The fortunes of the Chinese economy have implications for the rest of the world given its sheer size and share of the global economy. Given recent weakness driven by the collapse of its property sector, the world was hoping for some measures to turn around the economy at the recently concluded Third Plenum of the Chinese communist party earlier this month. However, nothing seems to have materialised out of it. Why are the Chinese unable to pull themselves out of this rut? Here are answers from a long-standing China watcher.
Michael Pettis has lived in the country for more than two decades and teaches as a professor of financial theory at the renowned Guanghua School of Management at Peking University. In an interview with The Market, he begins by highlighting how bad the property sector in China is:
“How much have property prices in China gone down already? The answer is we don’t know. According to official data for new apartments in the 70 biggest cities, prices have gone down 5%. But those numbers are highly distorted and we know that real price declines have been much greater, perhaps 25% across the country. So are they near a bottom? Probably not. In Spain and Ireland, for example, property prices declined by over 50% after the 2008 crisis, and at its peak the Chinese property bubble was more inflated than that of Spain and Ireland. This suggests to me that perhaps we are only halfway through the process.”
He then notes why China’s attempt to make up for its over investment in infrastructure and property by boosting manufacturing is not particularly effective:
“…their magic trick to solve all problems, was to pour investment into the manufacturing sector. The problem with that is, if you are a small country, you can do that and nobody will notice. But when you’re the second largest economy, 17% of world GDP, and you already account for 31% of global manufacturing, you can’t do that unless the rest of the world is willing to accommodate the increase in your share of global production.
…Even if the world were a friendlier place, there was no chance the rest of the world would accommodate all that overproduction coming out of China. And of course, given how unfriendly things are, the rest of the world has said ‹absolutely not›. As America and Europe take steps to reduce their imports from China, some hoped that China could shift its surplus to the developing world. But it turns out that the developing world also wants to protect their manufacturing share. We’ve already seen Brazil, Turkey, and Indonesia putting up import tariffs, and that is likely to spread. This is a big thing. They made a huge bet that they would be able to shift investment out of the property and infrastructure sectors and into manufacturing. It seems they seriously miscalculated the willingness and even the ability of the rest of the world to accommodate such a rapid increase in China’s already-large share of global industry.”
With property, infrastructure and now manufacturing ruling out any possibility of boosting the investment side of the economy, he turns to what China is doing to boost consumption instead:
“They’ve discussed introducing what in the US a few years ago was called a ‹cash for clunkers› scheme, in which people get a subsidy to sell their old car and buy a new one. In China, they’ve discussed doing a similar scheme not just for cars but also for household appliances. The question of course is how big these subsidies will be, and if there will be a multiplier effect to consumption. I don’t think there will be a multiplier effect at all.”
Even if it were to find a more effective way to boost household income to boost consumption, the rebalancing from investment to consumption has other challenges:
“The problem is that there are two sides to the restructuring. The good side: The household share of GDP increases. That’s mostly the part that everyone is now talking about. The bad side: The GDP share of some other sector of the economy must decrease. A transfer, after all, is not just a transfer to but also a transfer from. If we’re not discussing where the transfer comes from, then we’re not really discussing where the transfers goes to. Almost everyone I talk to in China now agrees, perhaps a little late, that boosting the household share of GDP would be the right thing. But so far I haven’t seen any discussion of the flip side, which is who will take the other side of the transfer.”
He reckons of the three possible options to take the other side – private businesses, central government and local governments, the last of them should be the most preferred option and even that isn’t as straightforward given the dire state of local government balance sheets. He elaborates citing this incredible example of one of its provinces:
“Guizhou. A beautiful province, mountainous, but very poor; its per capita income is a little bit higher than in Cambodia. It has the most beautiful bridges in the world. Of the hundred highest bridges in the world, Guizhou has fifty of them. Do you think you have high bridges Switzerland? They are nothing compared to Guizhou. But the per capita income in Guizhou is about a tenth of yours. How do you justify these spectacular bridges? The productivity of workers is not high enough to justify them, so these beautiful bridges ended up becoming a huge burden for the local government. That is probably why Guizhou was the first province to effectively go bankrupt. But, here’s the weird thing: The second most valuable company in China, after ICBC, is Moutai. It sells premium liquor. And who owns Moutai? The government of Guizhou. Why do they need to own a liquor company? Why not sell it and use the proceeds to lower the debt? Everybody knows why. Because the dividends from Moutai pay for much of the functioning of the government and for the relationship between local banks, local businesses, and the local government. That makes it very difficult to force local governments to pay for the transfers needed to pay down debt and boost local consumption. But ultimately it is the best solution: local governments should sell or transfer the assets they own to pay for China’s economic adjustment costs.”
If you want to read our other published material, please visit https://marcellus.in/blog/
Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.
