Response to "China's "overcapacity" reveals two different visions of the world"
An overall good post by Kyle Chan misses the mark on a few key points
Kyle Chan has a good blog post over on his SubStack “High Capacity” that analyzes recent conversations about China’s industrial capacity through two lenses: one focused on competition and the other focused on jobs and fairness. It’s a good post, and you should read it. However, I believe that Kyle misses the mark a few important points that could lead some readers to draw the wrong conclusions, even though pretty much all of Kyle’s ultimate recommendations seem sensible.
Issue 1: China pays for it’s overcapacity through more than just risk
About a third of the way into Kyle’s post, he takes a moment to note that Chinese industrial policy is not without its downsides. While it produces highly competitive industries, there is always a risk that state backed companies “might not succeed and even go bankrupt”, wasting resources on “supporting products that no one wants”. This is true, but it misses the much larger way in which China pays for industrial policy: by suppressing domestic living standards. Chinese industrial policy is paid for by transfers from the household sector to producers. This means that the average Chinese worker retains a much lower share of what they produce compared to other nations. This can be seen in China’s low share of GDP from consumption:
There are plenty of arguments to be had about whether consumption is the perfect measure of living standards, but it seems hard to argue that this incredibly low level of consumption, especially relative to output, is good for Chinese citizens.
This in and of itself might be fine, though, at least from other nations perspective. After all, why do Americans care if the Chinese government pursues policies that suppress their own citizens living standards? This brings us to…
Issue 2: In the current global trade system, other countries must respond to Chinese industrial policy.
Hypothetically, countries could just ignore China’s industrial policy and continue to do things their own way. Unfortunately, in the current global trading system this isn’t really an option. Failing to respond in any way would result in Chinese companies dominating their markets, forcing them into massive trade deficits. Because the current account and capital accounts must balance, this will push down their savings rates and force unemployment, household debt, or fiscal deficits to rise. This is completely unsustainable in the long term, but the only way to avoid it is to either erect trade barriers or match Chinese policy and suppress domestic consumption. There is a reason 20th century economists called this approach a “beggar thy neighbor” policy. The best way to resolve this would be for countries like China, which have savings rates far in excess of their investment needs, to increase their consumption levels, as Michael Pettis has argued.
Issue 3: Countries without substantial unmet investment needs should produce as much as they consume.
Another issue with Kyle’s post is his assertion that countries don’t need to consume as much as they produce. Kyle cites a few examples of comparative advantage, such as Norwegian Oil and American Natural Gas, and uses those to conclude that “The idea of exporting … is suddenly being talked about like it’s borderline criminal behavior”. This is decidedly not the issue. No country needs to consume exactly what they produce. Kyle’s issue here is a confusion of total consumption with the composition of consumption. It’s fine for Norway to produce more oil than it needs, good even, but it should get an equal amount of goods and services back in exchange for the surplus. To do otherwise would be to suppress domestic living standards, which only makes sense if there is unmet investment need that the resultant savings could address. This is not the case in developed nations. The one thing I’ll say in Kyle’s defense here is that it’s true other nations operate trade surpluses, some even larger (proportionally) than China’s, but China is so much larger in absolute terms than the others that it tends to be the focus of criticism. This might sound like a political issue, but …
Problem 4: China’s mistake is not just political
I’m in a particularly good position to judge this, because until recently I was a Trade and Technology Policy advisor in the US Senate. Kyle asserts that China’s main issue is not that is it out-competing other countries, but that “it’s also bragging about it”. This is undoubtedly true to some degree, but even if China were to talk a lot softer it would still run into the same issues, because China’s trade surplus is incompatible with a stable global trade system. For all the reasons I talked about before, there is a zero sum nature to trade imbalances that will inevitably result in conflict. This doesn’t mean that China has to abandon all features of its industrial policy, but it does mean that for China to be a well regarded participant in global trade it will have to rely less on transfers from households and more on the inherent strength of its industries. The good news is that China can probably do this, because Chinese industrial policy seems to produce genuinely efficient companies! That said, it may be difficult to maintain it’s share of manufacturing because…
Problem 5: It’s also about National Security
A lot of western nations are worried by China’s military buildup. Manufacturing capacity plays a large role in war-fighting capabilities, and so many nations are loath to allow someone else to specialize in it and become “the worlds factory”. Kyle seems to miss this point entirely in his post, though to be fair that may simply be for the sake focus. Nevertheless, this is one of the defining issues with regard to the distribution of manufacturing capacity, and will remain an issue as long as there are concerns that The West and China may someday come into conflict. Of all the issues with trade, this is probably the most intractable for the time being. However…
Kyle’s Recommendations Are Probably Still Good Ideas
Kyle’s recommendations at the end of his post seem sensible enough. Chinese companies setting up shop abroad would help other nations move up the manufacturing value chain, because Chinese firms are genuinely quite efficient even after factoring out the huge subsidies they receive. This would help them build their domestic markets, creating new buyers for Chinese products. However, doing so would require providing subsidies to foreign production, or reducing domestic transfers from households, because otherwise the subsidized domestic plants would simply out-compete the unsubsidized foreign ones, even if they are equally as efficient. Similarly, “work[ing] with other countries to make sure they get a larger share of the jobs associated with advanced manufacturing” is a great idea, but will require a proportionately lower share of advanced manufacturing in China. It’s not clear at this point that Chinese policymakers are willing to do this.
All that is to say … subscribe to Kyle’s blog. It’s really interesting and he has insightful commentary. The reason I’m writing this post is that I enjoyed reading High Capacity so much it really got my mind working. Also, while you’re at it, consider subscribing to my blog here.