Optimism on China from Goldman Sachs

I've actively argued that China faces the threat of a dangerous financial crisis over the next few years. But a new report from Goldman Sachs,
Michael Mandel

I've actively argued that China faces the threat of a dangerous financial crisis over the next few years. But a new report from Goldman Sachs, "China's Ascent: Can the Middle Kingdom Meet Its Dreams?" makes a much more positive case.

First, they show that total factor productivity (TFP) growth has been the main source of Chinese growth (for my explanation of TFP and its importance, look at this piece that I wrote a few months ago). Over the past 25 years, GDP growth in China has averaged 9.4% per year. Here's the GS breakdown of where it came from.

Capital stock 3.4 percentage points
TFP 3.4
Labor 1.2
Education 1.4

The two authors of the GS report, Hong Liang and Eva Yi, expect that these productivity gains will continue:

We foresee the next several year as a sweet sport of further sizable gains in "reform dividends," originating from China's WTO membership-related reforms. As China fulfills its WTO commitments to deregulate key state industries, revamp its financial system, and forge clsoer ties with the global economy, we expect to see significant improvement in the efficiency of resource allocation, and therefore substantial gains in productivity over the medium term.

Moreover, the GS economists poo-poo the notion of a crash, saying that

Sustained and substantial gains in per capita income have improved the lives of millions and cannot be lightly described as a "mirage" or "bubble."

I have no trouble with their productivity argument. It's clear to me that the gains in China are real.

But they miss the main point: High productivity growth does not protect you against a financial crisis. In hindsight, the U.S. dot.com crash came in the middle of an extended period of high productivity growth. The Great Depression, too, seemed to come in period of rapid productivity growth and technological change.

One can argue that high productivity growth--because it gives a rational basis to the enthusiasm--makes it harder to resist the siren call of overshooting. I'm still solidly in the bust camp.

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