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About China’s Rebalancing

—August 29, 2013

We pay attention to the “growth” debates about China. Aside from arguments (important, for sure) about when or if mounting bad debt from poorly conceived infrastructure projects and ebullient property markets will crater GDP growth, the larger debate concerns the impact on the economy from its rebalancing.

An insightful addition to this debate comes from Michael Pettis, in the July 28 Financial Times, and in his recent more detailed and wide-ranging book “The Great Rebalancing”. Paraphrasing Pettis, rebalancing the Chinese economy is crucial because its export-oriented and debt-fuelled investment growth model is no longer tenable in the face of lower global growth rates, its increasingly unproductive investments in infrastructure and high levels of debt. Instead, household consumption (only about half the global average as a percentage of GDP), which has been dramatically subsidizing China’s growth through low wages, low interest rates and other social transfers, must be increased by boosting household income. Raising wages, interest rates and the value of the renminbi, in other words, transferring wealth from the state and corporate sector back to households, is the only way to grow the economy over the very long term without running into the constraints of the current growth model.

To meaningfully increase the percentage of household consumption in GDP over a decade, assuming it grows at historical rates, increases in investment must decline dramatically – to almost zero. Owing to the relative size of each GDP component, a decline in investment of this magnitude could reduce GDP growth to 3-4%. A wealth transfer of this magnitude is not likely to be achieved without unemployment and lower household income unless state assets are transferred to the private sector.

We believe Pettis’s commentary and analysis provide a robust framework with which to think about Chinese economic and social policies and how these policies may affect the companies we invest in as well as the world at large.

—Thomas Lamb

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