Will China’s shift to a consumer-oriented economy succeed?
Editor’s Note: China’s growth slowed to 6.9 percent in 2015 — a high number for any other country in the world, but low for China, a country that averaged 10.6 percent growth in 2010. And what happens in China, the second largest economy in the world, doesn’t stay in China. When the country devalued its currency this summer and when its stock market plunged at the start of the new year, it sent ripple effects around the world. Currencies were devalued, stock markets nosedived and some economists urged the Federal Reserve to reconsider its course on interest rates.
Making Sen$e spoke to economist Stephen Roach, author of “Unbalanced: The Codependency of America and China” and a senior fellow at Yale University, where he focuses on the impacts of Asia on the broader global economy.
The following text has been edited and condensed for clarity and length.
— Kristen Doerer, Making Sen$e Editor
Kristen Doerer: Why is China’s downturn affecting the rest of the world?
Stephen Roach: A series of forces are coming into play right now — some of which are real, some of which are exaggerated. The real one is that China accounted for over a third of the cumulative increase in the world economy over the past decade. It’s been the dominant engine of global growth, and as that engine slows down for a number of important reasons, many of the drivers of activities in other countries that have become dependent on China are obviously operating at a slower rate. That’s particularly true of resource economies that have fueled China’s industrial machine — countries like Australia, Brazil, Russia, Canada and New Zealand. It’s also true of the East Asian economies that are part and parcel of a China-centric global supply chain, which drives the production assembly of manufacturing goods, which are then sold to Europe and the United States. But demand is sluggish. So a lot of the pieces of this increasingly integrated globalized economy are tightly connected to China, and as China slows and as the world slows, these forces are now operating at a much slower speed.
Kristen Doerer: Why is it affecting the U.S. so much considering how independent we are of the Chinese economy for exports?
Stephen Roach: Well, I think there’s a miss there. I think we’re actually more dependent on Chinese for exports than we would like or care to believe. China, over the past decade, has become our third largest and by far the most rapidly growing major export market. Now, it’s true that the United States isn’t as dependent on exports as China or other Asian economies or even Germany. But in a sluggish consumer demand climate — such as that which we are operating in and have been operating in for the last 8 years in the U.S. — we need exports, which are increasingly an important source of growth. It provided a really big offset to the weakness in the economy and to our early stages of the post-crisis period. And the Chinese demand for U.S. products was an important part of that.
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It’s not just that China is our most rapidly growing major export market, but that growth rate is most likely going to be increasing as China shifts to a more of a consumer-led economy that will draw heavily on products made overseas in countries like the United States. So I don’t think we can just dismiss the fact that the U.S. is not dependent on Chinese markets for exports. And I’d go even further to say that the U.S. has also been heavily dependent on China’s demand for Treasuries to help fund the budget deficits in our deficit-prone economy. I wrote a book a couple of years ago on the codependency between the United States and China — we both depend on each other.
Kristen Doerer: Would you say that the codependency is a bit dangerous or risky? Are we too reliant on each other?
Stephen Roach: Well, it’s not a sustainable state of affairs to become overly reliant on one another, but to take that sort of codependency for granted is also a mistake. For years, we have been beating on the Chinese in political circles and even in academic circles to become more of a consumer-oriented economy. And China has actually taken that advice quite closely and is in the early stages of shifting its growth equation away from exports and investment to consumption demand.
But what happens when they do that is that the surplus savings that they have built up for years that has been invested in U.S. Treasuries — surplus savings that they have lent effectively to the United States on very favorable terms — now gets absorbed in their own shift to consumer-led economies. And if China isn’t there to buy the Treasuries and surpluses we need to grow, and we are unwilling or unable to boost our own savings, how are we going to grow? That’s a question that we need to address in looking to our own growth strategy in the United States.
Kristen Doerer: Are we afraid that China is going to dump U.S. bonds and drive up our interest rates, as we have to offer more attractive returns to lenders to get them to buy our bonds?
Stephen Roach: No, we’re not afraid of this at all, and we probably should be. Not that they’re going to sell huge positions in U.S. Treasuries, but we just can’t take for granted that China will always be there to be a predictable and important source of buying Treasuries in our savings-short, deficit-prone economy. And the only way that China will begin to unload these Treasuries is if we get overly aggressive and put a tax on, say, Chinese goods that continue to play a part in fueling our imports.
There’s one candidate, who shall remain nameless, who has made the brilliant proposal of putting a 45 percent tariff on all Chinese products in the U.S. I mean that’s absolutely ludicrous. If we do that, you could expect China to unload Treasuries as a quick quid pro quo. We’ll see how that makes America great again, but I don’t want to name any names.
We have to recognize the relationship between the United States and China is very important, but that it’s a two-way relationship. We depend on them, and they depend on us. And when one partner in a codependent relationship changes in human terms, it has significant implications for the other, and that’s true in economic terms as well.
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Kristen Doerer: MIT economist Yasheng Huang warned the NewsHour audience about an over-construction bubble about a decade ago. Is that over-construction bubble finally catching up with the Chinese economy?
Stephen Roach: Well, there’s been a huge amount of discussion about ghost cities and high investment, and I think some of the concerns are legitimate, but the broad thrust of the critique is overblown. China is committed to urbanization and rural-urban migration is a central building block of its development strategy, and there is a high-investment requirement associated with that commitment. And there have been some mistakes along the way in terms of too rapid a pace of construction and some projects with low economic returns, but in large part, given the urbanization prospects in the future, I think China is going to have to continue to run a much higher investment to GDP ratio than most are willing to concede. And look, the economics are very clear, Kristen. Investment is a means to an end, and the ultimate driver of economic activity is rapid productivity growth, and you need an increasing stock of fixed capital relative to labor to continue to boost productivity growth. China’s stock of productive capital relative to labor is still very, very low. It’s still about 13 to 15 percent of that in the United States and Japan. And so by focusing on the flow, which is investment to GDP, you’re overlooking the fact that the stock of capital is still too low and needs to rise significantly in the years ahead.
Kristen Doerer: I keep hearing about the ghost cities, and I’m curious to what degree that is an exaggeration? To what degree is that going on in China right now?
Stephen Roach: It is an exaggeration. There are development projects that have been built on the basis of speculation, but they’ve been exaggerated in terms of scope and the incidences of these problems. China moves between 15 and 20 million people a year from the countryside to the cities. They are going to be doing that from now until 2025 or 2030. They don’t do urbanization the way the India does, bringing people into cities and not building shelter, roads, bridges, highways and infrastructure. China builds in anticipation of that. So a lot of the urban developments — whether it’s residential complexes and office complexes or empty airports, roads and bridges — are aimed at providing the urban foundations for what’s going to be another 250 to 300 million people moving into these cities over the next 10 to 15 years. Some of it has gotten well ahead of the rate of absorption of this capacity by the likely rural-urban migration over the next few years, but I think over time, you’ll see an awful lot of this turn out to be very much in line with the rural-urban migration trajectory that I just traced out.
Kristen Doerer: So most of these ghost cities are going to be filled soon?
Stephen Roach: That may be a bit of a stretch. They will eventually be filled. The first ghost city I saw was Shanghai Pudong in the mid-1990s and people made the same point about Shanghai Pudong. Now it’s fully occupied with 5 and a half million people. And there’s one that everybody has popularizes, that’s Ordos in inner Mongolia, and it is a ghost city. But even there, it’s in an area that is rich in energy resources, and eventually, it will be more popular than it is today. But has development gotten ahead of itself? Absolutely.
Kristen Doerer: Is a long-term Chinese bust now in progress?
Stephen Roach: No, it’s not. The fixation is on headline GDP. The 30-year trend was 10 percent, the latest number was 6.9 percent or 6.8 percent if you want to look at a quarter-to-quarter basis. There are those that tell you that the number is a third of that, and somehow they know more than the Chinese statisticians do. I would dismiss that.
But if you take the numbers literally, there’s been a material slowing of the growth rate, and the crash landing means that there has to be further repeated cumulative decline in this growth rate down to a low single digit or even negative territory. I think that is an exaggeration. The story of China is not the slowing of top-line GDP, but the shift in the mix of GDP from manufacturing to services, from investment and exports to consumption. And there is really excellent progress on the first count, on the manufacturing to services, where the service share is now over 50 percent of the GDP, 10 points higher than the share going to manufacturing and construction combined. The second piece of this — the shift to consumption — is glacial, and there’s very little progress thus far, but I think there will be significant progress over the next 3 to 5 years.
Kristen Doerer: Why do you think that will work out and that the shift to consumption will increase?
Stephen Roach: They have a strategy with three key building blocks that are now being put in place. One, more job creation, and that’s what you get from services, which are far more labor intensive in China than the old manufacturing sector. Two, higher real wages, and that comes from rural-urban migration. Urban workers earn about three times their counterparts in the countryside. The combination of those two factors, services-led job creation and urbanization with increases in real wages, gives Chinese families an increasing share of personal income as a portion of GDP. And that gets you to the third building block, which is putting in place a social safety net, which encourages families to spend their income, rather than save it out of fear of an uncertain future. So far, that’s been the major fly in the ointment, the disappointment here.
The savings rate for urban families — currently around 30 percent — is high and still rising. But I think the government recognizes the need to provide more incentives for families to convert that saving and that precautionary, peer-driven savings into discretionary consumption. They have enacted reforms — which were actually reinforced by a big meeting in late October of 2015 — to provide a more secure safety net in terms of retirement, health care, the funding of those plans through taxes on state-owned enterprises and further liberalization of interest rates to provide more interest income to augment the labor income. They’ve made benefits more portable now, so they now depend on where you work, not where you were born, and this deals with this sort of antiquated household registration system, which limited the portability of benefits.
And finally, they’ve addressed an issue they’ve needed to address for decades that has really exacerbated the fear of the future, and this is the one-child family planning policy, which really puts huge pressure on the young working age population to fund the retirement security of their parents and their grandparents. And so by relaxing family planning controls, that addresses it. So these are all important developments in terms of buttressing the social safety net, that I think ultimately, but not immediately, will give Chinese families the confidence to begin stepping out as consumers rather than savers.
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Kristen Doerer: China’s government said that it grew by 6.9 percent last year. You had touched upon this before, but do you believe the official numbers? And if not, how far off are they?
Stephen Roach: Well, I don’t believe the numbers to a tenth of a decimal point for any economy in the world. I’ve written for years about the inaccuracies of U.S. economic statistics. I think that China has comparable problems in majoring its economy with accuracy, but not for reasons that most would lead you to believe, because it’s a conspiracy on the part of a bunch of communists that are trying to pull wool over our eyes or whatever. It’s very difficult for them, it’s very difficult for us to measure the pace of economic activity in a system where the structure is changing as rapidly as it is in China. Services are notoriously hard to measure, and that’s true in the United States, and that’s true in China. Shifting to this hard to measure service sector is a big challenge for government statisticians all over the world.
The World Bank and economists from the Federal Reserve Bank of San Francisco sort of conclude that there is standard error around the growth rate of about 1 percentage point in either direction in terms of GDP. And I think that that’s a fairly reasonable guess as to how far the numbers are off. The important thing to note is that the numbers, as flawed as they may be, are doing a good job of capturing this big shift from this slower growth in the Chinese economy and a shift in the mix again from manufacturing to services, from investment and exports to consumption, and I think that we have to look at the numbers with that in mind. They’re giving you a good approximation of the big stories that are emerging right now in China.
Kristen Doerer: So you would say that it’s probably off by 1 percent up or down?
Stephen Roach: I say that based on the research that has been done by the World Bank and the San Francisco Fed.
Kristen Doerer: Is there anything else that you think the NewsHour audience should know about?
Stephen Roach: There’s one thing I wrote about the other week on the Financial Times. All eyes are on plunging oil prices, and the standard explanation is that it’s about supply — the Saudis aren’t cutting back and America is now the swing producer for fracking. There’s just a glut of supply on the market.
I think there’s more to it than that, and China’s playing a very important role on the demand side of the equation. In the 10 years ending in 2014, China — even though it’s hugely dependent on coal as its major source of fuel — accounted for 48 percent of the total growth in the world oil demand in physical terms. Forty-eight percent. China is now growing more slowly and shifting to low carbon services, so this huge source of demand for global oil is about to unwind or has started to unwind. And I think that that underscores the role that China is playing and will continue to play on the downside of the oil price cycle, and the same logic and argument is true for other industrial commodities including base metals.