Transcript: Pettis and Krugman on China, Mark Blythe on Austerity

Today on the podcast, China, GDP numbers down there as well as here, and Mark Blythe, author of Austerity: The History of a Dangerous Idea, with Bloomberg Surveillance team Tom Keene and Michael McKee.

Several banks have followed Michael Pettis into marking down Chinese GDP numbers into the 3 to 4 range, down from the 7, 8, 9 that has been the assumed norm for now until forever. While Pettis does not see that as a tragedy or crisis, necessarily, for China, and those numbers may be several quarters away, it is hard to tell what the markets will do.

Listen to this episode

We put up an excellent interview on the flagship feed last Sunday with Pettis courtesy of FT Alphaville. If you're still on the legacy site, you can access that interview via demandsideeconomics.net. No ads there, but there is a donate button. Thanks to those of you who have found it already.

Pettis makes several good points.

One is that there are more Chinese entrepreneurs in California than there are in China. Chinese capitalism is not entrepreneurial capitalism. It is crony capitalism. To get rich, you get close to cheap money or you get close to government officials.

Another is that the Chinese miracle is the same miracle of other investment-led countries which lever up and deliver high growth for a time, but get addicted to the process, and continue to expand debt long after the productive investments have been financed. This means the debt begins to get more and more rolled over, rather than paid off.

A third point here that Pettis makes is that the Chinese households are not really over-savers, as they have been pictured by some, including us here at Demand Side. Their savings are in line with other developing nations. They simply receive a far lower proportion of GDP than households in any other nation, possibly any nation in modern history.  I'm not sure I buy that. We've said people hoard against old age and want in China, since there is no social safety net.  Whatever the real story, the remedy of instituting a social safety net, for retirement and health care, would go a long way to bringing the Chinese economy into balance.

Pettis says the slowdown to 3 percent need not lead to massive unrest, but if income is diverted to households from investment, the authorities can manage an orderly transition to a more consumer-based society.  He gives the central government high marks -- as opposed to the corrupt regional and local governments -- and says the central authorities have credibility with the population as well.

You should listen to the interview for a very good take on the situation.

Ours is different.  The Chinese downturn was the inevitable result of the global downturn. It had to happen to the sweatshop for the world, when demand falls from Europe and the U.S. It exposes an endemic corruption that is not under control, no matter how well the central authorities impress various observers. You only have to look at the skies of China to see that the government is unwilling or unable to invest in the right things -- just as here in the U.S., I suppose.  And for the same reasons, the deniers are in power, sponsored by the entrenched interests.

We predicted five years ago that China would be the first environmentally failed state of the modern era.  Growth has not been so much growth as conversion of the Commons and the natural environment into marketable commodities, a one-way trade that is more eating the future than growing a stable economy.

The massively polluted skies and waters and soils are obviously not leading to prosperity. If the population has ridden with this group on the promise of ever increasing prospects, they will not be happy now.

In fact, just as in the U.S., the productive investments are really in protecting the environment and planet, but are not pursued because they do not enrich the entrenched interests.  A great proportion of the population are active deniers, no less guilty and perhaps more so than the holocaust deniers.  It is too inconvenient to stand up, so we will let the whole planet -- our children and ourselves included -- burn.

But our point, or the point we started to make, is that the Chinese slowdown is the result of being the sweatshop for the world, and the world is cutting back on its purchases.  The multitudes of interlocking financial arrangements that contingent production involves are coming unwound. The rollover debt is becoming Ponzi debt. You can have a Minsky Moment there just as well here.  This is a downward self-reinforcing spiral, just as the boom in credit and investment was an upward self-reinforcing boom.


The New York Times columnist and Nobel Prize-recipient Paul Krugman penned a piece titled “Hitting China’s Wall.” He wrote, “The signs are now unmistakable: China is in big trouble. We’re not talking about some minor setback along the way, but something more fundamental. The country’s whole way of doing business, the economic system that has driven three decades of incredible growth, has reached its limits. You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be.”

Let's see how the redoubtable Krugman does without the benefit of debt as a descriptor. For you remember that Professor Krugman believes debt does not matter, since it is owed by one spender to another, "We owe it to ourselves," and absent an unrealistic difference in our spending habits, it should make no difference. In piece one, Krugman postulates that China is running out of "surplus labor":

Hitting China’s Wall, by Paul Krugman, Commentary, NY Times: All economic data are best viewed as a peculiarly boring genre of science fiction, but Chinese data are even more fictional than most. ... Yet the signs are now unmistakable: China is in big trouble. ...

Start with the data, unreliable as they may be. What immediately jumps out ... is the lopsided balance between consumption and investment..., for China ... almost half of G.D.P. is invested.

How is that even possible? ... The story that makes the most sense to me ... rests on an old insight by the economist W. Arthur Lewis, who argued that countries in the early stages of economic development typically have a small modern sector alongside a large traditional sector containing huge amounts of “surplus labor” — underemployed peasants making at best a marginal contribution to overall economic output.

The existence of this surplus labor, in turn, has two effects. First, for a while such countries can invest heavily in new factories, construction, and so on without running into diminishing returns, because they can keep drawing in new labor from the countryside. Second, competition from this reserve army of surplus labor keeps wages low even as the economy grows richer. ...

Now, however,... to put it crudely, it’s running out of surplus peasants. That should be a good thing. Wages are rising; finally, ordinary Chinese are starting to share in the fruits of growth. But it also means that the Chinese economy is suddenly faced with the need for drastic “rebalancing”... Investment is now running into sharply diminishing returns and ... consumer spending must rise dramatically to take its place. The question is whether this can happen fast enough to avoid a nasty slump.

And the answer, increasingly, seems to be no. The need for rebalancing has been obvious for years, but China just kept putting off the necessary changes...

How big a deal is this for the rest of us? ... Western economies are going through their “Minsky moment,” the point when overextended private borrowers all try to pull back at the same time, and in so doing provoke a general slump. China’s new woes are the last thing the rest of us needed.

No doubt many readers are feeling some intellectual whiplash. Just the other day we were afraid of the Chinese. Now we’re afraid for them. But our situation has not improved.

Ah, perhaps not. Failing to connect the pullback in demand from the West to the downturn in China is at best, obtuse.  To say that China is running out of surplus peasants is quite an odd take on the situation.  Perhaps if the factories were booming... Or maybe if they cut back on the 400,000 who die every year in China from environmental pollution. But it also runs in the face of another observation by Michael Pettis, that the great investment boom in China meant that it was capital, not labor, that was driving production. Krugman ought to trade W. Arthur Lewis in for Michael Pettis.

But Krugman is entertaining to read. In another post he ponders the appropriate image for the slowdown.

One of them was that in a way, China’s low-consumption high-investment economy was a kind of Ponzi scheme. Chinese businesses were investing furiously, not to build capacity to serve consumers, who weren’t buying much, but to serve buyers of investment goods — in effect, investing to take advantage of future investment, adding even more capacity. Would there ever be final buyers for what all this capacity could produce? Unclear. So, a kind of Ponzi scheme.

Also, my worries are that China doesn’t know how to slow down — that it’s a bicycle economy that falls over if it stops moving forward.

And of course I’ve argued that running out of peasants creates a wall.

So, the Chinese Ponzi bicycle is running into a brick wall. Also, the fascist octopus has sung its swan song.

Elsewhere, More Krugman:

How Much Should We Worry About A China Shock?

Suppose that those of us now worried that China’s Ponzi bicycle is hitting a brick wall (or, as some readers have suggested, a BRIC wall) are right. How much should the rest of the world worry, and why?

I’d group this under three headings:

1. “Mechanical” linkages via exports, which are surprisingly small.

2. Commodity prices, which could be a bigger deal.

3. Politics and international stability, which involves some serious risks.

So, on the first: this is what many people immediately think of. China’s economy stumbles; China therefore buys less from the rest of the world; and the result is a global slump. Or, maybe not so much.
Some quick, rough, but I think useful math: In 2011, the combined GDP of all the world’s economies not including China was slightly over $60 trillion. Meanwhile, Chinese imports of goods and services were about $2 trillion, or around 3 percent of the rest of the world’s GDP. 

Now suppose that China has a slowdown of 5 percent relative to trend. Imports would fall more than this; typical estimates of the “income elasticity” of imports (the percentage change from a 1 percent change in GDP, other things equal) are around 2. So we could be looking at a 10 percent fall in Chinese imports — an adverse shock to the rest of the world of one-tenth of 3 percent,or 0.3 percent of GDP. Not nothing, but not catastophic.

And even this is arguably an exaggeration, because a significant part of China’s imports are components for its exports,and don’t depend on Chinese domestic demand.

As I said, then, the mechanical links through trade flows are relatively small, although they could bulk much larger for some of China’s neighbors (but would be smaller for the United States).

Commodity prices are a potentially bigger story. China is a major consumer of raw materials — for example, about 11 percent of world oil consumption. And because the supply and demand of commodities tend to be relatively unresponsive to prices in the short run, a sharp drop in Chinese demand could lead to sharp falls in commodity prices. So the Ponzi bicycle shock could be a bigger deal for countries that sell raw materials, whether they sell to China or not, than it is to China exporters.

Finally, politics and international relations. I am obviously no kind of expert here. But it’s obvious, first, that China’s political regime is remarkable, even given the annals of history, for the hypocrisy of its position: officially it’s building the socialist future,in practice it’s presiding over a crony capitalist Gilded Age. Where, then, does the regime’s legitimacy come from? Mainly from economic success. Let that success falter,and then what?

And if you really want to get nervous, think about what cynical governments trying to distract their populace from domestic failures have often done in the past. Saber-rattling over some islands somewhere, anyone?
No particular bottom line here, except that you probably want to focus much more on the indirect effects than on the direct export multiplier.

 Michael Pettis makes a very, very good point, which I'm sure Krugman would agree with, when he says that what is most lacking in economies across the globe is demand.

But again, the claims that the authorities are fully cognizant of the situation and are trying to do the right thing, and deserve high marks, etc., fly in the face of radical repression of democratic rights, the manifest destruction of the Chinese environment, and the basic crony capitalist scheme that is producing billionaires ready to move to the U.S.If they really understand they have to do something and are determined to do it., they're a dozen years too late.

Now to Mark Blythe, Brown University, in interview with Blooberg's Tom Keene and Michael McKee, on his book Austerity: The History of a Dangerous Idea.