China experts Michael Pettis and Eswar Prasad recently debated via Bloomberg Briefs whether China could maintain 6 – 7% GDP for the rest of the decade, despite the inefficient, credit-driven investment model that has sustained high growth in recent years.
“When a country’s growth has been driven by wasteful investment, GDP growth exceeds real economic wealth creation, productivity is overstated, and debt rises faster than debt servicing capacity,” writes Pettis. He argues that every time the Chinese government has moved to rein in easy credit, growth has suffered until the government back down. If they’re serious about tackling credit this time around, they will have to accept the economic pain that comes along with it.
Pettis also says that a number of factors like slow wage growth and an undervalued currency have favored industry and investment over consumption, which makes the reported GDP growth less productive than you would normally expect. Increasing consumption relative to GDP may result in more productive GDP growth, but the headline number should drop.
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Reform could offset tightening credit
Prasad is far more optimistic about the potential impact of financial reform. “China has torn up the traditional playbook and its leaders seem willing to muscle through key reforms at a time when short-term growth is secure, even if that involves some risks and dislocations,” he writes.
While he accepts Pettis’ premise, Prasad thinks that the Chinese government has proven its ability to walk a fine line and adapt to difficult circumstances. He points to the elimination of the one-child policy (to ease demographic pressure), eliminating the interest rate ceiling on deposit accounts so that people can earn interest on savings, and restructuring public finances among other reforms that could offset the losses that come from tightening up on credit.
“If all of the proposed reforms are implemented in the next three to five years, they will improve the allocation of resources, push up productivity, and make growth more balanced. Taken together, they will allow China’s economy to continue growing at 6 to 7 percent for the next few years,” he writes.
Pettis isn’t convinced that these reforms, even if implemented successfully, can do enough to prevent GDP growth from falling by 1% per year for the next decade. “The proposed reforms will certainly unleash greater productivity, but they will also eliminate the mechanisms that had previously turbo-charged economic activity,” writes Pettis.
China has maintained balancing act so far
On some level, Prasad’s argument boils down to having a lot of faith in the ruling party to govern effectively. “In the last decade, a steady drumbeat of warnings has predicted imminent collapse of the Chinese economy. They have so far proven wrong,” he writes.
But, catchy headlines aside, the hard landing that investors have worried about hasn’t been the consensus stance among experts, even among bearish experts.
“China’s failure to collapse does not prove the bull case, especially when most China skeptics – me included – never predicted or expected any such thing,” writes Pettis. “We predicted that as China rebalanced, growth rates would drop much more sharply than expected. This is exactly what happened.”