Monday 27 Jun 2022 | 12:49 | SYDNEY
Monday 27 Jun 2022 | 12:49 | SYDNEY

China: Still decoupled, still converging


Stephen Grenville

5 September 2011 11:18

As the advanced economies slipped into recession in 2008, many observers doubted that China (and other emerging countries such as India and Brazil) could continue to grow rapidly without the help of strong demand for their exports from the US and Europe. As it turned out, the emerging countries did just fine.

Now, with recovery in the advanced countries stalling, the same doubts have re-emerged: has China decoupled from the US cycle, so that it is able to go on growing even as the US stagnates? Prominent among the doubters is Michael Pettis, who predicts that 'by 2013-14 Chinese GDP growth will slow sharply, and by 2015-16 predictions of a sustained period of growth rates at 3% or lower will no longer seem outlandish'.

The Pettis argument has two threads. The first identifies policy deficiencies which might trip the economy up. Paramount is the legacy of bad debts and over-investment from the huge stimulus of 2008, which allowed regional governments, local authorities and state enterprises to implement their favourite projects. This expenditure kept China going over the past three years, but investment rose from the already abnormal levels of around 40% of GDP to 50%.

The second thread of the argument is about convergence. If a country starts out with low income and capital stock, it ought to be able to grow very quickly as it implements high-productivity techniques borrowed from overseas, as the capital stock per worker rises and as underemployed rural workers move to high-value work such as manufacturing. These above-average growth rates might continue until the economy uses up these convergence opportunities.

The classic example is Japan, where per capita annual growth was over 7% in the three decades after World War II. Japan came out of the war with its production capacity devastated, but with strong institutions, technology and entrepreneurial experience. It experienced a four-decades-long convergence catch-up. It then ran into the lost decade of the 1990s and has since grown slowly, with not the remotest prospect of returning to earlier growth rates.

Taken at face value, the convergence argument doesn't seem to foretell a slowing in China. Japan slowed only when it could no longer make the easy gains from adaptation of borrowed technology. This would suggest that China, still only one-quarter of the way towards the technological frontier, still has decades of potential convergence ahead.

Dani Rodrik and Barry Eichengreen offered more carefully argued ideas on convergence (with China in mind), at the recent Jackson Hole conference.

Of course, de-railings on the way to the technological frontier are common. But since 1950, 24 countries have averaged per capita growth of more than 4.5% for three decades or more. Rodrik tries to distill a consistent generalised story of the convergence journey from diverse country experience.

There is nothing automatic about convergence. But nor is there anything automatic about interruptions to the path. Each of the countries that slowed was unhappy in its own way. While the average fast-growth period is sixteen years, there is enormous variation around this. The lesson may be that it takes consistently smart policy (and luck) to stay on the convergence path. Not many can do it, but it is possible.

Thus if China, India, Brazil and the rest of non-Japan Asia are going to save the world economy by continuing to grow quickly, they have to get a lot right. In China's case, this is where the first thread of the Pettis' argument is crucial. China's investment pace makes it inevitable that some of the projects will be white elephants, and at some stage this extraordinary capital accumulation has to slow.

But it's not obvious that China has overbuilt in general. Economies usually need around $4 dollars of capital to produce $1 of output. On this basis, China needed to invest 40% of its GDP to create the capital required for its 10% growth. To increase the ratio of capital to output (which is part of the convergence story), China's investment had to grow even faster — which it did.

There are still many Chinese without adequate electricity and running water, and urbanisation will require further huge investment in housing and infrastructure. Increasing consumption could offset the loss of exports to advanced countries. Big wage increases would produce a de facto appreciation, reducing external imbalances. Inflation would remain uncomfortably high, but politically-critical prices can still be kept stable.

China's huge saving reflects the high retained profits of state-owned enterprises, giving room to absorb the bad debts within the overall government sector. Thus it's possible to map-out a set of adjustments which would keep China on a high-growth track.

Of course, Pettis may turn out to be right. Consumption is currently only 35% of GDP, so would have to grow much faster than GDP to have much effect. But China's policy challenges (reducing savings, getting consumption up and the current account surplus down) seem infinitely easier than the challenges faced by America, which has to narrow the huge budget deficit by raising taxes and rein in the external deficit by expanding exports.

One thing is clear: if Pettis is right, the world economy is in for a bleak period.

Photo by Flickr user Jakob Montrasio.