Michael Pettis’ take on the Chinese economic picture is always worth keeping tabs on, but his latest dose of pessimism about the sustainability of Chinese growth seems to me interesting for its broader implications about how we think of savings and investment policy. He writes that Chinese growth is based on unsustainable over-investment as illustrated by the fact that “Chinese households consume only about 35% of gross domestic product (GDP), far less than any other country.”
How does that happen?
Well according to Pettis, China’s “growth model transfers income from households to the corporate sector, mainly in the form of artificially low interest rates” whereby “[l]ow yields on deposits force them to sacrifice consumption, to save more.” So now forget about China for a moment and think about the United States. Here in the USA people often feel that over the long run, we have unsustainably low rate of household savings, and that investment-boosting measures would improve our long-term growth rate. But if somebody proposed that we step up government regulation to reduce the returns to household saving, the conventional political pushback would be to say that this will push the savings rate down. If you want to boost savings and investment, what you do is take steps to increase the returns to investment. Hence the popularity of lower taxes on capital gains and the like.
What’s interesting is that as best I can tell widespread acceptance of this model — more incentives to save will lead to higher savings — coexists with fairly widespread mainstream acceptance of the Pettis Model of the Chinese economy. And yet the Pettis model is exactly the reverse of this. He says that households target an acceptable threshold level of saving, and that therefore if you reduce the returns to saving households need to save more in order to meet the target. Hence, according to Pettis, China is able to create an investment oriented economy precisely by depriving households of lucrative savings vehicles and investment opportunities. This is the precise opposite of the policy trajectory that US policymakers have been following for the past thirty years.
One piece of evidence for the Pettis view is that, current recession aside, the era of policymaker obsession with increasing incentives to save has in practice been associated with steadily falling savings rates. This has long struck me as an under-discussed problem for the conventional wisdom and the Pettis Model of Chinese growth perhaps gives us a concrete example of how a different paradigm might operate.