It was perhaps predictable that China’s initial sharp rebound from the global financial crisis would serve to entrench widespread perceptions that the prc represents an alternative and, on some readings, superior model of capitalist development.footnote1 Desperate pleas by Hillary Clinton and Tim Geithner for Beijing to continue its purchase of us Treasuries in the immediate aftermath of the 2008 meltdown seemed to confirm that China was indeed displacing the us, the alleged culprit of the crisis, and becoming a new centre of the global economy. Yet the celebrations of China’s rise at the expense of the us evoked more sceptical responses too. Michael Pettis’s provocative and well-informed new book, The Great Rebalancing, presents a more critical view. It contends that countries that run a persistent trade surplus, like China, are at least as responsible for the global financial crisis as those running deficits, like the us. In his view, the outcome of the crisis will put an end to the ‘economic miracles’ of the surplus countries and may lead them into Japan-style lost decades. The only way out would require a profound rebalancing of the surplus countries’ economies. I will argue that a third scenario could be derived from the book’s analysis, beyond Pettis’s alternatives of a prolonged, deepening crisis or smooth, coordinated rebalancing. But first let us examine The Great Rebalancing’s account.
Pettis is a professor of finance at Peking University and a veteran Wall Street wheeler-dealer specializing in ‘emerging markets’, initially in Latin America. His first book, The Volatility Machine: Emerging Economies and the Threat of Financial Collapse, appeared in 2001, and since then his contrarian views have become well known through his widely cited blog, ‘China Financial Markets’. Drawing diverse theoretical insights from Keynes and, surprisingly, Hobson, Lenin and David Harvey, The Great Rebalancing is a systematic elaboration of Pettis’s diagnosis of the origins of the financial crisis and suggestions for its remedy. He sees the global trade and capital-flow imbalances underlying the crisis as primarily a consequence of the consumption-repressing growth model adopted by the surplus countries, most notably China and Germany.
The Great Rebalancing sets out the principles at stake, in the form of ‘accounting identities’. Where consumption is repressed relative to production, the result is a rise in saving. If domestic savings exceed domestic investment, then in an open economy the excess saving will flow abroad to other countries, in the form of net capital export. China’s purchase of us Treasury bonds and Germany’s lending to Spain and Greece are examples of such exports. Similarly, for a country that imports capital from abroad, investment will exceed saving. It follows that the amount of net capital outflow or inflow will be equal to the difference between savings and investment; the difference will also be equal to the country’s trade balance. (Formally put, if y is national product, c is total consumption, g is government spending, i is total investment, (x–m) is trade balance and s is saving, we have y=c+g+i+(x–m), which leads to y–c–g–i=s–i=(x–m), since, by definition, y–c–g=s.) Therefore, an economy’s trade surplus/deficit will be equal to that economy’s net capital outflow/inflow, which in turn is equal to its saving less investment. As open economies are linked to one another through trade and investment, capital export and trade surplus originating from one country’s under-consumption must be balanced by capital imports, trade deficit and over-consumption in another country. In other words, domestic imbalances of trading partners will mirror each other, generating global imbalances.
Examining how these principles have operated in the concrete case of China’s domestic imbalance, Pettis, like many other authors, finds that the prc’s model of repressed-consumption growth is not new, but is an extended replication of the Japanese model. As Pettis emphasizes throughout the book, a country’s consumption levels and savings rate have nothing to do with its culture and the habits of its people: China’s high saving and low consumption are consequences of explicit policies: wage repression, an undervalued currency and financial repression. Since the 1990s, the vast supply of rural migrant labour, whose rights and access to services where they worked were denied under the hukou system, in addition to what Pettis describes as ‘government-sponsored unions that more often see things from the point of view of employers than from that of workers’, ensured that wages grew much more slowly than productivity, hence repressing the growth of workers’ income and consumption relative to the growth of production. At the same time, China’s central bank intervened in the currency market to prevent the yuan from appreciating alongside the growth of the trade surplus. The undervalued currency benefited exporters, but made domestic consumption more expensive; the policy has therefore operated as a hidden tax on household consumers, which is transferred to exporters. The low interest rates maintained by state banks for both depositors and borrowers have also constituted a hidden tax on households: while ordinary depositors have had to put up with meagre or even negative real interest rates, state enterprises and government units could borrow at give-away rates to fuel the orgies of real-estate and infrastructural construction. This again is tantamount to a subsidy to the state sector paid by financially repressed depositors.
This model of development brought about miraculous economic growth rates, rapidly improving infrastructure and an internationally competitive manufacturing sector. Paradoxically, though the growth rate has attracted high investment, the financial repression involved also pushes saving—here, mostly corporate and government rather than household saving—to an even higher level. As such, the excess saving of China has to be exported overseas in exchange for external demand for its manufactured products. Given the size of the us market and the high liquidity of us assets, Treasury securities in particular, most of China’s excess saving ends up heading to the us. To Pettis, the Chinese purchase of dollar assets is a trade policy, ‘aimed at generating trade surpluses and higher domestic employment’. For the American economy, such large-scale capital imports are ‘usually harmful’, as the us has ‘no choice but to respond to the growing net inflows [of capital] with higher investment, higher unemployment, or higher consumption’. With capital inflows pushing up the dollar, cheapening manufactured imports and penalizing us manufacturers, ‘there was little incentive for American businesses to borrow and expand production domestically’. Instead, the massive inflows of capital fuelled the expanding real-estate bubble and debt-financed consumption. Pettis concludes that the us consumption spree and trade deficit was caused by excessive foreign (Chinese) investment in dollar assets that ‘force Americans to consume beyond their means’.
In his analysis of the Eurozone crisis, Pettis sees the relation between Germany, a surplus country, and Spain and other ‘deficit countries’, as reminiscent of that between China and the us. In the 1990s, post-unification Germany put into place ‘a number of policies, agreed on by trade unions, businesses and the government, aimed at constraining wages and consumption and expanding production, in order to regain competitiveness and generate jobs.’ These consumption-repressing policies worked well. But excess saving has to be exported, in exchange for ‘importing’ external demand. In this instance, the context included the launch of the euro and increasing European integration. German capital was exported to peripheral Europe principally in the form of bank lending, but its harmful effects resembled China’s capital exports to the us in the form of buying Treasury bonds. Taking Spain as his example, Pettis contends that German’s anti-consumption policies eroded the profitability of Spanish manufacturing and discouraged private investment in the tradeable goods sector there, while at the same time Germany’s excess saving was being exported to Spain on a massive scale. The result was the expansion of a gigantic real-estate bubble in Spain.
Pettis reminds us that global imbalances caused by under-consuming countries which export surplus capital to other economies are not novel in the development of capitalism. Drawing from the insights of Hobson and Lenin, he notes that in the late nineteenth and early twentieth century, under-consumption in industrialized economies—where workers’ demand was repressed since wealth and income were concentrated in the hands of the rich—created pressures for those countries to export capital to their formal or informal colonies, which in turn started to run trade deficits and be indebted to the colonizing countries. The main difference between then and now is that, in the early 1900s, capital-exporting colonizers ‘managed the colonial economies and their tax systems, and so they could ensure that all debts were repaid’. Global imbalances could therefore last longer in the age of imperialism, as ‘large current-account imbalances could persist for as long as the colony had assets to trade [or to be expropriated]’.