My Blog

November 16, 2007

I was taken to task in my previous posting for having hurried over the idea that China might respond to a US and global slowdown by exporting unemployment to its neighbors, but I agree that it is a real possibility and even likely to happen.  In fact if China is locked into an overproduction cycle, declining global consumption will probably result in both a build-up of inventory AND an export push that unsettles its neighbors and competitors.

That is why I mentioned Richard Chew’s article on the 1797 crisis.  He argues that before the crisis the US was an export machine, heavily dependent on its export sector for its booming domestic economy (sound familiar?).  The global slow-down of the period totally derailed the US economy and caused a great deal of damage in the short-run, but in the long run it forced the US to re-orient its economy towards its own internal development and domestic demand.  This clearly was key for the subsequent economic rise of the US.

I am always branded a pessimist because I think a financial crisis is inevitable in China, but I think that this is just common sense – in fact China will have not one but many crises (and has had in the past two decades).  The history of any developing country, including China’s own history, makes that evident. 

But actually for me it is crucial that China make the same change that the US did after 1797 and reorient itself towards its own huge internal market, and as in the US I think it will probably take an export-led crisis to force the change – and the sooner the better.  Crises are painful, but they often result in necessary changes that permit long-term development, and there is no question in my mind that the current Chinese model has outlived its usefulness.

Of course there is one big difference between the US and China.  Americans were far more favorably disposed to the legitimacy of their government in 1797 than most Chinese are today (and yet still faced one major and many minor secession crises).  Most Chinese support their government, but that support is very brittle, and it doesn’t take much to break it.  This was made pretty clear to me during the SARS crisis.  The foundation of the support anyway is a nationalism that can as easily turn against the government as support it. 

So the question, more for the political scientists than for me, is whether a serious financial crisis that leads to an economic crisis can also result in a political crisis.  I was very interested four years ago when a professor at Tsinghua who advises senior Party officials told me that foreigners focus too much on the June 4, 1989, crisis (which of course followed a period of inflation) when, according to him, the real crisis that nearly brought the Party down was the 1993-94 inflation crisis.  I don’t fully understand why he thought so, but was impressed that he did.

One response to my entry suggested that China is still desperately poor and so could easily benefit from a massive spending program in the case of a US slowdown.  That is certainly true.  I travel a lot through China and it is probably only because I grew up in developing countries that I am not shocked by the level of poverty in some places.  But the government doesn’t need a US slowdown to justify that spending, and if it hasn’t done as much as it should that may be because the problem is huge and there is no real support for it -- poor farmers, frankly, are not nearly the political threat that poor city dwellers are.  In addition, if China is indeed facing a major adjustment caused by a drop in exports, the banking system may suddenly become a big concern again, and that won’t be the right time to engage in increasing government debt.

Comments (4) for "Can export crisis lead to in...

Keep up the good work. I appreciate your effort and insight. By Teresa Lo - 11/16/2007 11:57 PM

The ethanol bubble went bust: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=azYO_2glG5vk Promising new market-Speculative overinvestment - raw materials rising-end product falling-margins squeezing- capital devalueing. Isn't the same thing waiting for China? By Gabor Bereczki - 11/19/2007 5:47 AM

but how do you think the export-led crisis can take place? nothing seems to be able to hurt china's export given its fundamental characteristics. the chinese export is more of a manufacturing export, in my opinion driven not externally by demand from the rest of the world but internally by the low chinese labor cost (yes we are actually dumping goods!). this kind of export will not be really hurt if you reval the rmb, because although it might hurt the total volume as a result of the export price increase, it reduces the cost of manufacturing at the same time, and thus increases the unit profitability of the goods, so it makes the total value untouched. further more, i even doubt if it will hurt the volume, as china's oversupply of labor force makes it a snap to subsitute the existing workers, especially in these manufacturing businesses that stay at the low end of the value chain. this will keep the workers' salary really flexible, or more directly really low no matter what happens (if rmb appreciates and export volume is likely to be hurt, it is very easy and pratical that a pay cut happens so as to keep the price still competative). so i think the surplus problem will continue unless the structural problem is changed or the characteristic of export is changed (i don't see how). and i gradually tend to think that rmb appreciation accompanied by rate-hikes will actually worsen the liquidity problem, which is the immediate biggest threat. By megatone - 11/22/2007 12:09 PM

Megatone, I agree that Chinese exports are driven not by external demand but by domestic considerations, although I would place the focus on China's monetary policy more than low wages. And yes, I agree that a revaluation will not have such a big impact on exports at first, but it would drive up imports nd maybe slow down or even reverse capital inflows, and to that extent it should result in a reduction in reserve growth. This would then lead to a drop in fixed asset investment and induistrial production growth, which would eventually bring the trade surplus to a more manageable level. I also agree that rate hikes and faster appreciaiton are likely to make things worse. This is not an easy problem to solve. By Michael Pettis - 11/22/2007 6:48 PM