Is China the new Brazil?

by on June 3, 2013 at 7:07 am in Economics, Uncategorized | Permalink

The biggest external risk concerns China. Its real exchange rate has become overvalued. It is heavily exposed to developed world countries ratcheting down their real exchange rates. Since abandoning the fixed 8.28 yuan/dollar rate in 2005, China’s unit labour costs have been rising at 7 per cent a year, and its currency by 4 per cent, for a combined annual 11 per cent in dollars.

Overvaluation became a serious problem in 2011. Producer price inflation (PPI) of 7 per cent then matched unit labour costs (in yuan), but crumpled into 2-3 per cent producer price deflation over the past couple of years. April’s 2.6 per cent deflation has intensified from 1.6 per cent in February. Chinese businesses have to slash prices to keep a grip on their export markets. But unit labour costs are still rising at a 5 per cent rate, squeezing profit margins, and are up 20 per cent relative to the export competition since 2011.

Adding to this problem is the sudden, related, swing into high real interest rates. In mid-2011, the one-year lending rate from state-owned banks was 6.6 per cent, which combined with 7 per cent PPI to give a slightly negative real rate. But a flight of depositors from China’s banks has kept nominal interest rates high. The nominal interest rate is only down to 6 per cent now, but combined with PPI deflation, the real interest rate is close to 9 per cent. Such high real interest rates combined with squeezed profit margins have pushed China into a prolonged “investment-led” slowdown.

That is from Charles Dumas, here is more.  Dumas also notes that China is especially heavily invested in assets which are interest-rate sensitive in value.

1 8 June 3, 2013 at 9:12 am

It’s not “overvaluation.” What happened in 2010 is that the entry level workforce peaked. The supply of 18-year olds began declining, and entry level wages needed to rise in order to attract factory workers.

I don’t see how anyone knows what the yuan is worth. Supposedly it was undervalued when they were inflating like mad at the 8.28 to 1 peg, which was the target value of the yuan if they held the peg. Instead, they started raising the value artificially and shut down the market when the yuan was going to plunge in 2008. Then they inflated like mad from 2009-2011, yet the currency started moving higher again.

So what was the yuan worth in say, 2004, was it 5 to 1? The real value of the yuan has been collapsing steadily through inflation, yet the market value has been rising because they started from such a low point.

2 Peter Schaeffer June 3, 2013 at 1:34 pm

8,

China still has a vast (truly vast) rural population that has yet to urbanize. Substantive labor shortages are decades away. China’s economic growth has a long way to go.

3 8 June 4, 2013 at 2:47 am

Factories in the Pearl River Delta began importing illegal immigrants or moving to Bangladesh right around the time that the population of young females began declining. It doesn’t imply an end to growth, it implies that wages are going to have to rise and that the rise is due to demographics, not the currency.

4 Peter Schaeffer June 3, 2013 at 1:33 pm

To limit the comparison of Brazil and China to exchange rates shows a profound ignorance of the many factors that drive economic growth. To be blunt, China exceeds Brazil in all of the metrics that make a nation successful. The short list clearly includes family stability, education, saving, homogeneity, work ethic, and entrepreneurship. Compare each of the measures and China is far ahead of Brazil. It didn’t matter much as long as China was in the throes of Mao’s madness. After Deng took over, it mattered (and still matters a lot).

Let’s use a few numbers. Since 2000, China’s economy has grown by 245%. Brazil’s economy has grown by 52%. Since 1990, China’s economy has grown by 830%. Brazil’s economy has grown by 94.7%.

China is just the last East Asian ‘Tiger’ to make its way from agrarian poverty to industrial prosperity. Every successful nation in Asia has over a period of decades converged on 70% U.S. per-capita GDP (roughly). Why would anyone expect China not to do at least as well? Note that the greatest East Asian success story before China was Japan. Japan has never been accused of having an overly entrepreneurial corporate culture which shows that not all of the six success factors are mandatory.

Of course, with 1.2 billion people, China’s success is world shaking. The same wasn’t true for Taiwan, Hong Kong, South Korea, etc.

The bottom line is that people matter. They matter a lot in spite of the ‘blank-slate’ worldview that dominates much of economics and society.

5 Mike H June 3, 2013 at 2:11 pm

“The short list clearly includes family stability, education, saving, homogeneity, work ethic, and entrepreneurship.”

How about the rule of law and property rights? Don’t you think the lack of these crucial components will make China’s case much different from Japan,Taiwan, Hong Kong and South Korea?

“The bottom line is that people matter. They matter a lot in spite of the ‘blank-slate’ worldview that dominates much of economics and society.”

So Brazil will succeed if all Brazilians are replaced by the hard working, family-oriented, educated Chinese immigrant-type? I am trying to make sense of what you are suggesting here. How do you explain the success of Malays and other minorities in Singapore that thrived under its economic institution?

6 Peter Schaeffer June 3, 2013 at 3:16 pm

@Mike H,

“How about the rule of law and property rights?”

As an American, I am naturally enamored of the ‘rule of law and property rights’. However, the empirical side of me isn’t so sure. The lack of those things hasn’t impeded China’s development so far. Conversely, the relationship between the government of South Korea and the business community has been tumultuous (see “The Park Chung Hee Era: The Transformation of South Korea”) with no apparent adverse effect on growth.

Yes, Asian immigrants are quite successful in Brazil (that said, I have been to the Japanese neighborhood in Sao Paulo and it wasn’t impressive)

As for Malaysia vs. Singapore… Malaysia’s per-capita PPP GDP is $17,775. Singapore is $61,567. Note that Singapore’s GDP notably exceeds its GNP (like Ireland) so the actual income delta isn’t as large as it first appears.

7 Mike H June 3, 2013 at 9:06 pm

“The lack of those things hasn’t impeded China’s development so far. ”

They are the reasons why China is now having all the problems with urbanization, political corruptions, big and inefficient state-owned enterprises, copyrights infringement, labor unrest etc. Taiwan and South Korea had the same problems during 1980s to1990s but the rule of law and property rights helped their economics transformed and finally getting democratized. China on the other hand is only going to get worse.

“As for Malaysia vs. Singapore…”

But I wasn’t asking about Malaysia vs. Singapore. The ethnic Malays and other Southeast Asian minorities in Singapore have been doing a lot better than their countrymen back home. That goes to show the problem is not race or even culture, it is about institution. To say Brazil didn’t succeed because Brazilians are lazy or not as entrepreneurial as the Chinese is to ignore the deep-rooted problem that plagued Brazil’s political/economic institution (i.e. socialism).

8 Peter Schaeffer June 4, 2013 at 12:46 am

@Mike H,

“problems with urbanization, political corruptions, big and inefficient state-owned enterprises, copyrights infringement, labor unrest etc.”

Perhaps those factors will slow China at some point in the future. Too soon to tell is all we can say so far.

“The ethnic Malays and other Southeast Asian minorities in Singapore have been doing a lot better than their countrymen back home.”

Of course, an Indonesian taxi driver earns more in Singapore than in Jakarta (doing the same job with the same skills, tools, etc). Waiting tables pays better in Paris than in Senegal. Place makes a difference. That doesn’t make the taxi driver in Singapore or waiter in Paris more successful, just a lot luckier.

That leads back to why Singapore is so much more successful than its neighbors. Do institutions matter? Of course, Mao crippled China for decades (and in some ways helped China as well, to be fair). However, institutions are not exogenous. Brazil’s institutions were not imposed by a foreign army. Brazil has the institutions it chooses. So does Singapore for that matter.

While institutions certainly matter, they are not the be-all and end-all of ‘what matters’. People have been writing about China and the Chinese for a long time. Overseas Chinese communities have existed for hundreds of years in some cases. They have tended to be highly successful across a wide range of societies with quite varied institutions. The emphasis on education, hard work, family life, entrepreneurship, saving, etc. have been frequently noted.

9 spandrell June 4, 2013 at 12:47 am

Malays in Singapore of course benefit from having Singaporean judges and policemen. But how well are they doing anyway? No way as well as Chinese Singaporeans.

Where are all those biotech firms headed by Singaporean Malay entrepreneurs? How many top-scientists? Judges? Bankers?

Strong institutions only take you so far.

10 Mike H June 4, 2013 at 5:32 am

“Overseas Chinese communities have existed for hundreds of years in some cases. They have tended to be highly successful across a wide range of societies with quite varied institutions. The emphasis on education, hard work, family life, entrepreneurship, saving, etc. have been frequently noted.”

Fair enough. But that doesn’t mean Brazilians can’t catch up with the Chinese if they are willing to try something radical (and politically incorrect), like what happened in Chile under Pinochet for example. I would believe a radical change in institution like that can make up for their lack of entrepreneurial culture and put the country back on the right track within a generation or two. But I agree with you, that’s never going to happen with their political culture stays the way it is.

11 Peter Schaeffer June 4, 2013 at 7:29 pm

@Mike H,

One more note on Malays and Chinese. One very (very) famous Malay, Mahathir Mohamad, certainly viewed Malays as less hard working and less education oriented than the Chinese. Indeed, he wrote a book about it, “The Malay Dilemma”. Both Malaysia and Singapore have large Chinese / Malay populations living under the same institutions. The Chinese are notably more successful at least in terms of education and making money. Conversely, it’s easily arguable that the Malays have better family life than the Chinese.

12 mw June 3, 2013 at 8:35 pm

And how about energy? How do you rate Brazil’s medium-term from massive hydro power compared to China’s coal-ravaged air and water putting hundreds of thousands of their citizens in their graves a year? I understand this doesn’t hit the headline economic numbers so we pretend the issue doesn’t exist, but it really does.

13 Peter Schaeffer June 4, 2013 at 12:10 am

mw,

China has big environmental problems no doubt. Enough to impact growth? Not so far at least. It’s worth noting that China has a larger hydro sector than Brazil (60% bigger). Of course, China’s hydro sector provides a much smaller fraction of the total energy consumed in China (6%) vs. the hydro sector in Brazil (36%).

The converse point is that Brazil is much more oil dependent (44%) than China (16.75%). Brazil produces quite a bit of oil of late but is still a net importer. China produces more oil than Brazil but is also a much larger importer.

14 mulp June 3, 2013 at 2:11 pm

“China is especially heavily invested in assets which are interest-rate sensitive in value.”

The value of roads and bridges, railroads, ports change in value based on interest rates?

If interest rates go up, the value of moving a ton of goods over roads, bridges, rail, and out a port goes down, or up?

15 David June 8, 2013 at 4:03 am

China does indeed have a truly vast rural population yet to urbanise, the trouble is whether they will want to. Life in the major cities is so expensive for your average labourer here. Additionally they don’t have rights to schools or health care as this is reserved for people born and raised in the urban areas. Instead in places like Shenzhen they have places called handshake villages which are essentially the favelas of the big cities. These exist because it’s the only real estate that the rual population can realistically afford, however the government still owns the land and could kick people off whenever it chooses. The Chinese gov have a few major issues to tackle in the foreseeable future. The big ones I think are how to sustain the export lead economy for a good couple of years yet while they try and change the economy to a consumer based one, the major problem for China here is that Chinese people don’t trust local products and so will want to buy foreign stuff where they can as shown by the recent attempt of the main Chinese Pork Producer to buy a major American producer.
Additionally as the people become richer they are going to want more of a say in how the country moves forward, which spells trouble I believe for the communist party. How do you empower people and lift them from abject poverty and still try and retain control of the banking sector, construction and the entire political landscape.
The quandary is to maintain exports, make urban areas more attractive if they wish to continue this rural to urban migration.
There is also the issue of Africa where a number of prominent commentators are now beginning to question Chinese intentions in their countries. For example investment in Zambia has been huge with the promise for China to have access to the copper reserves which are huge. The problem is that China then built the largest copper mine in Zambia on the belt and promptly imported their own workforce. There is a growing discontent with Africans on the ground against the Chinese due to numerous instances like this. In my own Zimbabwe people are not happy at all, but Mugabe and his merry men are currently enjoying getting FDI and something resembling a stable economy.

A bit garbled but hopefully you understand the points I am making……

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