China can handle collapse of speculative inflows

Marshall Auerback here.  This will be short, but I felt compelled to post with my views on China.

There was clearly a bubble in exports in the past four years, with exports serving to cover capital inflow (overinvoicing must have been a big part of that).  So this is just part of the overall collapse of speculative capital flows, and not so much a decline in real effective demand.  China can handle this, the population is not constrained by either income or debt.

This is an aspect of China’s economy that most people don’t understand.  For the typical Chinese light-industrial firm, the optimal strategy for earning a profit is eventually to aim for exports, because export prices are multiples of those paid at home and therefore much more profitable.  The typical Chinese manufacturing, firm, then, produces and produces and produces, gaining practice, improving quality and demonstrating reliability – in the hope of eventually selling part of the production onto the export market.  For this, labour must be treated as a fixed cost. That is to say, that production must continue in spite of demand.  The strategy will be defeated if firms interrupt production and dismiss workers simply because the output they are producing cannot be immediately sold at the Wal-Mart price.

So with the output that is not exported, it is dumped domestically at whatever price it can command.  And the result is falling prices (deflation) for the Chinese consumer.  Relative to a fixed money wage, this implies a rising real wage in terms of staples for the average Chinese consumer, the result of which is a well-fed, well-clothed population and a near absence of significant human depravity in the cities.  That’s apparent to anybody who visits China.

So I don’t see any significant long term damage in China, even if it has a cyclical downdraft.  I realise this is not the fashionable view, but I think the alternative is based on a very superficial understanding of the country.

Your comments are welcome.

  1. tokyo joe says

    I have spent the last twenty plus years in a combination of Japan, China and SE Asia, so I do have some experience. Insight, well, that is still to be determined (though I top ticked Japan ’89 and China ’07). Back last year I saw all the constructions cranes lining the major Chinese cities, and where the casual visitor saw a boom, I saw bad debts in the making. It looked so much like 1990 Tokyo and Osaka that I had no choice but to get short. The hope was there, the demand was not.

    China has changed dramatically over the last few years, in a social sense. There used to be an underlying inferiority complex because folks could see that the majority of the progress of the human species since the Renaissance had been done without any Chinese input. To some extent that changed when the Chinese boom began, even when the country was still in the t-shirt and carnival prizes stage of development. The psyche, however, is fragile, and this current downturn is dashing hopes and popping egos. Somebody is going to have to pay, and it may well be the Party.

    By the way, did you know that by 2015 there will be 30 million more marrying age men than women in China, due to the One Child Policy and preference for males. It may sound silly, but this WILL affect the social stability of the country.

  2. Sobers says

    This argument that domestic sales will take the place of export sales seems spurious to me. If export prices are many multiples of domestic ones, domestic sales will have to be increased by large factors to enable a factory to continue production at the same level. Is it realistic for Chinese domestic demand to increase by say 25% even, within a year? Given the housing price and stock market falls in China, I would say not. My take is that domestic demand will be stable, or rise a little, and this will mean large swathes of manufacturing will become non-viable rapidly as 2009 progesses. As these enterprises fail, the unemployed will become a source of social unrest, as we are getting reports of already.

    I see China now as the USA of the 1930s. Dependent on export revenues, which dry up. A large drop in GDP is likely, and as China is a totalitarian state, there will be no safety valve of democratic change to prevent social unrest turning to violence and anarchy.

    1. Marshall Auerback says

      @sobers, My point is not that domestic sales replace export sales, but more that the resultant domestic deflation is beneficial to China’s consumers because they are not income or debt constrained as in the US. That is also a crucial distinction between China today and the US in the 1930s, where debt/GDP was quite high as we went into the Great Depression.

      Also, exports were likely overstated, as I mentioned earlier, so I don’t think the “collapse” is as great as implied by the dodgy statistics.

  3. Guest says

    The factory sells products at lower prices, but still pays high wages to workers. Forgive my ignorance, but does that make the factory to go bankrupt and make the workers unemployed?

  4. Denis says

    I’m 100% with sobers here.

    When global trade falls apart it’s the exporters who have the really bad problem – unemployment. Importers have a better problem – they have to make do with smaller buying power, constrained to essentials.

    1. Edward Harrison says

      Denis, I think China will suffer terribly during this downturn and the protectionist sentiment that is now mounting will be part and parcel of their suffering. However, I do think that once the recession is over China will rebound and take off again as the Korean and Japanese juggernauts did when their economies were the ones to watch in Asia. The shift to a Asian-centric world and away from the U.S. will continue, but not without serious pain for the Chinese economy from this downturn.

  5. knightrd says

    Your website is on my list of must-read blogs. Unfortunately, I don’t think China will be able offload enough product domestically. In fact, I think they already have failed to act quickly and appropriately.

    I have contacts in Asia as well and the story they have been telling me for the past 6 months is pretty grim. Layoffs have resulted in civil unrest and riots. I have friends who are worried about feeding their families now.

    Of course this is anecdotal evidence, but it stands out in my mind because I remember reading some rosy blog posts and talking to my friends in China about how well it sounded like their country can cope. Even now, I think they are in a superior position compared to the US. In a sense, China and Japan are propping us up. However, money has a way of disappearing quickly when you need it the most. My friends certainly didn’t agree with the positive blogs.

    I can’t really call this one. I think it will be bad for China, but at least they have more options available than we do in the US. Perhaps if they play their cards right, they can lessen the impact of the recession. Worst case (and highly unlikely) scenario would be mass riots leading to regime change. If China falls, Japan and the US are in serious trouble.

  6. Edward Harrison says

    knightrd, sorry for the late reply. Your post got lost in the comment system. Quite annoying I have to say. But, I did want to thank you for bringing those anecdotes to the blog here. When we are dealing with a country like China or Argentina (or the U.S.) where the statistics seem like they could easily be manipulated, it really takes an ear close to the ground to know what is really happening.

    Logic would say that China will not be able to offload enough product domestically. Yet, I am still hearing others — well-informed others, I might add — telling me that China looks good. It does loo good medium- to long-term but the 2009 outlook is not good in my view.



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