April 3rd, 2012
in Op Ed
by Michael Pettis
The Free Exchange blog at The Economist has accepted my bet, and very cleverly (the bastards!) they have added a second one. For two years I have been arguing that a Chinese rebalancing will require much slower GDP growth rates than we currently think possible and, working backwards from annual consumption growth rates of 7-8%, I have argued that this implies that China’s real GDP growth rate will average not much more than 3% annually over the rest of the decade.
The key is how the transition takes place. If there is a massive privatization program in which large amounts of wealth are transferred to the household sector, it will be possible for household consumption to grow much more quickly and so pull GDP growth behind it at higher rates than I assume. But such a program of wealth transfer is, of course, not politically easy, and perhaps in recent events we have seen just how hard the debate over reform has become. That is why I am not optimistic.
When I first proposed that annual average growth rates would probably not exceed 3%, the consensus for Chinese growth among local academic economists over this period was 8-9%. Since then the consensus seems to have dropped to 5-7%, and especially in the past few months I regularly hear private comments from Chinese academics expressing concern even about this growth range. Yesterday for example I received a very worried email from a professor at Zhejiang University who I had not met before. In the email he told me that he was especially concerned that the inability of the reformers to combat what in China are referred to as the “vested interests” might result in two years of rapid but strained growth and burgeoning debt followed by a crisis. I am not as knowledgeable about the politics of the transition as he is likely to be, but his focus on the debt is, I think, spot on.
But of course in spite of the growing group of worriers and extreme skeptics my “barely 3%” growth prediction is still very much an outlier. This worries me a little, of course, because one always assumes that conventional opinion must have some value, but I do remember that even the greatest skeptics about earlier investment-driven growth miracles seriously underestimated how difficult the adjustment was going to be, and that gave me some comfort.
Even after the skeptics became concerned about Brazil’s growth miracle in 1980-81, for example, no one, as far as I know, predicted negative growth for rest of the decade. And to take another example in Paul Krugman’s famous 1994 Foreign Affairs article, “The Myth of the Asian Miracle”, he warned – against all the hype of Japan‘s being the world’s largest economy before the end of the century – that Japan’s annual growth rate was unlikely to exceed 3% for any long period of time and that even by 2047 Japan would “probably” not overtake the US. (Editor's note: Full text of Krugman's article is available here.)
Probably? In retrospect Krugman’s “probably” seems almost perverse given two decades of near-zero growth, but it does contain an important warning. If even the very skeptical Paul Krugman wasn’t able to come close to predicting how bad things would get, why should we assume that we are a whole lot better today at understanding how difficult the adjustment process can be?
So of course as far as predictions go I am an outlier, with some trepidation, but in the end I suspect that if I am wildly wrong I am as likely to be wildly wrong in one direction as in the other. As Rudiger Dornbush once said, “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.”
So here are the two bets.
- The Economist says that at the then current dollar/RMB exchange rate China will be the world’s largest economy in 2018. I disagree.
- I say that in real RMB China’s average annual growth rate for the rest of the decade will average 3.5% or less. The Economist disagrees. There is some question as to how to define “real”, but I think we will be able to agree on an acceptable GDP deflator.
What are we betting? I was hoping I could get them to help promote some of the amazing young musicians coming out of Beijing if I won, but reasonably enough they can’t commit to the logistics, and propose instead a bottle of whisky or baiju. I accept.
Having said all that, let me note how pleased I am by their knowledgeable reference to Birdstriking, Offset: Spectacles, and most of all to a band known almost exclusively among the cognoscenti, and one of my favorite bands in the world, the otherworldly, Ourself Besides Me, comprised of three talented women led by that painfully shy genius, Yang Fan. This has nothing substantial to do with our bet, of course, but I am delighted that such smart and knowledgeable people at The Economist can refer so confidently to such brilliant musicians. At the very least it shows that the quality of Beijing music is no longer a secret.
P.S. The purpose of these bets is largely symbolic. I am not trying to earn additional income by making book on growth prospects, so please my dear readers do not offer to make additional bets with me. I simply don’t have the ability or interest to track multiple bets and there are much easier ways of making or losing money. If you want to bet among yourselves, of course, please do so.
Other Articles by Michael Pettis
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Analysis articles about China
About the Author
Michael Pettis is a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. He has taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is also Chief Strategist at Shenyin Wanguo Securities (HK). Pettis has an impressive work history on Wall Street, Latin America, Europe and Asia (see his blog China Financial Markets for a complete bio).