The Economist v. Nick Lardy
from Follow the Money

The Economist v. Nick Lardy

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China’s goods and services trade surplus is set to increase from $50b in 2004 to $185b in 2006.  China’s current account surplus is set to rise from around 3-4% of China’s 2004 GDP to around 9% of its 2006 GDP.   Net exports accounted for ¼ of China’s (impressive) growth in 2005 and are likely to account for 1/5 of China’s (even more impressive) growth in 2006.   No wonder Nick Lardy writes: 

“The contribution of net exports to China’s growth has rarely been as high as in 2005 and 2006.”  

Recent signs suggest the pace of China’s export growth has, if anything, picked up.  So you might expect the Economist to write an article emphasizing the contribution the increase in China's (goods) exports from around $265b in 2002 to something like $950b in 2006 has made to Chinese growth.    

But the Economist seems to have concluded that the real story in China isn’t spectacular export growth or stunning investment growth but rather China's consumption growth.  Never mind that consumption is slipping as a share of GDP in China and net exports contribution to growth is rising.

The Economist (probably Pam Woodall, given the Hong Kong byline):

“The doomsayers argue that Asia's growth has itself been based largely on exporting to America, whereas domestic demand in the region has languished. Their evidence for this is that Asia is running a combined current-account surplus of over $400 billion, implying that it is contributing much more to world supply than to demand.  …

Since 2001 the increase in emerging Asia's trade surplus has added less than one percentage point a year on average to the region's average growth rate of almost 7%. Contrary to the received view, the bulk of Asia's growth has been domestically driven.

It is true that exports account for 40% of China's GDP, but those exports have a large import component; only a quarter of the value of China's exports is added locally. The impact of a slowdown in export growth would therefore be partially offset by a slowdown in imports. China's GDP growth has come mainly from domestic demand, which has been growing by an annual 9% in recent years. … The idea that China's growth is mainly export-led is not the only popular myth.   Another, says Jonathan Anderson, an economist at UBS, is that China's consumer spending is feeble.”

Jonathan Anderson is a very good economist, one of the best working on China.  The facts in the Economist story are right.   Chinese consumer spending is growing faster than US consumer spending, even if Chinese consumption spending isn't growing as fast as the Chinese economy.  Household savings in Asia are not rising, contrary to the popular view.  Consumption is falling relative to GDP in places like China largely because labor income is falling relative to GDP. 

However, the spin in Economist's stroy -- and this resulting cover -- still seemed somewhat off.  Net exports rarely contribute more than a percent or two to GDP growth.   If a country’s trade surplus jumps from 3% of GDP to 7% of GDP in a two year period, that is a big deal even if net exports still only adds 2% to growth a year.  The fact that net exports have added nearly a percent point a year to Asian growth over a five year period – i.e. the overall trade surplus has jumped by almost 5% -- actually is rather strong evidence that exports have been a big part of Asia’s recent growth.    They certainly have been a big part of China's recent growth.

The US trade deficit has grown from 3.5% of US GDP at the end of 2001 to around 6% of US GDP now, so net exports haven't subtracted that much from US growth over the past few years.   But does any one really think the deterioration in the US trade balance hasn't helped spur growth elsewhere? 

The notion that China’s recent growth surge has been driven by an unusual surge in consumption is certainly way off. I’ll turn the microphone over Nick Lardy.

“The transition to a more consumption driven growth is off to a slow start.  In the first half of 2006, it appears that investment grew more rapidly than GDP; China’s trade surplus expanded by more than a half, meaning net exports as a share of GDP are still rising rapidly.    Thus, China’s external surplus continues to balloon and, short of a US recession, seems likely to expand further in 2007.  …. Household consumption as a share of GDP almost certainly continued to decline in the first ½ of 2006.”

Consumption is typically the biggest component of any economy, so it often the biggest contributor to growth.   Consumption though isn’t the biggest component of China’s economy.  And investment, not consumption, has been the biggest source of China’s recent growth. 

That is the story.  And the other part of the story is that the contribution of net exports to China’s growth picked way, way up in 2005 and 2006.

The bigger question raised by the Economist is whether Asian consumption and as importantly Asian and particularly Chinese investment could continue to grow at its present rate if a US slump led to Asian export growth to slow.   I have my doubts.   Remember, investment has been a bigger driver of Chinese growth than consumption, and a lot of that investment has been directed toward the export sector.   The indirect effect of rapid export growth – high rates of domestic investment – may be as important as the direct effects. 

True, investment outside of China has been weak.  But investment in inside China has been anything but.  And a slowdown in exports might spill over into a slowdown in Chinese investment.

The real questoin in some sense isn’t whether Asia can decouple from the US.  It is whether Asian consumption and investment growth can decouple from Asian export growth.  If net exports don’t contribute positive to Asian growth, but domestic demand – consumption and investment – is unchanged, Asia will grow rapidly no matter what.   Not quite as fast as now, but still very fast.   If net exports don’t contribute positively to growth and domestic demand growth also slows, Asia’s overall growth could slow quite rapidly.

I don’t want to be entirely critical of the Economist's story though. The Economist does correctly debunk the notion of high household savings rates in Asia account for high rates of national savings, and correctly notes that many Asian economies have lots of room to use fiscal policy to support domestic demand.    And I was pleased to see that the Economist noted that China now exports almost as much to Europe as to the US, and that its exports to Europe are now growing faster than its exports to the US. 

Incidentally, later in the article, the Economist notes that Chinese imports for domestic use are rising, and are now about as big as China’s imports for reprocessing. 

“Goldman Sachs reports that five years ago China's imports for domestic use were only half as big as those for the assembly and re-export of products, but now they are roughly the same size.”

How though does that square with the argument that 3/4s of the value of China’s exports comes from imported content? If China exports 40% of its GDP, imports 34% (assuming a 6% of GDP goods trade surplus) and ½ of those imports are for domestic use, isn’t the implied Chinese content of Chinese exports a lot higher than 25%? 

In 2006, China is on track to export about $975b worth of goods, and import around $800b.   If ½ those imports are for domestic use and ½ are imported components, isn’t the Chinese component of Chinese exports around $475b, or around 18% of China’s 2006 GDP? 

US goods and services exports, by contrast, are around 11% of US GDP – and at least some of those exports make use of imported parts.    Boeing imports components from Japan.    US car exports to Canada have some Mexican parts.   And so on.

I am geuinely puzzled by this.  All the standard estimates of value-added in China's export seem too low to me, given China's current trade surplus and the growth in its imports for domestic consumption. 

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