Michael Pettis, Professor of Finance, Guanghua School of Management, Peking University, author of The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy, Avoiding the Fall: China’s Economic Restructuring and The Volatility Machine: Emerging Economics and the Threat of Financial Collapse is out with his latest missive on China. Michael Pettis has gained fame for his bet about Chinese growth with The Economist. Pettis has a special distribution list for his in depth thoughts on China. We are privileged to be a member, but we are only permitted to quote 500 words, so we briefly summarize why Michael Pettis believes Chinese growth of 6 or 7 percent would be difficult, and it should be much closer to 3-4%.
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Michael Pettis on Chinese consumption and investment as % of GDP
Rebalancing in China requires that consumption grow significantly as a share of GDP over the next decade or more. China currently reports household consumption as representing about 35% of GDP, but globally, consumption represents a fairly stable 65% of GDP.
Also, investment must drop as a share of GDP. Investment will need to drop to 40% of GDP in ten years and that investment will drop to 35% of GDP in ten years. Currently China has the highest investment share of GDP in the world, with investment comprising 46% of GDP or more. By contrast, In emerging markets investment is typically around 30% of GDP.
Michael Pettis assumptions
We will assume two sets of adjustments for investment and consumption. The “easier” adjustment scenarios have household consumption growing from 35% of GDP to 50% of GDP, while investment declines from 46% of GDP to 40% of GDP. The “tougher” adjustment scenarios have household consumption growing from 35% of GDP to 55% of GDP, while investment declines from 46% of GDP to 35% of GDP. The table below lists the consumption and investment growth rates needed.
Assumed GDP growth rate Consumption growth as the consumption share rises from 35% to 50% Consumption growth as the consumption share rises from 35% to 55% Growth in investment as the investment share drops from 46% to 40% Growth in investment as the investment share drops from 46% to 35%
-2% 1.6% 2.5% -3.4% -4.6%
0% 3.6% 4.6% -1.4% -2.7%
2% 5.7% 6.7% 0.6% -0.8%
4% 7.8% 8.8% 2.6% 1.2%
6% 9.9% 10.9% 4.5% 3.1%
8% 11.9% 13.0% 6.5% 5.1%
10% 14.0% 15.9% 8.5% 7.0%
Michael Pettis GDP assumptions
This allows me to make statements like this: If you think that China’s GDP will grow by 7% a year over the next decade, and if you expect a minimal amount of rebalancing, then you are implicitly predicting that consumption will grow by 10-11% a year for ten years and that investment will grow by 4-5.5%. If you believe these two implicit predictions are plausible, then your 7% prediction is also plausible.
Average GDP growth rates of 6% require, as an arithmetical necessity, that household consumption grow by 9.9% a year over the next ten years and that investment grow by 4.5%, after many years of high double digit growth and more recently growth in the low double digits. would also argue, more importantly, that if annual investment growth drops to 4.5%, and GDP growth to 6%, it will be very difficult, without significant and politically painful transfers from the state sector to the household sector, for consumption to grow at anywhere close to 9.9% a year for ten years. Consumption growth is, after all, positively correlated with investment growth, especially in the internal provinces upon which a lot of useless investment has been lavished.
Michael Pettis conclusion
This is why I have argued since 2009 that that 3-4% average GDP growth for a decade is likely to be the upper limit once Beijing seriously begins to rebalance the Chinese economy, and if the administration of President Xi and Premier Li is able to pull this off, it would be a huge accomplishment.