GK Seminar HK Arthur China

8/3/2019 GK Seminar HK Arthur China

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What, me worry?Why China can keep on going

September 2011

Arthur KroeberManaging director, GK Dragonomics Research

Editor, China Economic Quarterly


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1. Chinas economy is an unsustainable investment

bubble2. Chinas housing market is an unsustainable

investment bubbleghost cities prove it

3. Chinas investment is financed by an unsustainable

and rapidly rising public sector debt4. Chinas growth is dangerously unbalanced and

there is not enough consumption

5. China is running out of surplus agricultural labor

6. Chinas growth is about to slow sharply because ofthe middle income trap

2

Six crises: the bear case


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1. Investment bubble?

Fact: Chinas capital stock is very low2. Housing bubble?

Fact: China has a severe urban housing shortage

3. Too much debt?

Fact: Sovereign debt load is manageable andfinances productive investments

4. Not enough consumption?

Fact: China has the fastest growth in per capitaconsumer spending in world history

5. No more workers?

Fact: Rural-urban labor transfer has a decade to run

6. Middle income trap?

Fact: There is no middle income trap

3

An answer for everything


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4

More investment needed (1)Chinas per capita capitalstock is far belowdeveloped country levels.

Chinas physical capitalper head is about the sameas Japans in 1970.

It is less than half thatachieved by the US at thebeginning of the GreatDepression.

It is less than one-fifththat of Japan at thebeginning of its bust in1990.

China needs to invest a lotmore before it achieves

developed-country status. There is no evidence thatChina is over built.

4

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

2010 2010 1930 2009

China China at PPP US

Capital stock per capita in China and the US

US$ at constant 2005 prices

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

2010 at PPP 1971 at PPP 1990 at PPP

China Japan

Capital stock per capita in China and Japan

US$ at constant 1990 prices


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5

More investment needed (2)Chinas investmentefficiency is well withinthe normal range.

There is no evidence tosupport claims that Chinasinvestment is in aggregatewasteful and inefficient.

For most countries, theratio of capital stock toannual GDP (capital-output

ratio or COR) is between 2and 3.

Chinas is now at 2.4,boringly middle-of-the road,and substantially lower thanthat of the US, which isaround 3.

The increase in Chinascapital-output ratio since1980 is also a normal signof capital deepening, andmuch smaller than theincreases in other Asiancountries.

5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

China Philippines Taiw an Indonesia Thailand S outh

Korea

Japan

Capital-output ratios in Asia

Net capital stock relative to annual GDP, at current prices

1980

2007

0.0

0.5

1.0

1.5

2.0

2.5

3.0

China's capital-output ratio

Net capital stock relative to annual GDP, at current prices


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6

6

Chinas housing marketis in shortage, not bubble.

Of Chinas 225m urban

households only 150m areadequately housed.

China still must house 1/3of existing urbanhouseholds (75m), plus100m new urbanhouseholds to be created

over the next 20 years.

After accounting fordepreciation, this impliesannual housing completionsmust average about 10m ayear for the next 20 yearsvs 6m/yr in 2000-08.

Many cities are buildingahead of this demand -creating ghost cities. Butthese are just Chinasequivalent of 1950ssuburban Levittowns.

Housing shortage (1)

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0

50

100

150

200

250

300

0

50

100

150

200

250

300

1998 2005 2009 2015f

Housing stock vs urban households, in m units

Urban

households:

migrants

Urban

households:

natives

Units of

independent

housing


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7

7

Housing shortage (2)

57.1%

19.3%

18.8%

3.9%0.9%

Migrant worker accommodation by type

share of total

Employer-supplied housing

Shared rental

Self rental

Other

Own home

Few migrants ownhomes.

The vast majority of the

unhoused are recentmigrants from rural areas,who account for about onequarter of urban households.

Only 1% of migranthouseholds own their home.Most migrants live in

employer-supplied housingin factories or on work sites.

Meeting migrant demandfor housing will require alarge increase in the supplyof both purchase and rentalunits.


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8

Public debt burdenPublic debt burden ismanageable, even after2009-10 stimulus.

Pre-stimulus, public debtwas stable at 80% of GDP.

Explicit liabilities of thecentral government werejust 26% of GDP in 2010.

Local government debt

jumped from 17% of GDP in2008 to 36% in 2010.

But the contingent liabilityfrom bank NPLs has shrunkdramatically.

90% of other financialsector debt is PBC

sterilization bills and policy-bank bonds; neither willlikely cause a direct liabilityto the central government.

Unlike US/Europe Chinasdebt finances economicallyproductive infrastructure.

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

China's public debt as share of GDP

Financial sector

NPLs on bank balance

sheets

Local gov't

Central gov't


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9

Strong consumption (1)Consumption growth isvery robust.

Critics focus on the private

consumption share of GDP,which fell from 46% in 2000to 33% in 2010.

Yet during the sameperiod, real per capitaconsumption growthaccelerated from 7% p.a.

to 10%.

Chinas per capitaconsumption growth overthe past decade is almostcertainly the fastest everrecorded by any nation.

The falling consumptionshare of GDP is a naturalphenomenon during asuccessful industrialization.

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5%

10%

15%

20%

20%

25%

30%

35%

40%

45%

50%

1996 1998 2000 2002 2004 2006 2008 2010

China's consumption paradox

Private consumption share of GDP (lhs)

Real growth in per capita private consumption, 3yma (rhs)


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10

Strong consumption (2)The fall in Chinas consumptionratio is similar to that of otherAsian success stories.

The fall in Chinas consumptionratio since 1990 is about the sameas that experienced by Japan in1995-70, and much less than thatof South Korea in 1975-90.

Consumption ratios normallywhen countries transition from

agriculture to industry, becausecapital earns a greater share ofnational income.

Even the US saw a 25pp fall in itsconsumption ratio from 1900-1950.

The only thing unusual aboutChina is how low its consumptionratio was when it startedindustrialization in 1980.

This is a legacy of the communistsystem, which suppressedconsumption, and may also reflectmeasurement problems.

10

-25

-20

-15

-10

-5

0

T T+10 T+20 T+30 T+40 T+50

Decline in consumption share of GDP after take off

percentage points

Japan (T=1955)

China (T=1990)

South Korea (T=1975)

India (T=2001)

30%

40%

50%

60%

70%

80%

90%

100%

1955 1965 1975 1985 1995 2005

Consumption ratios in major Asian economies

Private consumption share of GDP

India

Taiwan

Japan

South Korea

China


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11

Lots more workersChina still has plenty ofagricultural labor waiting tomove to the modern economy.

By our estimate (lower thanofficial figures), about 34% of thecurrent Chinese workforce (268mpeople) is employed in agriculture.

China has achieved faster growth,with less rural-urban labor transfer,than S. Korea or Taiwan.

China has a higher share ofworkers in agriculture than didJapan, S. Korea and Taiwan at acomparable stage of development.

Growth in those countries did notslow until the agricultural share ofemployment fell to about 20%.

Based on NE Asian precedentsChina can still plausibly enjoyanother decade of high-speedgrowth based on transfer ofworkers from traditionalagriculture to the modern urbaneconomy.

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0%

10%

20%

30%

40%

50%

60%

70%

At $2,000 per capita GDP At $7,500 per capita GDP

Share of workforce in agriculture

China

South Korea

Taiwan

Japan

0%

10%

20%

30%

40%

50%

60%

70%

80%

0 5 10 15 20 25 30Shareofworkforceinagriculture

Per-capita GDP, 000 US$ PPP

Agriculture and development in Asia

China 1980-2009 South Korea 1963-2005

Taiwan 1963-2005 Japan 1953-1990


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12

Middle income trap (1)Actually, there is noevidence for a middle-income trap.

Our survey of 96economies since 1970shows that 80% ofcountries that started poor(


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13

Middle income trap (2)Will China be more likeJapan/Korea, or morelike Thailand/Malaysia?

In Japan, catch-upgrowth slowed at 75% ofUS p/c GDP and stopped at90%. In Korea/Taiwanslowdown started at 55-60% of US GDP.

China is only at 20% of

US GDP, suggestinganother decade or two offast catch-up growth ispossible.

But there is some riskthat it will followThailand/Malaysia, whose

convergence slowed at30% of US p/c GDP.

However Chinasindustrial structure andpolicy system much moreclosely resemble NE Asianmodels than SE Asian.

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0

10

20

30

40

50

60

70

80

90100

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Asia's partial catch up:

Percentage of US per capita GDP at PPP

Japan

Taiwan

South Korea

Malaysia

Thailand

China

India


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14

Middle income trap (3)There is no pattern towhen catch-up growthstops.

Historically, the slowdownin catch-up growth startsanywhere from 20% of USp/c GDP (Thailand) to 80%(Finland).

China has just begun toenter the very broad range

where slowdown becomesmore likely.

The average slowdownthreshold is 55% of US p/cGDP, suggesting Chinacould have a continuedlong run of catch-up

growth.

14

0

10

20

3040

50

60

70

80

90100

1952 1960 1968 1976 1984 1992 2000 2008 2016 2024 2032 2040 2048

Which threshold will China hit?

Levels of per capita GDP (% of US) where catch-up slowed


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Our exhaustive review of the evidence suggests

that, with sensible policies, China can reasonablyexpect at least another decade of high-speedgrowth.

But high-speed means average real GDP growthof 8% in 2011-2020, vs 11% in 2003-2010.

Meanwhile, structural CPI inflation is rising becauseof an inexorably tighter labor market. In 1997-06CPI inflation averaged 1%; in 07-11 (excluding 09),it averaged 5%.

Slower growth and higher inflation mean thatcapital must be allocated more efficiently. This isespecially true in light of the stimulus hangoverof increased debt.

15

Nothing to worry about? Well


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16

Credit over-easyDeleveraging needed.

Between 2008 and 2011total credit soared from

117% of GDP to 160%.

Much of the increasecame from off-balancesheet shadow banking,which rose from a stable18-20% of GDP in 1997-2008 to 42% in 2011.

China shadow bankingis mainly dressed-up banklending, rather than therisky leveraged derivativeproducts in pre-2008 USshadow finance.

China successfullydeleveraged in 03-08,thanks to nominal GDPgrowth of 18% p.a.

With slower GDP growth,the next deleveraging willrequire greater capitalefficiency.

16

80%

90%

100%

110%

120%

130%

140%

150%

160%

170%

1997 1999 2001 2003 2005 2007 2009 2011e

China bank loans and total credit% of GDP

Total credit

(incl 'shadow

finance')

Bank loans


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Structurally, there is no reason why China cannot

achieve average 7-8% growth, with average 5%CPI inflation, over the next decade.

This performance would be about the same asJapans in the 1960s and South Koreas in the 80s.

Financial sector reform to improve the efficiency ofcapital is essential to long-run (post 2020) growth.

But financial reform would also attack one of thekey pillars of Communist Party rule.

If China grows without financial reform anddeleveraging in the next decade, the 2020s couldbe a replay of Japans 1990s.

But if it does deleverage, then the 2020s could seea solid average growth rate of 5-6%.

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Concluding thoughts


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GK Dragonomics, a GaveKal company, is an independent research and advisoryfirm specializing in Chinas economy and its influence on Asia and the world.

www.gavekal.com

www.dragonomics.net
http://www.gavekal.com/http://www.dragonomics.net/http://www.dragonomics.net/http://www.gavekal.com/

GK Seminar HK Arthur China

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