The following points appear frequently in mainstream media commentary on China:
- China’s economy is growing at a rate of 8% annually, perhaps higher
- The Communist party will not “allow” growth to slow because it would create social unrest
- China’s development is based on the “export-lead-growth model”
- The export-lead model has been successful in “creating jobs” but due the collapse in Western consumer demand for their manufactured goods, this model may no longer be working.
- Many Western economists believe that the savings rate is “too high” and that the Communist party should adopt more policies to promote consumption, which will help them transition to a more “consumption-lead growth model”.
Some questions I have about the Chinese growth story:
- The economy is still largely centrally planned. A significant percentage of the large industry is still state-owned. How can central planners overcome Mises’ problem of economic calculation? It is likely that a large amount of the savings is simply wasted on projects that are not economically rational if the costs were properly accounted for (not hidden by their currency peg).
While the savings rate of Chinese is very high, most of the investments are probably wasted because bank loans are largely politically, not economically, driven.
See for example, this Daily Bell column; an article in James Grant’s most recent Interest Rate Observer (paid content) calledChina Channels Monkeybrains; and Brad Setser’s paper on the Chinese banking system.
Grant explains that the banking system uses Soviet-style planning based on gross volume lending targets. Setser describes how the banking system in the past enormous quantities of of bad debts, which were taken off their books by the central planners.
- GDP measurement can be misleading or event irrelevant. Measuring growth GDP is like looking at the cash flow of a company while ignoring the balance sheet. Producing tons of physical stuff is not the same thing as economic growth if it costs more to produce things than they can be sold for. Also, GDP can increase during a credit-driven boom because the measurement of GDP has no way of distinguishing between mal-investments and economically sound investments.
- Why do media commentators think that the currency peg is such a brilliant move? Ultimately the goal of production is consumption; exports can only be paid for with imports. The currency peg only distorts their cost structure of Chinese firms, making their costs appear in local currency lower. The cost of the currency peg is paid by the Chinese people as a whole through a lower purchasing power of money. These artificial costs encourage firms in some industries to produce goods for export to the US market that Americans cannot afford. To maintain the peg, the Bank of China was required to accumulate dollars which they then loaned back to the US government, Fannie, and Freddie. As these loans will surely default (either through inflation or outright default) it will become clear many Chinese people worked hard and saved to give away a lot of valuable goods for free. The entire strategy is a massive wealth transfer scheme from Chinese savers to American consumers and the US government. This is not a “growth strategy” at all, it is an impoverishment strategy.
Along with “create jobs”, the phrase “export-driven growth” should be stricken from economic journalism. This phrase is so pernicious because it looks like a simple noun modified by an adjective, but it hides a false theory of cause and effect. How much sense does it make to talk about a “beer-driven safe driving strategy” or a “partying and drug using high academic performance strategy”. Putting words together in a sequence does not mean that cause and effect really work that way.
A mercantilist policy of subsidizing export industries does not make a country more prosperous. Economic growth can only mean an increase in the ability of an economic system to produce more consumption goods. In the global economy, the system is the entire world, with each nation contributing some portion of a single integrated capital structure. Producing a lot of capital goods – factories, shipping terminals, etc. — does not necessarily contribute to economic growth if the physical stuff is not economic capital. Economic capital means that it is integrated into the global structure of production through economic calculation.
The purpose of exporting is not to create more factories per se, nor is it to “create jobs”. The purpose of production is for the producers, is is to gain the ability to afford to purchase more goods — either capital goods or consumption goods. Producing things at a loss consumes capital and makes the producer poorer.
Nor is there such a thing as consumer-driven economic growth. Consumption is the result of economic growth — savings and investment drives it. The idea that a country can “switch” from “export-driven growth” to “consumer-driven growth” ignores the specific and heterogeneous nature of capital. The fact that people are talking about this so much only indicates that a lot of the physical infrastructure in China is not economic capital. If the existing capital structure in China was to be used to create a different mix of goods – say low-end consumer goods for Chinese consumers with lower incomes than Western consumers — then the values of these factories under economic calculation would be marked down considerably, in many cases below their costs.
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The “smart guys” assume China’s reported growth is part-faux-stimulus, part statistical baloney.
An insightful and informative article. Though please proof read, there are many spelling and gramatical errors.
Excellent commentary Mr. Blumen. Even though you didn’t state it explicitly, I assume that the conclusion is, China’s growth is not real.
These articles need to be proof read by someone.
I agree with Anthony. There is a sentence that is incomprehensible to me due to its errors:
“Sure they are producing a lot of physical stuff, but a lot of economic activity in China is simply the would have a negative rate of return, if they were subject to economic calculation.”
“is simply the would have a …”? Talk about mangled. This makes the sentence have no meaning to me.
I never realized that so many English teachers are interested in Mises theories…. Nice to have you with us…
Sorry for all the proofreading errors. I think that I’ve fixed most of them now.
“China’s economy is still largely centrally planned”
And their statistics are subject to central planning. How can anyone trust China’s statistics? A discussion is not even possible without a free flow of information and an open society. It is all disinformation without that.
We can barely trust the US statistics.
China is proof that slavery is a growth industry. It demonstrates that central planning can be viable with external demand guiding the planners in what they produce. America’s waning prosperity is riding on the backs of a billion Chinese, but that era is about to end in a spectacular implosion.
Mr. Blumen,
The many grammatical errors give this essay an amateurish quality. A proper essay must be edited. Furthermore, there is little source citation.
I expect more from this website.
Mr Blumen,
As a good Austrian, would you hazard a guess as to the consequences of such a mega-malinvestment project orchestrated by the state, while also “cooking up the national register” to hoodwink everyone?
I’m a chinese student,and interested in Mises theories.I think Mr Blumen’s words are probably right.We are also doubting these statistics.
I’m a Chinses student,and interested in Mises theories.I think Mr. Blumen’s words are probably right.We are also doubting these statistics.
By the way, this is a good website.
Mr. Ranson, please remove the pole from your anus, it is preventing you from having a fulfilling life.
—-
As per, Ben Ranson
“Mr. Blumen, The many grammatical errors give this essay an amateurish quality. A proper essay must be edited. Furthermore, there is little source citation. I expect more from this website.”
Though I did not emphasize this point in the blog post, I believe that there is a bubble in China. The bubble is driven by the necessity of creating more of their money in order to purchase enough dollars to matain their exchange rate peg.
I wouldn’t know how to measure the proportion of real growth out of the total economic activity but I suspect that there is some of each. Even though bank lending may not be economically rational, there is a lot of foreign direct investment going on that is surely profit-motivated.
I think there are (at least) two big forces in China’s economy; (1) the artificial holding down of the Yuan which means high inflation of the money supply causing misallocations of capital and labour an (2) growing productivity of Chinese labourers which can cause major wealth improvements when (1) busts and/or when this productivity growth is translated in growth of purchasing power (which is now only the case in a limited way).
The question then is if (2) can make up for the misallocations in (1), or in other words: whether the Chinese will be starting to consume their own produce or that the misallocation cannot reflect Chinese consumer preferences.
I have heard that the best estimate of true Chinese GDP is the year-on-year change in electricity production.
I think even that is dubious though. The rest of the statistics are rubbish.
Can someone please pose these questions to the likes of Schiff and Jim Rogers? They both seem very optimistic about China’s future – hailing it as the world’s next economic powerhouse. For reasons expressed in this article I remain sceptical.
There is so much wrong with this analysis I do not have time to address it all but let me just hit on a couple of things. First, the Soviet Union grew under Stalin. It should not be a surprise that China’s economy is growing. Concerning Mises’ economic calculation Mises clearly states that a command economy can function based on two things: 1) using the economic calculation of capitalist economies. 2) Relying on the historical price structure that will be sufficient for a time then began to fail. China is just entering its growth phase so it has not had time for problems of maturity to show.
Then the criticism of the monetary peg is foolish. The Chinese peg is against the US dollar China’s major trading partner. Maintaining a link of currencies would actually balance trade. The idea that the peg puts a burden on the local economy is a monetarist view that only stands up under partial analysis.
The economics of Schiff and Rogers is supposedly Austrian, and as Austrian they are also praxeological actors i.e. talking their investment books: Schiff in Emerging Markets and Rogers in commodities.
Fact of the matter is, China is a centrally-planned economy (not sure about it being controllable though as recent reports of runaway bank lendings show) and WILL NOT escape the Misesian socialist calculational impossibility thesis.
Why invest in China? It’s case of which market is less bad. Recession-plagued US, Japan and W Europe are all running up huge deficits and decimating their currencies in the process, vs China’s huge savings pool and (allegedly) still growing economy, mercantilist trade policies and Keynesian national aggregates being what they are.
So, how many U$586 bn stimulus packages do you think the Chinese can afford to sustain this dress parade? I’d say a major dressing down (painful correction) will be inevitable. Question of when, not if.
China is clearly becoming wealthier. It’s obvious to any visitor. The question is how fast. The growth rate has been lowered by some organizations because the state didn’t provide accurate measures of price inflation and it began providing better figures recently. A lot of past growth was actually inflation.
It appears that the private sector is creating more savings and wealth than the public sector can waste. But how long that will continue I don’t know. The danger is that the Communists will delude themselves into thinking that they are responsible for the growth and not the free market.
Mr. Fox,
Russia grew under Stalin because previously the country was significantly under invested in capital equipment and factory automation. The economy grew simply due to taking the peasants off the farm and forcing them to work in factories. But in the mean time agricultural production dropped dramatically resulting in massive starvation. The increase in investment was a one-off shot in that arm that could not deliver persistent growth in the Russian standard of living longer-term. Central planning fails miserably at efficiently allocating resources or providing continuous productivity growth.
Mr. Blumen,
The Chinese government is well aware of their predicament. The one way they can deal with the decline in exports is promoting policies that spur domestic consumption, which they have been doing. The very easy, near-term way they are accomplishing this objective is by promoting home ownership. Unlike in the US, the government had put the breaks on the housing market in 2007 and it had only to reverse previous policies that limited growth in this sector. With the growth in urbanization of the country running at 4% per annum, the poor quality of existing housing stock and the fact that affordability has been improving for the last 10 years means that targeted mortgage lending policies are a relatively low risk way to promote domestic demand, at least for now, via new home construction. It has worked remarkably well too. New housing stock in many cities has dropped by half from very high levels YTD.
Here’s an alternative theory:
The numbers are largely right, or at least convey a correct picture of increasing prosperity. But this is not because the current state-managed capitalism is good, it is simply because it is better than the Communism that prevailed until 1978.
Things are never completely black and white between freedom and central planning. There are always shades of grey. Going from less to more central planing, as America is doing now, leads to destruction of wealth and prosperity. Going from more to less central planning, as China seems to be doing now, leads to more wealth and prosperity.
Surely, China could do much better if it stopped buying treasuries subsidizing American consumption, if it reduced central planning more, if it neutered its government more, etc… but it could still be improving with all of that.
The real question is: What happens when (not if) the US defaults on its debt to the Chinese?
bandsma:
Consumption is a consequence of production, not a means to get wealthier. Consumption per se doesn’t “solve” anything. The only way it would help them out with the decline in demand for their products that were previously exported would be if they could find new customers for the same products. But Chinese incomes are not high enough to buy all of the stuff that they make for the West.
The capital stock they have is specific to the production of certain goods. Shifting that capital stock to produce different goods, say, things that Chinese consumers need, would reveal significant capital losses. This might be the way to go but that’s not the same as saying that promoting more consumption is any kind of solution to the decline in export demand. On the contrary, the export would need to go through the “bust” phase of the business cycle.
Mr Fox:
“Then the criticism of the monetary peg is foolish. The Chinese peg is against the US dollar China’s major trading partner. Maintaining a link of currencies would actually balance trade. The idea that the peg puts a burden on the local economy is a monetarist view that only stands up under partial analysis.”
That the critique of the currency peg is a “monetarist” idea does not make it right or wrong. My own reasons for doubting it are more of an Austrian nature. You state that it does not stand up under analysis but do not provide any analysis in support of your view.
By “balance” trade” do you mean that there will be neither trade deficits or surpluses in either direction? That does not seem consistent with the fact of China’s large trade surplus.
I will discuss here why I think it is a problem. In the absence of currency pegs, suppose one country exports more than it imports. Exporting firms accumulate holdings of the export nations’ currencies, say dollars. Exporting firms need to pay their costs, or enjoy the profits of their business. They must either use the dollars to buy goods from exporters in the dollar country or sell the dollars to someone who wishes to do so.
Now if the Bank of China steps in between the exporter and the forex market. They purchase the dollars either with funds collected by taxation, borrowing, or print the difference. As the difference is too great to make up by borrowing, they have monetized quite a lot of the difference.
This distorts the structure of production in China because the cost of the BoC’s activity is distributed over the entire country through inflation (which creates another set of distortions as explained in the Mises-Hayek theory of the business cycle). But the effects of a lower exchange rate are concentrated on the export sector. It makes their selling prices lower than they otherwise would be.
“The purpose of exporting is not to create more factories per se, nor is it to “create jobs”. The purpose of production is for the producers, is is to gain the ability to afford to purchase more goods — either capital goods or consumption goods. Producing things at a loss consumes capital and makes the producer poorer.”
That is exactly the purpose to China, they have no choice. They must create 10 million jobs per year, or the whole country will break out in riots. They do not, and will not care if it robs the people of productivity and wealth.
With this recession, I imagine they will try to print up money to create jobs, and when that fails they will try to spend their trillion or so in reserves, at which point relations between the USA and China could get sour very quickly as they try to liquidate their US treasuries.
The real question is – on one side we have a free market economy that printed up a bunch of money and pumped it into useless houses and on the other side we had a centrally planned economy that printed up a bunch of money and loaned it into factories. Massive misallocations aside, my bet would be that the factories are probably more useful to the global economy than the houses. So it would be in China’s national interest to push free market reforms to capitalize on that. Also, it’s in the US national interest to default.
So in sum, the US will default, China will rise as they continue free market reforms, and God only knows what will happen to the USA after that. In scenario A) we push the reset button on the US economy, kill the income tax, move to the gold standard, and birth into the information age. In scenario B) we become a socialist pigsty like France, and slowly decline into the abyss becoming another failed empire on the trash heap of history.
I just don’t know? That we were dumb enough to elect Obama is not an encouraging sign.
How can they be “growing” if they’re shipping everything over here?
“I have heard that the best estimate of true Chinese GDP is the year-on-year change in electricity production.”
By a funny coincidence (or maybe not), someone originally from China just told me a couple of days ago that “power plants are being shut down in China”.
While we’re speaking anecdotally, I can testify that I have seen massive and even bizarre malinvestment in China. When I was there three years ago I saw not only fine new highways, bridges etc. whose utility is hard to argue with and which were heavily used, but also a lot of massive new tourist infrastructure (museums, theme parks, etc.) which had virtually no paying customers at all. A lot of fine construction materials and human labor and ingenuity were being thrown into a deep hole labeled, “if you build it they will come.”
There was a TV news story about how something like a dozen brand-new water parks had been built in the Shanghai region and after a couple of years only a single one had enough customers to continue operating.
And I think I read something the other day which claimed that Shanghai has more new, unoccupied office space than exists in all of NYC.
So yes, I expect there will be some humongous writedowns coming in China’s near future.
Ohhh Henry: “And I think I read something the other day which claimed that Shanghai has more new, unoccupied office space than exists in all of NYC.”
I read that in PJ O’Rourke’s “Eat the Rich” but that was about 15 years ago. Anyone have any newer info?
prolly the most self-evident “measure” of REAL growth and prosperity for an emerging economy is the relative contentment of the everyday citizen. Problems in the south and west have been highlighted recently in china. maybe that’s due to a more prevalent communications apparatus available to the average citizen or maybe its a reflection of some not so rosy economic troubles.
Yes, I agree that the wordsmithing quality of mises.org articles has declined recently. Get in touch with me for expert and inexpensive editing services (degree in Creative Writing).
Second-to-last paragraph still has some typos.
The question for this article should have been is China’s growth optimal,sustainable, or inflated. The question of whether their growth has been real is not open for debate; just go to Wal-Mart and look for Made in China tags; look at the explosion of urban population in the Special Economic Zones. Even in its weak and constrained form, capitalism has produced a miracle in China. Free-Marketers should be looking at China and saying; “If a little capitalism can do this, just imagine what’s possible.”
@John Becker – sure they are producing stuff but if you are not producing at a profit, then that is not economic growth. And if the private sector is producing wealth but it is being destroyed at the same rate in centrally planned infrastructure products, centrally planned-politically favored SOEs, and the phony banking system, then there is no net growth.
So sad to see a great bunch of Western thinkers try to conclude on Chinese logic! China has more post graduates this year, with I Q s over 130, than the U.S.A. has high school students, drop-outs included! In a nation that can tap that kind of brain power, I don’t expect to many errors to be made! I expect the financial texts of the future to be written in Mandarin! We guess with our European based indoctrination, and speculate through our jaded Western eyes, on a totally foreign system and its direction! As far as they are concerned, they are on the right path to reach the goals they intend to hit – even the philosophy of goals to hit may be from and oriental point of view, and therefore very different! Fact is: while America prepares for a WWII style battlefield with superior Air power and Tanks and Ships, Asians win on the economic battle front over the Americans and beat them there, no question! We all drive Asian designed and manufactured but locally assembled automobiles – this is no error on the Asian’s behalf! They simply out-did the U.S. in engineering – so it is no great stretch to see them outdo America on financial matters also! Keep in mind they are Capitalistic when such formats serve them well, but not blindly devoted to these as strictly adhered to principles at all times like the Americans. They can flex and be communist at the drop of a hat! their hat to drop! not ours! Soon the mighty currency of international trade will be officially replaced, not just figuratively as now, by Asian currencies! Keep in mind, China is 4 times bigger than the U.S.A. and much further ahead in education. China is no fanatically Capitalistic. China eats primarily rice and veggies, China strives for and wins oil independence. China can so man bigger armies than the U.S. can imagine. China is in no way required to play economical ball with the U.S. – they trade with the rest of the world for 1/4th of their riches. China is deeply into Africa. China does not fear American Nuclear Power – they can so retaliate. China laughed out loud at Timmy Geithner’s dissertation on how things were to be in this world on his Beijing Embarrassment! This was not reported by CNN,NBC,CBC, ABC,CBS,BBC, – Americans and the Western World were kept in the dark about this! China has the BYD – Volt knock-off car in proven Shanghai Taxi service today! The Volt? still vapor-ware! GM(America) floundering as it flogs off bigger cars than Americans can afford! China has, up and running, proven in service, Nuclear Electric sourced, electric bullet train networks, and the 21st Century lifestyles it ensues, in place and producing not form oil power but from nuclear power!America languors in an oil-mired gulf desperate to such a degree for oil, yet too stubborn to convert to alternative energy sources. It appears that the 21st century belongs to the progressive Chinese, and their Asian partners and the West, tied to Arab oil is losing the battle fast! Yes! Chinese and Asian objectives are different! Yes! they march to the tune of a different band! Yes! they suffer loses in this fight for the future! Yes! they have outstripped the lazy fat-bummed air-conditioned Yankee Doodle! No he does not strive to catch up, or even compete! Yes! he is complacent in the propaganda of his military might. Yes! he has been deceived! Yes! he faces severe disappointment in the near future!
I think most people that visit this website know that spending money on becoming a military powerhouse is a waste. It comes a the expense of the economy.
Also, the purpose of this discussion is not aimed at how the economies will grow based on the different cultures of each country, but the different government burdens. The keys for economic growth are minimal government, minimal taxes, high savings, a sound currency, minimal regulation and respect for private property rights. It does not matter how high iqs are or anything else you mentioned in your rant. It’s great that you are very excited and optimistic about China’s growth, but centrally planned economies will inevitably fail. The question is, when China experiences a recession due to the government credit expansion, will it allow for more economic freedom or will it impose more regulations that burden economic growth?
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