Thursday, August 28, 2008

Is the China Economy Really That Invincible?

The US$40 billion spent by China on the Beijing Olympics is small compared to its 2007 nominal GDP of US$3.4 trillion.

Does this mean that China will not suffer the usual post-games growth hangover?
Is the China economy really that invincible?

It will be noted that during the preparation for the Games:
1. Metals and commodity prices rose to their highest levels yet.
2. Visitors to China and Beijing were discouraged so that triple-star Beijing hotels were complaining of only 40% occupancy during the Games.
3. Factories were moved out of Beijing to lower the city pollution.
4. Parallel construction by the private sector to take advantage of the games.

The basic point to note is that, for the two-week event, part of China had been put to work simultaneously to ensure that the project was completed on time. Indeed, it was and how spectacularly.

In economics, we call this "bunching." The problem with bunching is that all sectors are made to work simultaneously to achieve one point. Once that objective is achieved, all the forces suddenly disappear. While US$40 billion was spent directly, there could be more spent indirectly down the line to the basic supplies and infrastructure to ensure that there is no supply bottleneck. The multiplier could be huge (I would say 10x). When you expand capacity, you build whole facilities and they are chunky.

Now, suddenly, there is a vacuum. Only a small vacuum, they say.

There is a plan to plug that small vacuum with a small US$40 billion stimulus package.

Even if this is approved, there is still the demand shortage for the indirect expenditures which had to go in to build the extra facilities in order to ensure that all related projects either directly or indirectly were finished on time at one particular point in time.

The high global prices, although now softening, will already have their impact on global demand, and that impact is negative.

Now, the problem with negative impact is that it cannot be quickly resolved. There are ramnifications which take time to reverse. A person shot but not dead cannot be assumed to be able to get back on his feet immediately once the firing stops; he needs time to recover. So does an economy.

The high global prices will also induce increases in supply which, if already started, will produce excess capacity and lower prices in the next two or three years. These supply capacities will be in areas in addition to those related to the games.

The final factor is that, fromt the economic point of view, the expenditures related to the games are unproductive. They do not create an increase in productive capacity that can be considered as investments for future economic growth. The reverse seems to be the case.

I wish to suggest here that there is a demand vacuum, no matter how small, in the China economy, as well as a potential further increase in excess supply capacity in the world economy which together will create a possible implosion in the global economy in the next 2 to 3 years (2010).


CT Choo said...

Excellent analysis, etheorist. Very enlightening. The forecast is bleak, but I guess all prognosis must be real and the medication bitter.

ben said...

Prof, I tend to agree with your analysis and forecast. The high commodity prices is not sustainable. The commodity market (especially oil, metal, etc) has outpaced world economic growth, with plenty of hedge fund fueling the bubble. I guess excess supply will be the needle that will burst the 'commodity bubble'.

That being the case, wouldn't it be prudent to slowdown on the mega projects and ramping it up when the bubble finally burst ?