Krugman: China Is 'About to Hit its Great Wall'

Monday, 22 Jul 2013 08:10 AM

By Michael Kling

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No doubt about it — China is in big trouble, says Nobel Prize-winning economist Paul Krugman.

And this is no minor setback. Its entire way of doing business has reached its limits, Krugman writes in his New York Times column. "You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be."

The crash could send the fragile world economy into a slump, he warns.

Editor's Note:
Trump Says U.S. Losing Economic Power To China, No Longer A Rich Country

China has an enormous imbalance between consumption and investment.

The U.S. devotes 70 percent of its gross domestic product to consumption. China devotes half that amount. "It seems to invest only to expand its future ability to invest even more," Krugman states.

Why has consumption remained low? And why hasn't China yet reached a point of diminishing returns?

Krugman supports a theory put forth by economist W. Arthur Lewis that argues that countries in early sates of economic development have large amounts of cheap, surplus labor. They can continue investing in new factories and construction without reaching diminishing returns by continually drawing on that surplus labor, and wages can remain low even as the economy expands.

Consumption has remained low because Chinese workers have seen little of the income from the country's economic growth. Income goes instead to the publically connected elite or remains in businesses.

"Now, however, China has hit the 'Lewis point' — to put it crudely, it’s running out of surplus peasants," Krugman argues.

Investment has hit the point of diminishing returns and will drop drastically. Consumer spending must increase to take its place. In other words, China now faces a drastic need for rebalancing.

"The question is whether this can happen fast enough to avoid a nasty slump," Krugman states. "And the answer, increasingly, seems to be no."

The global economy could probably handle a Chinese downturn in ordinary times.

"Unfortunately," Krugman warns, "these aren’t ordinary times: China is hitting its Lewis point at the same time that Western economies are going through their 'Minsky moment,' the point when overextended private borrowers all try to pull back at the same time, and in so doing provoke a general slump."

The latest economic figures show that China is having difficulty rebalancing its economy, according to The Wall Street Journal.

Consumption growth in the second quarter was the lowest in three years, The Journal reported, citing Capital Economics research. Second-quarter growth was 7.5 percent. Investment was 5.9 percentage points of that total, up from 2.3 percentage points during the first quarter.

Consumption fell to 2.5 percentage points of the total, from 4.3 percentage points in the previous quarter.

Editor's Note: Trump Says U.S. Losing Economic Power To China, No Longer A Rich Country

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