Beyond being # 2

作者：謝國忠 | 评论(0) | 标签:中国, GDP, 第二, 经济, 谢国忠

China’s GDP surpassed Japan in the second quarter of 2010. The international media gave this milestone considerable attention. The domestic media hasn’t paid as much attention. As natural disasters, environmental degradation and property bubble at the center of attention, the domestic media isn’t likely to focus on this number. Besides, China has 10.5 times as many people as Japan does. The same GDP still puts China’s per capita income at less than tenth of Japan’s, which is hardly a moment to celebrate. Nevertheless, it would be useful to look back on how far China has come, study the risks to China’s future, and, if the country can overcome the existing challenges, how much further the country can go in the next ten years.

China’s economy took off in 2002: nominal GDP has grown at 18.5%, exports in dollars at 21.7%, and electricity consumption at 12.8% in the following eight years. (I extrapolated the economic performance for the remaining months of 2010.) In terms of levels the nominal GDP has increased by 2.9 times, exports by 3.8 times in dollars and 2.9 times in Rmb, and electricity consumption by 1.6 times in eight years. Japan had similar performance in 1960s, Korea and Taiwan in 1980s. But, they were much smaller. What China has done is unprecedented in terms of scale.

When growth lasts many years, it makes a huge difference over time. It is the miracle of compounding. China and India had about the same value in GDP twenty years go. In 2010 China’s GDP is roughly four times India’s. There is little doubt that China has done many things better than India or most other emerging economies. Otherwise its economy couldn’t be so much bigger in relative terms.

‘Reform and open up’ (改革开放) is China’s policy center in the past three decades. It is undoubtedly the most important factor. China’s exports have become the largest in the world from virtually nothing three decades ago and almost nothing two decades ago. In the last decade alone the exports have risen 5.2 times. ‘Being the workshop of the world’ is the most important part of China’s economy today. Without China’s export success China’s economy wouldn’t be near where it is today.

‘Joining the WTO’ was the critical difference to the country’s export success. It has given multinational companies the confidence to base so much production in China. As China’s domestic market becomes big, it gives MNC’s another powerful reason to keep production in China. No other country could offer the economies of scale from selling locally and exporting abroad plus low production cost.

China’s production cost is no longer the lowest. Bangladesh’s labor cost is merely one fourth of China’s. Indonesia’s labor cost was twice as high as China’s before 1997. It is now comparable to China’s and is rising slower. Some industries that don’t require the supply chain all nearby are likely to leave China. Shoe and garment industries, for example, may move to other countries. But, most other industries will stay in China.

Infrastructure development has been China’s second important competitive advantage. China could have delivered such strong performance in infrastructure development due to the government’s ability to mobilize resources. The state ownership of land and banks are the critical factors. Land and credit are usually the constraints to infrastructure development in most other countries. Without such constraints China could go for size to achieve economies of scale.

The development of the national expressway system, for example, is a good example. Only an interconnected system of size could deliver economic benefits. A few isolated expressways couldn’t deliver much benefit. This is due to the so-called network effect. In a dozen years China has completed over 60 thousand kilometers of expressways with another 30 thousand under construction. The expressway system has made the national population mobile, integrated villages and small cities into the national economy, and sharply decreased logistics costs.

The development of ports and industrial parks has made it possible for OEM industries to locate in China. Together with the highway system they have made it possible for China to become the largest export country in the world. Inability to build infrastructure quickly is perhaps the bottleneck in most developing countries. Money is a constraint in that regard but is not the most important. Land acquisition and government implementation capability are the most important barriers.

In addition to traditional infrastructure, China embraced early internet, the latest necessary infrastructure for a modern economy. When China decided to embrace internet in the 1990s, it laid the foundation for China to benefit from and be part of the global economy. It is hard to imagine that China could be where it is without internet. If China hadn’t embraced internet, its economy today could be only half as big as it is.

Third, China’s large and productive labor force has contributed more than any other factor to China’s growth. Until five years ago the nominal wage remained stagnant in nominal dollar terms for over a decade, even though labor productivity increased at nearly 10% per annum and total factor productivity at over 4%. Chinese labor’s increased productivity showed up in declining prices for western consumers, rising profits for multinational companies, and rising tax revenues for Chinese government. This is why more and more multinational companies have come to China to produce, and Chinese local governments have invested more in infrastructure to attract them.

China’s wage is rising from a low base. Many people are worried about China’s competitiveness. As I mentioned earlier, some like shoe and garment manufacturers would move. Others couldn’t easily. The manufacturers could pass the higher cost to consumers. They need to regurgitate some of the past price reduction. Also, multinational companies may have to accept lower profit margins. The consumer products that China exports retail for 3-4 times the factory-gate prices. There is plenty of room to absorb China’s labor cost rise.

China’s rapid growth has coincided with a weak dollar. The dollar index peaked in 2002 and has declined by one third since. The tiger economies and Southeast Asia had very high growth from mid-1980s to mid-1990s, which also coincided with dollar weakness. The dollar plunged after the Plaza Accord in 1985. A banking crisis kept it weak into the first half of 1990s. The tech burst in 2000 was really the trigger for the dollar weakness this time. It slowed capital from flowing into the US. The current financial crisis is keeping the dollar weak.

Is the dollar weakness during China’s boom entirely a coincidence, since the triggers for the dollar’s weakness could be indentified? Is the weak dollar a cause or the cause for the boom of China’s or other emerging countries’? Or is the booming in China and other emerging economies causing the dollar’s weakness?

I actually think the third scenario more likely. The US’s economic problems originate in its declining competitiveness or the responses to it. The current banking crisis is due to Greenspan’s loose monetary policy to support the US’s living standard during its declining competitiveness. It led to a series of financial bubbles that sucked in capital to fund its persistent balance of payment deficit-a sure sign of declining competitiveness. The current financial crisis reflects the logical ending to this bubble policy. And, the crisis is causing so much pain, because the effect of cumulative competitiveness loss is showing through at the same time plus the usual consequences of a bubble bursting.

The previous two bouts of the dollar’s weakness were due to a similar reason. The Nixon Administration de-pegged the dollar from gold in 1972, destroying the Bretton Woods System that pegged other currencies to the dollar that in turn pegged to gold at $36/ounce. The reason was that Europe and Japan gained competitiveness to the US during the post-World War II recovery. What occurred in 1985 was like in 1972, recognizing further competitiveness gain by Europe and Japan. As the Tiger economies and Southeast Asia pegged their currencies to the dollar, they gained competitiveness again Europe and Japan and boomed accordingly.

China’s industrialization is one factor for the dollar’s weakness. Globalization in general, however, is more important. The development of IT and internet in particular has allowed multinational corporations to shift production to wherever the cost is lowest. China’s infrastructure development has just made the relocation easier and faster. But, the fact that IT has made workers in developed and developing countries more equal to multinationals would inevitably cause the dollar to be weak.

While the dollar’s weakness is due to globalization and technology, it has a byproduct of driving liquidity into emerging economies, in particular China. This would cause problems for the later in future.

A crisis seems always to follow a period of high growth in emerging economies. People tend to blame the crisis on slow growth. It actually gets the causality wrong. The problems that are allowed to cumulate during the high growth period cause both the slow growth and crisis. Nothing hides problems like high growth. Hence, there is a tendency among policymakers to prolong high growth as long as possible, hoping to grow out of all the problems.

The problems that China’s economy faces today and the policy recommendations that many recommend bear resemblance to what were observed during high growth in other emerging economies. History teaches us that one couldn’t grow out of all the problems. The longer the growth lasts, the more intractable the problems are. Trying to grow out of one’s problems inevitably leads to monetary excess. The weak dollar makes monetary excess supportable in the short term, as the external pressure restricting money printing is weak. It leads to bubbles. The asset appreciation then becomes the source of profit that justifies investment. A collapse is inevitable.

China’s money supply has quadrupled between mid-2002 to mid-2010, growing at 19% per annum. Including the off balance sheet expansion of the financial institutions and underground financial activities, the ‘money supply’ may have grown at 22% per annum. During the same period the nominal GDP has grown at 18.5%. If one compares the official GDP data and monetary data, it seems not worrying, as the two are about the same. The problems are (1) that the nominal GDP has really been inflated by property that is a bubble, i.e., the rapidly monetary growth is probably a bubble, and (2) that the real monetary growth is much higher.

China’s electricity consumption grew at about 13% per annum between 2002-10. Historically, China’s real GDP grew faster than electricity consumption. The ratio of electricity increase to GDP increase is called the elasticity. The elasticity was around 0.8 in the 1990s. In the current round of growth boom heavy industries have taken the lead. The economy has become more dependent on electricity for growth. The elasticity should have increased. I suspect that it wouldn’t be more than one. Hence, it is reasonable to guess that China’s real GDP has grown at 13% in the past eight years. That would make GDP deflator, the broadest inflation gauge, at 4.5%.

The inflation has so far occurred mostly in land and commodities. The land price has increased by over ten times since 2002, thirty times in some hot coastal cities, and over one hundred times in the most speculative areas. For example, in many villages in Zhejiang Province, the land price has risen above Rmb10 mn/mu, 100 times the price a decade ago. Even though the land is rezoned for urban use, the price couldn’t be justified under any circumstance. It is nearly ten times the average land price in Britain for urban use. Britain’s urban land price is the highest among all major developed economies. It is reasonable to believe that China’s land price is highest among than all the major economies today, even though China’s average wage is one tenth of the developed countries’.

The inflating land price has shown up in the nominal GDP through rising property sales to over 14% of GDP last year. Moreover, so much investment has occurred due to the collateral value of land. Local governments have borrowed enormous amount of money (probably around 17% of the total bank lending) to fund or subsidize investment for creating GDP. The loans are secured with land. Without the high land price it is impossible for this source of financing to be possible. As fixed investment is close to half of GDP and driven by government, it is easy to understand how the land bubble has accounted for a big part of the growth in this cycle.

Recent manufacturing investment, for example, is partly due to high land price. Local governments have been competing fiercely for manufacturing investment. Many companies have learnt to exact so much benefit from local governments that they put down no equity capital for investment. They often ask for free land and use the land as collateral for bank loan. They then lease equipment from the manufacturers that obtain bank loans for the leases. Essentially, the equity capital is from the land donated by the government. This explains why so many companies have always had negative net cash flow but keep expanding. Indeed, expansion is critical to their survival, as they need new investment to bring in cash to sustain themselves.

Profit drives investment that in turn powers employment that then grows consumption. When profit is due to asset appreciation and not sustainable, it could lead to crisis. Large bubble often occurs during prolonged prosperity. People stop paying attention to risk and have excessive demand risk assets. It leads to an asset bubble that prolongs prosperity beyond the normal cycle time length. The more overextended the cycle, the more pain the adjustment would be after the bubble bursts.

Possibly half of China’s bank lending is to the property related businesses or local governments that pledge land as collaterals. While the current boom has catapulted China ahead of Japan as the world’s # 2 economy, we must remember the excesses in this cycle and the need for an adjustment as soon as possible. Nothing reveals the vulnerabilities more than the banking system’s exposure to the unsustainable economic activities that depend on land appreciation. China should proactively bring about the needed economic adjustment.