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.


A hard landing, I would agree. The real question, in my opinion, is can China eventually (within a decade) grow into this overcapacity, or will things like the highways to nowhere simply deteriorate to the point of uselessness. It is one thing to over-invest and then later to find productive uses for that installed capital- it is another to have wasted it entirely.

Why is this Austro per your headline. This is bubble economics.

As to Roubini's economics, I think Roubini would laugh and would disassociate with the Austrian school. He has been described as a neo-Keynesian. He is also a former Clinton Treasury advisor who said: " Another intellectual hero [of mine] is Larry Summers, the former President of Harvard, an amazing intellectual and academic, who is very deeply involved with the policy world. I worked for him for many years in the US Treasury during the Clinton Administration".[9] See Wiki link.

This is just economics.

The Austro is there because the description Roubini offered is textbook Austrian malinvestment. It matters not one whit what Roubini would call himself with regard to this article. I am sure Tyler was having a bit of fun for exactly that.

Every business cycle can be described as malinvestment.
Every economist, including private economists, makes mistakes. Even Austrians.
Therefore, every poor investment made by an economists or business person is an Austrian experiment.
Or, is it that economists--public or private (who invest in housing, or tech, or precious metals)--don't know a thing.
Regardless of country of origin.
The world is complex. Unexplained by an equation.
Even if we think it is.

I would like to see the Austrian theory rebutted with logic. To date, I have not seen it and boy do I search. Do you have any links to suggest? I would love to see Tyler explain why he isn't an Austrian anymore... I have looked at all ex Austrians and they are never clear about the reasons they quit. I suspect it is because once you understand the Austrian theory you realise there really isn't much useful role as an economist any longer and rather than accept your career is over, you try to find subtleties to dwell on, eg. Hansons obsession over signalling or will we all download ourselves in the end... interesting but moer for a single magazine article than an academic.

Read some behavioural economics to explain bubbles. When there exist alternative explanations, or multiple explanations for the same phenomena, sticking to one because it hasn't been refuted in your own mind simply means you haven't refuted others. And, if you say "once you understand the Austrian theory you realise there really isn’t much useful role as an economist", implying that logic does not have a role in explaining phenomena, then you can understand why, in your own mind, it would be difficult, in your own words, "to see the Austrian theory rebutted with logic."

The best refutation I've seen was by MIT economic historian Kindleberger in the opening chapters of Mania, Panics and Crashes where he discusses various theories of depression, recession, etc, and closely critiques the theories. I would quote or refer you to the passages, but I leant the book to a friend. Great book, no matter what your philosophy, for a historical review of the business cycles and responses through the ages.

Why logic? Why not just plain old evidence? How many Austrian theory economists predicted high inflation in 2008? If the theory predicts one thing and reality shows you another, the theory must be discarded.


There was high inflation in 2008, or did you not notice that?


Many Austrians consider Bryan Caplan to be their most knowledgeable critic. His "Why I Am Not An Austrian" is the best single place to go to, but on his homepage (not EconLog) he also had some back and forth on ABCT in the context of Rothbard's "America's Great Depression". Personally, I'm swayed by the plucking model's evidence of slumps being more correlated with subsequent booms than prior ones.

G' = 8piGT'/c^4; Hpsi = Epsi; F = ma; DDf = 0; etc

(Sorry, having a little bit of fun at your expense. ;))

You and Paul Krugman should sit down and have a chat.

Which one to choose: China with low current unemployment and idle (new) infrastructure or the US with millions of unemployed people and infrastructure in terrible conditions?

Which one to choose: China with millions of unemployed people and idle infrastructure in ten years, or the US with millions of unemployed people and idle infrastructure now?

Roubini was right in picking a bubble once. I'm happy to bet all my money against him this time. (I was with him the first time. Cassandras are only good once.)

BTW, since Roubini loves to play the prognosticator: how's his hedge fund doin? What?? He's just another dude blowin smoke in his own ass? What a surprise.

"I’m happy to bet all my money against him this time."

Okay, but why? The investment is unprecedented, the capacity utilization extremely low.

The circumstances are unprecedented. China is gambling on some small portion of 1.2 billion people demanding something much better. I'm willing to take that bet.

"Which one to choose: China with low current unemployment and idle (new) infrastructure or the US with millions of unemployed people and infrastructure in terrible conditions?"

Over what time period and for what purpose?

Tyler, I've just read the whole thing. Before arguing that it is another nonsense analysis of the Chinese economy, let me say that I've read only a few papers and columns written by Roubini because I've often found his analysis too weak to justify his conclusions and in particular his predictions.
Now he says that recently he has visited China twice (for a grand total of 15 days or less?) and we must assume his analysis is based on his meetings with a lot of people there. He doesn't refer to any work done by economists that have been studying the Chinese economy for a long time and to any idea advanced by a Chinese economist. Just his words. The numbers he mentions are reasonable so I will assume they are the official ones.
I have two main problems with his analysis. The first one is about reliance on 12th Five-Year Plan to analyze government policies. This is the first time that I read that someone takes seriously a Chinese's Five-Year Plan. I'm still remember Perón's Five-Year Plans of his first presidency (1946-1955) because we were told about them in elementary and high school. But in my three and a half years in Beijing and Hong Kong I never heard any economist or high- or low-level official to talk about the Five Year Plans. Actually, Roubini's description of government policy is limited to a few words that mean nothing --first he says that the new Plan intends to rebalance the country's long-term growth model (?) and aims at increasing the share of consumption in GDP, but the details reveal a reliance on investment, including investment in public housing. To make things worse, in his own assessment he refers to policies without saying which particular policies he's talking about.
The second problem is with Roubini's analysis. He repeats the standard story of China's growth based on exports but --as other economists that has been endorsing this view in the past 25 years-- he has to acknowledge a very high level of investment and even in Keynesian economics this investment accounts for high growth rates. In case of any doubt, ask Solow. China's economic reform has been based on integrating its production structure to the world economy. To grow China needs to produce, and it doesn't matter whether it sells its production at home or abroad.
Leaving aside all the serious problems to measure China's investment and output in the past 25 years, few countries have invested so much in relation to current output as China over a period of 25 years. China could do it first because they opened the country to foreign enterprises and second because Chinese households have been saving a high share of their disposable income and depositing their savings in the state banking system. This "model" poses two problems that Roubini fails to address directly. One how productive the investments in capacity have been, the other how sound the state banking system is. If half the investments in capacity during the past 25 years had not been productive, the capital/output ratio would have been increasing fast and the asset portfolios of state banks would have been deteriorating fast. These issues were already debated in the 1990s (in the mid 1990s, I spent three years and a half in China studying these issues and all my conclusions were very tentative). I don't think Roubini or anyone else have reasonable evidence to conclude one way or another.
Now, if today half of China's capital stock were unproductive, the loan portfolios of states banks could hardly generate enough revenue to pay interest on deposits. Even in if it were so, it would take a long time for the state banks to become a burden to the Ministry of Finance, however. First, the state banks --through the central bank-- have invested a large share of their deposits abroad (over 20%?) and although interest earned on this investment has been low, it has allowed the banks to diversify their assets. Second, they pay (as Roubini correctly says) the banks pay very low interest rates to depositors. And third, depositors have been increasing their holdings of deposits at those low rates. In other words, the conditions for a sudden end of a Ponzi game would not be there yet.
Roubini agrees that the Chinese currency is weak and that China needs a rapid exchange-rate appreciation. He also mentions that state enterprises could not pay MARKET interest rates because of their mismanagement of resources. Now, if there were no financial repression in domestic markets and China's financial markets were integrated into world markets, most likely there would be an exchange-rate depreciation. The reason is simple: Chinese households would quickly start investing a large share of their savings abroad, and not only their flow of saving but part of their stock of savings. What Roubini and other short-term visitors to China fail to understand is that the central bank (People's Bank of China) has been acting as an intermediary between Chinese households and the world markets (this happened after the high inflation of 1993 that led to a change in how the reserves of the state banks with the central bank were managed). Roubini and others fail to understand that China cannot invest such a huge amount of savings at home, and that under the current banking system the only way to diversify asset portfolios is to invest part of it abroad through the central bank (their accounting as international reserves reflects a misunderstanding of the Chinese system).
In sum, as many others before him, Roubini fails to understand the Chinese "model" --he is sure, however, that it must change. He joins the chorus of those waiting for the Chinese bubble to burst. I have seen the sign "TODAY NOT, BUT TOMORROW YES" every day since January 1, 1994. We know too little and so I cannot ignore the possibility that it may happen, but if the "model" succeeded (meaning no burst in at least the next 10 years), I'd not be surprised (I'd take it as evidence that indeed we all knew too little).

China's attempt to invest its excess savings abroad meant investing in a bunch of mortgages in the US. Shoving investment down other countries throats just meant accumulated a bunch of fannie and freddie bonds.

Indeed the People's Bank of China may be regretting some of its foreign investments in bonds of developed countries governed by inept and corrupt politicians with the complicity of cronies. But the Chinese are learning. Hope you can read Spanish to take a look at this story of the past few days (it has links to FT and WSJ but you have to understand the background as reported by the Spanish press)
In other words, they will not hire a Madoff to manage their savings and I hope nor they hire a Tim Geithner, or an Alan Greenspan, or a Ben Bernanke, or a Robert Rubin, or a Larry Summers.

Your analysis is more thorough and knowledgeable than mine. I judge analysis by the tone, and to me Roubini has the tone of a man blowing smoke up his own ass. But your analysis is able to articulate what I can only instinctively feel.

it must change. He joins the chorus of those waiting for the Chinese bubble to burst. I have seen the sign “TODAY NOT, BUT TOMORROW YES” every day since January 1, 1994. We know too little and so I cannot ignore the possibility that it may happen, but if the “model

I'm not a big Roubini fan myself, but the structure of an overinvestment argument is not that the integral of all past investment was excessive but that over time rising investment/GDP ratios are a danger sign. (Japan's investments seemed to be great up until that last surge just before the Lost Decade began.) So a rising capital/output ratio before now might not occur, but things could still go south pretty quickly. Giant empty cities are not encouraging. The government trying to cartelize mining, aluminum production, automobiles, etc. to reduce capacity and output is not encouraging. 25% unemployment of college grads is not encouraging. I think you've got to put at least a 10% probability on a sudden-dropoff-in-growth scenario over the next few years.

I've been haunted by the same question Ya-Sheng Huang has asked: Is China an Asian tiger or more like the Brazil of old, running up high growth figures for sustained periods before bombing out? The macro stats make it hard to distinguish.

Sorry you repeat everything that foreign journalists and weekend-visiting pundits have been writing over the past 25 years. They are not facts, as most of what Tyler posts as facts are not facts --they would not be accepted as evidence by any reasonable person applying any known standard of proof. At best they are impressions, often prejudices. You are comparing a large country with the capacity to produce a wide variety of goods with small countries (fyi, Brazil is a large country but it is too fragmented, perhaps more than China still is) that specialize in the production of a few goods. In the 1990s hundreds of foreign enterprises invested in China to produce mainly for the domestic market, something that you are not going to see in small countries where foreign enterprises produce for foreign markets. We know little about China, but for all practical purposes most people know nothing about China and the worst they can do it is to compare its experience with what has happened in small economies. Face it --in the past 25 years the global market economy has been changing drastically as a result of the inclusion of China, India, and several other countries The process is still going on and most economists have yet to figure out how to explain it. We are not talking about a marginal revolution, we are talking about the emergence of a new global market economy where the ineptness and corruption of politicians in old democracies increase significantly the cost of adjusting to a new reality. Get a mirror.

E. Barandiaran,

You say, quite rightly, that we do not know enough about China to make an analysis. Do you believe that the Chinese do? Or is the Chinese economy just too big (or data collection too small) for anyone to know?

Indeed a few Chinese economists know (a little?) more than foreign economists. Most --including most government and academic economists-- know at best as little as the most-knowledged foreign economists. The problem is that whatever your "model" of how the new Chinese economy works, you need data and none has the ability to collect good data (in Western countries data collection is facilitated by a long history of surveys and accounting standards). I doubt the improvement with respect to the time I worked there (1994-1997) makes a significant difference.

The crux of his argument, I believe, is that there are empty seats on the pricier trains and planes.

Yet, there is an exploding middle class moving up the ladder, and a truly incredible (understatement) unmet demand to move around the country, for both personal and business reasons.

Lower class train rides sell out, day in and day out. (I've ridden enough of them to know). Most of these people would prefer to fly or to ride a better/faster train.

Yes, the business cycle in China is influenced by the government more so than in other places, for better or worse. But I hardly see overcapitalized transportation infrastructure as the seeds of deflation.

I could go on at length with examples of routes, or anecdotes of people I met on trains there, but I would still have to face the fact that the more expensive plane and train routes will run under capacity for years to come. How many years to fill those seats, if no more tracks or airports are built? Probably not many. How big are the macro effects of the shifting investment pattern? Impossible to evaluate without considering other planned expenditures and, just as importantly, ongoing wage and price inflation.

I would reiterate precisely the same logic for housing and be happy that inflation in the manufacturing sector is expected to be muted in the medium term. The political trick may be to put a damper on expectations while maintaining confidence in the Party.

As we speak, China is remodeling its HSR trains to abolish luxury cars and lower train speeds (which reduces power consumption) to lower ticket
prices and thereby to better cater to the needs of the general public. So the HSR train may not remain empty for long. Also, while outsiders
talk about a housing bubble, the Chinese government is embarking on a HUGE public housing program.

Do China's planners know a little bit more about their own country than instant foreign experts with two weeks of ground experience in the country?

Why are Nouriel and Tyler assuming that Says Law doesn't work?

We will be better able to see the impending causes of Chinese melee,
After it occurs,
Unless you are E.,
In which case, it will be
Some last minute change,
In Chinese policee.

Burma Shave

Maybe Jon Stewart will hire you as a bubble buster once he makes clear what the problem is. Watch

Thanks for providing the material.

In other words: If you build it, they won't come?

This is one but one more example of a failure of macroeconomic theory to ever get beyond mere numbers. As is standard practice, activities are undertaken to make the numbers look good in the next quarter or over the next year. As such, the US uses stimulus dollars to fix potholes and the Chinese build rail lines that will obviate the need for airports now under construction and we both build bridges to nowhere, all in a vain effort to get the numbers back to pre-recession values. Economists in general appear to be clueless that certain expenditures are actually investments that can contribute to future growth, while other activities are pure consumption that merely create a short-lived sugar high.

As a society, we've lost the ability to see beyond the next meal.

Instead of thinking of China as a market economy, what if you thought of it as a regulated economy?

My concern is not that China will enter a recession, but rather that it will enter a period of excess capacity and will, in effect, tax its citizens to continue producing products below their actual costs while competing in a world economy.

Do state enterprises go bankrupt, or do they continue to get loans to keep them afloat? You know the answer. Foreign firms in China may be a different matter, but if they compete with state owned enterprises, their fat may be in the fire.

The WTO is not a very efficient way to deal with these state subsidy problems.

I hear China once tried to build this ridiculous wall, but the bubble burst before anyone ever used it.

This link shows the amazing result of China building ghost towns.

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