Michael Pettis is 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. Michael Pettis is out with his latest missive on China, and below we excerpt a small portion on the topic of re-balancing.
Pettis believes that the following are the six choices for China going forward, which are excerpted below.
Also read Michael Pettis On The Dilemmas Of Chinese Devaluation
1. Beijing can do nothing, maintaining its high investment growth rates, until it reaches its debt capacity limits, after which a sudden stop in investment will force up the household share (albeit under conditions of negative growth).
This is the do-nothing path to rebalancing, and given how seriously Beijing takes the rebalancing process I think it is fairly unlikely to occur except if opposition to the reforms strengthens considerably and there is enough pushback to stalemate the rebalancing process. If this were to happen China would continue to see a surge in credit and GDP growth would remain above 6-7%.
2. Beijing can quickly reverse the transfers that created the imbalances by , for example,by raising real interest rates sharply, by forcing up the foreign exchange value of the currency by 10-20% overnight, by pushing up wages significantly, or drastically cutting income and consumption taxes.[mk1]
This may be the most efficient way in the medium term to rebalance the economy and place it firmly on the path of real productivity growth, but in the short term it would lead to a surge in financial distress that could have significant social costs. For this reason I think it unlikely that Beijing will follow this path.
3. Beijing can reverse the transfers described above, but it can do so slowly and gradually, so that the impact on raising consumption by raising household income can create demand as quickly as the elimination of the transfers reduce demand.
This is occurring presently. Wages are climbing, the currency is appreciating, and interest rates have not been lowered even as the nominal GDP growth rate has collapsed in the past four years from 18-20% to 7-9%. The result, as expected, has been the sharp drop in GDP growth, which I expect will continue over the next several years, but no sharp rise in unemployment. The problem with this path is that it is very slow and runs the risk that, as debt continues to rise unsustainably, China reaches debt capacity constraints long before the adjustment is complete, in which case growth will collapse.
4. Beijing can directly transfer wealth from the state sector to the private sector by privatizing assets and using the proceeds directly or indirectly to boost household wealth, by implementing land reform, by eliminating the hukou (residency) requirements, etc.
This is the only way to keep growth rates at current levels while China’s economy rebalances. If Beijing can directly or indirectly transfer roughly 5-10% of GDP every year from the state to the household sector, consumption growth can accelerate to 10-11% while investment growth drops sharply, keeping the economy growing at 6-7% a year during President Xi’s administration.
There is likely to be, however, tremendous opposition from the elites to anything near this level of transfer. The elite has benefitted tremendously in the past from access to state resources, and is likely to resist any reduction in access, and resist especially ferociously any reduction of their wealth.
5. Beijing can indirectly transfer wealth from the state sector to the private sector indirectly by absorbing private-sector debt.
By transferring debt from the private sector to the state balance sheets, Beijing can reduce the amount of direct transfer and make the remaining transfer process more palatable to the elite. Rising state debt, however, places a cap on the GDP growth rate because it will force Beijing into further financial repression, and it will leave the country with a potentially destabilizing debt level.
6. Beijing can cut investment sharply, resulting in a collapse in growth, but it can mitigate the employment impact of this collapse by hiring unemployed workers for various make-work programs and paying their salaries out of state resources.
This, in a sense, is similar to the process of increasing the household income share of GDP by transferring debt to the state sector because government debt will rise sharply trough the fiscal deficit. It has the same constraints.