This is Getting Tiresome, So Please Let’s Declare the Crisis Over

I guess there is nothing like a summit meeting in the sunshine island of Hainan to bring out our optimism, but the speakers at the Boao Forum over the weekend seem to have been in fierce competition to see who could more forcefully declare the global economic crisis over, at least for China. One probable result of the forum, and Wen Jiabao’s comments that the stimulus has shown “better than expected” results, was that today the SSE Composite rose for the first time in three days, by a juicy 2.14%, to close at 2557.

During the forum SASAC chairman Li Rongrong said that more than 170 companies directly controlled or owned by the central government saw profits grow 26 per cent last month from a year earlier. According to an article in today’s South China Morning Post:

Revenue was down 5.4 per cent last month year on year, but was 25 per cent higher from a month earlier. Mr Li attributed the marked improvement to the 4 trillion yuan (HK$4.54 trillion) stimulus plan, which helped state companies spanning the banking, telecommunications, petroleum and petrochemicals sectors weather “a deep winter”.

Economists, who drew attention to other macroeconomic indicators, said the higher profitability of state firms added to anecdotal evidence that the worst of the financial crisis might have passed.

Former US presidential advisor John Rutledge put in a good showing for the US when he said, according to an article in today’s Xinhua, that “the worst of the financial crisis is finished, and the world is entering the time when things will get gradually better.” (I assume “getting better” doesn’t mean unemployment will decline, since most evidence is that, at least in China and the US, unemployment will continue rising through the end of this year) He added:

The recession in China has already “passed the bottom”, while the recession in the United States is “at the bottom”, he said while describing the current global economic condition. “The capital markets around the world are recovering very nicely,” he said, adding that the real economy and paycheck have not yet hit the bottom, but “very near bottom”, and will most certainly be improve by the end of the year.

He is more optimistic about the prospect of China’s economy, as he is likely to raise the forecast of China’s economic growth rate in 2009 between 6 percent and 8 percent. “I think the recent signs suggest the number is too low,” he said, referring to his previous forecast between 5 percent and 6 percent.

I guess it is hard to take forecasts seriously when they seem to fluctuate so directly with the most current numbers, but given the history of previous long crises – everyone of which had more than one temporary rebound, sometimes very sharp, on the way down – I would be reluctant to declare my optimism without a lot more data and a real sense that the underlying imbalances had truly been resolved.

I am pretty sure this hasn’t happened yet. On the contrary, I would argue that the temporary “rebound” (which seems more to be a slowdown in the rate of contraction than a real rebound) has probably been caused by little more than policies aimed at temporarily exacerbating the imbalances, and as such they are unlikely to have a long term impact.

In that light a friend sent me information reported in an April 15 article (“Henan: 1 trillion investment to create 650,000 jobs”) in the 21st Century Business Herald, a leading local business paper, that Henan province will be receiving RMB 1 trillion as part of the stimulus package and, according to the Henan Development and Reform Commission’s calculations, these key projects will only generate 650,000 jobs. Aside from the fact that the combined announced spending in the various provinces seems substantially to exceed the declared stimulus package, this really isn’t a lot of jobs for a province the size of Henan.

More worryingly, I work out that if the money was just spent on workers to give them wages of RMB 3,000 a month (probably more than twice what migrant workers make and a decent salary for college graduates in Beijing), RMB 1 trillion could pay salaries for 650,000 workers for 43 years.

This is not an efficient way to generate jobs. If these numbers are even vaguely correct it suggests that far more of the money is going into manufacturing and infrastructure investment than into job generation. This is not going to boost consumption by much in the short term and may boost production by at least as much, leaving unresolved the question of who is going to absorb the excess capacity if the US is not longer willing to play the role.

Fiscal deficits

Today’s South China Morning Post also has a senior Chinese official reporting the bottom of the crisis, but perhaps with a lot more realistic expectations about the duration of the contraction. According to the article:

Mainland’s economy is bottoming out, which will pave the way for needed reform of the resources tax, Jia Kang, head of research at the Ministry of Finance, wrote in a commentary in the official China Securities Journal on Monday. Meanwhile, the government should decide to implement further expansionary policies by the end of June, at the latest, if data for the second quarter turns out to be worse than expected, Jia said. Although mainland’s economy may begin to recover later this year, growth is expected to remain low for three years, while the cycle for expansionary economic policies may last five years, Mr Jia said.

Separately, the head of a government think-tank warned that risks to official budget projections were more acute after the first quarter in which fiscal expenditures rose by 34.8 per cent while revenues fell by 8.3 per cent. The government’s forecast of a 950 billion yuan (HK$1.07 trillion) deficit may prove too small should these trends continue, Pei Changhong, head of the Institute of Finance and Trade Economics in the Chinese Academy of Social Sciences, was quoted as saying in the China Securities Journal.

Meanwhile, far from Hainan in the run-up to the closely-watched Shanghai Motor Show, the chairman of Chinese auto giant Geely, Li Shufu, was casting a skeptical light on one of the most trumpeted pieces of evidence of Chinese recovery, the pick-up in auto sales. I have already indicated a few times my skeptical reading of the numbers. According to an article in today’s Financial Times:

The first-quarter recovery in China’s motor industry could prove only temporary, Li Shufu, chairman of Geely, one of China’s largest private carmakers, has told the Financial Times.

…Commenting on China’s unexpectedly strong first-quarter car sales – which made it the world’s largest light vehicle market for the first time in history – Mr Li pointed to government stimulus measures including tax cuts and subsidies for rural buyers. Last month’s 10 per cent rise in passenger vehicle sales “is driven by a temporary policy” and represents “superficial growth”, he said, noting that “only a strong recovery of the economy can help the Chinese auto market”.

JD Power, the car consultancy, predicts that Chinese passenger car sales will be flat in 2009. Such sales rose only 2.8 per cent in the first quarter, according to Mike Dunne, of JD Power in Shanghai. Most first-quarter growth came from mini commercial vehicle sales, he noted, adding that “for China to get back on track and gather sustained momentum, exports and foreign direct investment must recapture their previous strength and that’s just not there yet”.

More worrying, if you believe, as I do, that the fiscal response to the crisis may temporarily slow down the pace of contraction while making the ultimate cost deeper, was an article in Friday’s Economic Observer, one of my favorite Chinese business weeklies.

New loans in China for the first quarter of this year would amount to nearly 4.6 trillion yuan, but behind the staggering figure, millions of small and medium-sized businesses nationwide were still struggling to raise funds. Data from the National Association of Industry and Commerce (NAIC) showed that in January of this year, private firms had 421 billion yuan in short-term loans, a 700 million yuan decrease from December 2008. That was despite 400 billion yuan in new short-term loans released that month.

According to Chen Yongjie, an official with NAIC, the central government had become anxious to deal with the issue, with China’s Banking Regulatory Commission taking measures to ease borrowing for small and medium-sized businesses. But, despite the efforts, loans to them were still plummeting

The article goes on to discuss problems facing SMEs and quotes Meng Fu, chairman of the NAIC, as arguing (very correctly, in my opinion) that “small and medium-sized companies should receive a greater share of the distribution of national financial resources because they were not only the driving force of economic growth, but also the key to reducing unemployment, improving people’s welfare and increasing social stability, more so than so-called large projects worth billions in investment.”

The Chinese government has recently pushed measures to solve financing problems for small and medium-sized businesses – for example, China’s Banking Regulatory Commission has required banks to open loan departments exclusively for small companies.

But Chen said it was hard to tell how effective these measures would be: “What we can see clearly now from the statistics, is that loans for small and medium-sized businesses are still dropping.”

I think it is definitely not a good thing for China’s medium- and long-term growth that one of the consequences of the fiscal stimulus is an increasing role for state-owned enterprises and public investment and a relative decline in the SME sector. I don’t think I have previously mentioned Yasheng Huang’s very thoughtful and surprising book, Capitalism with Chinese Characteristics, in which he argues that following a period of real reforms that encouraged the development of SMEs and saw a huge increase in Chinese productivity, since the early mid-1990s there has been a refocusing on the state-sector, and a corresponding decline in productivity growth, but anyone who has read it will be struck by this trend.

Oh God make me chaste, but not yet

What does this grab-bag of stories add up to? The point I want to make is that if the purpose of the stimulus package is temporarily to slow the rate of contraction, it will probably succeed. This may be an important result. On Tuesday when I as being interviewed on CCTV 9’s Dialogue, I suspect host Tian Wei was a little exasperated by my unrelenting pessimism about economic prospects and asked “So should the government do nothing? Doesn’t it have to do something?” (I am paraphrasing).

Of course it does, and I am not criticizing it for making stupid moves. As I argued on the program, the government is faced with a tough choice between measures that boost employment and spending in the short term but may exacerbate China’s difficulties over the longer term and measures that speed up the pace and quality of China’s transition but may result in unacceptably high unemployment in the short term.

They seem to be doing the former, and I cannot complain or criticize since this is a political decision and not an economic one. The point, however, is that the paths facing China are not one leading to economic contraction versus another leading to economic recovery. The paths as I see it lead either to a very deep, short-term contraction followed by a healthy and balanced recovery, or to a slow contraction that may take many years and may result in much slower productivity growth over the next decade or so – perhaps we could call it a US-style crisis versus a Japanese-style crisis.

“When you come to a fork in the road, take it,” advised Yogi Berra. I think the discussion between the two paths is probably at the heart of the debate in Zhong Nan Hai and elsewhere. The Economic Observer had a recent editorial (“A shift is needed, but not overnight”) about a policy piece written by Chen Deming, head of China’s Ministry of Commerce, in which it is pretty clear that Mr. Chine is responding, perhaps with a bit of frustration, to precisely this argument.

Recently, Chen Deming, head of China’s Ministry of Commerce, wrote in the Communist party magazine Qiushi that China needed to stimulate domestic consumption by promoting foreign exports. He came down against certain common opinions in China, including that the country relied too heavily on exports, stressed that although a withering global market has sapped demand for Chinese goods, it has also presented great opportunities. Chinese enterprises needed to actively head abroad under such circumstances, and thus promote Chinese exports, he concluded.

In the past few years, the government has long sought to transform the economy from a export-oriented model to a consumption-oriented one, while the Ministry of Commerce strove to reduce the trade surplus. But the economy’s restructuring could not be completed within one day, and a consumption-oriented economy never meant wholly abandoning foreign trade. Eagerness for an overnight success could only lead to adverse consequences. In this sense Chen’s article reflected a realistic attitude.

The editorial goes on to say (via some wobbly translation):

We believe this was a positive sign that the Chinese government has a deep understanding of the necessity of economic transformation, and that the consumption-oriented model would remain the core of future policy. At the same time, it also meant China understood it needed to be patient throughout the process

…But it was also clear that China’s direction was still a consumption-oriented need. As Chen said, expanding the domestic market would be slow and limited should we rely only on its own cycle. Maintaining foreign demands would actually buy time and earn resources for economic development, create wealth, as well as provide sufficient capital for China’s social welfare net, all foundations for economic transformation.

So, the current logic behind improving exports was different from that of some years ago. Even if we are successful in expanding the international market, we would face more international trade protectionism without expanding the domestic one. In the meantime, if the RMB exchange rate remained under control, China’s foreign reserves would continue to balloon. China would be bothered by its 2 trillion US dollars foreign currency reserves, and only sink deeper would probably mire in a dilemma if that continued to expand.

Caijing also had a similar worried editorial last week, in which “Caijing’s chief economist Shen Minggao warns that without structural change of the economy, the recovery will only be temporary.”

This debate is likely to remain at the heart of policymaking for a long time. It looks, however, like Beijing has at least for now decided clearly which path it will take, notwithstanding the brutal criticisms I have delicately referred to in the past from some of China’s more independent think-tankers. China is not likely to collapse economically, and we may see one or more “rebounds” over the next few years, but the glory days of growth are well and truly behind us until, I suspect, the financial system is sufficiently reformed that it leaves behind governance constraints that almost automatically assure systematic and massive capital misallocation. That will take many years. Meanwhile the transition to a healthier and more balanced economy – which was slated to be long and difficult in the best of cases – is likely to be longer and more difficult as a consequence of the fiscal and banking response to the crisis.

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About Michael Pettis 166 Articles

Affiliation: Peking University

Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups.

Visit: China Financial Markets

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