this is true then, it seems that directing money toward the household sector and away from investment would not increase consumption as much as you have predicted as a lot of it is saved
    (but not invested- as we have constrained investment in this scenario) and that as a result national income will simply fall dramatically?

    • You describe a group of people that do not consume much. Such group of people in China account for a very small fraction of the population. Compared to the western living standard, China’s living standard is far lower and has way much room for improvement. Currently one third of the global luxury goods consumption is taken by China. If the household income increases, the number would be 50% or higher. Most people do not visit dentist regularly as Americans. When they get more income, they definitely want to get their teeth cleaned often. Milk is still luxury for hundreds of millions of people. You can go down a long list.

      • Your claims about luxury goods are doubtful. Why would the rate of luxury goods buying increase at or above the rate in household income increase. Luxury goods are more a symbol of extreme wealth. Average household income could easily rise even as China becomes more equal. Or, perhaps wealthier people could shift their lives and families overseas and buy their luxuries elsewhere.

    • I find that I also save much more living in China, but there are many reasons for that which I think are easier to explain:

      1) Can often get household items and electronics out of country at a better price. Most Chinese can’t skip across to Hong Kong whenever they want to buy toothpaste.

      2) I’m not living in China permanently, so I’m not inclined to purchase a home or make very expensive investments to that effect.

      3) As a foreigner, your salary will be many, many multiples higher than the average Chinese. So daily use things like restaurants and barber shops will be cheaper comparatively than in the US or Europe.

      4) Your sample is probably subject to selection bias. The Chinese that regularly work with foreigners on a daily basis are almost certainly of the upper classes, or at least upper middle class. So they will have more income to save as well.

      I don’t think the average Chinese in a fourth tier city in Henan or something would save drastically more than someone in the West. And if they do, it’s only to blow all the money on their overpriced house before they get married (or if they are a parent, to help their child purchase an overpriced house). One point I might agree on is the lack of investment opportunities. People in the West might put money into an investment fund or stocks, whereas a Chinese person would be more apt to keep the money in the bank. But really, they have the same effect for many.

      Anyway, the insane savings rate of China refers to corporate savings, not household savings, which aren’t that out of whack.

  24. big typo: b) a good deal of the extraordinarily high Chinese savings rate can be attributed to cultural
    traditions and lack of social security.

    should have been ” Can’t be”

  25. Just like Alan Greenspan tossed the housing bubble to Ben Bernanke, Ben Bernanke will now toss the bond bubble to Janet Yellen

  26. Andao-

    I made note of the sample size of one thing (now two including you) but and many of the things you are saying are true, but those things were also true in the other countries in which i have lived so I am wondering why I save so much in China (also- I find most of the arguments for China’s savings rates untenable- Cultural? what about HK, Taiwan, and Singapore). And sure electronic goods etc are more expensive here and I could (but rarely do) buy them abroad- oddly the money I do spend here is mostly on these items (tahnks God for Taobao) but local retail and other services I just don;t bother with much anymore. Price points seems so poorly set and consumer service is just so bad that, in the end, it cant really convince me to consume. Businesses seem almost contemptuous of the customers- long lines, poorly managed facilities, nonexistent customer service, at some point these must contribute to decision on the part of of Chinese to not bother consuming.

    Saying that this is all they know misses the point. It is the purpose and responsibility to attract Chinese- mostly through skillful marketing. If Chinese businesses are unable to do effectively then we would expect that to discourage consumption.

  27. I was hoping you could help clarify a concept for me. In the concept of transferring farmland from households/farmers to the local authorities (who then convert to industrial/commercial use and sell at a higher price to deverlopers), you mention that “As an automatic consequence the Chinese savings rate rises faster than investment (because even if investment is increased the full value of the transfer is not converted into investment) and with it the trade surplus must rise too.”

    I am hoping you can help me understand the phrase in parentheses. How can we be certain that the increase in investment does not exceed the full value of the transfer? I am sure this is a fairly simple concept that I am just not grasping, but until I do I feel that it is limiting my ability to fully grasp the somewhat mechanical nature of this relationship.

  28. Professor Pettis
    It is a pity that previous articles are no longer available on your site. I refer in particular to “German savings not thrift caused the European crisis”. The piece is now available on sites that copied it but not the numerous comments of your readers. Those comments add value and insight to the piece. Have you any way to recover them? I understand the site was hacked. So maybe no way. I have myself written a post with your piece.
    With regards

  29. Michael,

    I am not an economist, but find your arguments quite convincing. There were just one issue which I don’t quite know how it fits in. What about the idea of TFP or total factor of productivity. How does that factor into the model you use?



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