After more than a decade of observing China’s fast economic growth, Michael Pettis sees a lengthy and perhaps painful restructuring ahead.
Pettis, a U.S. economist who has worked and taught in Beijing for 15 years, told Minnesota investment professionals Thursday that economic miracles in the United States and Japan didn’t end smoothly and neither will China’s. “Every single time it’s been difficult,” said Pettis, who spoke at the annual economic dinner of the CFA Society of Minnesota.
Many investment professionals, economists and China experts are weighing in these days with ideas and theories, often in complex terms, about the fate of the world’s second-largest economy. Pettis says what’s happening is simple: China’s period of hyperfast growth is over, and the imbalances that grew during it have to be straightened out.
It’s the same situation that happened to the United States at the end of the 1920s and to Japan at the end of the 1980s, Pettis said. In those countries, as in China today, too much wealth became concentrated and needed to be spread out in order for consumption to take off.
“While China was growing, there was this huge transfer of wealth from the household to the state,” Pettis said in an interview before the speech. “We’ve got to reverse that transfer. We need to transfer wealth from the state to the household sector and consumption will automatically rise as a share of GDP. It’s just arithmetic.”
China’s leaders have started the reversal. But it’s difficult because of the people and institutions, in China’s case provincial governments and wealthier citizens, that benefit from the status quo.
“When you do these types of adjustments, you inevitably get tremendous resistance from those vested interests who benefited from the existing growth model,” Pettis said.
When the U.S. development miracle came to a halt in the 1930s Depression, the economy was rebalanced quickly but painfully. From 1930 to 1933, household income fell at a slower rate than the steep drop of overall GDP, resulting in consumption becoming a bigger part of the economy.
Japan experienced a similar transition in a slower, less painful way. Its overall GDP grew at a very slow rate from 1990 to 2010, with household income growing at a faster rate and gradually driving up consumption as a part of the Japanese economy.
China’s restructuring is more likely to be like Japan’s, Pettis said. That would be less painful for China, but it raises the risk that the Chinese economy will eventually become a smaller share of the global economy — as happened with Japan during the 1990s and early 2000s.
While some economists and investors wring their hands about the effect of China’s slowdown on the rest of the world, Pettis said it’s unlikely to be as impactful as many would think. He pointed to Japan’s restructuring, noting that people in the late 1980s thought the country was the engine of the world economy, just as some portray China’s role today.
“Japan wasn’t the engine of global growth. The engine of growth is demand,” he said, and greater consumption in Japan created more of it, as is likely with China.
More consumption in China will pay off for global producers of goods for consumers, such as food and household products, Pettis said. But producers of metals and other infrastructure commodities will suffer. That’s partly because China will need fewer materials and partly because the country is already the top producer of things like steel.
“Capital-intensive exports — steel, shipbuilding — will do badly because the Chinese have invested so much in those that they can’t stop,” Pettis said.