Wednesday, May 20, 2009

Is it time for the death of Chinese growth model?

Michael Pettis argues that the fiscal stimulus enacted in the Asian economies, particularly China which is providing a “steroid-fuelled” growth, will potentially boost growth in the short term but their growth model is not sustainable.

One of the consequences of the Asian development model has been that production outgrew consumption for decades. When a country produces more than it consumes, it must run a trade surplus to export its excess capacity. The Asian model consequently required high and rising trade surpluses that allowed Asian producers to produce far in excess of what Asian consumers could afford to absorb.

But there cannot be trade surpluses without trade deficits elsewhere. A fundamental requirement for the Asian model was that foreigners were able to run the requisite trade deficits. In practice, only the US economy and financial system were large and flexible enough to play this role. The Asian model, in other words, implicitly involved a massive bet on the willingness and ability of the US to continue to run large and rising trade deficits.

The assumption that implicitly underlay the Asian development model – that US households had an infinite ability to borrow and spend – has been shown to be false. This spells the end of this model as an engine of growth. The sooner Asian policymakers accept this and force through the necessary economic and political changes, the less painful the transition will be. Unfortunately this does not seem to be happening.

Many Asian nations are using fiscal stimulus to prop up export-based sectors. Is exports-based growth model still the answer to higher GDP per capita in developing and emerging nations? As the main buyers (US and the EU) are cutting back consumption expenditure and the governments ‘required’ to maintain fiscal balance down the road (deficits can’t go forever), will the exports-based growth obsessed nations find customers to buy their goods and services? Also, will domestic demand in the developing countries be strong enough to prop up GDP growth rate? Is the exports-based growth model still relevant for the low income countries? And, is the model nearing death for emerging nations? Interesting questions that need answers!

Here is Szirmai arguing that the manufacturing sector still matters for growth and catch up in the developing countries.