The Changing Debate Over China’s Economy

August 12th, 2013
in Op Ed

by Michael Pettis, China Financial Markets

Author's note: I apologize for taking so long to repair my blog, but it hasn’t been easy. We are slowly fixing up the mess on my website. There will be a link on the site directing interested readers to the old site if anyone wants to read older blog entries. I will do this because I have been advised that there might be infected code buried in my site that creates a backdoor that allows the hackers to break into my site regularly. By not transferring anything from the old site to this one, presumably, I lower the likelihood of accidentally importing the virus.

Follow up:

A lot of very kind people have privately and publicly expressed their concerns that my site has been hacked for political reasons, perhaps because I am saying things that they think might anger important people in China. Although I have certainly been the target of sometimes hysterical attacks – more so in the past, when my analysis of the Chinese economy seemed more unlikely than it does now – I have no reason at all to think that my blog was hacked for anything other than commercial reasons having to do with the sale of excitable pharmaceuticals.

Part of the reason for the concerns that my blog has been hacked for political reasons may be the wide-spread belief abroad that no debate is permitted within China about the urgent need for economic reform. In fact this isn’t true. The discussion within China is quite vigorous, and the misperception is probably fueled by the belief – spread often enough, it seems, by China bulls – that the debate about the weaknesses in the Chinese economy is largely a debate between foreigners and Chinese, with some bulls even arguing that it is a debate between those who wish China ill and those who wish it well. The implication, of course, is that only someone who is incapable of understanding China – i.e. a foreigner – could possibly believe that China has problems.

But this is just silly. I will ignore the irony involved in a foreigner’s claiming that it is precisely because they are foreign that it is impossible for the foreign skeptics correctly to understand the Chinese economy, Chinese culture, and the thinking of the Chinese people (those inscrutable orientals!). I suspect the reason they find China so different and alien is because they have little experience of other developing countries, and know almost nothing either about developing countries outside East Asia or about economic history.

The Chinese growth model, as I have pointed out many times before, is not radically new. It is based primarily on the growth model developed by Japan in the 20th Century.  It involves policies that can be traced at least as far back as the “American System” of the early 19th Century, and it has been implemented in various forms by many different countries around the world during the past 100 or even 200 years. There is, in other words, actually quite a lot that we know and understand about the model, even if many of us seem to have forgotten much of it – including its typical weaknesses, one of the most obvious of which is the tendency for over-investment in the late stages of the miracle-growth period leading to an unsustainable increase in debt.

More importantly, the claim that “foreign” skepticism lacks credibility precisely because it is foreign has very little historical support. There have been many cases in which foreigners were able, perhaps because they tend to be more objective, to identify risks earlier than locals.  The real estate boom in the US before the 2007-08 crisis, for example, was widely discussed by worried European economists for years, and Paul Krugman, a foreigner, was famously skeptical about the Japanese and Asia miracles at a time when most analysts, local or foreign, regarded such skepticism as evidence of either ignorance or ulterior motives (his work was based at least in part on earlier work by Alwyn Young, another foreigner).

Dismissing the credibility of skepticism about the Chinese miracle because it is foreign, in other words, has little in the history of economic analysis to support it. But the real reason why it is completely nonsensical is that it is simply not true. Among China economists living and working in China there is a great deal of worry about the sustainability of the growth model, and this has been the case for many years – so much so that former Premier Wen groused publicly about these issues long before most foreign analysts had doubts about the sustainability of the growth model, and he did so based on Chinese analysis, not foreign. Just as clearly, Premier Li has made it obvious that he sees the need for reform as urgent, and it is hard to believe that he would consider this to be such an urgent need if Chinese economists as a group were as oblivious to the risks and as optimistic as the traditional China bulls claim they are.

In fact I think until the recent shift in sentiment abroad, there was even more skepticism about the long-term functioning of the growth model within China than abroad, and one has only to read magazines like Caixin, and even the occasional article in the People’s Daily, to see how vigorous the debate is. It is true that sentiment abroad has shifted remarkably in the last year or two, but this reflects, in my opinion, the fact that foreign observers are not as close to events on the ground as are locals. Until about 2009-10, it was widely believed abroad that China’s growth model was functioning well – brilliantly, in fact – and that China would continue to grow at 9-10% a year for the next decade or longer.

Within China, however, most economists that I speak to were far more pessimistic. I remember meetings as far back as 2008, for example involving senior US or European government officials looking to be debriefed on the Chinese economy, in which the foreign (and some Chinese) analysts present spoke jauntily about the great success of China’s growth policies and the brilliant future ahead, while many of the Chinese economists present were much more cautious and even gloomy as they discussed the sheer intractability of China’s economic distortions. In those days, I would argue, skepticism was disproportionately to be found among Chinese economists, and not foreign economists.

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