More on China

I thought that I would put yesterday's China convergence comment in some context.

I was thinking about a very good Scott Sumner post* where he looks at whether or not China can be called a free market success.  He discusses how China moved from a communist system towards a mixed system, and in countries with Confucian cultures the level of involvement of State Owned Enterprises (SOEs that are monopolies, not SOEs that compete on the open market like many of Singapore's) is correlated to their absolute wealth. Within China, the prevalence of SOEs in a region is correlated with that region's growth.

China is converging to a certain level of wealth which is limited both by how free its economy is and the amount of resources available.  If Beijing is already 2/3rds as rich as South Korea (and Seoul itself) on a PPP basis**, there is reason to think that the level of convergence might soon slow down as China is closer to reaching its equilibrium convergence level than people think. Of course, Matthew Yglesias points out, if people continue migrating from less free areas of rural China (where the prevalence of more SOEs mean that the natural convergence level is even lower) into China's richer cities where they will work in industry and services instead of agriculture, then the impact of slower growth in the richest areas might not impact the overall economy too much.

China's future growth path is very important because if they aren't growing fast enough in normal times it will be more difficult to deal with the inevitable volatility.  China's current policy is generating a lot of loans that many people think will turn into nonperforming loans. These NPLs could be less significant if China grows enough, since there are less bad loans in a well performing economy and the bad loans that do exist will be smaller relative to the economy. If China's growth slows down because it is closer to convergence than people think (and because their working age population is no longer growing and the market for their exports might not expand as quickly as it has in the past), then the resulting NPLs could end up being a very serious issue.

All of this suggests that there are a few things that are very important to track when figuring out China.

1. Some measure of how mixed an economy they are relative to comparable economies. In the heritage index China is closer to Vietnam than South Korea, though part of it is because of how the index is calculated.

2. A measure of China's demographics. Luckily, demographics are one of those indicators that are known far in advance so this data doesn’t need much tracking. The chart below shows the changing working age population of the BRICs countries from the UN’s World Population Prospects 2008 revision database (Medium Variant).  From this perspective, India is much better positioned than China.

3. Measures of China’s internal migration.  If they ever change their policy on migrant workers from rural areas, it could be a sign that the party is going to keep going for a while longer.

4. The prices of China’s property markets, to see when NPLs will become a big deal. Changes in China’s monetary policy might lead changes in the property market (which might be tracked via the relative prices on China’s commodity market), since property markets are less liquid and therefore react more slowly to changes in fundamentals. Another potentially useful indicator is the Shanghai market.

5. The state of the rest of the world, since China’s exports depend on a healthy global economy.

This list is by no means exhaustive, except I did mention “the rest of the world” as a single data point to be tracked.



*Yes, again. If he is going to keep being relevant I’m going to have to keep linking to his posts.

**If GDP counted construction activity by migrant workers and the official population numbers of Beijing excluded them, then Beijing might have a long way to go before their PPP GDP per capita approaches South Korea’s level.

2 responses
Wife just came back from China a few weeks ago and found just about everything back here in the US is now cheaper than what you can get in China. The inflation has risen very dramatically where she can now get 6 Coach bags here for the price of 1 in China.

Obviously not stat. sig., but just some additional notes that she has seen to support this area--even more heavily with the real estate as well as you have noted.

Very interesting. And I forgot to mention that inflation itself is farther back in the causal chain of #4. It leads monetary policy which should lead China's property markets.