A reader (Alice) recently emailed me a rather interesting claim, that China is well on its way of becoming a $123 trillion economy. Alice links to a MarketWatch piece that repeats some of the same flawed myths that Michael Pettis and others continually debunk. Pettis for example argues convincingly in his latest piece (not up yet on his site) that China today is more like Japan in the late ’80s and thus will be growing at much smaller percentages in the future.
In contrast, the MW piece essentially says:
1. China grew ~8-10% annually over the past three decades
3. China continues to grow ~8-10% for infinity plus one
The MW piece in turn quotes from a slightly older Foreign Policy piece, written by Robert Fogel, whom argues a very bullish case for China based on five criteria.
The first of which, Fogel notes that educational investment pursued by Chinese policy makers will somehow reap large dividends. Par for the course, a recent WSJ article notes that the US and UK spend the most per student and that Chinese policy makers are trying another top-down approach to overtake the US in this metric as well — by pumping out ever larger numbers of graduates. Yet ceteris paribus, quantity of graduates does not equal quality. Or in other words massive state funding does not necessarily equal to (!=) massive gains in worker productivity. Their approach is indirectly debunked at the WSJ (here) and by a piece I recently wrote.
Fogel’s piece also suggests that there will be continued, substantial contributions from the rural countryside. While there is no doubt that Chinese subsistence farmers (~45% of the population) that average roughly $1,100 in earnings each year will probably continue to be measurably productive and generate wealth, it does not follow that they will somehow generate massive GDP multiplier coefficients. If that were the decisive case then rural-heavy, developing countries like India, Indonesia and Pakistan are all up for double & triple digit trillion dollar economies soon as well.
What matters in terms of GDP (the sole metric in Fogel’s exercise) is what these unskilled rural workers can increasingly produce with same amount of (or less than) inputs (e.g., marginal productivity gains & TRP). And unfortunately, there is no clear connection between: state education + rural migrants -> Sheenian $123 trillion winning. In fact, there are at least two large barriers facing migrant workers:
1) Rural migrants typically do not have the funds (even when pooled together) to afford many of the new apartments being constructed, thus becoming part of an evergrowing disenfranchised “ant tribe“ (yizu). And because of subsidized loans and relatively scarce land (which was sometimes confiscated by local governments from these same rural migrants) domestic developers such as SoHo (crying or not) have the potential to receive larger revenue margins by constructing high-end condos instead of low-cost housing in real estate boom towns (e.g., every city) throughout the country. Thus there is a disconnect between supply and demand (which unfortunately the government is trying to band-aid over). This indirectly leads to relatively high vacancy rates in some cities and NPL financial problems.
2) In the event that they do find work, they are actively discriminated against due to hukou restraints (household registration). The hukou is two-tier caste system which prevents these same rural workers that pay taxes and build the infrastructure, the public buildings, the schools and the hospitals from being able to receive access to the said services (e.g., cannot send their children to public schools or utilize the public hospitals). Every few months hukou reform receives lip service from various political and academic circles. Yet if the average Wang had a penny (or yi jiao) for every time reform was mentioned, they might actually be able to afford those high-end condos.
However as Bill Bishop noted, there is no political indication this rural reform will ever take place largely because it is simply too costly for cities to implement. Or in other words, if it were possible to do those reforms they would have probably done them already.
Speaking of property, another unintentional twist that directly effects every Chinese person, especially rural residents, is land eviction.
For example, in Mark DeWeaver’s upcoming book he notes that because land sales by local governments make up significant portions of their revenue, there are numerous instances of rural farmers being evicted from their land due to eminent domain and/or coerced buyouts by state-owned enterprises — to raise government revenues. This same fertile farm land is paved over and turned into unproductive assets such as malls no one goes to or housing development that now lay dormant.
And since this is the rule, rather than the exception, because there are fewer fertile farms to grow food — one of the unintended consequences is higher food prices (e.g., less supply, same demand) — and as a consequence China has become one of the largest importers of US agriculture; they are now dependent on the US for food security. Some have noted this is equivalent to the Western dependence on Middle East petroleum.
Back to $123 trillion
Fogel’s third point has to deal with underestimating China’s service sector and in particular the health care industry. While statistics gathering may not be as “professionalized” as it is in the West as Fogel contends, China actually is facing severe problems in health care now and certainly into the future.
For example, in a recent Nature paper Virginia Hughes notes that in China “chronic obstructive pulmonary disease (COPD) will kill 3 million people a year by 2030.” This is on top of the 1.2 million smoking-related deaths that already occurs in China annually. Some other highlights of that paper noted by Shanghaiist:
- Over half of all men, and about two-thirds of middle aged men, smoke.
- 41% of male Chinese doctors smoke, and about 15% have smoked in front of their patients.
- An anti-smoking clinic in Shanghai only sees about 300 people per year.
- 82.5% of women are exposed to second-hand smoke, despite the fact that only 1 in 50 Chinese women smoke themselves.
- Of the 240 million people in China over 50 in 2007, 1.9 million non-smokers died due to second-hand smoke.
- Women exposed to second-hand smoke were 2.3 times more likely to die from COPD.
- Rural Guangdong has the highest prevalence of COPD, at over 12%, compared to less than 4% in Shanghai.
- A lack of specialized medical equipment means that a large number of Chinese doctors are unable to diagnose COPD and prescribe patients antibiotics, which doesn’t do anything.
- The total cost per year of COPD medication is over 10,953 RMB ($1,732).
While smoking-related deaths and illnesses may not have the same direct economic consequences as HIV/AIDS has had on south African countries like Botswana — the economic impacts are both pronounced. HIV/AIDS laid waste to significant portions of Botswana’s able-bodied working-aged populations, stunting the country’s economic performance. Likewise, while the effects of smoking are more pronounced and detrimental in later stages of life, the total health care costs borne by friends and relatives (and insurance) will create an economic divot considering that the funeral bills, hospital visits, treatments and medicine for 3 million now-dead individuals is not chump change. That is equivalent to a large city, dying each year. Also for some perspective, the roughly 42,000 people that die in the US each year to second-hand smoke represent $6.6 billion in lost productivity.
And unfortunately the incentives for preventing smoking is diametric to preventing AIDS/HIV: no one economically gains from spreading these autoimmune disorder diseases. Whereas the Chinese government received $95 billion in taxes from tobacco sales last year alone (see more details from this CNN piece). To pre-empt all the angry emails from African-based NGOs, as bad as 3 million smoking-related deaths are, relative to China’s total population it is not nearly as devastating as the double-digit percentage that has decimated Botswana and neighboring countries.
Again, while I think nationalizing the US health care system and subsidizing it is detrimental both to the consumer and economy (see this excellent essay from Vijay Boyapati), the health insurance system in China is in a deeper financial hole. It is so problematic that it is actually discussed in the Chinese press; yet unfortunately there is no quick political solution to the issue aside from overpromising taxpayer funds.
Making the sausage
Fogel’s fourth point has to deal with China’s political system which in his words “has become much more responsive and open to new ideas than it was in the past.”
But how does he know this? There is still little transparency: we did not even know where Xi Jinping, the next president, was for 2 weeks this summer. Minxin Pei argues that there is no meritocracy and other research indicates that it is nepotistic Corleone-style families (Crown Prince Party, princelings, Shanghai clique) that make the key decisions behind closed doors (see John Garnaut’s excellent piece regarding princelings).
Which brings us to state-owned enterprises: if state planners were “open” to further reforms, then why have they not privatized the 110,000 SOE’s? They represent roughly 62% of the countries GDP. In our recent interview here at TLS, Mark DeWeaver noted that:
I don’t see how we can speak of a country as capitalist if the majority of the means of production are state owned. If capitalism means anything, it means that the means of production are in private hands. “State capitalism” is an oxymoron.
So not only is China not-a-capitalist country (which Fogel spuriously asserts on p.3), but as The Economist noted three days ago, the state-owned interests are actually growing at the expense of private companies:
Though fewer in number, today’s SOEs are more powerful than ever. One reason is that they can be vast (see chart) and so their market power is often greater in a given industry. Their shrinking number is the result of a concerted effort to consolidate disparate SOEs into national champions in a range of “strategic industries”, which range from telecoms to shipbuilding.
Liberal reforms got a boost with China’s WTO entry in 2001—but slowed after 2006, and then, argue critics, went into reverse as the stimulus spending of the past few years flowed to SOE coffers. GK Dragonomics, a consultancy, estimates that the SOE share of investment, which had been in decline, has risen in property, communications and finance. In 2004 the average industrial output of SOEs was six times that of the average private firm; by 2010 it had shot up to 11 times as much.
In addition to sheer size (and a nod and a wink from the antitrust authorities), SOEs enjoy a range of unfair advantages. In return for guaranteed profits and state backing, official banks lend to SOEs at a third of the cost of credit available to private companies (those that can get official loans at all). The government showers a range of tax breaks and subsidies on state firms, and favours them in procurement contracts. Unirule, a Chinese think-tank, reckons not having to pay for the land SOEs sit on was a subsidy worth some 4 trillion yuan ($640 billion) in 2001-09.
Contra Fogel, even if state planners were more responsive, several million Party members and their relatives directly benefit from the status quo. I believe Public Choice economists call this regulatory capture and intractable decision-making: or in other words, special interest groups will fight against such reforms.
The last point Fogel makes is that Chinese consumers are repressed and their pent up purchasing will be unleashed. In his words:
Finally, people don’t give enough credit to China’ s long-repressed consumerist tendencies. In many ways, China is the most capitalist country in the world right now. In the big Chinese cities, living standards and per capita income are at the level of countries the World Bank would deem “high middle income,” already higher, for example, than that of the Czech Republic. In those cities there is already a high standard of living, and even alongside the vaunted Chinese propensity for saving, a clear and growing affinity for acquiring clothes, electronics, fast food, automobiles — all a glimpse into China’s future. Indeed, the government has made the judgment that increasing domestic consumption will be critical to China’s economy, and a host of domestic policies now aim to increase Chinese consumers’ appetite for acquisitions.
There are several problems with this. The first of which is, as Michael Pettis has showed over and over again, consumption as a percentage of GDP has dropped every year for the past decade. According to Yukon Huang, it has actually dropped “from 50 percent to below 35 percent [of GDP] over the past 15 years.” And it continues to drop because of the silent bailouts that consumers (taxpayers) are giving to debtors. This is done through repressed interest rates offered by state-owned banks who are required to fulfill loan quotas set by agencies such as the NDRC. The banks and SOEs then service and refinance the subsequent non-performing loans with relatively low rates. Thus until the banking system is reformed and banks are allowed to function as banks (by setting higher lending standards and raising rates to reflect risk), consumer spending will continue to remain repressed because of this wealth transfer.
As far as bigger Chinese cities with high “living standards” and high “per capita income” comparable to the Czech Republic (at ~$20,500/capita), I am curious to know which metros Fogle is thinking of: Shanghai (~$13,000/capita), Beijing (~$12,500) and Guangzhou (~$13,000) are somehow comparable with the West? I have lived throughout China and I think Shanghai, where I have spent the last six months, is by far the most expensive city relative to the income earned. In fact, Mercer’s 2012 report on the most expensive cities – the cost of living for expats illustrates this: Shanghai (16), Beijing (17), Guangzhou (31) yet Prague is 69th.
Notes in the margin
I enjoy receiving emails, especially from readers curious about China. Alice mentioned a few other things in her email:
1) “China will have more skyscrapers than US in 5yrs” (Yahoo). I am not sure why this is a objective metric to measure wealth or growth by. Mark Thornton’s Skyscrapper Index suggests that certain central bank policies can distort the capital structure and capital formation — incentivizing firms to embark on real estate construction projects that are wholly unsustainable once interest rates rise and “cheap” credit is removed from the system. We have already seen construction booms that have stopped.
2) “Glut of Solar Panels Poses a New Threat to China” (NY Times). This certainly did not help her bullish case. In a nutshell, central planners in China have dumped massive subsidies into renewable/green technology in an unprofitable industry resulting in large losses for banks.
According to the NYT:
The result is a looming financial disaster, not only for manufacturers but for state-owned banks that financed factories with approximately $18 billion in low-rate loans and for municipal and provincial governments that provided loan guarantees and sold manufacturers valuable land at deeply discounted prices.
Readers are encouraged to peruse an earlier post from Reason magazine, “China Is Winning the Race to Lose Billions on Solar Power.”
One last note, in her email Alice mentioned that there were two American asset managers who held the same view as the MarketWatch writer: Jim Rogers who has said “America is More Communist than China” and Peter Schiff who said, “China More Capitalist Than America.” I do not think their hyperbole helps her case.
As I have mentioned previously, if central planning and state ownership of the means of productions does not work anywhere, why will it work in China? Emboldened Chinese planners may be biting off more than they can chew by trying to: build a moon base, build a blue water navy, build stadiums in South America & Africa (for free), build mian zi gong chen (face projects), etc.
Attempting to implement grand plans by ignoring markets may run into Misean coordination and calculation problems eventually leading to planned chaos. While Yogi Berra was correct to say it is impossible to guess or forecast what will happen in the next 30 years, the reasons laid out by Fogel, Rogers and Schiff are simply non sequitur — China may become wealthier than it is today, but probably not for the reasons they claim.