From Michael Pettis' China Financial Markets blog:
Chiwoong Lee at Goldman Sachs has a new report out (“China vs. 1970s Japan”, September 25, 2012) in which he predicts that China’s long-term growth rate will drop to 7.5-8.5%. I disagree very strongly with his forecast, of course, and expect China’s growth rate over the next decade to average less than half that number, but the point of bringing up his report is not to disagree with the details of his analysis.
I want instead to use his report to illustrate what I believe is a much more fundamental problem with these kinds of research pieces on China. The mistake I will argue he is making is one that is fairly common. It involves determining the past relationship between certain inputs and the outputs we want to forecast – say GDP growth. Once these are determined, the economist will carefully study the expected changes in the inputs, and then calculate the expected changes in the outputs, to arrive at his growth forecast.
This is pretty much the standard analysis provided by the IMF, the World Bank, and both academic and sell-side research, but, as I will argue, this methodology implicitly assumes no real change in the underlying development model – no phase shift, to use a more fashionable term. If this assumption is correct, then the analysis is useful. If however we are on the verge of a shift in the development model – perhaps, and usually, because the existing model is unsustainable and must be reversed, the analysis has no value at all.
Lee arrives at his 7.5-8.5% range by comparing China today with Japan in the early 1970s. He considers reasonable and very plausible changes in various inputs and concluding on that basis that Chinese growth will slow from the torrid levels of the past decade, but will nonetheless exceed the roughly 5% real growth rate achieved by Japan in the two decades following the early 1970s. I assume his Chinese growth prediction is also for the next one or two decades but I was not able to determine if this is in fact the case.
What about China? Like Japan, (1) real wages and the labor share of income are rising in some areas and (2) the pace of technological advances has surpassed its peak. However, (3) while consumer durables are spreading, there is still ample room for growth, (4) the export ratio is high due to economies of scale, and (5) growth remains high despite an increase in raw material prices reminiscent of the oil crisis.Although both potential and actual growth is expected to remain high in China, gradual decline is likely from the double-digit (%) pace of 2004-2007. Our China economics team calculates a range of 7.5~8.5% for China’s potential growth.As the excerpt above suggests, Lee focuses on six input factors specifically: the shift from labor glut to labor shortage, the pace of technological catch-up, the spread of consumer durables, economies of scale and export structure, the impact of raw material price rises, and political stability. He compares the impact of changes in each of these on the Japanese economy as a source of the Japanese slowdown, and then estimates their comparable impact on the Chinese economy. This allows him to estimate the amount of the expected slowdown in China.
The piece is a very interesting one, and it is well worth reading for the information and insights it provides, but in my opinion it shares a fundamental problem with nearly all of the other analyses that compare China today with Japan in the 1960-70s, rather than Japan in the late 1980s. Many of these analyses are much less sophisticated reasons than Lee’s. For example the most popular reason for comparing China with Japan of the 1960-70s is that China today is much poorer than Japan in the late 1980s. Japan in the late 1980s was rich, people will say, while China is terribly poor, so there can’t be any useful comparison between Japan in the 1990s and China in the next decade.
What are the real similarities?
This, of course, is silly. If you are arguing about the consequences of imbalanced, investment-driven growth, it isn’t the nominal levels of wealth that need to be compared. After all there are rich as well as poor countries that suffered from this kind of unbalanced, investment-driven growth, and all of them ended up suffering subsequently from the same kinds of economic rebalancing.
What really matters is the extent of the underlying imbalances and the relationship between capital stock and worker productivity. In that light it is just as easy for a poor country to have excess capital stock as it is for a rich country – perhaps even more so....MORE