Krugman: The great Chinese Ponzi Bicycle

Krugman wrote an interesting piece recently in NY times, titled "Hitting China's Wall", and later on his blog, called  " China’s Ponzi Bicycle Is Running Into A Brick Wall".

Nobel prize winning, Keynesian economist, Krugman has quite a reputation among economists, for his liberal political views.

In the article he explains, China's growth has finally hit the wall. For three decades, it's been fueled by surplus 'infinite' labour and high investments. The existence of this surplus labor, has two effects. First, for a while such countries can invest heavily in new factories, construction, and so on without running into diminishing returns, because they can keep drawing in new labor from the countryside. Second, competition from this reserve army of surplus labor keeps wages low even as the economy grows richer. Low wages in turn result in low Private consumption.

Private consumption accounts for only about 36 percent of China’s GDP. That’s about half of what it is in the United States. It’s almost two-thirds of what it is in Europe.
The reason Krugman states, is that surplus labour kept income low for years, and income generated from rapid industrialization was being bottled up by enterprises and government for re-investments.

He compares this low-consumption high-investment economy to a Ponzi scheme. Chinese businesses were investing furiously, not to build capacity to serve consumers, who weren’t buying much, but to serve buyers of investment goods — in effect, investing to take advantage of future investment, adding even more capacity.

However things are changing. China's running out of surplus labour and wages are rising. Though good for the the labour force, Investments are increasingly running into sharply diminishing returns which means private consumption needs to rise sharply to rebalance the growth. And Krugman thinks consumption can't keep up the pace, signs of which is being witnessed in their slowing growth rate.

In short run, investment projects are necessary before consumption catches up. In response, the government announced an additional  1 trillion yuan infrastructure stimulus package last year. In addition, easier private lendings from state-owned banks and the recent lifting of lending rate controls, should help stabilize the economy.

However, it's quite clear as the economy goes through a restructure, even China realizes, it can't keep growing at the pace we are so used to.

Chinese Finance Minister Lou Jiwei recently said the nation won’t use “large-scale fiscal stimulus” measures this year, signalling that the government will tolerate a slowdown in the economy. He further added, China will promote growth and boost employment while fine-tuning policies and keeping the fiscal deficit unchanged, and will also avoid big adjustments to short-term macroeconomic policies. The government in March set a 2013 goal of 7.5 percent, the same target as in 2012.

The world had hoped China's consumption would help fill the void left by US and EU. But the signs aren' that encouraging. With no signs of global recovery and China's slow down, we have interesting times ahead of us.