The National Bureau of Statistics has released a whole lot of data. A European TV station asked me to comment on the import of the data, and while I hate to make too much of a few data points, I was able to say rather glibly that the data pretty much confirmed the hopes of the optimists as well as the fears of the pessimists.
I will explain why I think this below, but I should note that most analysts were pleased with the results, and the stock market surged on the news. The SSE Composite was up 2.2% today. Surprisingly it was down 0.7% yesterday, suggesting that there was probably no information leakage. Things seem to be improving on that front.
To summarize the data released today, manufacturing output was up by 12.3% year on year, better than last month’s 10.8% and higher than consensus, although I think last August, during the Olympics, a lot of factories were closed so that this number may not be as impressive as it seems. Steel output was up 29% and auto production was up 90%, which as my friend Mark Williams at Capital Economics points out is not likely to soothe worries about overcapacity creation.
Urban fixed-asset investment was up 33.0% for the first eight months of the year, which slightly exceeded already-high estimates of 32.5%. This suggests that it is still investment that is in the driver’s seat, as far as growth is concerned.
This might not be as obvious as all that. A lot of people were excited that retail sales climbed 15.4%, slightly higher than consensus and the highest growth rate all year after seasonal factors are stripped out, but remember that retail sales are not a very good proxy for consumption growth. Also remember that this surge in liquidity can easily cause consumption to rise in a temporary way without indicating anything structural about changing consumption and saving patterns in China. In 1988-89 consumption in Japan also surged, probably as a consequence of the investment boom, but it was unable to survive, if I remember correctly, the contraction in that boom in the 1990s.
The most interesting piece of information is that net new lending for the month was RMB 410 billion, less than half the monthly average this year (RMB 1,105 billion). This seems small given the huge numbers we’ve seen but, as I pointed out two weeks ago, last August new lending was around RMB 272 billion, and if you strip out the bills coming due the real increase in medium- and long-term lending is closer to RMB 550-600 billion. More importantly, RMB 410 billion is a lot more than the rumors of RMB 300 billion that had panicked the market last week.
The one piece of news that everyone read as negative was the trade data. Exports were down 23.4% and imports down 17.0%, both substantially worse than expected, although leaving the trade surplus at a still-hefty $15.7 billion, which is roughly average for the year.
For the optimists, the economic numbers, with the exception of the trade data, were all positive and suggest that China is on track to recovery. For them, the great risk to China was that the global contraction in demand would result in terrible damage to China’s export industry and, with it, would cause factory closings and soaring unemployment. Rising unemployment would lead to a collapse in consumption, and of course would not make China’s transition easier.
The main purpose of the stimulus package, in this view, was to forestall an economic contraction and with it the possibility that the economy would fall into an ugly process in which rising unemployment would cause a contraction in Chinese consumption which, when added to the contraction in foreign demand for Chinese exports, would push the economy into a tailspin. In that sense the stimulus has proven to be a great success. Chinese growth has slowed, but by a lot less than expected, and unemployment seems to be manageable. The August data points pretty solidly to continued growth.
And yet, and yet….
For pessimists like me the global contraction underscored Chinese vulnerability to out-of-control US consumption, and the need to develop a more balanced approach in which Chinese consumers take a larger share of China’s production. This vulnerability existed in large part because China was overly reliant on investment for its growth. China has had probably the highest investment rate ever recorded for a large economy, and for years there has been widespread concern that much of this investment was misallocated.
It is only because the cost of capital is artificially so low (thanks to Chinese households, who are forced to earn a miniscule return on their savings) that many companies are able to show profits at all. A few months ago I wrote about an HKMA paper that suggested that the implicit interest-rate subsidy to SOEs – not relative to the “right” interest rate in China (whatever that may be but which is certainly many percentage points higher than the official lending rates) but relative to the borrowing cost of large Chinese private corporations – accounted for 100% of SOE profitability. If China had reasonable interest rates, in other words, (and in fact there were negative real rates for much of the recent past), SOEs would on average be value destroyers.
This, by the way, is why China’s supposedly puzzling addiction to capital-intensive growth rather than labor-intensive growth – more befitting to an economy with lots of unskilled labor and very poor technology – is not so puzzling. If you artificially lower the price of a particular input, it is not surprising that producers will use more of that input than might otherwise be considered optimal. With capital practically free, capital is everyone’s favorite input in spite of incredibly low labor costs.
With the recent surge in government financed investment (and I include most bank lending in this category), it would be surprising to me if much of this year’s new investment were not of even lower quality than the older investment, with very low or even negative expected returns. If this turns out to be true, it means that the only way these investments could be viable is by effectively continuing to “tax” Chinese households to subsidize state-owned enterprises and large manufacturers. This tax of course will come mainly in the form of low wage growth and extremely low deposit rates on the savings of Chinese households.
This is why we all hope Chinese growth will become more reliant on rising consumption rather than on rising investment, much of which is certain to be unprofitable. The current path requires a large trade surplus to absorb the difference between what China consumes and what it produces, but it is not clear that foreign consumers will absorb the balance. China is trying to plug the gap by a surge in government-financed investment, but this is likely only to widen the gap in the future.
So the August data suggests that while China is growing, it is actually more reliant, not less reliant, on investment. What is worse the very poor import numbers suggest that in spite of high retail growth figures, consumption growth in China is still sluggish.
For the pessimists, then, the August numbers confirm that the stimulus package may be boosting production solely because of government-financed investment, and that a serious misallocation problem will result in more future pressure on Chinese households to foot the bill. The export numbers show that China’s external accounts continue to deteriorate, and it will take more than simply an end to the global crisis to return to the good old days.
So who is right, the optimists or the pessimists?
In fact both are right. If the purpose of the stimulus package was solely to protect China from the immediate employment impact of the global contraction in demand, it has been an almost unqualified success.
But if at least part of the goal was to help China shift its unbalanced growth model to one less reliant on foreign, and especially American, consumers, it is not clear that any progress has been made. In fact to the extent that a significant share of new investment has been wasted, it may actually make future imbalances worse.
China’s response to the global crisis needs to be seen as a two-part process. The first part is to goose economic growth in response to the rapid deterioration in the external environment. The second part is to rebalance the economy away from its excess reliance on investment and foreign demand. The August data seem to confirm that China is very successfully managing the first part. Whether it has made any progress on the second part is still very much open to question.