China: Choosing More Debt, More Unemployment, Or Transfers | Michael Pettis

From Michael Pettis:

I have often written in this blog and elsewhere about the three policy choices Beijing faces as it tries to manage through the adjustment process. My argument is that subject to two very plausible assumptions, every economic policy Beijing implements ultimately can be abstracted to one choice among three options. These two assumptions are:

  1. China has overinvested in infrastructure and manufacturing capacity to such an extent that in the aggregate the cost of additional public sector investment exceeds the present value of future increases in productivity generated by the investment. China’s public-sector investment, in other words, is value destroying, and because it is funded by debt, additional investment causes China’s real debt servicing costs to rise faster than its real debt servicing capacity.
  2. China’s long-term sustainable growth rate is substantially below the economy’s current GDP growth target, and so the economy is only able to meet the growth target by increasing its debt burden.

…..any policy Beijing chooses must involve, usually implicitly, some combination of three outcomes. In every case, in other words, we will see as a consequence of the policy one or more of the following:

  • Higher unemployment, the limit of which is largely a political issue involving social instability, with the added wrinkle that certain types of unemployment are likely to be perceived as more politically costly than others – e.g. because returning to family farms acts as a kind of safety valve, even though a significant fall in living standards, unemployment among migrant workers is likely to be less costly, or because university graduates are presumably more communicative and have higher expectations, their unemployment might be more costly.
  • Higher debt, by which I really mean a higher debt burden, or an increase in debt relative to debt-servicing capacity, and this can rise until credit growth can no longer be forced up to the point where it can be used to roll over existing debt with enough margin fully to fund as much new economic activity that Beijing targets.
  • Higher wealth transfers, in which governments – and because the Xi administration is seeking to centralize power this is most likely to involve local governments rather than central government entities – must liquidate assets and use the proceeds directly or indirectly either to increase household wealth or to pay down debt, with the main constraint on Beijing’s ability to direct this process likely to be the tremendous political opposition of the so-called “vested interests”, for whom government control of these assets is an important source of power, patronage, and wealth.

The trade-offs between a higher debt burden, higher unemployment and greater wealth transfers to the household sector may come into sharper relief in 2016 because although unemployment still seems to be fairly low, in spite of much lower growth in the past three years, there is now reason to worry that any additional reduction in growth may begin to show up in the unemployment numbers…..

Centrally-planned economies inevitably get weighed down by cronyism and inefficiencies. Economist Thomas Sowell describes how he used to be a Marxist but working for the federal government cured him of the notion that centralized government could successfully manage anything, let alone the entire economy.

Source: China: Choosing More Debt, More Unemployment, Or Transfers | Michael Pettis’ CHINA FINANCIAL MARKETS

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