austro-chinese

China estimate of the day — the return of Austro-Chinese business cycle theory

“Ghost cities” lined with empty apartment blocks, abandoned highways and mothballed steel mills sprawl across China’s landscape – the outcome of government stimulus measures and hyperactive construction that have generated $6.8tn in wasted investment since 2009, according to a report by government researchers.

In 2009 and 2013 alone, “ineffective investment” came to nearly half the total invested in the Chinese economy in those years, according to research by Xu Ce of the National Development and Reform Commission, the state planning agency, and Wang Yuan from the Academy of Macroeconomic Research, a former arm of the NDRC.

…The bulk of wasted investment went directly into industries such as steel and automobile production that received the most support from the government following the 2008 global crisis, according to the report.

Mr Xu and Ms Wang said ultra-loose monetary policy, little or no oversight over government investment plans and distorted incentive structures for officials were largely to blame for the waste.

Don’t forget this part:

Misallocation of capital and poor investment decisions are not the only explanation for the enormous waste in China’s economy. A significant portion of China’s post-crisis stimulus binge was simply stolen by Communist Party officials with direct responsibility for boosting growth through investment, according to separate estimates by Chinese and overseas economists.

There is more here, from the excellent Jamil Anderlini.  As Arnold Kling would say, 祝你今天愉快…

Addendum: Here is a criticism of how that estimate was made.

Zhang Weiying on Austro-Chinese business cycle theory

Chinese officials no longer treat Mr. Zhang as a pariah. He reports that Ministry of Agriculture officials tell him they enjoy reading his articles. Other ministries and local governments, including in Henan and Liaoning provinces, invite him to speak. He says that when he recently wrote an article praising the late Austrian economist Murray Rothbard, the Communist Party secretary of Shanghai—a fairly high-level apparatchik—told him he liked it.

Here is much more, and for the pointer I thank Mark Skousen.

To the point (Austro-Chinese business cycle theory)

“There is persuasive evidence to conclude that the Chinese economy is actually growing at just 4 or 5 per cent right now based on a composite of other indicators,” says Patrick Chovanec, a business professor at Tsinghua University in Beijing.

“Of China’s 9.2 per cent GDP growth in 2011, 5 percentage points came from investment which means that if China builds just as many roads, bridges, condos and villas as it built last year and no more it will knock five points of this year’s GDP growth. Growth is dependent on ever-rising levels of investment in an environment where that investment is not creating adequate returns.”

That is from the FT.  Does this paragraph reassure you?:

Officials and state media reports have suggested local governments will be able to compensate for slumping exports and real estate construction by embarking on a new infrastructure building binge.

The ongoing development of the Austro-Chinese business cycle

That’s not the only title I could have given this post, here goes:

Beijing’s suburban Miyun County is going to build a large European-style town within five years and no one will be allowed to speak Chinese there, said the county mayor.

Wang Haichen said a local village would be turned into a 67-hectare English castle with 16 courtyards of unique houses. It will offer visitors souvenir passports and ban Chinese speaking to create the illusion of being abroad, Beijing News reported today.

So far 4.5 million yuan (US$708,300) has been invested to transform 16 peasant courtyards in Caijiawa Village into English-style dwellings. Wang told the newspaper that each of the 16 peasant households had received 30,000 yuan of government subsidy.

The county mayor insisted that one courtyard had been turned into a boutique hotel. “We built a laundry center to supply clean bed linens to the 16 households free of charge,” Wang said. “We are considering to offer them bicycles and electric bikes next year.”

The article is here, and for the pointer I thank M Kaan.  I predict it will end badly!

Update on the Austro-Chinese business cycle

Someone is sitting on a mound of $3.2 trillion in foreign exchange reserves, and yet this is possible:

With the same force that powered the most ambitious rail programme in history, China has slammed the brakes on its investment in high-speed trains.

The sudden halt has led to system-wide whiplash, leaving workers without pay, battalions of heavy machinery sitting idle and setting back plans for bullet trains that were meant to carry the nation’s future.

Spending had already been slowing after a surge from stimulus money in 2009 but the decline since the Wenzhou crash in July has been precipitous. In year-to-date terms, investment in railways and transport had been up 7 per cent in the first half of 2011. By the end of September it was down 19 per cent, according to official data.

There is little chance of a return to the construction frenzy of the past five years but the government appears to be slowly setting the high-speed rail plans back in motion. Restarting the investment would provide an immediate boost to the weakening economy. Longer term, it is also expected to encourage a big structural shift, opening up China’s interior to make domestic growth more self-sustaining.

But this is less encouraging:

Passenger numbers have fallen sharply since the Wenzhou crash. About 151 million trips were made on Chinese trains in September, almost 30 million fewer than in July, according to ministry data.

An outline of Austro-Chinese business cycle theory

From Martin Wolf:

Investment has indeed grown far faster than GDP. From 2000 to 2010, growth of gross fixed investment averaged 13.3 per cent, while growth of private consumption averaged 7.8 per cent. Over the same period the share of private consumption in GDP collapsed from 46 per cent to a mere 34 per cent, while the share of fixed investment rose from 34 per cent to 46 per cent.

Professor Pettis argues that suppression of wages, huge expansions of cheap credit and a repressed exchange rate were all ways of transferring incomes from households to business and so from consumption to investment. Dwight Perkins of Harvard argued at the China Development Forum that the “incremental capital output ratio” – the amount of capital needed for an extra unit of GDP – rose from 3.7 to one in the 1990s to 4.25 to one in the 2000s. This also suggests that returns have been falling at the margin.If this pattern of growth is to reverse, as the government wishes, the growth of investment must fall well below that of GDP. This is what happened in Japan in the 1990s, with dire results.

Nouriel Roubini on Austro-Chinese business cycle theory

At Project Syndicate, he writes:

When net exports collapsed in 2008-2009 from 11% of GDP to 5%, China’s leader reacted by further increasing the fixed-investment share of GDP from 42% to 47%.

Thus, China did not suffer a severe recession – as occurred in Japan, Germany, and elsewhere in emerging Asia in 2009 – only because fixed investment exploded. And the fixed-investment share of GDP has increased further in 2010-2011, to almost 50%.

The problem, of course, is that no country can be productive enough to reinvest 50% of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.

Commercial and high-end residential investment has been excessive, automobile capacity has outstripped even the recent surge in sales, and overcapacity in steel, cement, and other manufacturing sectors is increasing further. In the short run, the investment boom will fuel inflation, owing to the highly resource-intensive character of growth. But overcapacity will lead inevitably to serious deflationary pressures, starting with the manufacturing and real-estate sectors.

Eventually, most likely after 2013, China will suffer a hard landing. All historical episodes of excessive investment – including East Asia in the 1990’s – have ended with a financial crisis and/or a long period of slow growth.

Do read the whole thing.

Update on Austro-Chinese business cycle theory

Here is David Ignatius:

My favorite analyst of bubble economies is David M. Smick, who predicted the U.S. financial mess in his book "The World Is Curved." He notes some worrying statistics: Until the global financial crisis, Chinese exports represented 43 percent of its gross domestic product. To make up for collapsing foreign demand once the recession hit in 2009, China launched a $1.8 trillion stimulus and lending program — amounting to about 38 percent of its GDP. This money was supposed to reach consumers, but Smick estimates that 85 percent of the subsidized loans went to state-run companies and banks — pumping the investment bubble even larger.

Here is from the FT:

Prices of commercial and residential property in China’s 70 largest cities rose by 10.7 per cent in February from the same period a year earlier, a marked increase from the 9.5 per cent year-on-year gain in January, according to China’s statistics bureau.

I believe that in a time when the U.S. fiscal stimulus is under political fire, many American economists have been reluctant to criticize the Chinese program and send a potentially mixed message. 

On a separate but related note, here is a piece on forthcoming rural migration in China.

The Washington Post on Austro-Chinese business cycle theory

For investors, many of the usual bubble warning signs are flashing. Fueled by low interest rates, prices in Shanghai and Beijing doubled in less than four years, then doubled again. Most Chinese home buyers expect that today's high prices will climb even higher tomorrow, so they are stretching to pay prices at the edge of their means or beyond. Brokers say it is common for buyers to falsely inflate income statements for bank loans.

…The Xinhua news agency quoted Goldman Sachs as saying that housing price increases had outpaced wage hikes by 30 percent in Shanghai and 80 percent in Beijing in recent years.

A popular television soap opera known as "Snail House" depicts two sisters' desperate struggle to buy an ever more unaffordable home. One sister resorts to becoming the mistress of a corrupt, married official to get money for an apartment.

Here is much more.

Yet more evidence for Austro-Chinese business cycle theory

Zhao says Wang charges up to $30,000 per breeding session with Obama.

The full story is here.  Get this bit:

Last month, a Nanjing breeder paid $234,000 for his purebred pooch, reported the Yangtze Evening Times. In September, a young woman in Xian paid $600,000 for her pet, according to the Xian Evening News. Both led airport welcomes with long convoys of pricey automobiles.

For the pointer I thank Daniel Lippman.

My NYT column on Austro-Chinese business cycle theory

The column is here and one excerpt is this:

China uses American spending power to enlarge its private sector, while America uses Chinese lending power to expand its public sector.

A longer excerpt is this:

China has been building factories and production capacity in virtually every sector of its economy, but it’s not clear that the latest round of investments will be profitable anytime soon. Automobiles, steel, semiconductors, cement, aluminum and real estate all show signs of too much capacity. In Shanghai, the central business district appears to have high vacancy rates, yet building continues.

Chinese planners now talk of the need to restrict investment in sectors that are overflowing with unsold products. The global market is no longer strong, and domestic demand was never enough in the first place.

Regional officials have an incentive to prop up local enterprises and production statistics, even if that means supporting projects or accounting practices that are not sustainable. For an individual business, the standard way to get more capital resources is to put forward a plan for growth. Because few sectors are mature, and growth has been so widespread, everyone can promise to be profitable in the future.

Over all, there is a lack of transparency. China’s statistics on its gross domestic product are based more on recorded production activity than on what is actually sold. Chinese fiscal and credit policies are geared toward jobs and political stability, and thus the authorities shy away from revealing which projects are most troubled or should be canceled.

Put all of this together and there is a very real possibility of trouble.

I then outline how the negative scenario might run and that involves deflation on the goods side, for both China and the U.S., and higher U.S. borrowing costs on the capital side.  A few related points:

1. The word "malinvestment" does not appear in The New York Times style guide but it survived to the final published draft of the piece.

2. Scott Sumner offers a skeptical take on my claims.

3. The piece cites Malthus in the same breath as Hayek.  Malthus is a much-underappreciated economist and in macroeconomics he was much better than the naive overproduction theorists.  His cyclical story is ultimately about proportionality and it is based on a "tragedy of the commons" effect — for the production of capital goods — which is not so different than his population mechanism.  Malthus, by the way, had quite a modern understanding of supply and demand, well before the marginalist revolution.

4. I still am not convinced that we have avoided a new version of "the vertigo years," based on a fundamental discombobulation of economic expectations.  This is probably just historical coincidence, but the Great Depression did come last to China.

If I believed in Austro-Chinese business cycle theory

Most of China's growth this year has been unsustainable, driven by stimulus. China's money supply has risen 29% in the past year. At the government's behest, banks have increased their lending by nearly $1.4 trillion, or 32%, during that time.

That flood of borrowed cash has been channeled into new infrastructure and production capacity. These investments will account for up to half of China's gross domestic product this year, according to some estimates.

A key question is whether China needs all of this investment. Analysts at the London hedge fund Pivot Capital Management say that China already has enough idle steel-production capacity, for example, to match the steel output of Japan and South Korea combined.

Meanwhile, the ratio of investment to GDP is rising, suggesting China's investment is less and less efficient, says Edward Chancellor at Boston asset-management firm GMO.

The combination of soaring investment and dwindling returns was seen in Japan in its asset bubbles in the 1980s and in the "Asian Tigers" just before their crises in the late 1990s, he says.

The link is here.  Does anyone know how to say "excess capacity" in Chinese?  Even more importantly, can you get it past the typepad spam blocker?

Notes from Changsha, Hunan province

Changsha is the ugliest and most ungainly Chinese city I have seen, which is saying something.  Nonetheless for a food pilgrimage it is a serious rival for #1 spot in the world, perhaps surpassing Chengdu for the quality and novelty of its dishes.  Very little effort is required to do well, and some of my best courses I had at the Hunan restaurant in the Sheraton, also the only time I saw an English-language menu.

Even at major hotels, hardly anyone speaks passable English, much less good English.  But you can find many hanging portraits of Chairman Mao, who converted to communism in this city.

Carry an iPad, so you can look up and communicate the Chinese characters for “eggplant with orange chilies on top.”

There were plans to erect the world’s tallest building, and ground was broken, but the foundations were not extended and they have since been repurposed as a fish farm, hail Friedrich Hayek.

When they set their minds to it, they can build towers at the rate of three stories a day.

Changsha

The marginal value of entering a park here is high, as I stumbled upon card games, group exercise sessions, dance clubs, and performances of traditional music, all at higher rates than in most other Chinese cities I have visited.  At the entrance to one I read on the sign: “Don’t sneeze into the face of others,” and also I was ordered to reject “feudal superstitious practices.”

The people seem…different.  I feel the cab drivers often are on the verge of cackling, except when they are cackling.  Then the verge disappears.  The word “rollicking” frequently comes to mind, which of course is a sign you would not want to be governed by this province.

Kind of like New York.

China’s third interest rate cut and how to think about it

On Sunday the Chinese central bank cut interest rates for the third time since November.  I have read a number of pieces on this move, but overall am a little disquieted at how quickly people are comparing China to the Keynesian vision of the United States or for that matter Japan.  I would stress a few points:

1. Many of China’s municipal governments are broke or close to broke, and in the meantime too heavily dependent on land sales and land leases for revenue.  Lower rates are intended to help them refinance themselves.  That is not opposed to a Keynesian or AD framework, but it is distinct from it.

2. The Chinese government is at the same time relaxing controls over deposit interest rates, so some interest rates in the economy will be going up.  In other words, part of the problem is figuring out the optimal speed for removing financial repression, and in the process allowing to “shadow banking bubble” to deflate at an appropriate speed, all the while trying to keep deposits in the formal banking system.

2b. A lot of borrowers are paying effective nominal rates of six to seven percent — don’t you wish we had a better understanding of the true rate of price inflation in China?  One policy goal is to get more loans to these businesses, but there the very real jawboning of the Chinese government may prove more effective than the interest rate cuts.  But should those businesses get more loans?

3. In an Austro-Chinese, excess capacity model of the business cycle, there is a gain and a loss from cutting interest rates when an economy is well into the over-expansion phase.  The gain is that you may mitigate the costs of the “secondary deflation,” as the Austrians call it.  The cost is that you may overextend the excess capacity even further.  That is a call the central bank must make, noting that the excess capacity model applies only with some probability.

4. “China’s imports also plunged 16.2 percent in April from a year earlier, a fall that economists attributed partly to low commodity prices and partly to weak demand within China’s economy.”  I doubt if they are growing at a true seven percent, or even a “slightly below seven percent” figure.

5. For well over thirty years, the Chinese economy has lived in a world where both the AD and AS curves swing rather wildly (in a good way) outwards and to the right.  Some of this is driven by migration to the cities, some of it is driven by trickle-down growth and the adoption of foreign technologies.  Some of it may be driven by China’s own TFP, and for sure some of it is driven by policy reform.  In any case, as long as that process continues, China is semi-immune to the standard Keynesian dilemmas — who needs to lower nominal wages when worker productivity and customer demand are rising so quickly?  But does that ongoing outward real expansion it render them immune to Austro-Chinese business cycle theory as well?  Sadly, Hayek never seems to have considered that problem, but it’s very much on my mind out here in Shaanxi.

Trends and cycles in China’s macroeconomy

That is the NBER paper by Chang, Chen, Waggoner, and Zha, pdf here.  Here is the abstract:

We make three contributions in this paper. First, we provide a core of macroeconomic time series usable for systematic research on China. Second, we document, through various empirical methods, the robust findings about striking patterns of trend and cycle. Third, we build a theoretical model that accounts for these facts. The model’s mechanism and assumptions are corroborated by institutional details, disaggregated data, and banking time series, all of which are distinctive of Chinese characteristics. The departure of our theoretical model from standard ones off ers a constructive framework for studying China’s macroeconomy.
Not a very illuminating abstract, but I thought this was an important piece.  There is now real and apparently reliable time series information for China!   And with the accompanying model, the authors find there is low consumption growth and overcapacity of heavy industry with rising debt risks, both problems stemming from the preferential credit access given to large Chinese firms.  That is hardly news, but it is nice to see it confirmed and measured, I call that Austro-Chinese business cycle theory
I’ll again be live-blogging the presentation and discussion once it is up and running, in the MR comments section to this post, feel free to add your own comments.
  • 1
  • 2