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
