Michael Pettis had a great post yesterday, showing once again how China rebalancing is closer to a myth than reality, mostly because the causes of the imbalances (“excess” export vs. import and consumption) have not been addressed:
“Although China is still a very poor country, there is no question that Chinese household income has grown substantially over the past few decades, but it has not grown nearly as quickly as GDP. While China’s GDP grew at 11-12% over the 2002-2007 period, for example, MIT economist Yasheng Huang estimates that household income grew at a much lower 9%. If we were able to adjust Huang’s measure to take into account changes in other forms of household wealth, growth in household income would have been even lower. This is why consumption has declined as a share of national income, and why China’s total production has exceeded its total consumption by a large and growing amount. This is at the root of China’s high savings rate.
(…) Why haven’t Chinese households maintained their share of national income? Largely because the rise in household income was constrained, especially in the last decade, by industrial polices which were aimed at turbo-charging economic growth. These policies systematically forced households implicitly and explicitly to subsidize otherwise-unprofitable investment in infrastructure and manufacturing. Although these policies powered employment and manufacturing growth, they also led to wide and divergent growth rates between production and consumption. These policies included:
- An undervalued currency, which reduces real household wages by raising the cost of imports while subsidizing producers in the tradable goods sector.
- Excessively low interest rates, which force households, who are mostly depositors, to subsidize the borrowing costs of borrowers, who are mostly manufacturers and include very few households, service industry companies or other net consumers.
- A large spread between the deposit rate and the lending rate, which forces households to pay for the recapitalization of banks suffering from non-performing loans made to large manufacturers and state-owned enterprises.
- Sluggish wage growth, perhaps caused in part by restrictions on the ability of workers to organize, which directly subsidizes employers at the cost of households.
- Unraveling social safety nets and weak environmental restrictions, which effectively allow corporations to pass on the social cost to workers and households.
- Other direct manufacturing subsidies, including controlled land and energy prices, which are also indirectly paid for by households
By transferring wealth from households to boost the profitability of producers, China’s ability to grow consumption in line with growth in the nation’s GDP was severely hampered. Of course the gap between production and consumption is the savings rate, and as production surged relative to consumption, a necessary corollary was a rising Chinese savings rate”.
Stimulating investments without creating sufficient internal demand, at the same time global demand is contracting, leads to overcapacity:
“According to my model of China’s overcapacity problem, the source of the imbalance is a set of industrial policies that systematically shift income from households to producers, and as long as these policies continue there is little chance of resolving the problem of excess production.”
In summary, imbalances have not been addressed. Worse, they have increased:
“The basic problem, then, is that there are very powerful policies that force a discrepancy in production and consumption growth, and the only way to eliminate overcapacity is by reversing these policies. I am not sure that attempting to address overcapacity by administrative means can succeed, and certainly the track record of other efforts over the past year to address the imbalance doesn’t suggest otherwise.”
Posted by Gael 
Lesmaes 
