Michael Pettis - Avoiding the Fall: China’s Economic Restructuring

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Library of Congress Cataloging-in-Publication Data

Pettis, Michael.

Avoiding the fall : Chinas economic restructuring / Michael Pettis.

pages cm.

Includes bibliographical references and index.

ISBN 978-0-87003-407-7 (pbk.) ISBN 978-0-87003-406-0 (cloth)

ISBN 978-0-87003-408-4 (electronic)

1. ChinaEconomic policy2000- 2. ChinaEconomic conditions2000-

I. Carnegie Endowment for International Peace. II. Title.

HC427.95.P48 2013

330.951 dc23

FOREWORD

S ome experts and markets continue to be bullish about the Chinese economy, expecting that high rates of growth will continue indefinitely. But that focus on numbers obscures stark realities.

While the country certainly achieved remarkable growth over the last three decades, success came with significant costs. Like other rapidly developing Asian economies, China relied on repressed household consumption to make modernizing investments. Its economic model distorted interest rates, the currency, and even legal structures. And it led to burgeoning debt that is becoming increasingly difficult to finance. The time has come for China to adjust its model to the new circumstances success has produced.

Significant challenges lie ahead. To sustain growth, employment, and social stability, China must now deal with lagging wage growth, financial repression, environmental degradation, and the development of a social safety net.

In Avoiding the Fall , Michael Pettis offers a fresh look at Chinas economic situation and upends much conventional wisdom. A professor of finance at Peking Universitys Guanghua School of Management with extensive Wall Street experience and an intimate knowledge of China, Pettis offers unique insight.

In his cogent analysis of the Chinese economy, Pettis exposes the flaws in many analyses that often rely solely on past performance. And he assesses the potential impact of the six options China has for restructuring its economy.

It is clear that China needs to reform its development model to achieve a very different kind of growth. Rebalancing is inevitable, but the question is how it will occur. Whatever Beijing decides will have huge implications for the global economy.

Pettis wisely challenges the widely held myth that Chinas rise will continue without reform. This book is essential reading for anyone looking to better understand the worlds second largest economy and the difficult economic changes that lie ahead.

DOUGLAS H. PAAL

Vice President for Studies

Carnegie Endowment for International Peace

CHAPTER 1

THE LIMITS OF THE CHINESE GROWTH MODEL

B eijing began to reform the Chinese economy in the late 1970s and early 1980s. Since then it managed to generate such spectacular growth for three decades that, with the possible exception of postwar Japan, South Korea, and Taiwan, no comparable precedents exist. Even these limited precedents may understate Chinas achievement.

Japans success occurred in a country that had been economically destroyed by war but that had been socially and culturally an advanced economy since at least the end of the nineteenth century. It was already the sixth-largest manufacturing nation by the 1920s, surpassed only by the United States, Germany, Britain, France, and the USSR. As the cases of Germany after 1945 and Belgium after 1918 suggest, advanced countries destroyed by war tend to catch up to their former status very quickly, perhaps because they start the process with much higher levels of social capital and institutional frameworks that permit and encourage rapid growth in productivity.

For this reason, in some ways Taiwan and South Korea may be more useful comparisons to China. They are among the very few economies in the twentieth century to have transformed from poor-country status to rich-country status. Indeed, South Korea began its process of dramatic growth much more socially and economically backward than China was at a comparable time in its development. Still, South Korea and Taiwan both benefited from their strategic roles in the Cold War, when the United States and its allies considered it vitally important that they emerge as great economic successes.

China, of course, had no equivalent backing, and if today it is still much poorer than South Korea and Taiwan, its tremendous growth over the past three decades is in many ways comparable to their achievement. Granted, much of Chinas growth, especially during the first decade of the reform period, came about largely as a function of Beijings reversal of constraining policies put into place during the Maoist period. In the late 1970s, for example, China had fallen far behind neighboring countries that had been at similar or much lower levels of economic development in the 1920s and 1930s. Simply by eliminating the constraints imposed as a consequence of these policies, Beijing allowed China sufficient leeway to catch up to where it might have otherwise been under conditions more favorable to normal economic growth.

But just reversing bad policies is not enough to explain all that has occurred in the past three decades. Beijing has learned well from the history of other developing countries, and it has applied some of those lessons carefully and intelligently. Taking its cues from other countries that had experienced rapid growth, especially Asian countries that followed the growth model that Japan had partly put into place in the late nineteenth and early twentieth centuries, and which it had renewed in the postwar period, China was able to push much further than it otherwise would have. During this period China joined a group of countries whose growth rates were so high during one or more decades of the twentieth century that they were characterized as economic miracles.

But theres the rub. With the exception of South Korea, Taiwan, and perhaps Chile, none of the many miracle economies of the twentieth century has been able to sustain growth to the point where it was able to join the rich-country club, and Japan had already been a member of the club when its growth miracle began. In the late 1980s, University of Chicago Professor Robert Aliber proposed, partly in jest, what he called the Andy Warhol theory of economic growth: In the future every country will grow rapidly for fifteen years.

But, as he notes, this growth isnt enough to ensure continued success. In every case, I will argue in this book, decades of high growth, almost always driven by very high levels of investment, eventually faltered. Even among the successful countries, the period of growth was interrupted in every case either by a debt crisis and many years of negative growth or by a lost decade of very slow growth and burgeoning debt.