Will The Great Rebalancing Rebalance the Chinese Economy?

A word of warning: the following post may not be an accurate reflection of what Michael Pettis, a finance professor at Peking University’s Guanghua School of Management, actually intends to say. My own political-economics understanding is very limited, and misinterpretations in this post are therefore not unlikely. On the other hand, Pettis’ views certainly differ from what I get to read in most daily papers, and that’s why I’m trying to catch on.
It should be a good idea if you go there and check the consistency of this post with what Pettis actually says – JR.


China’s factory output shrank for an 11th straight month, Europe’s recession intensified and the manufacturing sector in the US had its weakest quarter in three years, the Guardian‘s economic editor wrote on September 20. Pressure was also mounting on Beijing for a fresh economic stimulus after the broad-based weakening in global demand continued to dampen export demand from China’s factories.

But not every economist is likely to endorse demands for another stimulus.

In July this year, Michael Pettis wrote that at least in June, previous interest rate cuts – or maybe just one of those – loan numbers finally surprised the market on the upside.

And that should be that, Pettis concluded:

[…] those calling for additional interest rate cuts and more rapid investment and credit expansion are wrong.  Why?  Because what is happening in China may be just what China and the world need.  After many failed attempts, over the past six months we may be seeing for the first time the beginning of China’s urgently needed economic rebalancing, in which China reduces its overreliance on investment in favor of consumption.

Pettis didn’t suggest that this was going to be easy, given high debt levels in China – but that in itself should encourage the rebalancing process now, rather than delay it, in his view. And rather than yet more investment (that’s what the previous stimulus packages were mainly about), at the cost of consumption, consumption itself had to rise.

The key to raising the consumption share of growth, as I have discussed many times, is to get household income to rise from its unprecedentedly low share of GDP.  This requires that among other things China increase wages, revalue the renminbi and, most importantly, reduce the enormous financial repression tax that households implicitly pay to borrowers in the form of artificially low interest rates. But these measures will necessarily slow growth.

To understand Pettis’ praise for the great rebalancing of China’s economy, it may be helpful to read one of his previous blogs, of May this year (but apparently also written in a newsletter weeks earlier), where he addresses the isssue of financial repression in China.

My understanding of these two blogposts by Pettis is limited – if you can add to it, so much the better. But I’m wondering if rising individual incomes would really lead to a significant rise in consumption. Don’t Chinese people have reasons to save still more, if their incomes increase – for their childrens’ (or, usually, their child’s) education, for their own retirement, etc.?

One of Pettis’ 2009 entries may provide some answers:

  • Chinese people feel poorer exactly when interest rates fall – because they save, and their means grow only slowly. Exactly that feeling of poverty would lead to – again – more savings.
  • Policies aimed at running trade surpluses is also implicitly aimed at raising the savings share of income. When you produce more than you buy, you won’t have spent all the production value on consumption – you are saving money.

Pettis re-stated his argument that Chinese policies were aimed at trade surpluses, and therefore made savings inevitable, in summer 2011. And he identified policies to the same end in Germany – including low interest rates, “set largely by Germany”, i. e. a country interested in such rates.

So this seems to boil down to the question if people in China – or Germany – would use their increased disposable incomes on consumption, or on still more savings (then at rather higher than lower interest rates). Saving money would become rather more than less rewarding – but given that Chinese (or Germans) would feel richer with their existing saving amounts, they might be more inclined to consume more. This would create Chinese demand for consumer goods made in China, and for consumer goods made abroad.

If current Chinese (and German) savings are really angst savings, Pettis could be right – provided that China (and Euroland) are good at implementing these “great rebalances”. But I believe that there are “cultural” and demographic factors in this, and that they are big. In his 2009 post, Pettis acknowledged that there may very well be such a thing as a cultural predisposition towards savings – but found that explanation muddled when it comes to predictions: after all, the very Confucianism that today supposedly fosters high savings rates nonetheless was the cause of the deep and persistent poverty fifty years earlier. Obviously, his 2009 post didn’t leave demographics out of the account either.

No misunderstanding here (I think) – Pettis only took issue with the “cultural”-drive explanation for savings in the context of Asian economic success. It’s certainly true that lots of savings – if possible – have always been a “Chinese characteristic”. But why should it cease to be one when disposable incomes rise? Old-age provisions and getting the best possible education for the children will continue to matter. People may save for the best, rather than the second-best goals once their disposable incomes are rising.

As her disposable income is rising, ...

Saving has never been so rewarding! As her disposable income rises, she’s saving on a John Deere 5R , and it’s going to take YEARS (click picture).

Rising interest rates may lead to a rising interest on the part of the banks to lend to “anyone” – and not just to big buddies.  That could also help to help smaller businesses to grow. But that would be investment, not consumption.



»  China’s Options as Exports Dwindle, Oct 12, 2011
» Not so Straight to the Bank, March 11, 2011


2 Comments to “Will The Great Rebalancing Rebalance the Chinese Economy?”

  1. Personally, whilst I feel that we can now say that the slow-down does appear to be here, this does not in any way vindicate the doom-mongering about the Chinese economy that has been incessant ever since I started following Chinese issues back in 2001. It most likely means ~7% growth (reported) – still a very healthy rate – and no word as to how low/high it will go after that.


  2. this does not in any way vindicate the doom-mongering about the Chinese economy that has been incessant ever since I started following Chinese issues back in 2001

    That’s true. But then, neither Prof. Pettis nor this blogger suggest that doom was immanent. What I believe, though, is that savings will rise with disposable income, even if people no longer feel that they are “poor”.


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