China and Japan's economic development path

Reading: http://mpettis.com/2010/11/what-happens-if-chinese-growth-slows

Michael Pettis pointed out several important things:

1. Chinese development is unbalanced, heavily depend on export and investment.

2. Chinese economic re-balance toward more consumption and less investment is essential for its own continued prosperity and will benefit not just China but economies worldwide.

3. A Chinese slow down in its GDP growth rate does not mean worldwide contraction. It may boost economic growth in other parts of the world by two ways: a higher level of Chinese consumption and a higher export share for countries other than China.

4. Chinese economic development model is very similar to Japanese, with probably a 20 to 30 years time lag. So China is on a cross road similar to what Japan faces in the late 1980s.

I think all these points are well argued and the history of Japanese decision could be a useful guide. I also think these arguments are mainstream in the US policy circles. Here is an evidence:

http://www.federalreserve.gov/newsevents/speech/bernanke20101119a.htm

There are several interesting theoretical questions being raised here by others. One concerns Say's Law and the Keynesian view: Does supply creates demand? Or Demand creates supply? I think a modern version of Say's Law should be: When a person finds a job he/she will have demand for consumption: housing, car, furniture, etc. Keynes's idea is that government spending/investment will create jobs, which in turn creates private consumption – a more sustainable demand. If we consider the economic development strategy in a poor country such as China in the early 1990s or Japan in the early 1960s or the US sometime in the 19^th century, the obvious truth is that household income is very low and aggregate demand is very weak. This low income is due to weak productivity that is true to any country pre-industrialization. There is a chicken and egg problem in the poor country: low level of productivity (supply) caused weak demand. That weak demand also creates an environment that suffocates productivity growth – no customer even if you build a super efficient factory with government funding. Japan and later China decided that they can rely on richer country's demand for their economic growth. First they will use their low labor cost and government funding to build factories for export. This will create jobs and savings in the household. Government and banking system will channel this saving back to the rich country (read US), so that rich country consumers can leverage their stronger balance sheet for more consumption and investment. This translates to more export for Japan and later China. I think it is a successful model for rapid industrialization. I also think this gives the US cheap financing, and cheap imported consumer goods, both fostered the unprecedented prosperity. Without Japan and China there is no doubt that interest rate will be a lot higher and consumer goods a lot more expensive in the US. Just imagine what would happen if China and Japan withdraw their combined 2 trillion dollars deposit from the US treasury. The US will also have to devote a much larger work force to low value added manufacturing, a high opportunity cost. My conclusion is that supply and demand are just like chicken and egg – it is meaningless to debate which one comes first. Keynesian idea is useful in the Great Depression of 1930s and the Great Recession of 2008. It is also useful in constructing Japanese and Chinese industrial economy when they were poor. Now that China is rich it should consume more and let other countries have a chance to industrialize. The Say's Law is also true: demand expansion through borrowing is unsustainable, regardless it is from consumer or the government. A healthy economy depends on the growth of high pay jobs. High pay job is a form of supply. It is also a source of demand.