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Nomura’s Richard Koo — he of ‘balance sheet recession’ fame — has been inspired.
He’s spent a week with Chi Hung Kwan, of the Nomura Institute of Capital Markets Research and an all-around China expert, and come back with the discovery that the “conventional wisdom on [the] Chinese economy has begun to collapse.”
Here’s Koo’s thinking, with our emphasis:
It is well known that China's sustained rapid economic growth has resulted in numerous problems … Domestic consumption is just 35% of GDP, and the country faces a widening disparity between rich and poor, a sharp increase in wages in coastal regions, and growing indications of inflation … Many argue that the Chinese save so much because the country lacks a reliable social safety net, forcing them to put aside more money in preparation for old age. Consequently, China's economy cannot achieve a better balance until a stronger social security system is in place. I used to concur with this view …
But he doesn’t anymore.
Instead Koo thinks that China is basically experiencing teething problems as it becomes a developed economy. China’s cheap, surplus labour of poor rural farmers has been the source of the economy’s savings glut — and now it is drying up as the one-child policy (finally) takes effect and more and more Chinese move to the cities.
The problem is that these urban workers were not receiving wages commensurate with their productivity. In the past, city factories could attract as much labor as they needed simply by paying slightly higher wages than were available in rural areas"”regardless of how productive their employees were"”because there was a nearly endless stream of rural workers seeking work in the cities …
This situation led to tremendous profits for the factory owners. Instead of the "consumer surplus" that economists often talk about, China's economy was characterized by a massive producer surplus.
A large producer surplus meant large profits, which prompted owners to further increase investment, leading to further GDP growth. Meanwhile, the labor share of GDP actually decreased because wages did not keep pace with productivity gains …
Can you see where Koo is going with this?
China’s labour market structure was basically the source of China’s income disparity — and consequently also the source of that high savings/low consumption problem:
Put differently, China's "high savings" and "high investment" were due largely to actions taken by foreign and domestic businesses investing in the country, and not to the behavior of ordinary workers. From a macroeconomic perspective, these businesses' large profits and their reinvestment of the same appear as high savings and high investment.
The people actually working in Chinese factories do not earn enough to save 60% or 70% of their salaries. If anything, the opposite is true: given their low wages, I suspect their propensity to consume (when we include remittances to family members) is extremely high.
If so, neither corporations nor workers are likely to change their behavior significantly even if the government does succeed in bolstering the social security system, and the nation's propensity towards high savings and low consumption will persist. After all, it is China's corporate sector"”which is unaffected by the presence or lack of a social safety net"”that is doing the saving.
Never fear, though.
Remember Koo thinks that cheap labour is rapidly disappearing — “companies' ability to attract unlimited quantities of cheap labor may be about to end.” And that means China will inevitably have to shift from being a producer to a consumer:
If China's surplus of rural labor has in fact been exhausted, the authorities are more likely to tolerate additional appreciation of the currency. The rising price of wheat and other foodstuffs also makes it easier to support a stronger RMB, as higher overseas wheat prices limit the negative impact of RMB appreciation on Chinese wheat farmers.
In summary, I think the Chinese authorities are likely to allow a gradual appreciation of the RMB as wage inflation becomes more evident
On the other hand, individual business owners are likely to reject this approach, claiming that rising wages and a rising currency represent a double blow to their global competitiveness. But we need to keep in mind that these are the same owners who did not pay workers wages commensurate with their productivity because the surplus of rural labor meant they did not have to.
That golden era for owners of capital has now passed. As China's economy reaches full employment and wages normalize, labor-intensive industries whose business model is based solely on low wages will either have to raise employee productivity or leave China. Nearly all of these changes are occurring as part of an inevitable shift in Chinese demographics. I expect the balance between investment, consumption, and wages will gradually normalize as the remaining surfeit of rural labor dries up.
Ladies and gentleman, the Great Chinese Rebalancing Act.
(H/T Dutch Book)
Related links: China’s yuan-child policy - FT Alphaville Urban (commentary) combat in China – FT Alphaville China’s rebalancing - Econbrowser
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