James Pethokoukis

Politics and policy from inside Washington

China’s black box economy

Jul 5, 2011 21:03 UTC

The more you know about Rising China, the more you want to know. Minxin Pei gives some valuable perspective on the nation’s suddenly emerging debt problem:

Based on the figure released by the National Audit Office (NAO) at the end of June, local governments have accumulated debts totalling 10.7 trillion renminbi (RMB) or $1.65 trillion – about 27 percent of China’s GDP in 2010. Because the NAO’s figure was based on a sampling of 6,500 local government-backed financial vehicles (out of more than 10,000 such vehicles nationwide), the actual magnitude of local government indebtedness is much greater. The People’s Bank of China, the central bank, recently estimated that local government debt totalled 14 trillion RMB (most of which was owed to banks), almost 30 percent higher than the NAO figure.

… On paper, China’s debt to GDP ratio is under 20 percent, making Beijing a paragon of fiscal virtue compared with profligate Western governments. However, if we factor in various government obligations that are typically counted as public debt, the picture doesn’t look pretty for China. Once local government debts, costs of re-capitalizing state-owned banks, bonds issued by state-owned banks, and railway bonds are included, China’s total debt amounts to 70 to 80 percent of GDP, roughly the level of public debt in the United States and the United Kingdom. Since most of China’s debt has been borrowed in the last decade, China is on an unsustainable trajectory at the current rate of debt accumulation, particularly when economic growth slows down, as it’s expected to do in the coming decade.

The longer term effects of massive non-performing loans owed to state banks by local governments are likely to manifest not in the form of a banking crisis, but in other more insidious – yet equally – harmful ways. Because the Chinese state owns trillions of RMB in assets (land, natural resources, state-owned monopolies, and $3 trillion in foreign exchange), Beijing should have enough resources to bail out local governments when these loans have to be repaid. But there’s no free lunch. Bailing out local governments with valuable financial resources in the coming decade – a decade in which China will experience the end of the demographic dividend, rising costs of healthcare and pensions, and slower economic growth – will mean China will have less capital to invest. For an investment-led economy, this implies even more sluggish growth.

I dunno.  Covering local debt, dealing with an aging population — is there really enough dough left over for a military that can project power globally?


“Once local government debts, costs of re-capitalizing state-owned banks, bonds issued by state-owned banks, and railway bonds are included, China’s total debt amounts to 70 to 80 percent of GDP, roughly the level of public debt in the United States and the United Kingdom.”

It is clearly misguide and wrong statement. 80% of GDP is counting only US federal debt. If all local and state government added together using same measurement, it is way more than 80%.

Posted by jim1981 | Report as abusive

The U.S. jobs gap

Jul 5, 2011 16:18 UTC

This chart from the Heritage Foundation kind of says it all:


That chart is missing three lines:
1: Date Obama was elected President
2: Date President Obama was inaugurated
3: Date the “stimulus” passed

My eyeball line says the line started misbehaving sometime between 1 and 2, but I’d love to see reality.

Posted by GregTD | Report as abusive

What Reaganomics meant to accomplish

Jul 5, 2011 15:43 UTC

Excellent piece by Brian Domitrovic of Forbes:

What was the point of Reaganomics? Starving the beast? None of the above. The point was to get the private sector booming. And could we ever use this as an objective today.

The prophet of the renaissance of the 1980s was the Reagan budget team’s economic forecaster, John Rutledge. Rutledge noticed that in the dozen years prior to 1981, money had been fleeing from the real economy, what with its taxes, regulations, and currency devaluations, and into tangible safe havens – especially commodities: oil, gold, and land.

Rutledge calculated that over the 1970s, some $11 trillion had migrated out of real economic enterprises into these hedges – a whopping number. And yet if the burdens on the economy were to lessen, a prodigious amount of money stood to flow back into the real sector, with epic growth, employment, and profits in tow.

This is of course what happened in the 1980s, as taxes got cut, regulation stymied, and money stabilized. GDP growth was north of 4% per year for a seven-year run, job creation was measured in the eight digits, and the stock market was off on a 15-fold advance. All because huge money had been parked elsewhere waiting for the real sector to become attractive again.

Sound familiar? Today, we see gold at $1500 an ounce, oil crossing $100, massive retained profits at corporations, and excess reserves at banks. And we’ve just endured a real estate bubble. If economically inert investments – vehicles that are not themselves businesses or their financing instruments – are capturing an extra-large portion of our financial capital, our economy is underperforming.

America’s missing trillions

Jul 5, 2011 15:18 UTC

In the WSJ, David Malpass and  Steve Moore note a disturbing trend in foreign investment in the U.S.:

It is true that foreign direct investment rose to $236 billion in 2010 from $159 billion in 2009. But that was still well below the $310 billion invested in 2008. The White House also neglected to disclose that in the first quarter of 2011 foreign investment fell by 51% from the first quarter of last year, according to data released last month from the federal Bureau of Economic Analysis. Foreigners of late have not found the U.S. to be a receptive, high-return home for investment.

… To be sure, foreigners still park a huge amount of money in this country, but in the last several years they’ve shifted their investment toward U.S. Treasury securities and government-guaranteed bonds, and away from the private-sector staples—corporate bonds, intellectual property, ownership of businesses—that create sustainable jobs. Since 2009, foreigners have invested just over $1 trillion in U.S. Treasury bonds, according to the Bureau of Economic Analysis.

Some economists argue that investing in low-interest-rate government bonds works fine for America because it allows the government to boost spending on programs—the latest doozies are windmills, high-speed rail and 99 weeks of unemployment benefits. The low interest rates, this argument goes, prove there is no negative “crowding out” from America’s near $1.5 trillion deficit.

That misses the point. To produce rapid growth, most capital must be allocated by markets. The effect of $4.5 trillion of borrowing since 2009 is that foreigners and Americans are buying Treasury bills instead of investing in the next Google, Oracle, Wal-Mart or biomedical company. Today, foreigners are financing food stamps and the next bridge to nowhere while Americans are building state-of-the-art production systems abroad. This is the real pernicious “crowding out effect” of the federal government’s borrowing.

But wait, there’s more. Don’t forget about the more than $1 trillion in U.S. corporate earnings parked offshore, just waiting to be repatriated if U.S. corporate tax rates were lowered.

Why Christina Romer is wrong on taxes

Jul 5, 2011 14:41 UTC

President Obama’s economic all-star team from 2009 is all but gone. But it’s the gift that keeps on giving. In yesterday’s NY Times, former White House economist Christina Romer offered a rather strange op-ed in favor of tax increases. The crux of her argument is this:

The economic evidence doesn’t support the anti-tax view. Both tax increases and spending cuts will tend to slow the recovery in the near term, but spending cuts will likely slow it more. Over the longer term, sensible tax increases will probably do less damage to economic growth and productivity than cuts in government investment.

And her evidence?

Some in Washington and in the news media have seized on a study I conducted with David Romer, my husband and colleague, that they say shows tax increases having a bigger short-term effect on the economy than spending cuts. Our study, which examined only federal tax policy, found that conventional analysis underestimates the effect of tax changes on the economy substantially. The key problem we address is that changes in taxes are often linked to what is happening in the economy.

That Romer-Romer study offered this conclusion:

Our results indicate that tax changes have very large effects on output. Our baseline specification implies that an exogenous tax increase of one percent of GDP lowers real GDP by almost three percent. Our many robustness checks for the most part point to a slightly smaller decline, but one that is still typically over 2.5 percent

Right, tax increases hurt economic growth. Agreed. And they may only raise half of the revenue predicted by static analysis that does not take into account behavioral effects. But then Romer makes this claim:

If there were a similar study on government spending, it would likely show that spending cuts also have larger effects than conventionally believed. Like tax actions, spending changes are often correlated with other factors affecting economic activity. For example, large cuts in military spending, like those after World War II and the Korean War, were typically accompanied by the end of wartime taxes and production controls. Those probably lessened the economic impact of the spending cuts, leading many researchers to underestimate the reductions’ effects.

It is hard to argue against a hypothetical study. But Romer’s reasoning, though flawed, is hardly novel:

1) She states that, at least over the short-term, $100 less in government spending reduces aggregate demand by $100. On the other hand, a $100 tax increase on “wealthier households” does not reduce demand by $100 since at least part of that tax increase would be paid from savings rather than consumption.

Me: Been there, done that. This is sort of the flipside of the Keynesian argument in favor of the $800 billion Obama-Romer-Bernstein stimulus plan.  Except she uses a smaller fiscal multiplier here , 1.0, than she used in analyzing potential impact of the stimulus plan, 1.6. But even that may be too high. Economist John Taylor thinks the multiplier is about 0.5. In fact, there are several models that find such a low multiplier.

Unfortunately, we find substantially smaller government spending multipliers than those used by Romer and Bernstein. For example, the multiplier associated with a permanent increase in government spending by the end of 2010 lies between 0.5 and 0.6. In other words, government spending does not induce additional private spending but instead quickly crowds out private consumption and investment.

We also provide an assessment of the impact of the American Recovery and Re-investment Act. This legislation implies measures amounting to $787 billion and spread over 2009 to 2013 but peaking in 2010. Our estimate of the total impact is closer to 1/6 of the effect estimated by Romer and Bernstein. By 2010 we project output to be about 0.65% higher. Using the same rule-of-thumb as Romer and Bernstein, this increase in GDP would translate to about 600,000 additional jobs rather than three to four million.

2)  Next, Romer says that while “higher tax rates reduce the rewards of work and investing,” raising current tax rates by 10 percent would only reduce reported income by 2 percent.

Me: Again, I am not sure whose taxes she is talking about, but research by Martin Feldstein on the 1993 Clinton tax increase found that a) high-income taxpayers reported 8.5 percent less  taxable income than if their taxes had not been raised, which resulted in b) the tax increase only raising about one-third as much dough as Team Clinton has predicted.

3)  Romer also worries that “certain spending cuts may also have small effects on long-run growth.” She’s talking about stuff like basic scientific research, education and infrastructure.

Me: Ah yes, the “good” sort of spending. But as I have noted before, McKinsey consultants have found that if the U.S. public sector could just halve the productivity gap with the private sector, its productivity would be as much as 15 percent higher and would generate annual savings of up to $300 billion a year. We’re far from cutting into the muscle and bone. And there’s no reason not to take a look at basic research, infrastructure and other investment spending to see if they could be done  more productively.

Bottom line: But the basic problem here is that Romer, like the rest of Obama’s all-star team, is worried about stimulating consumer demand rather than encouraging — by the removal of tax and regulatory barriers – established businesses and new entrepreneurs to invest, expand, hire and create. And talk of raising taxes distracts from the real work that needs to be done to reduce spending. Whenever economists talk about the need to raises taxes, they are actually making a political argument rather than an economic one.  Either they are ideologically opposed to smaller government or they don’t believe Washington will ever cut spending. But that isn’t surprising since there really isn’t a valid economic argument to support the long-term Obama spending binge.