Michael Pettis: China's Growth Miracle Has Run Out Of Steam

Authored by Michael Pettis, op-ed via The Financial Times,

Beijing must reveal the true level of GDP and wasted investment...

China’s 19th Communist party congress ended last month with an indication that Xi Jinping’s new administration plans to rein in debt by abandoning the country’s long-term economic targets and allowing gross domestic product growth to fall.

Typically, analysts assume that changes in reported GDP reflect movements in living standards and productive capacity. In China, however, this is not the case. Local governments are expected to boost spending by whatever amount is needed to meet the country’s targets, whether or not it is productive.

GDP growth is not the same as economic growth.

Consider two factories that cost the same to build and operate. If the first factory produces useful goods, and the second produces unwanted ones that pile up as inventory, only the first boosts the underlying economy. Both factories, however, will increase GDP in exactly the same way.

Most economies, however, have two mechanisms that force GDP data to conform to underlying economic performance.

First, hard budget constraints, which set spending limits, drive companies that systematically waste investment out of business before they can substantially distort the economy.


Second, there is a market-pricing factor in GDP accounting that when bad debts caused by wasted investment are written down, the value-added component of GDP and the overall level of reported growth are reduced.

In China, however, neither mechanism works. Bad debt is not written down and the government is not subject to hard budget constraints. It is the government sector that is mainly responsible for the investment misallocation that characterises so much recent Chinese growth.

The implications are obvious, even if most economists have been surprisingly reluctant to acknowledge them. Anyone who believes there has been a significant amount of wasted investment in China must accept that reported GDP growth overstates the real increase in wealth by the failure to recognise the associated bad debt. Were it correctly written down, by some estimates GDP growth would fall below 3 per cent.

Historical precedents suggest the potential magnitude of this overstatement.

Japan’s economy in the 1980s, for example, had distortions that resemble those of China today. Although not nearly as extreme, Japan too suffered from a very low consumption share of GDP and an overreliance on investment that, by the 1980s, had veered into substantial misallocation.


In the early 1990s, Japan’s reported GDP comprised 17 per cent of the overall global total, and few doubted that its soaring economy would become the world’s largest by the end of the century. Instead, once credit growth stabilised, Japan’s share of global GDP began to plummet, and has since fallen by nearly 60 per cent.


The same happened to the former USSR. It grew so quickly after the second world war that by the late-1960s it comprised 14 per cent of global GDP, similar to China today, and was widely expected to overtake the US. But two decades later, its share of global GDP had fallen by more than 70 per cent.

These cases may appear shocking, but, like China today, 1980s Japan and 1960s Russia lacked the mechanisms to account for wasted investment in reported GDP. At their peaks, growth for each country was seriously overstated by the failure to write down the waste, and understated once debt levels stabilised.

The implications are clear.

China’s growth miracle has already run out of steam. It is only by allowing debt to surge that the country is able to meet its GDP targets. This may be why President Xi has been eager to stress more meaningful goals, such as increasing household income. Whatever the reason, analysts should not read GDP growth as an indicator of China’s underlying economic performance.

Piling up unsold and unsaleable goods or building empty airports may boost GDP in an economy whose financial system does not recognise bad debt, but it does not measure its performance.


Escrava Isaura A Sentinel Wed, 11/22/2017 - 04:28 Permalink

Exactly. For China to match the US power, China will need another 10 to 15 million barrels of oil a day. It ain’t gonna happen. Second, the real issue is not that economic growth is dying. And that it will have a fatal heart attack by the end of next decade. The real issue is that population growth is unsustainable. But people keep making babies.   

In reply to by A Sentinel

Ghost who Walks Escrava Isaura Mon, 12/11/2017 - 22:17 Permalink

You have identified two separate issues within one sentence, Power and Energy consumption.Energy has been identified by at least one economist (Steve Keen) as the key component in Economic Production and thus Economic Growth. In the event that China has access to unlimited Energy, then its economic prospects are changed. This technology may exist in secret programs, but can't be released without changing Geo-political balances. The USA would drop behind China and Russia, due to China having lots more trained people, and Russia having lots more accessible resources.US Power is based on a number of things, not least a propensity for the use of Military Force and Financial sanctions to achieve its strategic aims. There is a term called "Training your enemies" that is, if you keep on doing the same patterns of behaviour repeatedly, then you can expect your competitors to adjust their strategies to turn your strengths into weakness, and use asymmetric warfare. Two examples of this are1. Chinese development of the D22 mobile ballistic missiles to target carriers.2. Use of currencies other than the US dollar for trade.There is a lot of discussion on the ZH site about the "magic" behind the US currency. Magic works well until the trick is revealed. So it doesn't take too much effort to collapse an illusion. If I were an American I would be very worried if I held paper wealth denominated in US Dollars. The issue of the trade balances and the value of the US Dollar has got to the point where many people are questioning the sustainability of the status quo. Compare this to the question of how much snow can fall on a steep slope before the snow will slide down? The answer to the question is not accurately known, as external factors can trigger a collapse earlier than predicted.I note that this article is a re-hash of an earlier piece by Michael Pettis. I believe that he is well informed about conditions within China, and may be relied upon to call a trend.I agree with your summary about the real issue of unsustainable population growth. However the matching issue is how much resource is used by individuals in each society. China cannot currently aspire to achieve American lifestyles, because of the load that this would put onto the Global resource base. The flip-side to that is that Americans will not be able to continue living the way that they do in an oil-based economy. Benoit Mandelbrot noted the population variations in density-dependent organisms. There are lots of animals when food is abundant, and when the food supply drops the population crashes quickly.The time will come when a new technology provides energy, and there is a re-ordering of the Global order of National importance. Same thing has happened each time a new power source was introduced globally. In the last change from coal to oil the Brits were overtaken by America. Steam to the Internal combustion engine.

In reply to by Escrava Isaura

spag . . . _ _ _ . . . Tue, 11/21/2017 - 23:00 Permalink

the retards at the ft got to learn a new song. instead of feeding the poor food stamps and social security china pays their state industries to keep these people employed.ok, this truely fucks up productivity at the state run industries but it sure as hell is better than paying someone social security so they can get fat and immobile and never again employable in front of the tv

In reply to by . . . _ _ _ . . .

besnook Tue, 11/21/2017 - 22:23 Permalink

so what does that say about the usa economy with the likes of the fangs and other companies like mcd(26x declining revenue propped up by closing stores and selling company owned stores) and all the othe rstock buyback companies?china still has several hundred million people they need to bring into the 21st century. the west is dependent upon moneyless refugees with no education or training imported from the result of the the only western growth industry, weapons of incremental destruction.

BobEore Rainmaker Tue, 11/21/2017 - 23:50 Permalink

Behind the silly 'China's economy is about to crash' storyline, the Chine Perma-Bears were always hiding one salient truth...

that the leeching of wealth and power from the west to the east was proceeding apace, papering over the obvious economic malfeasance and dislocations which inevitably stem from statist command/control policy

and canceling out the enormous waste and attrition of growth potential which resulted from chasing GDP numbers growth.

The wealth thus funneled into the pockets of Chinas' elite political class was recycled into offshore investments which built up liquidity in the form of shell company IPO's that used shaky accountancy to back the take over of western enterprises whose books could then be used to further expand credit provided from western investment bankers for more takeovers...

rinse and repeat. The economies of the west hollowed out and taken over by the stealth coalition of talmudic international finance capital and their Chinese dogsbodies, all happened in front of the sightless gaze of complicit medias, while the victims were watching endless reruns of promotional videos featuring sllky dreams of OBOR roads n beltlines, snaking thru ASIA with loads of toys for good girls n boyz.

A cautionary tale of make believe for grown ups.

In reply to by Rainmaker

slipreedip Tue, 11/21/2017 - 22:42 Permalink

The chinese dont have a population problem in the same way as Japan did, and the population doesnt have the same expectations as those in western nations do. The reality is that the Chinese economy is so big nowadays that when China sneezes the world the rest of the world gets covered in snot.  

Ghost who Walks warsev Wed, 11/22/2017 - 05:56 Permalink

I agree. Michael Pettis has been lecturing at a University in Beijing for a few years and runs his own website where he and his readers comment on Chinese economic issues and particularly the key issue of "What does ineffective capital investment look like?"So this piece is based on a lot of prior research and correction and comment from both Chinese and non-Chinese who live in China.His point is well made and many old China hands are aware of the non-rcognition of non-performing loans on the books of the Chinese State Banks.China is different enough that this has managed to go on for a lot longer than many western experts thought was possible.I am curious about the recent decision to allow western businesses to take equity positions in the Chinese Financial sector. The thinking behind this decision may throw some light on the magnitude of non-performing loans and the timing of any recognition of impairments and or write-downs. I suspect that any due diligence conducted prior to a major investment would identify part of the problem loans.I am aware of the difficulty of proper audits in China and the recent history of vanishing steel stockpiles and dodgy warehouse receipts for stored metals and other commodities. So I for one would not want to be an auditor for the due diligence on the early investments in the Financial sector, or an investor.I am not critical of the system as it currently is, and I recognise that it is a very different system to what I studied and used in the West. So I am cautious about making assumptions on how it might or should run.

In reply to by warsev

pitz Tue, 11/21/2017 - 22:53 Permalink

What about the level of wasted investment in the United States?  The trillions in market capitalization in the financial sector, for instance, which provides little to no value for society.  The malinvestment in excess government.  An 'education' system whcih educates far too many for the jobs available, and mal-educates large numbers as well.  Why not write an article on this before criticizing China because they have been bold enough to make long-term fixed investments that really put America to shame.

Let it Go Tue, 11/21/2017 - 23:14 Permalink

The fact is more money from the United States has been finding its way to China than we thought. When you follow the money the United States huge trade deficit with Mexico becomes even more disturbing as you begin to understand where the money eventually ends up.When you start thinking about all the money and jobs we shift into Mexico each year you would think by now Mexico would be rolling in cash. A bit of research quickly confirms that the money Mexico receives by way of trading with America quickly passes through its lands and flows to Asia. It could be argued that when all is said and done we are still transferring our wealth to the far east only by the scenic route. More on the problem with this in the article below. http://Follow The Money-The US rade Deficit With Mexico Benefits China.html

Pol Pot Tue, 11/21/2017 - 23:05 Permalink

Let's see...if we remove GDP attributed to a bloated and nonproductive defense budget and that attributed to substandard medical care for mostly overweight, unhealthy, hypertensive, prediebetic American citizens......what is left....flipping burgers, pouring coffee, and stacking shelves....

fangulos Tue, 11/21/2017 - 23:09 Permalink

Another talkhead don't know what he is sprewing, and never been to china, obviously. Don't be surprised if China's real gdp is underestimated, lots of small business run in the old fashion and never been recorded as part of the data, chinese trust network relationships and dare to pay thousands of dollars without a dime, there is no record, no receipt, no vat, no eot, ya tell me those are not economic 'activity'? By having one the largest saving deposit in the world, chinese have distributed their wealth quite evenly, gdp sheet data is slowing down but hey, ain't those students loan their ass off for a mediocre college while chinese parents generally have the savings to pay their kids' tuition fees.

roddy6667 fangulos Wed, 11/22/2017 - 00:39 Permalink

Having lived in China for a few years now, I agree. There is a huge slice of the economy that operates completely cash. Sidewalk and street vendors are everywhere. They make enough to support themselves, but are entirely cash. Everybody seems to have some kind of side buisness. Capitalism is more prevalent here than in America.

In reply to by fangulos

Ghost who Walks fangulos Wed, 11/22/2017 - 06:19 Permalink

Michael Pettis has spent more than a few years lecturing in Beijing and is extremely well informed on local conditions. I assume that he lives in Beijing.Your point and Roddy's about the cash economy are well made but not pertinent to the point of the article.Pettis has long been concerned that the people doing the 5 year plans are focused on big projects to the detriment of the efficiency of the Chinese Economy. I am sure he would agree with your objections to the under-reporting of small business activity. He does run a website that covers the issues in detail and over a long period. I have not checked the website to see his views on investment recently, but I suspect that he would prefer more investment is directed to the small business sector.The savings system is as you describe but is plundered by SOE's to fund these big projects and pays a pitiful return that in real terms is negative, hence the interest in Real Estate in China.

In reply to by fangulos

ds Tue, 11/21/2017 - 23:22 Permalink

Xi rooting for more meaningful goal such as household income. This is because the Party cannot have massive unrests caused by unemployment. The GDP myth attached to the Ponzi economy together with blind faith that China's economy must be on the trajectory to be #1. All types of cultural diffences, etc will be used to support the blind narratives. It is a great service to China while they acknowledge the Ponzi and trying to deleverage. The Analysts even without being silenced by China media regulators, are creating the conditions for China to go for its long soft landing. It is You drinking the snake oils of the Analysts who have faith while Xi and Party have worries. There is little risk to ride the best case long soft landing and get the bonuses from any interim volatilities that cause dramatic crashes. They do not have a deep domestic capital market and what the non independent PBOC can do is to fire fight.

zerotohero Tue, 11/21/2017 - 23:32 Permalink

#1 problem in the world today is the population - over 7 billion people consuming and wanting wanting wanting - there is only so much this planet can give and we are heading towards a cull


I am Groot zerotohero Wed, 11/22/2017 - 00:35 Permalink

We got Marburg, pneumonic plague, and monkeypox raging around Africa. Hep A is making quite the comeback here. Antibiotic resistent STD's and infections are all the rage now. Plastic pollution is everywhere in the water all over the planet. The bees, coral reefs and fish are all on mass die offs. Fungus is killing trees, ants, coffee plants and banannas. People are killing each other off en mass everyday. Everyone is either on some kind of drug or dying from drug overdoses. Be patient Zerotohero, a good stew takes time to cook.

In reply to by zerotohero

fangulos zerotohero Wed, 11/22/2017 - 05:41 Permalink

That's why I gave credit to china where it's due.It's for indians and africans to step up and practise 'one child' policy for a forseeable time frame, earth is only this big and we all know it. Population is nothing taboo but a very serious topic, key point is who should lay fewer eggs, i'd say start with dem niqqers and mestizos, lots of human garbages just gotta go to be honest.

In reply to by zerotohero

slipreedip Tue, 11/21/2017 - 23:59 Permalink

America is the drunk guy at a bar, throwing cash around for lap dances and blow....great while it lasts but when everyone realises the cash has run out...whose that guy....ewwwwww

PitBullsRule Wed, 11/22/2017 - 00:14 Permalink

American management, and American workers, are not competitive.  The managers are dumb, the workers are rude, arrogant,  and lazy, the industries cannot compete.  China will continue to grow, replacing us.  They are about 1/3 of the way there.

Ghost who Walks PitBullsRule Wed, 11/22/2017 - 06:36 Permalink

I've never been to America so you might be right. I Have lived and worked in China and when I compare what I have seen there to American Management outside of America I wouldn't write your chances of being competitive off just yet.America has a well-developed professional management culture and has been creating management techniques for the last century. I am not impressed by the Financial wizardry or engineering used to beat earnings per share forecasts, but while there are some very impressive Chinese Corporations making mining equipment, I don't see CAT going out of business yet. CAT has a whole corporate knowledge base and management systems that won't be copied quickly.

In reply to by PitBullsRule

the_narrator Wed, 11/22/2017 - 00:16 Permalink

China doom is this thing that never freakin' comes.  You know why?  Because China prints its own money and can bail the economy out forever and ever as long as it maintains a trade surplus.  These retards are so brainwashed by the private federal reserve stuff that they think that money creation by banks is a law of physics.

TrumanShow Wed, 11/22/2017 - 03:16 Permalink

''like China today, 1980s Japan and 1960s Russia lacked the mechanisms to account for wasted investment in reported GDP''You mean like QE and limitless almost free debt to stop you going bust, those types of mechanisms?

Davidduke2000 Wed, 11/22/2017 - 04:30 Permalink

who is this pettis asshole? even assholes are experts on China, what they cannot hide is the fact that China is the largest economy and it is too late to follow China in manufacturing cheap stuff that most of the world consume. the us economy is a fraud based on fraud , markets are rigged to the max, the futures markets are the biggest fraud and worse than gambling, luckily people are staying away and the crooks now are trying to con each other to avoid holding the empty bag.