Can China Survive a Trump-led Trade Attack?
(Bloomberg View) -- This week, President Xi Jinping will attend the Davos forum for the first time -- a sign of how concerned China is about a possible retreat from globalization. Till now, easy access to world markets has underpinned the country's remarkable expansion. How badly Chinese growth could be hurt by new trade barriers may be the most pressing question facing the world economy. Beijing University professor Michael Pettis, one of the best-known China skeptics, is gloomy; Bloomberg Intelligence economist Tom Orlik, less so. They met online to debate China's prospects.
Orlik: President-elect Donald Trump’s talk of tariffs and the rise of populist nationalism evident in the Brexit vote are warning signs of a coming storm. At this point, though, there’s no way of knowing how severe the storm will be. The history of U.S.-China relations shows tough talk on the campaign trail rarely translates into action in office.
Trump has already backed away from other pledges. It’s possible tariffs won’t materialize. Indeed, a fiscal stimulus that puts more money into American shoppers' pockets could actually boost demand for China’s exports. In Europe, anger is focused more on immigrants than trade. Absent sweeping tariffs, our forecast is for exports to grow about 5 percent in 2017, reversing the contraction in 2016.
Pettis: You may be right, Tom, but the global economy continues to be distorted by huge trade imbalances. The worst offender is Germany, whose record-breaking surpluses just keep growing. Meanwhile Japan is running large surpluses again after five years of deficits. These and other large surpluses are driven not by rising productivity but rather by structurally weak domestic demand, and in most cases this weak demand isn’t being addressed except by being exported. China is one of the few surplus countries that has actually improved domestic demand, driving its current account surplus down from 10.1 percent of GDP in 2007 to under 3 percent today. In absolute terms, however, China’s surplus is barely 10 percent below its previous peak.
To make matters worse, while collapsing commodity prices until recently forced commodity-exporters to absorb part of these imbalances, they no longer can do so. Nearly half the responsibility for absorbing foreign surpluses now falls onto U.S. consumers. That's why, even if Trump is bluffing, this problem isn't going away.
Orlik: Here's another way of looking at those China numbers: With the current account surplus down to 2.7 percent of GDP, trade is clearly a smaller contributor to growth than it used to be. Even if Trump did erect major trade barriers to Chinese goods, perhaps even the 45 percent tariffs he's talked about, the costs to China wouldn't be as great as many imagine. Bloomberg's estimates suggest a trade war would reduce 2017 GDP growth to 5.6 percent from our baseline forecast of 6.3 percent. That would present China’s government with a tough choice -- accept lower growth and employment or ramp up demand with another credit-fueled stimulus -- and there are costs associated with either option. But they’d be manageable, not catastrophic.
Pettis: It depends on how quickly it happens. To achieve last year’s GDP growth target, Chinese debt had to grow by a gut-wrenching 40 percentage points of GDP. Every one-point contraction in China’s trade surplus raises that amount by nearly one-third. As things stand, China probably has little more than two to four years in which to reverse its dependence on debt. Another credit-fueled stimulus would just give Beijing even less time.
Ultimately the only meaningful way to reverse China’s debt dependence is to boost consumption as a source of growth. Yet with household income at just over 50 percent of GDP, among the lowest in history, Beijing must raise household income even as it cuts back investment. This won’t be easy: It requires aggressive reforms that effectively transfer wealth from local governments to ordinary households. China has been trying to do this since 2007, but political opposition from so-called vested interests has been, as you know, ferocious. Even if this year’s Party Congress centralizes decision-making enough to allow Chinese leaders to implement the necessary reforms, it could easily take two to three years before the impact is felt.
China was always unlikely to have a financial crisis, but the more debt there is, the more downward pressure there will be on the economy, which means growth will drop substantially whether or not there is a crisis. A contraction in trade just makes a bad problem worse.
Orlik: All valid points, Michael. But I’d place the emphasis slightly differently. First, household consumption is already doing some work to offset weak exports; it's been rising as a share of GDP since 2010. Higher wages, increased returns on savings and improved welfare coverage are all gradually adding to stronger consumption. Direct subsidies -- like the tax cuts that boosted auto spending in 2016 -- can accelerate the trend.
Second, debt fatalism assumes an unchanging structure of credit allocation. Old-economy industries like steel don’t produce much output or employment bang for their credit buck. New-economy sectors -- services and high-tech -- do. By shifting credit allocation from the former to the latter, China could maximize the boost to growth and minimize the increase in financial risks. Admittedly, there’s not been much progress in that direction in recent years. Even so, the risk of trade tensions could sharpen incentives for China’s policymakers.
Pettis: Growth in household consumption is certainly becoming a bigger share of GDP growth, but largely because decelerating growth in investment and net exports automatically raises the consumption share. This is just passive rebalancing, and at this pace it will take nearly a decade before consumption meaningfully drives the economy. As for shifting credit allocation to the new economy, this has always been a bit of a red herring. New-economy consumption has certainly grown quickly, but mainly by cannibalizing old-economy consumption. It is consumption growth overall that must drive the economy, and consumption is necessarily constrained by the growth in household income.
In the near term, ironically, none of this might seem relevant. Chinese capital is pouring into the U.S., in part because of trade worries, and the U.S. current account deficit must automatically rise with net capital inflows. In the next year, in other words, China’s trade surplus might actually rise along with the American deficit. As long as it depends on such surpluses to resolve domestic demand, the Chinese economy will remain vulnerable to trade war.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Tom Orlik is the chief Asia economist for Bloomberg Intelligence and author of "Understanding China's Economic Indicators," a guide to Chinese economic data. He is based in Beijing.
Michael Pettis is a Professor of Finance at the Guanghua School of Management at Peking University in Beijing, China. He is an expert on the banking and financial markets in China, topic on which he has taught courses, conducted research, and published numerous papers. Prior to his tenure at Guanghua, Mr. Pettis spent fifteen years as a banker and trader on Wall Street, serving most recently as a Managing Director and Head of Liability Management and Latin American Capital Markets at Bear Stearns. Mr. Pettis also currently serves as a Senior Associate at the Carnegie Endowment for International Peace. He holds an MBA in Finance and an MIA in Development Economics from Columbia University.
To contact the authors of this story: Tom Orlik at torlik4@bloomberg.net.
To contact the editor responsible for this story: Nisid Hajari at nhajari@bloomberg.net.