Streetwise Professor

July 12, 2009

Keynes Goes to China

Filed under: Economics,Financial crisis,Politics — The Professor @ 8:50 pm

Thinking more about the Chinese statistical issues that I wrote about on Thursday brought to mind my posts on the “stimulus” package and Keynesian economics.  A major theme of those posts was that massive government spending could raise measured GDP, but that the real value of the output created through such programs could fall far short of the recorded value.  Just because the government spends $100 billion doesn’t mean you’d get anything anyone would be willing to pay $100 billion for.  Keynesian accounting is based on the fallacious notion that there is some homogenous stuff called “output,”  and the loss of $100 of private output can be offset by a $100 of government spending/output.  

This seems to fit China to a “T”. China has undertaken a massive stimulus, drawing down a decent chunk of the nation’s savings to pay for all sorts of infrastructure projects, and other things.  This allows China to record GDP figures that match its forecast of 8 percent growth at the same time that its output of private goods and services (a very large fraction of which were exported) has declined due to the economic problems in the nations to which China exports.  

And the very fact that China has achieved this 8 percent growth target almost exactly, despite plunging exports, is the very thing that raises my skepticism.  The “aha” moment came in a phone call with a friend, who spends one month of every 4 in China.  I asked him about the economy, and he indicated how the government was trumpeting the meeting of the growth target.  I immediately had flashbacks to companies that met earnings targets quarter after quarter, like clockwork, only to have it revealed subsequently that this was achieved through accounting legerdemain.

China’s government can effectively do the same thing.  A yuan of government spending increases measured GDP by a yuan, even if it is spent on a project that generates no economic value.  It may generate political value, however, as a nervous Chinese government is anxious to spend to prevent social unrest.

And that’s a reasonable calculation for the Chinese government to make.  My concern is that many of the forecasts (and hopes) about an economic rebound in the US, Europe, and Japan are based on Chinese growth (and growth in other emerging markets) dragging the rest of the world along with it.  If reported Chinese GDP growth is driven primarily by government expenditure on dubious projects–and many of those in non-tradeables–it is quite difficult to see how these hopes can be realized.  It is unlikely that Chinese consumers are going to dramatically change their spending habits, especially in times of economic uncertainty; it is also unlikely that Chinese consumers are going to increase their demand for non-Chinese consumer goods; and it is further unlikely that recorded growth based on increases in government expenditure is going to lead to increased demand for Western-or-Japanese produced investment goods.   So just how is the Chinese stimulus going to be converted into increased demand for non-Chinese products?  

In brief, it seems to me that a crude Keynesian focus on economic aggregates is preventing people from assessing critically China’s actual ability to spur economic growth not just in China, but in the world at large.  It is highly likely that Chinese growth is largely chimerical, and that such chimerical growth is hardly the basis for a recovery in the world economy, especially given the export-driven nature of China’s recent growth.  

So, apropos my earlier posts, just as I was extremely skeptical that stimulus spending in the US would generate an economic recovery here, it seems to me that reported Chinese growth is a very weak reed on which to base hopes for an economic recovery in the US, Europe, Japan, or elsewhere in the world.

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1 Comment »

  1. There is nowhere to hide in this hideous global meltdown. China is a big meltdown waiting to happen. An export economy tied to our debt with only a small middle class to consume domestically, times are going to be harder for them too.

    The Obama administration is going to regret that they didn’t take their lumps at the beginning of this mess. The losers should have been allowed to fail. We still have zombie banks propped up with taxpayer money with toxic paper on their books. We’ve already on the unemployment numbers surpassed the higher range of the bank stress test scenerios. What could have been a few years of pain I feel will now stretch into a generation.

    Oh, well, I’m off to buy more FXP(ultrashort China)…….

    Comment by penny — July 13, 2009 @ 8:11 am

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