效率的紧迫性 / 謝國忠
2009-05-25
谢国忠搜狐博客　http://xieguozhong.blog.sohu.com/
The urgency for efficiency



May 22, 2009



The world is awash in Keynesian liquidity. Market consensus has shifted from depression in early March to a new bull market at present. The bull case is built on liquidity pumping up asset prices first, improving corporate and household balance sheet next, and increasing demand afterwards. This Greenspan dynamic that worked for the past twenty years won’t work this time. The liquidity flood will lead to inflation soon, nipping the bud of the nascent asset bubble.



Liquidity works when a disinflationary force keeps inflation down and channels liquidity into asset markets. Rising asset prices then lead to demand for debt. Rising leverage increases demand. This asset market-led growth model worked because globalization and IT kept inflation in check. As the upside from both has been absorbed and there isn’t another source of production growth in sight, liquidity will soon lead to inflation.



Most analysts argue against inflation on the ground that excess capacity due to demand slump will keep inflation in check. Hence, the liquidity boom won’t be a problem until the global economy is fully recovered. I think this logic is faulty. Financial markets can channel liquidity directly into inflation through commodity speculation. Despite demand declining oil price has nearly doubled from its spring low. It mainly reflects rising financial demand; a rising amount of liquidity has flowed into oil futures, which is powered by inflation expectation. Like the 1970s expectation alone is capable of turning liquidity into inflation.



Rising labor activism is another source of inflation. Most think that labor union is no longer an important force because its influence has waned in the past three decades. I think that the power of labor union is demand rather than supply driven. During economic boom few are interested in supporting labor union. But in economic hard time workers are more supportive of labor unions. Globalization drove the boom of the past quarter century. The bottom half of the income earners in the developed countries lost out in sharing the income growth; their wages stagnated through the boom. However, they benefited from rising property price and easy credit condition. They improved their living standard from borrowing like running up credit card debt, minimizing down payment for auto or property purchase, or running up debts against rising property price. Pacifying the losers in globalization with easy credit is coming to an end. Creditors now know the risk and won’t lend like before anymore. When the credit card stops working, labor unions are likely to come back demanding wage increase.



The excess capacity won’t hold inflation down for two reasons. First, manufacturing value added is so much smaller than before relative to the cost of raw materials. Globalization has forced multinationals to shift their production to low cost countries like China. In the process, manufacturing has decreased in importance. For example, steel price is moving in tandem with iron ore price despite huge processing overcapacity. The reason is that iron ore accounts for over half of the production cost. Coking coal is another quarter. Equipment depreciation, labor, and profit account for small shares in product price.



Second, much of the overcapacity needs to be scrapped, because demand won’t recover back to yesterday’s composition. The bubble exaggerated demand in many industries. Automobile, IT and financial services stand out in that regard. Credit won’t be so cheap in future. Auto demand will reflect that. The industry may shrink one third.



The bankruptcy of Chrysler is the first step. GM may be next. The profitability of the financial sector was exaggerated by over 100% at the bubble peak. It led to outrageous capex expenditure in IT. As the financial sector shrinks and its profitability normalizes, IT demand will remain much lower than before, even as the global demand recovers. Lastly, the financial sector has to shrink enormously, possibly by 50%. The bubble-inspired demand simply won’t come back.



The macro concept of excess capacity as a check against inflation wouldn’t work this time. Pumping liquidity on this flimsy concept would lead the global economy down a dangerous path. I expected stagflation as the end game for the Greenspan era in 2006. It seems the world is sliding into this path without any resistance. After two decades of easy life during the Greenspan era, policymakers, markets, and workers all want an easy solution-a euphemism for free lunch as a way out of an economic downturn. Free lunch may appear likely during a unique era, defying economic logic. But, the longer a ‘free lunch’ lasts, the more painful the eventual adjustment becomes.



Instead of overindulging in Keynesian stimulus, the world, especially China, should focus on reform. I have written on the need for China to shift demand from export to household through wealth redistribution. For example, distributing the shares of the state-owned enterprises evenly among the Chinese population would spark an economic boom for a decade. In this article, I want to emphasize the need to focus on the need for improving efficiency. It is a necessary condition for China to experience another high growth cycle.



China has experienced high growth for the past three decades. Good policy mix was the catalyst. But it was a necessary, not sufficient condition. Low base in the 1980s and 90s gave good policy ample room to be effective. The low base could be understood in terms of wage level, urbanization rate, or export penetration. The last element has played the dominant role on the demand side. Through attracting manufacturing relocation and building supporting infrastructure, China’s exports have achieved nearly 20% annual growth rate. The low base effect, however, no longer applies in the future; n terms of the share of GDP in value added, China’s exports are now by far the largest in the world among large economies. Some economies have larger export to GDP ratio due to cross-border shipping of parts and components.



On the supply side, the economies of scale from building up infrastructure networks boosted productivity enormously. The key was the so-called network effect. When one builds one highway, it improves efficiency by decreasing the transportation cost along the route. When one builds a network, the efficiency improvement per unit of investment is squared because it lowers the transportation cost from one point to an entire area. China was building networks like highway, telecom, electricity, etc., for the first time in the past decade. As the networks were completed, productivity improved enormously by lowering production costs. China’s low cost was as much due to low wage as due to infrastructure development.



Market was puzzled by the conflict between poorly performing businesses (e.g., low profitability and lack of sustainable assets like IPRs) and strong macroeconomic performance in China. In the 1990s, most investors thought that China’s growth would fall apart soon due to underperforming businesses. It didn’t happen because the benefits from infrastructure development spread through the economy by decreasing production cost and boosting export competitiveness. The upside from the economic growth went disproportionately into asset inflation and government revenue. Corporate profit and labor income didn’t benefit as much. The productivity gains from infrastructure development were critical to sustaining good macro despite bad micro.



The productivity gains in future would be more difficult to achieve. China’s infrastructure networks have formed. Expansion won’t generate the same gain. The reason is that the rising economies of scale when a network begins eventually turn into diminishing economies of scale. For example, if one builds a highway to alleviate the congestion of an existing highway, its economic benefit is proportional to the investment, not exponential like building a highway network for the first time. If one builds a highway next to one not congested, its benefit is probably less than the investment.



Economies of scale are not well understood in economics. The standard economic theory assumes diminishing economies of scale, i.e., more of the same will lead to less output. When a company expands, it runs into coordination problem sooner or later. We frequently hear of corporate sliming down stories for that reason. At an early stage of growth, coordination at firm level is not a problem, while the advantage from sharing resources is significant. Hence, a company exhibits increasing economies of scale during its early development and diminishing economies of scale when it matures. As economic theory deals with equilibrium state of economic activities, diminishing economies of scale is the right assumption.



Network economies of scale are similar to that at a firm level except with more intensity. When a network construction is just beginning, its economic benefit is probably linear or proportional to investment scale. When a network is about to be completed, its economic benefit grows exponentially. When a completed network expands, the benefit is diminishing relative to investment, i.e., every additional dollar of investment gets less economic benefit.



Has China’s infrastructure investment reached diminishing returns? It is hard to say. But, its effectiveness is much less than before because the networks have already formed. As there will be less productivity gains from the infrastructure, one productivity gains are needed from elsewhere to maintain economic growth.



China’s macro policy is now dominated by liquidity pumping into business and government sectors. The argument is that spending more will bring the economy back regardless of efficiency; it just needs more to achieve the same result with less efficient investment. Of course, if there are no bad consequences, printing money would be able to solve any economic problem: if it’s not working, just print more. However, boosting liquidity or printing money will lead to inflation. The less efficient the investment, the earlier inflation arrives. As I elaborated before, inflation is easier to happen now as the benefits from globalization and IT have been absorbed.



China has a lot of room to maneuver: the government debt level is low, the loan deposit ratio of the banking system is low, and the household leverage is low. The high leverage of the corporate sector is a worry. The country has excellent spending power overall as reflected in the large foreign exchange reserves and persistent trade surplus. Today’s options reflect the past successes in achieving productivity gains and export penetration. Both stories are running into barriers. Hence, China should spend money carefully to nurse golden gooses for the future rather than on unproductive white elephant projects for pumping up today’s GDP.



China should spend carefully even though it can spend more, because money won’t come so easy in future. Easy productivity gains and export penetration are over. This is why China should tighten its monetary policy as soon as possible. In the five months between December 2008 and April 2009 China’s bank lending rose by 20%. If the current pace is maintained, the annual loan growth would reach 50%. Lending rose this fast last in 1992. It led to rampant inflation. If inflation becomes a problem again, it will be more difficult to tackle than last time. As China tightened to contain inflation, exports rose rapidly to maintain economic growth in the mid-1990s. The same luck is unlikely this time.



If inflation pops up while the economy remains sluggish, the government may not be willing to tighten sufficiently for cooling inflation. It may lead to a prolonged period of high inflation and sluggish economic growth. This risk of stagflation is quite significant for China, the US, and the world. While the initial burst in lending was necessary to stabilize the economy, its continuation may carry more negatives than positives. It is not worth risking virulent inflation for one or two more percentage points in GDP growth rate this year.



Bank lending should switch from extremely expansionary to neutral for the remainder of the year. Neutral means that bank loan/GDP ratio should remain the same. For example, the current loan stock is Rmb 37 trillion or 1.2 times GDP. If nominal GDP grows by Rmb 200 billion per month or 8% for the year, bank lending should grow by Rmb 240 billion per month. The lending in April cooled to Rmb 640 billion from an average of Rmb 1.4 trillion in the previous four months. It is still too high relative to the neutral level. Monetary tightening has a long way to go.



In my view, China should focus more on improving supply side efficiency to sustain high growth. The global economy is likely to be much slower in the next decade than the past. China has to be much more efficient to achieve the same growth rate. The efficiency improvement in the future cannot rely on fixed asset expansion. The problem in the past was small scale and old equipment. Neither is the problem now. Most of China’s industries seem to have state-of-the equipment but suffer from excess capacity.



Efficiency improvement in future is less an investment issue than a system or incentive issue. Because fine-tuning rather than brutal force must drive productivity growth, market force rather than government intervention should drive efficiency.



Many now argue that what’s happened in the US and in developed economies shows the bad side of market economy and, hence, China should not move further towards market. This is drawing the wrong conclusion from the current crisis. Market remains the best tool for motivating businesses to deliver the best products at the lowest possible costs. All other systems have failed in delivering prosperity. Markets, however, need regulations to function properly. For example, food safety standards need to be there for the industry to function properly. The main purpose of regulation should be to enable market to function more efficiently rather than to replace market.



Some economies like the US or UK deregulated too much a decade ago, which laid the foundation for today’s crisis. China’s economy, however, is excessively regulated and controlled by the government. The lesson from the today’s crisis has little bearing on China’s policy forward. China still has a long way to go before its market may become ‘too free’.



Excessive liquidity stimulus today may lead to inflation economic chaos in future. It’s time for China to rein in money supply. The policy focus should shift towards promoting household demand and supply side efficiency. Otherwise, China could suffer low growth and high inflation for years to come.

谢国忠搜狐博客　http://xieguozhong.blog.sohu.com/