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The good and bad news in the World Bank’s China Quarterly

by Brad Setser
June 21, 2009

The good news in the latest World Bank China Quarterly:

One. China is growing, thanks to China’s government. The World Bank estimates that the government’s policy response will account for about 6 percentage points of China’s 7.2% forecast growth (p. 8). That’s good. There is a big difference between growing as 7% and growing at 1%. This was the right time for China’s government to “unchain” the state banks. Ok, it would have been better if China had allowed its currency to appreciate back in late 2003 and early 2004 to cool an overheated economy instead of imposing administrative curbs on bank credit and curbing domestic demand. Then China might not have ever developed such a huge current account surplus and avoided falling into a dollar trap. But better late than never: this was the right time to lift any policy restraints on domestic demand growth.

China has, in effect, adopted its own version of credit easing. It just works through the balance sheets of the state banks rather than through the balance sheet of the central bank. Andrew Batson:

By some indicators, credit in China is even looser than in the U.S., where the Federal Reserve has extended unprecedented support to private markets. … China’s methods for pumping cash into the economy are quite different from those of other major economies. Its banks, almost all of which are state-owned, made more than three times as many new loans in the first quarter as a year earlier. Central banks in the U.S., Europe and Japan lack such control over lending, and have instead used extremely low interest rates and direct purchases of securities to support credit.

Two. China’s fiscal deficit will be closer to 5 percent of GDP rather than 3 percent of GDP. That’s cause for celebration in my book. Last fall I was worried that the desire to limit the fiscal deficit to three percent of GDP would mean that there was less to China’s stimulus than met the eye (or hit the presses). I was wrong. If the likely future losses on the rapid expansion of bank credit are combined with the direct fiscal stimulus, China almost certainly produced a bigger stimulus program than any other major economy.

Three. China’s current account surplus is now projected to fall in 2009. Exports still haven’t picked up — and we now have data through the first five months of the year. Imports by contrast are starting to pick up. That shows up clearly in a chart of real imports and real exports, a chart that draws on data that that the World Bank’s Beijing office generously supplied me:

china-world-bank-q2-09-1

Some of that is commodity stockpiling and thus not a reflection of underlining demand. And some stockpiling sounds a lot like simple speculation. But let’s set those debates aside for a bit.

In dollar terms, China’s 2009 current account surplus will be a bit smaller than its 2008 surplus (The World Bank assumes that China’s trade surplus in the last half of 09 to be significantly smaller than its surplus in 08, as the surplus was up in the first five months of 09). And since the fall in commodity prices would be expected to push the surplus up, all other things being equal, that indicates a real shift in net exports. Net exports, according to Dr. Kuijs of the Bank’s Beijing office, will subtract about 2.5% from China’s overall GDP growth in 2009.

The not-so-good news:

One. It isn’t clear that China has put in place policies that will bring about a sustained rise in domestic consumption. The stimulus has worked by pumping up investment, especially state investment. And investment already loomed large in the national accounts. Olivier Blanchard:

“In response to the crisis, China has embarked on a major fiscal expansion, with a focus on investment rather than on consumption. This was the right policy given the need to increase spending quickly, but this increase in investment can only last for a while. The question is whether, as time passes, China will allow an increase in consumption.”

Two. The negative drag from net exports stems from a faster fall in real exports than in real imports, not a rise in real imports that exceeds the rise in real exports. For the year, real exports are forecast to fall by 10% and real imports by almost 5%.

If China’s exports fall faster than global demand, that opens up space that allows others to cut back less. The alternative — fast Chinese export growth amid a shrinking global economy — would be a sure source of trouble. But China still isn’t really acting as a locomotive for overall global demand growth.

Three: Real imports of manufactured goods are still down 16% y/y. The rebound in Chinese imports has been driven entirely by the rise in commodity imports; real imports of primary products were up 17% (y/y) in April.

china-world-bank-q2-09-2

Back in 2003, when China was going through another lending boom, real imports of all kinds were up way more than they are now. Of course, back in 2003, China’s export sector was also booming and that pulled in imports for the “processsing trade.” The comparison isn’t perfect. But it does highlight how different China’s current lending and investment boom is from past lending and investment booms.

Part of the explanation for the weak rebound in Chinese demand for manufactures is no doubt weak demand for exports, and thus weak demand for imported components.

And part of it is that there is plenty of spare capacity in China to meet a surge in Chinese demand. For say cars. Chinese auto sales may top US auto sales this year – and China seems able to meet that rise in demand without importing a lot of finished cars or auto parts.

But part of it seems to be that Chinese consumers are less interested in Western — or even Korean and Japanese– brands. Maybe Chinese consumers concluded that if foreign banks weren’t better than Chinese banks, they shouldn’t assume that foreign goods were better than Chinese goods.

And China’s government also seems particularly keen on making sure China’s stimulus is spent in China. Jamil Anderlini reports: “Beijing said government procurement must use only Chinese products or services unless they were not available within the country or could not be bought on reasonable commercial or legal terms.”

Kind of risky for a country that still exports way more than it imports.

But it shouldn’t be a total surprise. The usual argument for why China would keep its exchange rate undervalued even though the undervalued exchange rate meant that China was overpaying for foreign assets and thus would eventually take losses was that China needed to keep up Chinese employment, and this was a way to do so. And don’t forget, the undervalued renminbi has encouraged jobs through import substitution – not just the expansion of China’s export sector. China’s hasn’t been interested in undistorted trade; it has been interested in using trade to support domestic activity in China. It isn’t a huge jump then to see why China might want to make sure that its domestic stimulus creates, in the first instance, as many Chinese jobs as possible.

But it does suggest that China’s commitment to say the G-20 is limited. Just giving China a seat at the international negotiating table won’t necessarily change China’s policies.

All in all, I would say the good trumps the bad. But real problems will come if China’s buy China policy is still holding down Chinese demand for the world’s goods when global demand for Chinese goods returns; rising exports and still stagnant manufacturing imports from the world’s biggest surplus country wouldn’t be terribly popular globally.

60 Comments

  • Posted by Twofish

    bsetser: tell what the us would sell to the world to cover its imports of autos, oil and (many) electronics?

    Management services, design, and technology. The autos would be designed in the United States and manufactured overseas for the China market. The Chinese auto market is now larger than the US auto market and growing rapidly. Manufacturing cars in Shanghai for the Chinese car market, makes is possible to pay people in Detroit.

    Also I said that General Motors will end up overseas, I didn’t say that US auto manufacturing will end up overseas. Toyota and VW can open plants in non-union states in ways that GM can’t.

    bsetser: At the end of the day, trade flows have to roughly balance (i.e. it is a real trade of one good for another, or a service for another).

    They really don’t. International trade is taking on the characterstics of intra-state trade, and there is no particular reason that trade flows between say Michigan and California have to balance. Especially since all the money is in cyberspace anyway.

    bsetser: Otherwise one country simply ends up running up deficits and ultimately debt in a way that isn’t sustainable.

    If the money is recycled in a way such that the debt produces higher returns than the real interest payments on the debt, then you have a situation that is sustainable, and that’s not terribly difficult since the long term returns on Chinese reserves is negative.

    For Chinese exports to grow 30% y/y is quite unsustainable, but there is a level of trade deficit that the US can run with the rest of the world that is sustainable,

  • Posted by Glen M

    TwoFish: Management services, design, and technology. The autos would be designed in the United States and manufactured overseas for the China market. The Chinese auto market is now larger than the US auto market and growing rapidly. Manufacturing cars in Shanghai for the Chinese car market, makes is possible to pay people in Detroit.

    That is the most ridiculous idea I have ever heard. China has no interest in creating any sort of employment opportunities for any other nation. China won’t pay a premium for the design of an iPhone, they will just make the HiPhone (look it up). They want to ‘invest’ in Canada’s oil sands, but use Chinese labour. Have a look at how well Chinese ‘investment’ in Africa is doing, where they import labour into countries that have 40% unemployment……..

    http://www.theglobeandmail.com/news/world/the-dark-underside-of-chinese-building-boom-in-africa/article1192825/

  • Posted by Thomas

    I recently spoke to a guy from Angola who said he can sort of understand why China sends its workers there. In his words: “They really work. Our people just want to loaf around. Preferably with good benefits, but if none are forthcoming, simply loafing around will do nicely.”

  • Posted by Thomas

    @twofish

    if I’m not mistaken, nearly all the design and research work for all mid- and small-sized GM models is currently done in Germany.

    Might not stay that way going forward, but it certainly isn’t the current core competency of GM US.

  • Posted by Thomas

    Regarding the drop in China’s imports:

    The Q1 country breakdown of Germany’s exports has finally come out. Exports have plummeted to all destination countries worldwide. Except exports to China, which dropped by a mere 3 % yoy.

    Seems to partially support the assumption that the import drop is mainly due to imported components for processing (imported from other East Asian coutnries) and lower commodity prices.

  • Posted by Glen M

    Thomas,

    I have read some reports that it is prisoners that are being sent to work. I don’t know if I believe it though. If so, is it any wonder they work so hard? There is also the issue of compensation. For 35 cents per hour there time would be better spent foraging for food.

    http://ipsnews.net/news.asp?idnews=46935

  • Posted by D Gross

    http://www.nst.com.my/Current_News/NST/Tuesday/Columns/2589079/Article/index_html

    Interesting op-ed in the Straights Times

    “Gloss cannot hide China Rot”

  • Posted by DOR

    Straights [sic] Times . . . interesting choice as a source of “information.”

    Read Zhao Ziyang’s memoirs, Prisoner of the State, for an insight into how hard it was for China to actually move onto the modernization and liberalization path. Put it in context.

    .

    When huge portions of US trade are within companies, the bilateral trade balance losing a lot of meaning. Sure, those few (9% of employed people, in straight-line decline since 1943) manufacturing workers still left would like to continue to live their old lifestyles. But, if they haven’t increased their productivity at a pace that compensates for their pay and benefits, they just have to do better.

    .

    Where’s the US consumers’ union in all this China trade talk?

  • Posted by Twofish

    Glen M: That is the most ridiculous idea I have ever heard. China has no interest in creating any sort of employment opportunities for any other nation.

    China has an interest in doing whatever is good for China. Having research and development done in the US ends up being good for China because a lot of the R&D that gets done in the US is or will be done by Chinese companies (see Lenovo) and by Chinese (see any graduate department of any American university).

    Glen M: China won’t pay a premium for the design of an iPhone, they will just make the HiPhone (look it up).

    Which is getting nowhere. You can’t have an innovation driven economy copying other people. You don’t build your economy by just copying designs, what the “big plan” is is to send your people to the best US universities and companies, and then after a few years they learn enough to help you. Given the number of Chinese engineers that work for Apple and live in California, China is getting a lot more supporting Apple than Hiphone.

    Glen M: They want to ‘invest’ in Canada’s oil sands, but use Chinese labour.

    The article quoted someone that was pretty clueless about the oil industry, this ain’t going to work. Canadians know more about oil sand than Chinese do.

    Glen M: Have a look at how well Chinese ‘investment’ in Africa is doing, where they import labour into countries that have 40% unemployment……..

    Which is a general problem with oil industries. Oil tends to be very capital and knowledge intensive, which means that if you are a third world country with oil deposits, surprisingly few people get hired. Look at Nigeria and see how many people are Nigerians. Then look at Norway and Alberta.

  • Posted by Glen M

    TwoFish:China has an interest in doing whatever is good for China. Having research and development done in the US ends up being good for China because a lot of the R&D that gets done in the US is or will be done by Chinese companies (see Lenovo) and by Chinese (see any graduate department of any American university).

    Yes, until doing so is no longer necessary. And as long as Michael Pettis is teaching in China, no one can ever say that a good education in economics is not available in China.

    TwoFish: You can’t have an innovation driven economy copying other people. You don’t build your economy by just copying designs, what the “big plan” is is to send your people to the best US universities and companies, and then after a few years they learn enough to help you. Given the number of Chinese engineers that work for Apple and live in California, China is getting a lot more supporting Apple than Hiphone.

    Conversely you can’t have a healthy economy when circumstances make it impossible to do nothing but design things.

    The Chinese labour for the oil sands comes from another article quoting a Chinese official.

    TwoFish: Which is a general problem with oil industries. Oil tends to be very capital and knowledge intensive, which means that if you are a third world country with oil deposits, surprisingly few people get hired. Look at Nigeria and see how many people are Nigerians. Then look at Norway and Alberta.

    It’s not just the oil industry.

  • Posted by Thomas

    @GlenM

    one of my wife’s university classmates works in Angola. He appears to be quite happy and is well paid (by Chinese standards). But of course he’s “management”, not “workforce”.

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