“It is very unwise to place much store in the ability of Chinese consumers to save the world, or even do much about the Chinese economy.”
This quote comes from the head of a Beijing-based economic consultancy called Dragonomics, Arthur Kroeber, who presented to a small gathering at Austrade last night. And the reasons we shouldn’t expect Chinese to replace the over-borrowed Americans are both surprising and worrying.
In fact, in the past 24 hours I have had two important insights into the fundamental problems with the Chinese economy – not about a coming crash, although a credit bubble seems to be developing, but about the imbalances that will block a realignment of the Chinese economy towards consumption and therefore hold back growth in the long-term.
And they both have to do with democracy, or the lack of it.
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The first was last night from Kroeber and the second was an article this week in the Far Eastern Economic Review by Jonathan Anderson, the global emerging markets economist of UBS.
Kroeber joins those who argue that the model on which China’s growth has been based for 30 years has now ended because the debt-funded consumption boom in the west, particularly America, was unsustainable. China’s rate of economic growth will slow, he says, from the 10% average of the past 30 years to 8% over the next decade and then 5% after that.
“China used to rely on exports, now it must be domestic consumption, but the structure of the economy does not permit it,” he said.
There are two things that reduce consumption: while there is a large number of “consuming Chinese” (as opposed to “surviving Chinese”, who just buy necessities of life only) they are hard to get to and don’t have much money; and secondly, they need to save because of the lack of a decent welfare safety net in China.
More on these things in a moment, but Anderson’s insight takes the savings issue a little further.
He argues that the lack of a welfare safety net is not the main problem – if it was “then why don’t we see even higher domestic saving rates in Algeria, Bolivia, Cameroon, Egypt, Indonesia, Kenya, Mongolia, Philippines, Thailand or the remaining many dozens of nations with social indicators that fall considerably short of those in China?”
Anderson says that although personal savings are very high in China, “the real story is the sudden rise of gross corporate savings, which shot up to more than 26% of GDP by 2007 from about 15% of GDP at the beginning of the decade.”
To summarise the underlying points of Kroeber and Anderson:
1. Individuals save a lot because there is an inadequate safety net, in turn because China is not a democracy with the normal ratcheting up of welfare transfers that goes with elections, and;
2. Chinese companies save and over-invest because they are owned by the state and don’t pay any dividends – to anybody.
Anderson invites us to think about China as Saudi Arabia. When the country strikes oil there is a sudden and massive increase in the trade surplus and an equally large increase in domestic savings, as export earnings pile up in the Government and oil companies’ coffers.
“The domestic consumption share of GDP falls precipitously, as only a small share of those export earnings actually make it to the pocketbooks of Saudi households.”
“And so it is in China – with the sole difference that instead of oil, the Chinese ‘struck’ steel and basic materials.”
Not only do Chinese households not get much of the money, they have a low “marginal propensity to consume”, in the words of Kroeber last night.
On hearing this, one of those present at last night’s Austrade discussion asked a pretty good question: surely the vast numbers in China generally mean that there is a group of middle class consumers roughly equivalent to the entire population of the United States, buying cars, fridges and other consumables and durables?
Well, said Kroeber, there are actually only about 120 million of what he called “consuming Chinese” (as opposed to “surviving Chinese”), living in 40 million households. Their disposable income is roughly $US5000 per annum – one tenth of the US.
“Yes, but what about purchasing power parity”, asked someone else. “Surely that 5,000 bucks goes a lot further in China than the US.”
Kroeber’s answer was very interesting. He said PPP was meaningless because proper data is unavailable, and he related the story of how, according to the Economist’s “Big Mac” index the renminbi is 30% undervalued, but using Starbucks coffee in the same way shows the undervaluation is zero. It depends on the product.
Then he told another story about haircuts. Officially, you can get a haircut in Beijing for $3 whereas in New York City it usually costs $30. But Arthur has tried to get decent haircut in Beijing for that price (with the emphasis on decent), but it’s impossible. He’s had to settle for a barber who charges $US70.
Kroeber’s third point – on top of the need to save for retirement and health care, and the lack of enough disposable income – is that it is difficult to supply the Chinese middle classes with products as well.
Seventy five per cent of the 40 million ‘middle class’ households are in three cities that are a long way apart.
“If you transpose this to Europe, it would be like having 40 million people in Madrid, 40 million in Belgrade and 40 million in Moscow and nothing in between.
“The result is that the unit distribution costs in China are very high.”
Anderson’s basic point is different but equally interesting: “The massive surge in heavy industrial supply and exports did not lead to much of an income boost (if at all) for average consumers; these are mostly state-owned or local government-led companies, and even the word ‘state-owned’ is not really correct in the case of China since there is very often no residual claimant on earnings at all. The state normally doesn’t receive dividends, minority shareholders are usually small and fragmented, and in this environment large companies often have nothing to do with profits but reinvest them or simply accumulate assets.”
So, two things need to happen at once for a dramatic increase in Chinese consumption: corporate ownership reforms that would force more profits to be distributed to the people and more political democracy so that the Chinese leadership is driven to distribute more money in the form of welfare transfers.
In other words the unelected political and corporate elites of China are hoarding the cash. Unless they let go of it, China won’t become a consumer society. And with the export model dead, that means lower growth and lower commodity imports.
This article first appeared on Business Spectator.