Courtesy of Mish.
China bulls point to China’s plans to move millions from farms to cities as some sort of guarantee that that China’s growth will continue.
What If?
- What if such analysis is ass backwards?
- What if urbanization is the result, not the cause of growth?
- What if pressures to maintain the symbolism of growth (as opposed to actual growth) do far more harm than good.
Michael Pettis at China Financial Markets tackles the above questions via email on “The Urbanization Fallacy“. What follows is a synopsis from Michael Pettis, written as a guest post.
Begin Pettis
The Urbanization Fallacy
Special Points
- Sentiment among China analysts is changing rapidly, and there is a great deal more pessimism about growth prospects, allied to greater support for the radical reforms the new administration is proposing, but the very late change in analyst sentiment underlines how mistaken most analysis about the Chinese economy has and continues to be. Over the next few years, as a consequence of this failure, analysts will continue to lower their growth forecasts for China dramatically.
- If we were expecting the June 20 liquidity crunch to slow growth in Wealth Management Products (WMP), we may be disappointed. Preliminary numbers suggest that WMP rates have risen dramatically but WMP issuance may be as strong as ever.
- The main impact on WMP issuance may turn out to have been deterioration in asset quality, as higher rates are likely to turn away real business borrowers but will probably have no impact on borrowers who simply need to roll over their existing funding.
- China’s plans to shift 300 million people into cities has become the new default argument for high growth, but it is based on a fallacy. First, urbanization does not create growth. Growth creates urbanization, and so the urbanization process is simply a highly pro-cyclical mechanism that increases high growth and exacerbates slowing growth.
- Second, urbanization is actually a cost, not a source of growth, and this cost is only economically justified if the increase in the overall productivity for newly urbanized workers is greater than the cost of urbanization. If China is growing so quickly that it is desperate for new workers to leave less productive jobs in the countryside and take more productive jobs in the city then urbanization will make China richer.
- Urbanization, in other words, is a consequence of rising wealth and can accommodate it. It is not a cause of rising wealth.
- Use of the “stopped clock” analogy – when those who warned about an unsustainable process turn out to be right, for example, they are only right in the way that a stopped clock is right twice a day – is almost always an indication of economic illiteracy.
This year there has been a huge shift in sentiment about China, with many analysts, especially on the sell side, struggling to remain relevant in the face of their earlier assurances about growth and risk in China. That their attitudes have shifted is probably a good thing, but it is not always clear to me that increased skepticism about China’s growth prospects has occurred because of a deeper understanding of the root cause of the investment/consumption imbalances and the relationship between debt and growth. I worry that many analysts are arguing now that the current disruption in Chinese growth is a temporary effect of unexpected adverse shocks – especially shocks caused by poor lending decisions on the part of individual entities – and so they are underestimating both the urgency of fundamental reform and the extent of the slowdown in economic growth.
For many years, and even as recently as 20011-12, these analysts were fairly confident that China’s growth model was in reasonably good shape and required only minor reforms to keep growth rates high for many more years, but now these same analysts are celebrating the new administration (correctly, in my opinion) for the vigor and determination with which they are forcing through dramatic changes in China’s growth model.
I mention this not to criticize the change in sentiment, but rather to point out that as I see it there have been no substantial changes in China in the past five to seven years that would justify such a dramatic change in sentiment. It should have been obvious, at least back in 2009, when analysts were all falling over themselves to applaud China’s fiscal and credit response to the global crisis, that we were making a bad situation immeasurably worse, and that the reforms, urgent then, would become all the more urgent under the new administration.
If it wasn’t obvious in earlier analyses of China’s economy why we were in trouble back then, I worry that the latest analyses are also failing to understand the underlying problem. While everyone correctly applauds Premier Li’s determination to tackle the underlying problems, it is important that we understand what the underlying problem has always been. For the newly converted, the risk is that they see the recent slowdown as a consequence of unexpected adverse developments, rather than as an expression of the underlying systemic problem with the growth model. This should have been obvious many years ago, and not just a problem this year now that local government financing and shadow banking have hogged the headlines….
