Savings, investments and industrialisation/urbanisation versus external balance

Comments on Michael Pettis “Ten signals to watch as the world resets”, 19/02/2013, http://www.businessspectator.com.au/bs.nsf/Article/China-rebalancing-growth-markets-GDP-trade-pd20130219-52RAQ?OpenDocument

I am not too sure how much finance Professor Michael Pettis understands economics, even the basic economic principles.

China is still industrialising and urbanising. It's level of per capita income is very low compared to industrialised countries. It has more than half of its population, probably more 700 million, still live in rural villages. There are a lot of infrastructures that need to be built to facilitate its industrialisation and urbanisation.

Naturally, that needs investments, huge investments over many years.

It is against this background that Professor argues the following highly questionable points:

"China must bring both its savings rate and its investment rate down sharply. If it can bring savings down faster than investment, China is probably rebalancing in the right way, and this should show up as strong growth and a declining trade surplus."

Without savings and investments, how could China industrialise and urbanise?

This is where some academics just simply follows some popular topical sayings and prescribe non-sense ideas.

Given its needs for investments, the sensible policy is to channel its savings to investments in infrastructure and urban constructions to accommodate the transfer of hundreds of millions of rural people to urbanised living.

Professor is understndably worried more about so called external balance. But that should not necessarily require a cut of both savings and investments. As long as savings are balanced by investments, external trade should also be balanced.

That is probably economics 101 and even a finance professor should understand that.

Apparently Professor Pettis does not appear to.

This is also why many Chinese university students are so disappointed with their professors and lectures.

Now we can see some of the reasons why that is the case.

Savings, consumption and investment, as well as external balance

Comments on Mohamed Ariff “Asia’s obligations in the new order”, 28/04/2010, http://www.eastasiaforum.org/2010/04/28/asias-obligations-in-the-new-order/

Statements like the following are misleading and unhelpful, because they ignore the role investment in the saving equation:
"East Asia needs to consume more and save less, just as the US needs to consume less and save more, which means that the US and East Asia need to export more and import more, respectively."

It is highly questionable and likely to be illogic and pointless to force any person to consume more and save less, if that person has pursued his own welfare and be optimal in terms of decisions on saving, consumption AS WELL AS investment.

The so called external imbalances are not necessarily caused by savings, or consumption, because investment can play a balancing role, in another word, can "rebalance" the external "imbalance", without affecting internal savings and consumption.

It is a simple matter of analysis, isn't it?

Wrong diagnose, focus, and prescriptions

Comments on Eswar S. Prasad “REBALANCING GROWTH IN ASIA”, July 2009, http://www.nber.org/papers/w15169, quoted in fancunhui的日志, 美国经济研究局论文：亚洲再平衡式增长, http://www.pinggu.name/space-11768-do-blog-id-17325.html

It seems to be a useless study from an equally incompetent economist, disguised as something to help high savings countries.

They should be focusing on how to rebalance the high consumption countries, especially the US economy. It has been a real problem of theirs, but they blame for high saving countries.

If they don't import, how could other countries export to them? If they don’t consume much, how can other countries force them to do so?

If they can sort out their own behaviour, the issue of international imbalance will be solved.

What is the main difference between high and low income countries from economic point of view? It is the difference in their productive capacity, and in turn their physical capital stocks on a per capita level.

How to reduce that difference rapidly? By investment and capital accumulation. Investment requires savings and that is why developing nations need to have higher saving rates.

Financial crisis, scapegoat and regulations

Comments on Jagjit S. Chadha “Is the love of finance the root of all evil?” 24/07/2009, http://www.eastasiaforum.org/2009/07/24/is-the-love-of-finance-the-root-of-all-evil/

I like this article. I find it fascinating and can’t help from commenting, though I didn’t rush in doing it earlier on after my first noting it.

Although it is against the current wind blowing heavily, it appears to be more sober analysis than most very loud noises calling for this and that.

While there may well be a case for strengthening some financial regulations, there is a real danger of overdoing it and over-regulation of the financial sector, at the expenses of efficiency and suffocation of innovations.

It is true that the world main financial and banking system came near collapse. But what were the main direct causes? It was the subprime problems and the malpractice of selling subprime mortgages in the US to the largest degree, wasn’t it? Imagine what would have been if there had not been those malpractices in which people without the ability to pay were given more 100% loans of the equities they bought, at very low interest rates.

International imbalance in saving and consumption may have contributed to the financial problems in the US. But, I would argue that the causal relationship is by no means inevitable and what had occurred in the US should have been avoidable in the first place.

For example, the US could have used the low interest rates afforded by excess international savings to invest in more productive sectors and areas, or even other countries, that would generate much higher returns and enhance the well beings not only in the US, but also other countries.

This in an indirect way would be similar to the argument of readdressing the patient and non-patient internationally discussed by Chadha in this article.

So I agree with Chadha that the size of the financial sector was not necessarily the problem. If looking at the worldwide, savings are not necessarily too high, because there are so many countries, mostly developing ones, have extremely low level of physical capitals and need to increase investment and accumulate them. Even in some advanced economies, infrastructures may need to be upgraded or replaced.

I find the argument that too much savings amusing, but can’t help laughing at it. When there are problems, it is easy and tempting to find a scapegoat, whether there is any justice to it or not is irrelevant to most people.

The financial and economic crisis is such a case in unprecedented scale.

Savings and consumption choices for long term growth for China

Comments on Louis Kuijs “China: what long-term policies and reforms are needed to sustain growth?” 3/07/2009, http://www.eastasiaforum.org/2009/07/03/china-what-long-term-policies-and-reforms-are-needed-to-sustain-growth/

This is my first comment on this article. It is likely that I will make another comment on the point of deregulation later on.

Louis Kuijs has made a number of interesting points in his article on what policies China should pursue. Most of them may be correct. However, I would like to argue two points of policy of development, in the Chinese current context.

The first is about savings and consumption and their role in long term growth. It is mostly natural to assume a country like China should increase consumption in the face of the current great global recession and the much talked point of international imbalance in savings and consumption between the US on the one hand and some other countries including China the other.

China has had until recently current account surplus and has high savings. Exports have fallen due to the global recession. Saving rate is going up in the US, mainly because of the burst of housing and equity markets bubbles, rising unemployment and the difficulties in credit and financing. So if international consumption is falling, an increase in consumption in China may be able to offset that. But is that the correct and most optimal action to take for China? That is the most important question for China’s policy makers.

I am not sure to change savings and consumption is the best course of action for China to take. The main reason for my doubts is that China is still a low income country with low physical capital per capita and it has huge potential for rapid growth. Unlike most industrialised countries where the marginal return for investment may be naturally lower due to the fact that they are mostly in the world production possibility frontier, the return to investment in China may be much higher due to the potential of rapid growth in the catching up phase. So, there is an alternative to increase in consumption, China can increase investment in infrastructure and physical capital for even faster or at least sustained rapid growth.

So most people / economists with the view for China to increase its consumption as a long term policy to sustain growth may be misguided. China has more options than most industrialised countries in terms of savings and consumption trade off. It also has a much greater feasibility set in terms of investment than most countries. So it is not good enough to simply argue for an increase in consumption and a reduction in savings. It is a much short-sighted view. It reflects a poor understanding of development processes and the important role of domestic savings in those processes.

Don't knee-jerk when facing great recession!

Comments on Mario Lamberte “Some positive consequences of the Global Economic Crisis”, 1/06/2009, http://www.eastasiaforum.org/2009/06/01/some-positive-consequences-of-the-global-economic-crisis/

I agree with most of Mario Lamberte's arguments in the following paragraph, to quote:

"The Great Depression challenged mainstream economic thinking in the 1930s and produced revolutionary economic theories and paradigms. If the severity of the current GEC has so far been unmatched since the Great Depression, it is likely to have similar effects on economic thinking and policy making. If there is a fundamental change in the way of economic thinking, global and national institutions, such as the central bank and macroeconomic policies, could change too."

But I think it is likely to be premature to infer too much from these arguments, no matter how useful they are. I think some of Mario Lamberte's prescriptions need careful analysis. They include, especially things how to rebalance composition of GDP, the role of exports and the argument that to avoid future external shocks, Asian countries need to boost domestic demand and rely less on export, export incentives, how fiscal resources should be readdressed, changes in the production structure in favor of non-tradable goods and services, reducing precautionary motive for saving.

What I am concerned is that many people, including policy makers and advisers, have a tendency to overshoot in their responses to the great recession. My view is that an open and free trade international system will still be much more superior than self reliance and autarky. Benefits of trade and economic integration will outweigh the cyclic shocks that can be transmitted through an integrated international system, even though there are short term negative consequences if there are downward external demand pressures from time to time. Knee-jerking in the face of economic difficulties by throwing the baby out with bathwater is hardly ever a prudent strategy.

More specific comments are likely to follow.

It is the real effects on the economy not the perceived pride that matters

Like the monetary/market interest rate, the economy's neutral rate of interest is also variable over time, as the behaviours of both savers and investors change in responses to changed or perceived circumstances and/or opportunities. This means the central banker's job to fine tuning the market rate is more difficult than most would have thought. Besides, with international capital flows, the concept of savers and investors in any individual economy becomes much more fluid and harder to define in terms of their domestic equality.I think that, while there is naturally a distinction between the Australian case and most of its OECD counterparts, one should not over indulge oneself in the pride of being seen as "mark of confidence". To the contrary, it is still necessary for the RBA to do more to further lower the rate to stimulate the economy even though there will exist strong fiscal stimulus. One should not forget Australia is experiencing a recession. If it can better help manage the economy, the RBA should do so to its full capacity, even though it may mean it needs even more finer tuning in its work.