Tyler Cowen has a good post on the debate over China’s economic policy, which links to a recent WSJ article on the topic. I’ve noticed that when people debate this issue, they tend to talk past each other. This is because people throw around phrases like “more consumption”, without clearly indicating what they are talking about. Regarding China’s economy, here are some issues to consider:
1. Nominal demand vs. real demand.
2. Fiscal policy vs. monetary policy.
3. Consumption vs. investment.
4. Private investment vs. public investment.
I cannot emphasize enough that each of these four issues is radically different from the other three. Let me first describe what I think China needs, and then discuss the WSJ article:
1. China needs steady growth in nominal demand (NGDP.)
2. China needs to rely on monetary policy, and should not use fiscal policy for stabilization purposes.
3. China should let the market determine the relative size of consumption and investment.
4. China should reduce the role of the government in investment.
With this framework in mind, lots of confusing issues raised in the WSJ article begin to make more sense:
Economists and investors have been calling on Beijing to make bolder efforts to boost output—especially by promoting consumer spending, if necessary, by offering cash handouts, as the U.S. did during the pandemic.
Accelerating China’s transition to a more consumer-led economy—such as that of the U.S.—would make growth more sustainable in the long term, economists say.
But top leader Xi Jinping has deep-rooted philosophical objections to Western-style consumption-driven growth, people familiar with decision-making in Beijing say. Xi sees such growth as wasteful and at odds with his goal of making China a world-leading industrial and technological powerhouse, they say.
Xi believes Beijing should stick to fiscal discipline, especially given China’s deep debt. That makes stimulus or welfare policies akin to those in the U.S. and Europe less likely, the people said.
Notice that the WSJ frames this as welfarism vs. austerity. So which view is right? I’d say neither. Xi’s right that welfarism is not right for China, and the economists are right that China needs stimulus.
So if there is to be no fiscal boost to consumption, and yet demand must increase, does that mean I favor more government investment? No. I favor monetary stimulus to boost NGDP.
This is where the Keynesian framing is so counterproductive:
GDP = C + I + G + NX.
This framing tempts economists to want to play God, to wave a magic wand and determine how much of GDP will be C, how much will be I and how much will be G. The government clearly determines G. But the government should not be determining the mix of consumption and investment. No policymaker could realistically have the information required to make that judgment.
Take a second look at this:
Accelerating China’s transition to a more consumer-led economy—such as that of the U.S.—would make growth more sustainable in the long term, economists say.
How can we make sense of this claim, which on the surface seems bizarre? For growth to be sustainable, you need investment. And yet these western experts are not fools; they must have some sort of valid argument for this claim.
I suspect the actual claim here is that China needs to stop its extremely wasteful investment in certain areas, in order to avoid ending up with lots of “white elephants” and a mountain of unsustainable debts. In a healthy economy, only productive investments are undertaken. The current level of China’s investment as a share of GDP seems higher than can be justified by the low rates of return experienced in recent years:
Investment in roads, factories and other hard assets to drive growth has been yielding diminishing returns as the government runs out of useful projects to build.
Rather that say,”China needs more consumption”, I’d argue that China needs less wasteful investment. Aren’t those the same thing? Not really:
Also unlikely are major market-oriented changes, or a dramatic reversal in the multiyear shift toward more centralized control of the economy. Although Beijing has eased off efforts to clamp down on consumer internet firms and other private companies—a campaign that led to weaker private investment—it remains skeptical of their unregulated expansion. . . .
More likely options now include greater spending on infrastructure and other government-favored projects, as well as further credit loosening—following several recent interest-rate cuts—economists and people familiar with Beijing’s thinking say.
Such moves reflect Beijing’s preference for having the government play the central role in goosing growth, either by investing in infrastructure or by channeling funds to selected sectors such as semiconductors and artificial intelligence that can advance Communist Party aims.
The Chinese government has been discouraging private investment and encouraging public investment (as well as quasi-public investment, as in real estate and favored tech sectors.) That’s a mistake.
For many western economists, “stimulus” is synonymous with fiscal stimulus, whereas stimulus should be done by the central bank. And monetary stimulus is viewed as being synonymous with low interest rates and more investment, whereas the term ‘monetary stimulus’ should mean more nominal GDP—which might be either consumption or investment.
Some might argue that my analysis is naïve because China is far from being a laissez-faire economy. Monetary stimulus won’t necessarily go into the most efficient sectors. I agree. I am describing the sort of outcome that China should be aiming for. Determining which policy levers to push requires an in depth knowledge of the current policy distortions that lead to a misallocation of resources. Thus monetary stimulus might be combined with banking reform to reduce moral hazard. The goal would be to reduce lending for nonproductive investments, such as dubious real estate projects. But again, that’s not aiming for “less investment”, that’s aiming for less wasteful investment.
I am not suggesting that public investment should be zero. By all means continue doing public investments that pass cost/benefit tests. But that will not include more bridges in Guizhou province, an area that is already absurdly overbuilt. (And many “public investments” could be done by the private sector—look at Hong Kong’s excellent subway system.)
To summarize, much of the debate conflates unrelated concepts. Pundits conflate nominal demand and real demand. They conflate monetary and fiscal stimulus. They conflate public and private investment. They conflate consumption with aggregate demand.
Sorry, but “More consumption!” and “More investment!” are meaningless slogans. The real issues are using monetary policy to assure nominal stability, and moving to a more market oriented economy to insure economic growth and higher living standards for the future.
If you want a simple slogan, here’s something that all sides should be able to agree upon:
More Chinese consumption in the year 2040!!
PS. Here’s China Daily:
Guizhou is home to 49 of the 100 tallest bridges in the world, including four of the 10 tallest, the commission said. Four bridges in the province have won the Gustav Lindenthal Medal, one of the most prestigious bridge construction awards in the world.
Check out the link. They sure built some beautiful white elephants in Guizhou province, a poor mountainous backwater in China’s interior. Imagine being told that West Virginia had 49 of the world’s 100 highest bridges. Might you suspect a bit of pork barrel politics?
READER COMMENTS
Thomas Hutcheson
Sep 3 2023 at 9:56am
This is the way I reached to Tyler in my “Radical Centrist” SubStack:
Cowen is spot on. The idea that “China needs more consumption” on its face does not make much sense.
But just agreeing 100% with someone, especially someone who needs no “support” from a Substack writer with a minuscule audience compared to Cowen, would be a great waste of time. Instead, let me agree 98% and try to find some sense that could be made of the statement.
Geopolitical. Maybe the concern is that continued rapid growth of China will enable/facilitate greater influence of the CCP on other nations. Chinese people do not value CCP influence on other nations and would prefer more consumption
“Keynesian.” Maybe the concern is that there are many unemployed resources that can be more easily (only?) employed in producing consumption goods instead of investment goods. Policy should shift demand toward more consumption.
Mis-perceptions. Maybe the concern is that people are mistakenly concerned about their future economic prospects, e.g. that their incomes after their income earning years will be low, and are saving more than they need to. They would be better off if they consumed more now and less later.
Low rates of return. Maybe the concern is that past high levels of investment have used up all the high-yielding (non-zero yielding?) investment opportunities. More consumption has zero opportunity cost.
Forced saving. Maybe the concern is that policy (some combination of taxation and public expenditure) has suppressed certain kinds of consumption and shifted those resources to investment. Without the policy “error” there would be less forced saving and more consumption.
Consumption vs Consumption* Maybe the concern is that the CCP does not allow as much of some kinds of consumption*, e.g. healthcare, that people wish, so their consumption is deflected to other things of lower value. Therefore China needs more consumption*.
Unlike Scott, I have zero specialized knowledge of China, but the “’Keynesian’” and “low rate of return” ideas strike me as quite implausible. The others may be valid, but “more consumption” is the best way to express any of them.
Philo
Sep 3 2023 at 12:38pm
“In a healthy economy, only productive investments are undertaken.” OK, we get the point, but you might want to insert some qualifying phrase here.
Scott Sumner
Sep 3 2023 at 10:37pm
Good point. I should have suggested “only investments expected to be productive.”
That was sloppy wording on my part.
vince
Sep 3 2023 at 1:46pm
Interesting. Looking at infrastructure, China has too much investment and the US has too little investment.
Jim Glass
Sep 3 2023 at 1:56pm
The US Ambassador to Japan, Rahm Emanuel (former Chief of Staff to President Obama), this past week made a couple, um, candid and forthright public statements about China. Rahm has a longstanding well-earned reputation for being ‘candid and forthright’, and he does not disappoint!
https://www.youtube.com/watch?v=K-TvLExjUh8&t=526s
Go! Rahm! Go! (Context for the larger discussion?)
Scott Sumner
Sep 3 2023 at 10:42pm
He makes good points about China’s mistakes, but glosses over the US role in this mess. We’ve also abandoned the international trading system.
So we are the last country that should be throwing stones.
Ahmed Fares
Sep 3 2023 at 4:23pm
From an article by Michael Pettis titled: “The Only Five Paths China’s Economy Can Follow”.
https://carnegieendowment.org/chinafinancialmarkets/87007
Andrew_FL
Sep 3 2023 at 6:27pm
“Monetary stimulus” is not neutral towards investment-consumption trade off, or indeed towards profitable and unprofitable investment.
Scott Sumner
Sep 3 2023 at 10:38pm
I disagree, at least if it’s aimed at stable NGDP growth.
David S
Sep 4 2023 at 5:37am
Your suggestions for China are sensible. I put the odds of Xi implementing them at around 25% within the next five years. There is a chance that the next administration in China will implement some of them, but for now a tight money regime signals collective virtue.
I would also argue that bad policy on the part of the United States is contributing almost nothing to the economic problems that China is facing. We’re still buying stuff from them, but it seems to be less important to many businesses there than the trading volume with the rest of Asia and the EU.
Dan Meiers
Sep 4 2023 at 6:39pm
Scott, President Xi likes your “description of the sort of outcome that China should be aiming for” & adopts your framework 1, 2, 3, 4.
However President Xi maintains 2023 Capital Account policies forevermore.
This would be riding a bike with the hand brakes on, right?
Godfree Roberts
Sep 4 2023 at 7:55pm
Thank you, doctor, but the emergency has passed and no prescription will be necessary.
Upon closer examination, we discovered only four years in which an economy grew $1.5 trillion, and that was back in the go-go days.
This year, 2023, China’s economy will grow $1.5 trillion (5% x $30 Tn.), too. And in support of that, so will real wages – which 4.5% last year and are on track to repeat that this year.
So we can stop worrying about China’s economy and start focusing on catching up with China’s chip industry, which now turns out chips – with their own CPUs and 5G chips – that even Intel can’t match.
Scott Sumner
Sep 5 2023 at 2:27pm
Are those figures for nominal or real GDP?
Luis Pedro Coelho
Sep 4 2023 at 11:37pm
Even when it comes to housing, China could productively use large investments in better housing. In Shanghai, >90% of housing stock is really low quality (for the level of income—it’s funny to see luxury cars parked in front of housing that in the West we associate with run down public housing projects) and should be torn down and rebuilt. Ideally, the external architecture of some of the beautiful buildings (not all) should be kept, but the interiors need to be completely renovated. Too many places use old pipes so that no one drinks the tap water.
Of course, more residential towers that have poor noise and temperature insulation and will lack modern amenities are not the answer
David
Sep 5 2023 at 9:25am
“Less wasteful investment” is also a meaningless slogan. Who doesn’t want that? For me, Pettis and Klein’s consumption and investment share framework provides essential insight into China’s past economic performance and the constraints it is facing. Is it that you think this framework is wrong? Or you just object to the calls for “more consumption”?
Scott Sumner
Sep 5 2023 at 2:32pm
I don’t disagree with the claim that it would probably be better for China to have more consumption. But I don’t agree with all of their specific policy proposals. The main thing China needs is to move toward a more free market economy (including removing barriers to international trade and investment), not have the government try to manage the C&I shares of GDP.
Jim Glass
Sep 7 2023 at 12:30am
I agree with all four of your propositions — but they are not going to happen. Xi himself says so…
It’s remarkable how a one-party state so strongly believes spending best stays concentrated in the state (individuals being so fickle and hard to control). 🙂
The inimitable Kotkin, at Hoover, gives the best single conversational description I’ve ever heard about the nature of the CCP and why it must act as it does…
Stephen Kotkin on China: Unpacking the CCP, Communism, and US-China relations. Starting at minute 40:00: What US policy towards China should be. Counter-intuitive and optimistic. “Why are we afraid of Confucius Institutes? We should be opening them ourselves.” But also tough.
At minute 55:30: Cold War with China!
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