Scott Sumner on “The Confusing China Debate”

You should read yesterday’s post before tackling this one. Consider yourself warned!

Scott Sumner, whose post on China we’re discussing today, has a nice excerpt from the WSJ, which I’ll reproduce below:

Economists and investors have been calling on Beijing to make bolder efforts to boost output—especially by promoting consumer spending, if necessary, by offering cash handouts, as the U.S. did during the pandemic.
Accelerating China’s transition to a more consumer-led economy—such as that of the U.S.—would make growth more sustainable in the long term, economists say.
But top leader Xi Jinping has deep-rooted philosophical objections to Western-style consumption-driven growth, people familiar with decision-making in Beijing say. Xi sees such growth as wasteful and at odds with his goal of making China a world-leading industrial and technological powerhouse, they say.
Xi believes Beijing should stick to fiscal discipline, especially given China’s deep debt. That makes stimulus or welfare policies akin to those in the U.S. and Europe less likely, the people said.

He goes on to say that Xi is right when he says that welfarism ain’t right for China. But, he goes on to say, the economists are also right when they say that China needs stimulus. So if the government won’t give the meds but China needs the meds, then where do the meds come from? Monetary stimulus should step up to the plate, per Sumner.

GDP, as any first year student of econ will tell you, is C+I+G+NX. Well, any Indian student, at any rate, but that’s a whole other story. Look this up, if this is not familiar to you.

Scott Sumner says that this framing is problematic. Why problematic? Because if we economists see that I (investment) is down, and GDP needs to go up… well then, we’ll say that either C should go up or G should (or both). But Scott says that this is wrong. No policymaker, he says “could realistically have the information required to make that judgment.”

His point is that what we should be saying is that China needs to do less wasteful investment. China has a lot of “white elephants“. Stop building those out, and let the market work out what is needed. The Chinese government should encourage more private investment and discourage public investment.

Well… that’s a bit like saying that an alcoholic should not drink quite as much. Easy to say, difficult to make happen. This is not, to be clear, me making fun of Scott’s argument. I’m simply trying to give you an analogy that might make understanding this easier. In fact, Scott himself later on in his post says that he is describing what ought to happen in an ideal scenario:

Some might argue that my analysis is naïve because China is far from being a laissez-faire economy. Monetary stimulus won’t necessarily go into the most efficient sectors. I agree. I am describing the sort of outcome that China should be aiming for. Determining which policy levers to push requires an in depth knowledge of the current policy distortions that lead to a misallocation of resources. Thus monetary stimulus might be combined with banking reform to reduce moral hazard. The goal would be to reduce lending for nonproductive investments, such as dubious real estate projects. But again, that’s not aiming for “less investment”, that’s aiming for less wasteful investment.

I find myself in agreement and in disagreement with Scott’s post. Agreement because the advice is sound. Disagreement because there isn’t a snowball’s chance in hell of this happening. How does the Chinese government, of all institutions, credibly show that it will be a passive and benevolent spectator to market-driven investment? Remember, this is XI’s government!

So as a theoretical solution, sure. As a practical solution? Not so much. If you want the Chinese economy to get out of the situation it finds itself in, you have to come up with solutions that take into account the ground reality. And the ground reality is that the Chinese economy works at the pleasure of the Chinse government, and the Chinese economy is never quite sure about what the Chinese government will do next. So for the Chinese economy to muster up the courage to gather funds and deploy them on multi-year investment projects, and to trust that the Chinese government will do nothing to get in the way across all of those years is… well, not happening.

Scott Sumner knows China a million times better than I do, so of course he knows this. Don’t read his blog post as being indicative of what he thinks the Chinese government will do. Read it as what he things the Chinese government ought to do.

The real issues are using monetary policy to assure nominal stability, and moving to a more market oriented economy to insure economic growth and higher living standards for the future.

You may or may not agree with the first half of that sentence (I personally think there is room for fiscal policy along with monetary policy). Everybody agrees with the second half.

Everybody, that is, except the Chinese government.

More’s the pity.