Michael Pettis’ new volume, The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy, is an important new take on the ramifications of global imbalances, in particular for China and the United States.
The book sketches the familiar outlines of Chinese domestic and external imbalances, a sky-high investment share of GDP, a historically low household consumption share of GDP, and a large current account surplus.
What Pettis adds to the discussion is a remarkably cogent explanation of the transmission mechanism from China’s consumption-repressing policies to its external surplus.
The Savings-Investment Identity states that the difference between national savings and national investment is equal to the current account surplus. To put it more simply, production that is not consumed or invested domestically is sent abroad.
China’s consumption-repressing policies include negative real interest rates on household bank deposits, an undervalued exchange rate, a thin social safety net, and restrictions on the ability of labor to organize and demand higher wages. This suppressed level of consumption combined with subsidized over-production generates a large trade surplus. Pettis describes the linkages between these policies and the external environment with admirable clarity.
Unfortunately, this description has become less relevant in recent years. As those who closely follow China’s GDP statistics know, trade is a lot less important to Chinese economic growth than it has been in recent years. Pettis’ volume devotes little space to identifying this trend. In 2009, 2011, and 2012, net exports have actually subtracted from, rather than added to, economic growth.
While the external rebalancing that has taken place over the past several years is real, unfortunately it has occurred in a less than ideal way. To return to the Savings-Investment identity, over the past several years the investment ratio in China has shot up and therefore the current account surplus has gone down. This merely compounds the problem of over-investment in China. A far more desirable way of reducing external imbalances would have been to bring down China’s excessively high savings rate.
On the policy front, Pettis is skeptical of the ability of social safety net reforms to increase consumption. His point that a build out of the social safety net that is financed by new fees on households will not boost consumption is well taken. However, most policy proposals looking at this issue identify increased taxes or dividend payments by profitable state-owned firms, rather than higher household taxes, as a natural source of funds to finance a more generous safety net.
The two main problems with the text center on debt levels and future projections of economic growth. On the issue of debt, Pettis repeatedly claims that Chinese debt levels are growing and will soon reach unsustainable levels, triggering a sharp correction. What is missing is a specific estimate of China’s overall debt-to-GDP ratio to judge the severity of this risk. Our analysis shows that Chinese debt levels have not increased significantly since the 2008-09 lending boom and that overall levels, while on the high side for an emerging market economy, are not yet at a crisis point. More importantly, unlike other emerging markets that have suffered debt-related crises, Chinese debt is overwhelmingly denominated in renminbi and therefore immune from exchange rate swings.
The second point of contention is Pettis’ projection that Chinese GDP growth must slow significantly in order to achieve rebalancing. His analysis is that GDP growth must slow to 3 to 4 percent on average over a decade. Here Pettis underestimates the potential for catch-up consumption growth in China and mistakenly assumes that rebalancing must be abrupt and disruptive.
Chinese economic imbalances built up over a decade and there is no reason that they have to be unwound overnight. Moreover, consumption growth has been quite robust over the past five years, averaging 9.5 percent annually. It follows that a steady reduction in the growth of investment combined with consumption-promoting policies can keep Chinese economic growth growing at respectable 7 to 8 percent. We will outline why we think this scenario is achievable in soon-to-be-released policy brief called A Blueprint for Rebalancing: Creating a More Sustainable Chinese Economy.
Pettis’ book is commendable for the clarity with which it describes the international linkages between Chinese domestic policy and its external surpluses. Its main faults lie in a lack of specificity around the issue of unsustainable debt levels and overly grim projections for economic rebalancing. Overall, it is a worthy addition to the global debate on these issues.