What are the comparable numbers for China? US GDP ($13.5 trillion) is about 3.4 times the size of China’s ($4.0 trillion). In that case a 5% adjustment in the US is equal to roughly a 17% adjustment in China. That means, all other things being equal, Chinese consumption must go up by 17% of GDP just to compensate globally for the decline in the US, and bear in mind that consumption in China is only around 30-35% of GDP. What is worse, there is reason to believe that Chinese private consumption is likely to slow down in response to rising uncertainties and a slowing economy. Domestic consumption tends to be positively correlated with exports – a very pro-cyclical type of relationship typical for developing countries with large export components.
There are great hopes pinned on fiscal expansion in China, but I have already expressed my doubt about the government’s ability to expand as rapidly as many of us hope (and Stephen Green and Nouriel Roubini have anyway argued that there is less here than meets the eye). Even if they are able to expand dramatically without crowding out domestic investment, the sheer magnitude of the numbers make it almost impossible that China can successfully bear the burden of the global adjustment.
Of course it is not China’s job to replace US demand. Chinese policy-makers are only interested, in principle, in protecting growth in the Chinese economy. So why worry about whether China can or cannot replace US demand? Because with the rest of the world unable to step up, and in many cases even reinforcing the decline, if China cannot do so the whole world must see declining growth and a rise in savings, and since China was the main counterbalance to excess US consumption, it will probably bear much of the brunt.
An excessively high savings country, in other words, cannot benefit from a massive rise in global savings, and just as the astonishing flexibility of the US financial system meant that until recently US consumption had to adjust to absorb excess Asian savings (warning: I am a believer in the Bernanke savings glut hypothesis), the seizing up of its financial system means it no longer can absorb those savings, and so something must break. Instead of the US adjusting to excess savings, excess savers must adjust to declining US consumption. The world must balance.
I know this quick analysis is going to be accused of excess oversimplification, and I accept the accusation, but the point of this exercise is not to work out the process in full complexity, and certainly not to make policy prescriptions, but rather simply to get an idea of the adjustment that must be made, and if it isn’t China, as one of the two main players in the global imbalance, that will make the adjustment, then we need to figure out who else will. The biggest potential mistake in my argument, I think, might be my assumption about how much US savings will need to adjust. Perhaps the adjustment will be much lower.
2. What difficulties might China face in trying to reduce the cost of the adjustment?
The second point is to discuss some of the policy options that I think China will consider. The first and most obvious is fiscal expansion, something which I and other China experts have discussed and about which there is very real and very honest disagreement, with very plausible arguments on both sides. I have already discussed many times why I am skeptical about the ability of fiscal expansion to make up the slack.
As I write this Xinhua reports that the State council has approved fiscal spending equal to nearly 15% of GDP. The very short article says in its entirety:
China has decided to adopt active fiscal policy and moderately easy monetary policies to boost fast but steady economic growth by expanding domestic demand, according to an executive meeting of the State Council on Sunday. It is estimated that investment into infrastructure, social welfare and other key sectors will amount to four trillion yuan by the end of 2010.
A Bloomberg article gives a little more color:
The spending announced today, of which 100 billion yuan is earmarked for this quarter, will cover low-rent housing, infrastructure in the rural areas, as well as roads, railways and airports, the State Council said. The government will also allow tax deductions for purchases of fixed assets such as machinery to stimulate investment, a move that will reduce companies' costs by an estimated 120 billion yuan
This seems like a very large spending plan (nearly $600 billion, or about 14-15% of GDP over two years), and I think it may be enough to keep Chinese growth close to current levels, but only under the following conditions:
¨ It represents net new spending above current levels of expenditure. I think government expenditures represented around 14% of GDP last year, so if that suggests government spending will increase by around 50%.
¨ These are actual expenditures – for example tax deductions aimed at stimulating investments much actually stimulate investment by as much as the numbers project. Without looking carefully at the numbers (and possessing an understanding of budget issues much greater than mine), it is hard to say how much of this is real spending and how much “projections”.
