A fascinating piece from Michael Pettis, an economist I regularly reference, on how China is probably growing much more slowly than the official GDP figures make out, alongside a discussion of the nature and measurement of GDP itself.
This would confirm his long-held thesis that China’s ultra-high investment growth model has been unsustainable for some years, and will change of necessity, either through enlightened policy or, more painfully, in the absence of such a policy.
Trade tensions and rising protectionism are combining with the exhaustion of the recent economic upturn to slow growth in many countries.
The slowdown in China could lead to a ‘lost decade’ of relative economic stagnation there, until growth rebalances away from a significant share of unproductive investment and towards a higher share of consumption and a lower but more productive share of investment in overall demand.
Although the country is already economically powerful, its rise to global dominance could be much further away than many ‘China bulls’ have predicted. Even so, given its prominence in global manufacturing value chains, relative stagnation will have a large but uneven impact on global economic activity.
The Economist magazine has an interesting article this week questioning the sustainability of the Chinese growth model and drawing some parallels between it and the Soviet Union in the post-war period.
During the last 40 years, the rapid development of China has been perhaps the most extraordinary example of economic transformation in human history, both in speed and scale. The economy grew by around ten percent per year for three decades. Growth has in recent years begun to slow, but is apparently still humming along at more than six percent, a decent clip by any standard. Hundreds of millions of its population have escaped from poverty and the new ‘workshop of the world’ has flooded the world with cheaper goods.
But cracks have begun to show, particularly since the financial crisis of a decade ago. The Chinese government’s response to a collapse of exports was to ramp up lending from state-owned banks and embark on a massive spending spree on infrastructure. Continue reading →
David Pakman’s videos are well worth watching for his incisive and progressive analyses of US current affairs. But on the question of the global role of the US dollar, which he describes below, I think he is wrong. Watch this short video first, before reading my critique below.
Is the US dollar’s dominant role in world trade and reserve policy an exorbitant privilege or an exorbitant burden? I go with the latter. The argument that it is a privilege and benefits the US economically is often made. This argument draws the conclusion that the US is able to borrow and spend beyond its means as a result. The US current account deficit is therefore a good thing, as it reflects the higher consumption and lower savings that can be sustained. It also apparently allows the US to sustain a higher level of debt, whether on the part of the private sector or the government, which boosts aggregate spending or demand.
But as Michael Pettis argues in his book The Great Rebalancing, it is perhaps just as accurate to say that the dominance of the US dollar in global payments and reserves forces the US to consume beyond its means. It results in lower US savings relative to investment, reflected in the current account deficit, and higher savings relative to investment in the rest of the world.
The stronger demand for US dollars in the rest of the world produces a stronger dollar than would otherwise be the case. This makes US exports more expensive abroad, and imports cheaper in the US, and will thus tend to widen the trade deficit (exports minus imports) and the current account deficit, other things being equal. Production and employment will be lower among US exporters, who will find it harder to compete with rivals abroad. US firms producing for the domestic market will similarly find it harder to compete with cheaper imports.
Larger trade and current account deficits act to drain demand from the US economy. A larger capital account surplus is the flipside of a larger current account deficit, and represents the net inflow of funds required to fund the latter, or what the US is borrowing from the rest of the world. These funds will either be used to fund domestic investment, which can be productive or unproductive, or to fund domestic consumption.
The result is that the US savings rate will be lower relative to the US investment rate than it would otherwise have been. The savings rate could fall, while the investment rate stays the same, necessarily leading to a higher rate of consumption. Or the savings rate could remain the same, while investment, whether productive or unproductive, rises.
If the new investment is productive, and generates flows of income in the future greater than its overall cost, then the US economy will end up larger and more productive, while employment should be higher. If the new investment is unproductive, such as takes place in a housing bubble, then this will ultimately raise the debt burden and slow future growth in output and employment.
So a larger current account deficit need not be a negative factor for an economy, if the funds borrowed from abroad are used to fund productive investment. But this only tends to be the case for an economy which is short of domestic sources of finance for investment. For an economy like the US, with sophisticated and liquid financial markets, there is little evidence that domestic investment is constrained by a shortage of domestic saving. So capital inflows will tend not to lead to higher productive investment, but rather to higher unemployment or higher debt.
The capital inflows to the US, resulting in a capital account surplus, and reflected in the gap between domestic investment and savings, described by some commentators as a shortage of savings, are the consequence of excessive savings relative to investment in the rest of the world, or a ‘savings glut’.
Savings and investment must be equal for the world economy as a whole, but can be out of balance for individual countries. If savings rise in one country but investment does not, the surplus must be exported abroad, and lead either to higher investment or lower savings in the rest of the world, so that global savings and investment continue to balance.
The US can only be a net borrower from the rest of the world and therefore continue to run a current account deficit if foreign economies are net savers in aggregate relative to the US. Economies such as China, Japan and Germany have run the largest current account surpluses (meaning that they are net savers) in recent years. It is their policies as much as those in the US which lead to a lower savings rate in the latter.
This is because, for the world as a whole, the balance of payments must balance! Current account deficits in some countries must be offset by current account surpluses in others. The major surplus countries are avoiding significant appreciations of their currencies by accumulating dollar reserves. They do this in part to sustain relatively weak currencies which boosts net exports by making their exporters more competitive.
These surplus countries are relying on their exporting sectors to boost demand, growth and employment because the growth in their domestic demand is relatively weak. So any rapid appreciation of their currencies would hobble their exporters and growth would falter. It would also probably take some time for the necessary adjustment and certain economic reforms in order for domestic demand to take up the slack.
The surplus countries therefore have a strong incentive to sustain the status quo, which helps to maintain the dollar as the dominant world currency, keeping it stronger than it otherwise would be. This is the exorbitant burden which the US, and ultimately the world, must carry.
All this played a significant role in causing the global imbalances which led to the Great Recession of 2008. These imbalances need to be resolved in order for the world to begin a new period of sustained growth. So Trump and his advisers may be on to something when they complain about the US trade deficit. It may therefore be a good thing if the dollar becomes less widely used for global trade and the accumulation of reserves, whether this is intended or not. Everything else being equal, a decline in the dollar would help the US economy rebalance in the longer run, boosting growth and employment and reducing the debt burden.
Is there a solution to all this, which would go beyond Trump’s muddled bluster? There is, and it has been around since the formation of the Bretton Woods institutions in 1944. It was then that Keynes proposed the creation of an international currency, bancor, which would be used to prevent excessive international payments imbalances and the unsustainable buildup of debt, which he strongly believed would tend to stifle growth. His US counterpart Harry Dexter White rejected the idea.
We have been left with Special Drawing Rights (SDR), a basket of international currencies maintained by the IMF, which were created in 1969 as the Bretton Woods system of fixed exchange rates and managed international payments began to unravel.
If, as Keynes had hoped, something like the SDR were used more widely, then global payments imbalances should be less severe and more easily resolved. But this would, in the short to medium run, and contrary to the arguments of many economists, benefit the US economy and harm the major surplus countries which would be less able to run up large current account surpluses by keeping their currencies relatively weak and boosting their exports. Despite this, the argument should be made that it would create a more balanced global economy, and more sustainable growth.
Perhaps the trick is to appeal to the right vested interests, since ultimately consumers in the current surplus countries would benefit. Exporters in the US, and also in other major and long-standing current account deficit nations, such as the UK, would gain too.
As ever, one can’t ignore the politics. For Trump, whose muddled policies are currently encouraging a stronger dollar, a successful reduction in the US current account deficit might reflect a reduced global role for the US, as Pakman argues in the video, but a less dominant dollar would ultimately be good for US growth and stability. There might be some debate over whether the outcome would be making America ‘great’ again or not. But more widely-used SDR would also be a good thing for the prosperity and stability of the global economy, though this is perhaps a long way off, if it happens at all. Politics will get in the way of good economics, and not for the first time.
Post-Keynesian economist Steve Keen, of Debunking Economics fame, discusses in the video below his criticisms of mainstream economic thinking and his work constructing a model based on the work of Hyman Minsky, which necessarily incorporates money and finance.
The model can produce periods of economic stability with rising inequality, followed by instability and recession as possible outcomes. These patterns fit very well the experience of many rich countries during the last few decades.
He also touches on the dialectical thinking of Hegel and Marx, which he studied during his early career.
Keen was one of the heterodox or non-mainstream economists to use a mathematical model to predict a major economic crisis a number of years before the Great Recession of 2008 occurred, by modeling Minsky’s ‘financial instability hypothesis’.
Another in this occasional series from Michael Hudson’s excellent J is for Junk Economics:
“John Maynard Keynes (1883-1946): In the 1920s, Keynes became the major critic of World War I’s legacy of German reparations and Inter-Ally debts. Against the monetarist ideology that prices and incomes in debtor countries would fall by enough to enable them to pay virtually any level of debt, Keynes explained that there were structural limits to the ability to pay. Accusing Europe’s reparations and arms debts of exceeding these limits, Keynes provided the logic for writing down debts. His logic controverted the “hard money” austerity of Jacques Rueff and Bertil Ohlin, who claimed that all debts could be paid by squeezing a tax surplus out of the economy (mainly from labor).
Modern Germany has embraced this right-wing monetarist doctrine. Even in the 1920s, all its major political parties strived to pay the unpayably high foreign debt, bringing about economic and political collapse. The power of “sanctity of debt” morality proved stronger than the logic of Keynes and other economic realists.
In 1936, as the Great Depression spread throughout the world, Keynes’s General Theory of Employment, Interest and Money pointed out that Say’s Law had ceased to operate. Wages and profits were not being spent on new capital formation or employing labor, but were hoarded as savings. Keynes viewed saving simply as non-spending on goods and services, not as being used to pay down debts or lent out to increase the economy’s debt overhead. (Banks had stopped lending in the 1930s.) He also did not address the tendency for debts to grow exponentially in excess of the economy’s ability to carry the debt overhead.
It was left to Irving Fisher to address debt deflation, pointing to how debtors “saved” by paying down debts they had earlier run up. And it was mainly fringe groups such as Technocracy Inc. that emphasized the tendency for debts to grow exponentially in chronic excess of the economy’s ability to carry its financial overhead. Emphasis on debt has been left mainly to post-Keynesians, headed by Hyman Minsky and his successors such as Steve Keen and Modern Monetary Theory (MMT), grounded in Keynes’s explanation of money and credit as debt in his Treatise on Money (1930).”
I recently re-read John Maynard Keynes’ magnum opus, The General Theory of Employment, Interest and Money (hereafter GT). First published in 1936, this was the great man’s attempt to persuade his fellow economists that changes to their understanding of economic theory and policy were necessary to remedy the mass unemployment which seemed to be a recurring feature of capitalist economies, particularly during the Great Depression of the 1930s.
It is now a decade since the onset of the Great Recession, when governments across the world ‘rediscovered’ Keynes, or what they thought were Keynesian ideas, for fighting the economic slump. There was a brief revival of activist fiscal policy: taxes were cut, public spending increased and government deficits rose. But once the threat of collapse had been averted, there was a turn to austerity in many countries, amid renewed worries about ‘credibility’ and business confidence. Continue reading →
“[Karl Polanyi] identified a tension between what he considered to be the two organising principles of modern market society: “economic liberalism” and “social interventionism”, each with their own objectives and policies as well as support from the groups within society whose interests they are seen to serve. The aim of economic liberalism is to establish or restore the self-regulation of the system by eliminating interventionist policies that obstruct the freedom of markets for land, labour and capital. Through laissez-faire and free trade, social relationships are embedded within the economic system and subjected to unregulated market forces with support from the propertied classes, finance and industry. By contrast, the aim of social interventionism is to embed the economy within social relationships, thereby safeguarding human beings and nature through market regulation, with support from those adversely affected by the destabilising consequences of economic liberalisation and the self-regulating market – notably the working classes.
Polanyi argued that there is a conflict between the interest of capital in freeing itself from the constraints of society – and society’s interest in protecting itself from the social dislocation of the market (particularly that of finance). This generates a “double-movement” of counter-reactions by both capital and society, mediated by politics and the legal process. Without compensating social intervention, Polanyi contended that the pressure on vulnerable individuals and groups within society, arising from attempts at market self-regulation, would generate resistance in the form of labour, civic, social and political movements. If these become widespread – and discontent with the damaging effects of the self-regulating market intensifies – social order becomes more difficult to maintain; and in an effort to safeguard the existing system, political leaders may attempt to deflect dissatisfaction by scapegoating. However, at some point, the state is likely to be put in the position of having to decide whether to intervene on behalf of those affected or to risk social breakdown. In turn, the impairment of market forces associated with protective regulatory measures could set into motion a counter-movement on the part of capital to attempt to protect its own interests by freeing itself from social and political constraints. In response, the state would have to decide the degree to which laissez-faire should be restored and social protections and market regulations relaxed.”
Suzanne J. Konzelmann, Simon Deakin, Marc Fovargue-Davies and Frank Wilkinson (2018), Labour, Finance and Inequality, p.5-6