Taxes and Economic Growth

Uwe Reinhardt Economix July 16, 2010

With the ability to pile on the stimulus and ignore bad news, the country's system is inefficient but productive. Long-term prospects, however, may be harrowing.

What exactly don't investors understand about the term "command economy"?

I've been pondering that question as I watch global financial markets retreat on worries that economic growth in China is going to slow precipitously.

Details on world population growth

It's not that I think China's economic system -- or the people who run it -- is perfect. For example, China's leaders allowed a buildup of bad loans brokered by local governments that in another system would be big enough to bankrupt many of those local governments and a majority of the country's banks. In China's system, however, the government can bury that bad debt, as it did after the Asian currency crisis of 1997, and engineer the recapitalization of the country's banks. (For more on this debt problem and China's "solution" to it, see my June 1 column, "China's Ponzi-like banking policy.")

In fact, I'd argue that the Chinese economic system is generally bad at short-term economic decisions, because the Chinese economy doesn't provide either fast or accurate signals on pricing, supply or demand.Msn.Video.createWidget('PlayerAd1Container', 'PlayerAd', 300, 213, {"configCsid": "MSNmoney", "configName": "player-money-articles-16x9", "player.vcq": "videoByUuids.aspx?uuids=0048d096-5f60-4564-9055-7cb62ba02aaa,4c84a007-8f7a-4cc6-817e-593d55c12552,0048d096-5f60-4564-9055-7cb62ba02aaa,05bcfca0-2f6f-488c-bb99-68e5083df0aa,e890bd48-aae7-4888-945f-0dbc84116d56,3771183e-8850-48a9-b9c5-cc0997246c40,1521bc23-6e6e-4c57-b0e9-43bed812d1f4,4aca6a8e-1a72-4f55-8f72-e070619a6aa9,7057f895-f38e-4ac4-851c-e8ea1bd8d977,46ecff02-2093-4cca-9c17-1d98d6dc0497,447d720d-ba66-4a73-a570-17a0fbfc54b1,322cc6d8-c309-4182-b0ec-5888a891a22c", "player.fr": "iv2_en-us_money_article_16x9-Investing-JubaksJournal"}, 'PlayerAd1');Msn.Video.createWidget('Gallery4Container', 'Gallery', 304, 150, {"configCsid": "MSNmoney", "configName": "gallery-money-articles", "gallery.linkbackLocation": "bottom_left", "gallery.numColsGrid": "3", "gallery.categoryRequests": "videoByUuids.aspx?uuids=0048d096-5f60-4564-9055-7cb62ba02aaa,4c84a007-8f7a-4cc6-817e-593d55c12552,0048d096-5f60-4564-9055-7cb62ba02aaa,05bcfca0-2f6f-488c-bb99-68e5083df0aa,e890bd48-aae7-4888-945f-0dbc84116d56,3771183e-8850-48a9-b9c5-cc0997246c40,1521bc23-6e6e-4c57-b0e9-43bed812d1f4,4aca6a8e-1a72-4f55-8f72-e070619a6aa9,7057f895-f38e-4ac4-851c-e8ea1bd8d977,46ecff02-2093-4cca-9c17-1d98d6dc0497,447d720d-ba66-4a73-a570-17a0fbfc54b1,322cc6d8-c309-4182-b0ec-5888a891a22c;videoByTag.aspx%3Ftag%3Dmoney_dispatch%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1;videoByTag.aspx%3Ftag%3Dbest%2520of%2520money%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1"}, 'Gallery4');And it's often spectacularly bad at long-term economic decisions because, with no effective brake on government decisions and truly distorted feedback on the results of those decisions from the economy and the lower levels of government bureaucracy, wrongheaded policies can run for years and years, as initial evidence of disastrous long-term consequences simply never filters up to top-tier decision makers.

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Trust China's sweet spot But in a big swath of the middle term, China's economic system does a spectacular job at making sure that nothing goes terribly wrong. Over one, two or three years, China's unique combination of market and centralized command-style economics has the ability to make decisions far more quickly than most other economic/political systems. It also has the brute power to mobilize a high percentage of the country's resources behind the decisions. And that's exactly the time frame that includes current worries about China's economic growth.

Right now, I've got big doubts about, say, short-term (a quarter or so) profits in China's auto industry. In the long term, I've got big doubts about China's ability to solve its terrible demographic problem over the next 20 years.

But China's ability to keep its economy humming at 8% to 10% a year for 2010 and 2011? Doesn't keep me up at night. Especially because China has successfully reloaded its stimulus pipelines with enough cash to overwhelm any slowdown in just the manner it did in November 2008.

In fact, I'd say that current problems operate on a time scale that's in the sweet spot for China's economic/political systems. These problems play to the strengths of China's economic system.

Let's take a look at China's Goldilocks worries, and at the short and long term, where China's system doesn't work nearly so well.

To understand the drawbacks of the Chinese economy in the short term, you don't need to look any further than China's auto industry. In 2009, subsidies and credits from Beijing boosted total auto sales in China by 45% from 2008 levels.

In the first half of 2010, sales growth dropped to a 30% annual rate.

And the rate looks like it is headed lower. Beginning in April, car sales have dropped every month from the month before. In June, for example, sales dropped 5%. That took the annual growth rate down to just 14% from June 2009.

Now that's volatility. And in a market with many features of a command-style economy, volatility gets magnified, because everyone jumps in the same direction on orders from the central government. And because there's very little pushback from market signals, the initial response to the volatility and the eventual response can get, well, out of control.

For example, in response to the 45% growth rate in 2009, the auto industry in China went on an expansion binge. The top 14 automakers in China, many of them foreign, launched plans to reach a combined production capacity of 23 million vehicles by 2012 -- even though demand in China is projected at only 20 million vehicles by then. And that measures only the big guys' plans. China now has more than 100 domestic car companies.

In other kinds of economic systems, banks would have pushed back against at least some of those expansion schemes. Financial markets might have pushed back against plans to raise all that capital. But in China in the short run, banks had been officially encouraged to make loans to car buyers with little or no effort to document incomes, and banks and the financial markets had been officially encouraged to provide financing to car companies. Only in recent weeks has the central government reversed course and started to push back against the trend that it set in motion. Beijing has not just announced an end to some of the subsidies for buying a car, it has also promised an investigation into why it was so easy to get financing to start or expand a car company. (Gee, you think they'll figure out who's to blame?)

This isn't an efficient economic system at work.

Continued: Unintended consequences, multipliedMore from MSN Money and MoneyShow.com

China's Ponzi-like banking policy

Jubak on video: What to watch this earnings season

China's dangerous balancing act

Jubak on video: Has investor fear bottomed?

Are stocks cheap? (And which ones?)

Why to stick with stocks this year

1 | 2 | 3 | next >

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The question asked should not be why investors are worried about China's economy. Instead we should be looking at what makes China's economy reminiscent of our economy gone bad.

China is just now emerging as a super economic power; USA, been there did that. What investors see is government interference on capitalism, regardless of the difference in how China's government is interferring. Investors think they know where this is heading based on a few historical lessons from the USA. Government over-corrects and things get out of control.

The other red flag thrown on the investment field is that the Chinese government plays a heavy handed role in following the ill-fated logic we used to destroy our economy. Government to government trade deals only mask the real numbers. Too high of a surplus is bad for profit. Over-pricing over-production is just too high a risk for a savvy investor.

In the aftermath of the Wall Street crash, investors want to see some security. It is not a matter of if China makes it the world will buy it. Investors are looking for the edge: If consumers demand it, China will make it. What investors need to see is how China is going to fill consumer demands.

Always on the investor's horizon is the fact, eventually, China will reach a critical point in population. In order to sustain the growing production demand, the Chinese government will have to divert resources to repopulate. If the Chinese economic model follows the USA model, worker demands are going to rise, eventually, leading to higher incomes, safer working conditions, and more assistance in the social welfare sector.

It is not a question of if, it is a question of when and if it occurs too soon, the investor is left holding the bag while funding what is necessary for equilibrium. You wrote that China reacts within one, two, or three years? At least in the USA, we had over thirty years to profit from bad decisions before it was corrected.

The Chinese government may be on top of things with a control economy, but investors want to see where it is heading before they get burned once again. The only true sign of a good investment opportunity is consumer demand producing a nice cozy fire of profits. Unfortunately, governments have a tendency to create flash fires followed by floods and China may not be an exception.

Investors are not worried, they are simply cautious now when they play with fire.

ReplyReport AbuseLost Dollar #4Tuesday, July 13, 2010 7:18:31 AM

About 10-15 years ago, I read an article about China, and how Couples were giving up unwanted Female Infants alongside the road, leaving them as Orphans, or giving them up for International Adoption. This is going to be an interesting Science Fair Project that China is working on. If, as a society, you remove your Females from the Population or a significant percentage of them, then how or who do you plan on pro-creating with. You end up with a high percentage of Males fighting over a small enclave of Females for the Rights of Sex, Marriage, and Procreation. Yes, the Chinese Government will have an Incredible Standing Military and Labor for the various Industries, but you end up with a Population unable to sustain Continuing Growth. With 1 Billion People, they can spare several Million with no problems. Currently, they are still restricted to only having 1 child per family. The problems will occur when you have War, Drought, Famine, Swine Flu, Influenza, Epidemic or Pandemic of Sizeable Magnitude then we will see what happens.

As far as worker's rights, safer conditions, higher pay, etc., that will probably not happen. Companies will get rid of workers who try to organize for those things---Government may Purge them. In the name of productivity, great lenghts to details must be followed. If one region starts to organize, newspapers and media outlets will not pick this up on the AP (Associated Press) because it will look bad against the Chinese Government(maybe Hong Kong will pick up the story). I see Multi-Regions in China where Industries will be propped up and then transferred if worker's become incorrigible. With Emerging Markets and an eye for lower Labor Costs, do not think for a second that if Chinese workers start to demand certain things, companies can go right to India and play right into the Caste System. Emerging Markets will become Developing Countries only to be deflated with loss of Industries as Companies again will look to Outsource. With lower wages, unsafe conditions, long work hours, something has got to give "Eventually". I look at US History with the Organization of the Workers/Children in Factories, etc. and I see the same things in China happening now that happened to the US years ago.

In due time with a significant Military, I really do believe Countries will be able to pay for Chinese Intervention and China will gladly accept because they will have the Largest Standing Army in the GLOBAL WORLD. Picture this for a second: A Country like Iran is getting picked on by the UN and the Countries that are sanctioning them, Iran makes some phone calls to China, and China mobilizes several Million troops surrounding several countries borders. Iran then makes some more phone calls, stop the sanctions/Embargo or I send the Order in to the Chinese troops enter your Country and take your Capital City. Essentially, China will do the bidding/dirty work for other Countries. This is completely Fiction, but I can totally follow the rationale of them being a Supreme Superpower capable of Extreme things. He could be the Big Brother that many Countries would need to handle the small things.

ReplyReport AbusePaul Chesterworth #5Tuesday, July 13, 2010 7:56:04 AMWhen China announces its banking and credit problems we have hit bottom. Until then it is just a gamble.ReplyReport Abusekrewalandersen #6Tuesday, July 13, 2010 8:05:33 AM@PeggyBetter to see a global competitor promote growth with excessive debt and leveraging and other shenanegins(sic) than us after our worst recession in a long time. We need to retrench. If China slows down I think we could be looking at a worldwide depression.It'll be a bumpy ride when China's bills come due but by then hopefully global markets will have achieved some balance.@ Lost DollarThe "social experiment" your referring to is fricken fascinating. And it'll happen in real time for us.Though Iran or whomever can call whomever they want, no country ever will get past our Navy and our missiles. In modern warfare, numbers of troops mean absolutely nothing. What we should be concerned about is keeping our technological edge in weaponry and computers (cyber warfare), and keeping our currency valuable so we can fund our military endeavors. ReplyReport AbuseLost Dollar #7Tuesday, July 13, 2010 10:17:45 AM

It takes an Act of Congress to get the Army, Navy, Air Force, and Marines to go to War. The Coast Guard works independently, and all it takes is a distress signal or call to get their attention. Top Brass at the Pentagon will tell you Cyberspace and Satellite Placement is or has been the know how of things to come. With that said:

1)Have we been able to ascertain Osama Bin Laden since 911?

2)We are bogged down in Afghanistan and Iraq in a Conventional War...Standing Army fighting a Guerrilla War similar to Vietnam?

3)Yes, I would say for the amount of money that is spent, we have the finest Military in the World, but we still fight Wars the old fashioned way, and not the way that you may want. Top Brass executes decisions from the Pentagon with Congressional Oversight along with President's go ahead, passed down to Officers who delegate down to Lower Ranking Officers down to Non-Commissioned Officers. NCO's typically will be put on the front lines with M-16's, air power supplied by Navy and Air Force after giving them adequate coordinates.

So, if China could mobilize several Million and have allies such as India, Russia, etc. and could surround a small country(s), there would be nothing the US could do but launch an Atomic or Nuke. To be blunt, by the time 9am EST hit, several countries could be ramsaked,a Treaty ascertained by China, all done by the US actually got involved. Game, Set, Match, Checkmate. It literally would be faster than Grant storming Richmond! Technology is not tantamount to winning wars especially when you have debris in space that knock out satellites and you can probably get some 15 year old Russian to hack into satellites and knock them off orbit. When you have the Naval Academy, West Point, Air Force Academy, VMI, Citadel producing the top brass, and then they have to face some group of Infidels that do not make any sense with fighting tactics coupled with Civilians from Congress who have no idea about War then you get what we have. US concerns itself with Loss Ratios based on Troop Levels, and all I am saying is that China would just be concerned with taking the Target at all costs and not worry about Troop Loss Ratios.

Currently, China nor India pose this kind of threat, but by God, they have the Man Power to be able to do this kind of threat.

ReplyReport AbuseToadvine #8Tuesday, July 13, 2010 11:22:19 AM

People need to read Hayek and what he called “fatal conceit” or “the pretense of knowledge.” This basically means that the market decides what is needed and desired, not some big gov't with a political agenda. Look here at the US where Obamugabe is pouring billions of dollars into inefficient green technology that the private sector won't fund because it is inefficient and there is no consumer demand. So Obamugabe is taking billions of dollars of capital away from the market which would distribute them in the most efficient means possible to give it to a privileged sector to develop a product not in demand that is worse than what the market offers. Obamanomics in action! Redistribute the poverty.

How will this be different in China? Gov't CANNOT MAKE AN ECONOMY RUN !!!! All it can do is hinder it. Why did our GDP hit 8-10% AFTER the Reagan tax cuts? Because he let the MARKET keep THEIR capital and allocate it efficiently. There's a novel concept. Laissez faire. Let the economy grow. Why ANYONE would invest in ANY nation that has tyrannical methods of controlling the economy as is the case in China and the US (ask the GM shareholders) is beyond me. Cisco was woo'd to Russia who offered them ZERO % capital gains taxes. Another novel concept. Sad commentary that Russia has a better concept of free market principles than these liberal morons in power.

By the way, take off the tin foil hats. China won't let it's army be one giant mercenary force. We can wipe out 30 million Chinese militia with three bombs (assuming we have three after Obamugabe makes us all less safe).

ReplyReport AbuseToadvine #9Tuesday, July 13, 2010 11:24:38 AMLostDollar, we could do the same thing with nukes. ANY nation with ANY means of violence on any other nation can theoretically make threats and black mail any other nation into its bidding. Hasn't happened and won't happened. Might make for a good Hollywood flick, but that's it.ReplyReport Abusekirk1963 #10Tuesday, July 13, 2010 12:14:39 PMToadvine - your post on Obamugabe and his theft of wealth building capital from the private sector is simply outstandingReplyReport Abuse1 - 10 of 25PreviousNext_ucf13('0'); _iuc2Om1('MSNPortalInlineComments','Initial_Load_Comment_View','http://articles.moneycentral.msn.com/Investing/JubaksJournal/can-china-keep-its-economy-afloat.aspx?page=3&','en-us');Are you sure you want to delete this comment?Report AbusePlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease notify us using the Report abuse form below. We will investigate your report and take appropriate action against offenders. We report all illegal activity to authorities.CategoriesSpam or advertisingChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatOtherAdditional comments(optional)100 character limit To add a comment, pleasesign in/*MSN PrivacyLegalAdvertiseRSSHelpFeedbackSite mapAbout our ads© 2010 Microsoft/*