Louis Kuijs’ latest analysis seems to suggest – based on my reading — that three common perceptions of China are more myth than reality.
Myth one: foreign direct investment has been a big driver of China’s growth.
The reality: most investment in China has been financed domestically. FDI accounts for no more than 10% of total investment. That is consistent with the analysis in Goldstein and Lardy’s critique of Bretton Woods 2 as well. Obviously, that FDI is concentrated in China’s export sector, so foreign firms account for a much larger share of exports than of total investment.
Analysis based on the total amount of FDI may understates its impact, as innovations that start with foreign firms diffuse through the economy.
But there is little doubt that most investment in China is financed domestically. FDI this year will probably by something like $70b or so. That is small relatively to the $1300b in total investment that Stephen (a bit more bearish once again?) Roach expects in China this year.
Myth two: China’s state banks do little more than finance investment by China’s unprofitable state-owned enterprises.
The reality: There is some truth to the argument that state banks finance money losing state owned enterprises. But it also may be a somewhat dated argument that ignores some recent reforms. Jon Anderson of UBS consistently argues that there reforms have increased the profitability of (many) Chinese state firms. And Kuijs’ data suggests China’s increasingly profitable state-owned enterprises finance lots of investment out of their own retained earnings, without having to turn to the banking system. A surge in business savings, according to Kuijs, is why overall national savings have risen so strongly in the past few years. Some of that surge comes from a surge in private profits. But a decent chunk of it comes from a surge in the profits of state-owned companies. And rather than paying out dividends, state-owned enterprises plow their current profits into new investments.
Incidentally, some of the big state commercial banks seem to have been rather active in the mortgage market recently.
Myth three: China’s current account surplus comes from its demographics, not from its policies.
The reality: According to Kuijs, policies – not demographics – explain the recent surge in Chinese savings.
Kuijs highlights two sets of policies, both in his paper and in the earlier powerpoint. First, those profitable state enterprises need to start paying out dividends, not just empire building. Second, China shouldn’t finance large capital investments at the local level with revenues transferred from the center. This pushes up government savings. Far better for the government to finance a bit of health care – and start to provide some of the social services that now–profitable state-owned firms don’t want to provide.
I am probably stating Dr. Kuijs’ arguments a bit more starkly than he would, but that is one of the advantages of a blog – I can opt for a more provocative framing.
Kuijs isn’t the only one with interesting things to say about China recently – check out Yu Yongding’s latest paper.
You don’t have to read too far between the lines to figure out that Yu believes that China has put too high a priority on maintain a (de facto) exchange rate peg (and keeping domestic interest rates low to reduce incentives for money to flow into China) and too low a priority on other objectives. He thinks China needs tighter monetary policy and looser fiscal policy (seems right to me) – and realizes such a policy mix is inconsistent with targeting a weak RMB. He isn’t quite that blunt: he just notes “the multi-objectives of China’s monetary policy have deprived the ability to the PBOC to implement a relatively tight monetary policy” … and calls for “reform” to “China’s macroeconomic management regime.”
Kuijs doesn’t really discuss monetary policy. But there is one point of disagreement between Yu and Kuijs. Kuijs emphasizes the growth in Chinese corporate profitability over time – and the failure of Chinese firms to distribute retained earnings. Yu thinks corporate profitability is now falling, as big increases in input costs have not been passed on. But a host of factors – liquid banks, ambitious local governors and the like – have led investment growth to accelerate even as corporate profitability falls (see p. 17 of his paper).
They may be looking at the data over different time frames. Or they may be looking at different sets of data. No one seems to have a great grip on how profitable Chinese state firms really are. Or what exactly should count as a state-owned firm. Stephen Roach:
China, however, is far from a normal economy. Despite over a quarter century of impressive reforms, it remains very much a "blended" economy — a mixture between state- and privately-owned enterprises. While the ownership balance continues to shift dramatically away from the state, the latest statistics put state-owned enterprises at about 35% of Chinese GDP. Moreover, that share undoubtedly understates the degree of state control in the newly privatized — or "corporatized" in Chinese parlance — segment of the economy. Even after public offerings, the state still maintains sizable majority ownership stakes in most of its so-called publicly-listed, privately-owned companies.
I know enough to have an informed view about capital flows into China, and Chinese reserve growth. But not enough to have an informed view on current levels of Chinese corporate profitability.
Do read Kuijs, Yu and Roach. I'll probably have more to say about Yu's paper later.