Saturday, August 22, 2009

China and the US - savings and investment

Interesting discussion at dinner last night with a member of the board of a major Australian retailer who argued that the Australian economy was far more fragile then people realised. I am not sure that he is right, but I found the conversation interesting.

There has been a fair bit of discussion since the global financial crisis began about over saving in Asia especially China, over consumption in the west, especially the USA. You will find a sophisticated version of the argument here on Michael Pettis's blog.

This argument confuses me. In this post I want to explain why.

If you look at China, you see a country whose average standard of living is still quite low. You also see a country where there are significant imbalances in wealth across the country. China needs to increase the standard of living for its people, while also ensuring a more even spread.

To do this, China needs to fund investment. This has to come from local savings or from overseas capital. A high local savings rate is not a bad thing in these circumstances.

Leaving aside export subsidies or an artificially low exchange rate, these are different issues, China's semi-centrally controlled economy has been investing in export related activities. This has generated a major balance on current account surplus, mirror imaged by deficits in other countries. To my mind, this is not a savings problem but an investment one.  

I left aside export subsidies and an artificially low exchange rate. To the degree that these things have occurred exports may increase, but China is also effectively subsidising consumers in other countries. I do not think that this is a sensible longer term strategy.

The suggestion that China should increase consumption for the sake of increasing consumption does not make a great deal of sense to me. Looking at the Chinese position through Australian eyes, the fact that China has been accumulating such large trade surpluses provides an opportunity for the Government to do new things.

This is a bit like what happened here, but on a much grander scale. Australia came through the global downturn so well because and only because our net trade position suddenly improved. This was a necessary but not sufficient condition.

In China's case, the challenges are far greater, but so are the opportunities. If I were an adviser in China, my focus would be on the best ways for China to benefit. Here I am worried by some of Michael Pettis's posts because he points to areas where some of the policy responses do not appear to be very sensible.

In all this, I would not be worried by the US except to the degree that it affected China.

In a post last November, Scoping the global downturn - a few numbers, I looked at relative shares of global GDP. The US has shrunk to a bit over 25%. China is a long way behind at a bit over 6%. My point then was that relativities meant that China could not be the type of universal  cure-all as often presented. This makes me very cautious reading some of the savings/consumption arguments.  

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