Twofish's Blog

August 11, 2009

Overproduction is a problem ????

Filed under: china, finance — twofish @ 12:55 am

It’s always seems to be bizarre to me when people say that the Chinese economy has a problem with overproduction that must be resolved or else China is doomed.  It sounds like a parody of Stalinist propaganda.  Our factories are too efficient and productive, please save of.  The fact that the big problem that people see right now is that people save too much and factories are too efficient should tell you that China is *not* a Soviet style centrally planned economy.  Soviet propaganda lived in a world of overproduction, but Soviet reality was one of chronic shortages.

Anyway there is one solution to overproduction which is trivial economically but hard to do politically:

  • Pay people to do nothing.

That’s actually quite hard to do politically.  The political problem is that people get quite upset if they see their neighbor getting paid to do nothing while they aren’t getting the money.  Figuring out who gets paid to do nothing is quite tricky, but there are ways around it.  One way of doing this is to make people think they are doing something useful, when they aren’t.

The other problem is that paying people to do nothing, or worse yet getting people to think that they are getting paid to do something when they are doing nothing tends to become a habit, and if you have to change so that you are no longer in a situation of overproduction, you have a problem.

One alternative way of saying “pay people to do nothing’ is to say “be less efficient” which is why I think it is weird when a lot of the people who say that the problem with the Chinese economy is that it overproduces also come up with ideas to make the economy more efficient.  If the real problem is overproduction, you really want to make the economy *less* efficient.  Sometime less efficiency is a good thing.  A power saw is more efficient than a hand saw, but it leaves a bigger mess if something goes wrong.

Anyone some other things that I disagree with Michael Pettis about:

a) In general, I don’t think that the government is pumping money into the economy to create “excessive investment.”  In fact I would argue that with banking policy, it’s doing the reverse.  Lending interest rates are high, which discourages borrowing while borrowing interest rates are low, which discourages savings.  The reason people save is that they are looking forward to retirement, and the reasons that companies are saving is because they are making profits, and make investments out of retained earnings because it cost them a great deal of money to borrow from banks.  The one area that the government could change policy to reduce investment is by taking some money in the form of dividends, but as I point out later there are good reasons not to do that.

b) Also it’s interesting that the examples, that Pettis gives to argue that the government is biased toward investment really show no such thing, and the policies that he proposes to remove this bias also do not fix the problem.  It’s true that China make be keeping it’s exchange rate low, but keeping it’s exchange rate low doesn’t change the consumption/investment ratio.  Also it is also true that banks are biased toward large enterprises, but again if the Chinese government removed this bias it wouldn’t change the consumption/investment ratio, and if this bias changes so that small and medium enterprises such that interest rates go down, this will actually increase investment.

The big problem here is that people when they talk about China, they aren’t talking about China, but rather Japan and Korea which had very radically different economies.

c)  Finally, I do not think that China is overinvesting.  The danger in thinking that you are more efficient than you really are is that it leads to Great Leap Forward type situations, in which you cut back on production, and later found that this was a bad idea.  What worries me about statements that China should consume more is that they fail to take into account China’s very rapidly aging population.  Once the baby boom generation ages, then all of that previous investment is suddenly going to prove useful.

One final thing.  Michael Pettis likes to use the phrase “it has never happened before.”  That doesn’t prove anything with regard to China.  In the case of China, there are so many things that have never happened before in human history, that “it’s never happened before” is just not an argument.


1 Comment »

  1. There is more than one way to deal with underconsumption. In a country like China, where many people are still quite poor, there should be no reason to slow production, even if you have warehouses full of goods. It sounds to me like a perfect case for more expansionary monetary policy and/or transfers. Imagine if the Chinese government printed 500 Renminbi and just handed it out to peasant farmers (or better yet, used it to pay for land instead of just confiscating it). The additional spending would take care of the surplus of goods in no time.

    The surplus of savings and lack of overinvestment supports the theory that monetary policy is contractionary. In a simple Wicksellian model, the interst rate would fall to bring savings and investment into equilibrium. If China’s currency appreaciated, people would be left holding higher real money balances and would spend it to return to their desired levels of money savings (cash, governement bonds, not productive investment). That expansionary shock alone might do the trick and get rid of the overproduction problem. In any case, destroying production is a bad way to deal with a general glut.

    Comment by azmyth — August 14, 2009 @ 7:43 pm

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