Michael Pettis has a really good post up today on China Financial Markets. He discusses the math that will dictate how much Chinese private consumption needs to grow in order to cause a meaningful rebalancing. Don’t be put off by the math reference, it’s a wonderfully straightforward article. No arcane formulas.
He points out that Chinese private consumption is a startling 35% of GDP and then does some calculations as to how much growth in consumption would be required to raise the rate to something on the order of 40%. Note that his calculations are based on net growth in consumption. In other words, he factors in growth in GDP as well as growth in consumption as it isn’t sufficient for consumption to grow in tandem with GDP as that won’t lead to any meaningful rebalancing.
You need to read the whole article (relax, it’s a quick simple read) but here is the crux of the math:
What kind of consumption growth will we need for the country to rebalance? The numbers are a little worrying. If China grows by 8% a year, consumption would have to grow by a little over 11% to raise the consumption share of GDP from 35% to 36% in one year. It would have to grow by a little over 9 1/2% annually to do it in two years. Consumption, in other words, must grow substantially faster than GDP for the rebalancing even to begin to take place. This is arithmetically true because China begins the process with such a low consumption ratio.
Look at it over the longer term. Just to return consumption to 40% of GDP over the next five years (and even that level is widely considered to be way too low, and probably unprecedented in the world excluding recent Chinese history), 8% average annual growth rates in GDP would require just over 10.9% growth in consumption annually. 7% average annual GDP growth rates would require that consumption grow annually by nearly 9.9%.
In other words while GDP growth slows significantly from its 12-13% rate of the past several years, consumption will nonetheless have to surge at rates far in excess of the 8-9% growth rates of recent years in order for even a small, partial rebalancing to take place. I don’t think I have ever seen a case in which consumption has grown at nearly that rate for any length of time. I believe if China pulled it off it would be unprecedented.
Pretty daunting figures, aren’t they? I would dearly love to hear from Pettis his opinion as to whether China can indeed get by with GDP growth as low as he postulates for his examples.
I have read elsewhere that merely to absorb the pressure for jobs from the rural population, China needs GDP growth in excess of 10%. I have no way of knowing how true this figure might be, but assuming that it has some validity, then it suggests that rebalancing would be even more difficult to achieve.
Pettis thinks that it will be a long haul to get private consumption up in China and thinks that it will result in much lower rates of economic growth. But, again, can China politically afford to slow growth that much?
Putting that aside, barring some miraculous recovery in incomes in the U.S. and the West in general, I don’t think that a transition requiring years will suffice. Pettis suggests a prolonged period to achieve any rebalancing, which probably won’t play in this country and others.
I’ve posted often, as have others, that the end game of this entire meltdown is quite likely to be one that involves some level of protectionism. If Pettis is right and the growth of Chinese consumption is going to be a drawn-out affair, then I see no way that Western politicians will be able to keep the fires of trade retaliation from blazing. If the Chinese leadership is indeed constrained from dialing back their growth rate, then that to my mind only increases the odds of a nasty outcome.
There is a lot left to play out from this recessionary episode. We’re likely to be distracted by some sort of recovery over the next few quarters but we’re also moving into a more highly charged political environment in 2010 and beyond. If growth is anemic and China spurts ahead, look for the rise of demagogues and probably more.