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Global Anti-Macro Turkey Seventeen Quarters and Counting View GEF Archive

There’s a good chance we are all deluding ourselves about China.  In the first part of this essay, I argued that China was less of a traditional macro story and more of a fragmented collection of provincial and local power enclaves (see my 30 June dispatch).  If this conclusion is correct, it has profound implications for the Chinese economic outlook, as well as for China’s impact on the rest of Asia and the broader global economy.  The second part of this essay explores the “anti-macro” of China in greater detail.

Jonathan Spence, Yale’s great Sinologist, probably had it right in arguing that most Western observers have long wanted to see China in the same light they see themselves (see Jonathan D. Spence, The Chan’s Great Continent: China in Western Minds, W.W. Norton & Company, New York, 1998).  Dating back to Marco Polo’s 13th century accounts of his travels through China and going up through the Kissinger/ Nixon impressions of the 1970s, Professor Spence deploys his well-honed tools of forensic history to demonstrate how the outside world has failed repeatedly to grasp the “inside China.”  Well, as best I can tell, we’re doing it again.  The ascendancy of China onto the world stage has spawned a cottage industry of instant China experts in the West who are using a very traditional macro framework to depict the opportunities, as well as the stresses and strains, of the Chinese economy.  But there is an interesting twist at work today: To some extent, Modern China has played along with this ruse -- reinforcing our misimpressions of the Chinese economy.  The risk is we’ve all got it wrong. 

On the surface, China presents itself as a very tidy macro package -- unwittingly compounding the perceptional problem.  It has a well-constructed national statistical system that conforms to international GDP accounting standards.  It releases a full gamut of economic statistics on a regular monthly basis.  It has a central bank that was reorganized in 1998 along the lines of America’s Federal Reserve System.  Its fiscal policy stance is conveyed annually to the National People’s Congress in the form of the Premier’s “Work Report.”  China regularly attends G-7 meetings, weighing in as an outside observer on a broad range of macro issues -- from global imbalances and world growth issues to trade policies and currency matters.  And as the Chinese economy has come of age over the past 15 years, it has had increasingly important impacts on the rest of the world -- especially with respect to inflation trends, global trade and capital flows, commodity markets, and the cross-border arbitrage of job and real wages. 

With China now having such a western appearance as well as a major impact on the global economy, we in the West want to believe that we can examine the Chinese economy the same way we look at any other macro system.  That way, when things go wrong and it looks like China can be implicated in the problem, we draw comfort by opening up the macro playbook and selecting orthodox policy remedies.  The clearest example of this approach comes with respect to America’s gaping trade deficit.  Since the bilateral imbalance with China accounts for the largest piece of the multilateral US trade deficit -- some 25% in 2005 -- the orthodox Washington and academic view has been to recommend a sharp appreciation of the renminbi relative to the dollar.  I’ve never bought that line of reasoning because I view the US trade deficit as a multilateral problem traceable to America’s unprecedented shortfall of domestic saving.  To “deal” with the Chinese piece of the problem would simply mean diverting one slice of the US trade imbalance elsewhere.  Yet even if I’m wrong and China is the problem, there are no guarantees that a currency revaluation will work.  An economy needs a well-developed market system to redirect quantities (i.e., trade flows) through changes in relative prices (i.e., foreign exchange rates).  Yet China is still very much a blended economy -- only partly “marketized,” with a still large state-owned sector and a relatively undeveloped financial system.  Lacking the “invisible hand” of Adam Smith, the orthodox currency fix is likely to be stymied by the still very “visible hand” of the Chinese state.

This is not to say that China is lacking in macro issues.  To the contrary, the world’s most rapidly growing large economy has a number of serious macro imbalances that must be addressed sooner rather than later -- namely, an overheated investment sector, inefficient oil- and materials-using production technologies, a chronic deficiency of private consumption, and excessive reliance on exports.  In a market-based system, these problems could be tackled through a combination of monetary tightening and currency appreciation.  Considering the unprecedented excesses of investment and exports -- two sectors that collectively account for more than 75% of Chinese GDP and are still growing at a 30% y-o-y rate -- China has taken only baby steps in this direction.  Since 2004, there have been two modest 27 bp increases in short-term lending rates and a tightly controlled 3% revaluation of the RMB versus the dollar.  Instead, the heavy lifting on the policy front has been done by the modern-day counterpart of the old Chinese central planning administration -- the National Development and Reform Commission (NDRC).  Under the leadership of Chairman Ma Kai, the NDRC has emerged as China’s most powerful policy authority -- taking a series of targeted administrative actions aimed at restricting investments in a number of overheated sectors.  Currently, such actions are aimed at aluminum, cement, ferrous alloys, coal, coking coal, carbide-based PVC, and speculative activity in residential property construction

By opting for quantity adjustments over price signals, the Chinese leadership is sending the world a very important message: China is simply not ready for the more orthodox approach of macro management through monetary, fiscal, and currency policies.  Not only do such tactics require more of a market-based system, but they are executed through adjustments of very blunt policy instruments.  In a still highly fragmented Chinese economy, it may be very difficult to achieve traction with a blunt policy instrument.  This constraint -- the localization or, in some cases, regionalization of the Chinese economy -- seriously complicates Chinese policy strategy.  What the central bank says about nationwide lending rates often has little bearing on how local bank branches choose to allocate credit to locally-driven investment projects.  Moreover, when the macro authorities adjust the currency, Chinese subsidiaries of foreign multinationals don’t automatically curtail their foreign sourcing arrangements.  In short, Beijing’s control of the macro economy is very much stymied by the deeply entrenched fragmentation and autonomous behavior at the local level.  An ancient Chinese proverb puts it best: “The mountain is high, and the Emperor is far way.”

As I traveled through China on three different visits over the past 12 weeks, I was struck more by fragmentation than macro cohesion.  A trip to Tianjin -- two and a half hours west of Beijing and China’s newest and potentially largest hyper-growth zone -- pretty much sealed the verdict.  Tianjin has a special status inside of China -- it is one of only three cities that have been elevated to “provincial status.”  Its mayor, Dai Xiang Long, is the former governor of the nation’s central bank and has considerable clout in Chinese leadership circles.  Tianjin is but the latest of China’s special economic zones.  Through a combination of special tax incentives and massive infrastructure investments -- including a major expansion of what is currently the largest port in Northern China -- Tianjin is projected to grow at nearly double the rate of the national economy for years to come.  Incremental monetary and currency adjustments will do next to nothing to arrest this powerful dynamic.  Nor is this an aberration.  From Tianjin in the north to Shenzhen in the south, it’s hard to envision a slowing of hyper-growth in the mega-urban centers of coastal China.

This is where the rubber meets the road for the modern-day Chinese economy.  Macro China has reached a critical sustainability impasse -- the economy is far too reliant on investments and exports.  And yet Micro China continues to power ahead -- driven by autonomous development imperatives at the local level.  The all-important social-stability constraint bridges the gap between the macro and the micro.  Massive migration to China’s urban centers -- estimated to be at least 15 million citizens per year for the next 15 years -- leaves the nation’s leadership with little choice other than to condone pockets of hyper-growth at the local and provincial level that will be required to absorb this enormous influx of families.  Otherwise, the threat of rising unemployment, widening income disparities, and social unrest could be seriously destabilizing.  In the end, an accelerated pace of reforms to a market-based economy is the only means to relieve these mounting tensions.  Only then can traditional macro policies achieve the traction they need in order to be effective. 

In the meantime, my advice is to look less at the high-profile pronouncements of the People’s Bank of China and other macro officials and more to the micro managers of the NDRC for guidance on the direction of the Chinese economy.  The threats of protectionism and excess capacity both speak to an increasingly urgent need to cool off an overheated Chinese economy.  A slowing of export growth, a reduction in the commodity intensity of Chinese GDP, and an increase in the nation’s private consumption share are all likely outgrowths of an NDRC-led rebalancing of the Chinese economy.  For a blended system, such administrative actions on the quantity front will continue to be far more important than adjustments in orthodox stabilization policies that are so familiar to those in the West. 

I also suggest heeding the advice of Jonathan Spence.  It’s always tempting to view China through the same lens we use to examine our own problems.  That temptation could be seriously misleading insofar as the current state of the Chinese economy is concerned.  China is lacking in the well-developed macro economy that orthodox macro analysis and efficacious stabilization policies require.  Its fragmented structure is more anti-macro than anything else.  That complicates control and ultimately heightens the risks of economic management.

Turkey
Seventeen Quarters and Counting
Jul 05, 2006

Serhan Cevik (London)

Turkey, like all open economies, faces the challenge of ebb and flow in global risk appetite.   It has become one of the world’s fastest-growing countries, owing in large part to prudent policies and structural reforms, which put an end to the infamous boom-bust business cycles.  Was this extraordinary economic performance, especially considering the burden of higher oil and other commodity prices, just an illusion created by abundant global liquidity?  Some think so, but we have a different view.  The Turkish economy is certainly exposed to liquidity-driven international capital flows, but the rise in real economic activity is not a result of speculative asset bubbles or financed by hedge funds.  Turkey, like all open economies, faces the challenge of ebb and flow in global risk appetite, but even an abrupt risk reduction in financial markets does not necessarily imply a prolonged period of economic distress.  Unfortunately, the global volatility shock has led to an excessive focus on ‘uncertainty’ and, we feel, clouded investors’ perception of fundamentals.  In our view, the benefits of macroeconomic normalisation and globalisation — bringing a marked increase in productivity growth — should keep growth momentum on track in the foreseeable future, as long as the authorities maintain prudent fiscal policies and move structural adjustment beyond the macroeconomic sphere.  But before making predictions, let us look into the latest set of national accounts to understand where the economy is coming from.

Turkey is experiencing the longest stretch of economic expansion in history.   Turkey suffered a financial meltdown in 2001 that led to a 7.5% contraction in real GDP, but fiscal consolidation and structural reforms later on paved the way for productivity-driven above-trend output growth.  As a result, real GDP expanded by an astonishing 33.5%, on a cumulative basis, in the last four years — and 6.4% year on year in the first quarter of this year.  The rate of growth is moderating, but remains robust on a seasonally adjusted basis as well, thanks, once again, to a 4.8% increase in output per hour worked.  Despite the weakness of the labour market, private consumption increased by 8.4%, slightly lower than 8.8% last year, and provided good support for the rest of the economy.  Although some see the strength of consumer spending as a threat, we look at it as a natural source of output expansion in a young and dynamic society.  Moreover, investment spending, especially on new machinery and equipment, continues to outperform — increasing by 30.5% — eliminating the risk of overheating in the economy.  As we have long argued, investment-driven productivity gains keep pushing the economy’s production frontier to a higher plateau, thereby allowing non-inflationary income growth.

Monetary tightening and restrictive financial conditions likely to restrain domestic demand.   Though we remain optimistic about Turkey’s macroeconomic performance over the medium term, the global volatility shock that has already led to monetary tightening and restrictive financial conditions will undoubtedly restrain domestic demand in the short run, in our view.  Both consumer and investment expenditures are vulnerable to higher interest rates and reduced credit availability.  This is why we cut our real GDP growth estimate from 6.2% to 5.4% in 2006 and from 6.5% to 5.8% in 2007.  However, even though extreme noise in financial markets increases the margin of error in our projections, we do not see any reason for a ‘collapse’ in economic activity.  First, the central bank’s commitment to price stability should support the yield curve’s inversion and thereby limit the shock’s fallout.  Second, the accelerator effects entail a positive growth reading even in the second half of the year, with more restrictive financial conditions.  Third, the improvement in the quality of external financing — long-term capital now accounts for 70% of the total inflow — and macroeconomic normalisation will likely keep investment appetite strong.  And last but not least, a weaker currency, albeit bringing no improvement in the aggregate terms of trade in Turkey’s case, will boost export growth in labour-intensive sectors, such as textiles and clothing, as long as real wages do not increase.

We think there are no more skeletons — systemic risks — in the closet.  Despite a challenging global outlook, Turkey should weather the latest storm, thanks to fundamental improvements in the economy.  The mother of all problems in this country was fiscal excess, and maintaining an average primary surplus of 6.2% of GDP in the last seven years has already lowered the overall budget deficit from 16.5% in 2001 to 1.9% in 2005 and to around 1.0% this year.  In other words, fiscal dominance is no longer a threat, although the commodity bubble and further tightening in global financial conditions are obvious macro risks.  More importantly, Turkey faces real challenges stemming from institutional shortcomings and microeconomic flaws.  Take, for example, the growth rate of total factor productivity, which increased from 0.5% per year in the 1990s to 5% in the past four years, but remains well below the OECD average.  In our view, this is a consequence of technological backwardness, managerial inefficiencies and inadequate access to capital markets (see Of Lemons and Dinosaurs, March 1, 2006).  This is why we think currency devaluation is no panacea, and the key to sustained high growth is the continuation of economic and institutional reforms that would accelerate the country’s transformation away from low value-added, informal activities.

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