Wednesday, November 16, 2011

China's Problems

FLG read this post about China with some interest and he agrees with it, but thinks Mead misses the larger picture somewhat.

Long-time readers know that FLG sees a lot of problems with China's economy. Firstly, if you've read Krugman's The Myth Of Asia's Miracle, then you'd have seen this passage about the USSR, but applies just as well to China:
This economic analysis had two crucial implications. First, most of the speculation about the superiority of the communist system--including the popular view that Western economies could painlessly accelerate their own growth by borrowing some aspects of that system--was off base. Rapid Soviet economic growth was based entirely on one attribute: the willingness to save, to sacrifice current consumption for the sake of future production. The communist example offered no hint of a free lunch.

Second, the economic analysis of communist countries' growth implied some future limits to their industrial expansion--in other words, implied that a naive projection of their past growth rates into the future was likely to greatly overstate their real prospects. Economic growth that is based on expansion of inputs, rather than on growth in output per unit of input, is inevitable subject to diminishing returns. It was simply not possible for the Soviet economies to sustain the rates of growth of labor force participation, average education levels, and above all the physical capital stock that had prevailed in previous years. Communist growth would predictably slow down, perhaps drastically.

To put this in the simplest of terms, China's economic growth over the past few decades has been because farmers with shovels became factory workers with machines. As far as FLG is concern, this is great news. It has lifted hundreds of millions out of poverty. But, contrary to what lots of so-called sophisticated people like Thom Friedman think, China isn't some sort of technocratic miracle.

So, overall, China's rise, while important and impressive, doesn't end up being all that interesting, at least in terms economic growth. However, what is more interesting to FLG, unsurprisingly, is this part:
the willingness to save, to sacrifice current consumption for the sake of future production.

One of the first lessons in economics is that saving equals investment S=I. Ah, but what turns that savings into investment? The Financial System. Well, China's financial system is a complete mess that has had to be recapitalized several times.

Herman Schwartz argues in Subprime Nation that, to overcome their financial system's piss poor performance at doing anything with savings, the Chinese funneled dollars right back into the US financial system, which in turn financed housing, which in turn created demand for Chinese products. Thus, the Chinese, knowing their banking system sucked, sort of borrowed ours. (If FLG remembers correct, Schwartz has an note about how as long as the Chinese stay with treasuries, then all's well. Worry when they start taking equity stakes.)

Ultimately, there's only so much concrete that the Chinese can pour to keep their economy going.

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