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China's economy has hit the Great Wall

Paul Krugman blames dwindling investment and labor shortages.

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Workers build a wall at a construction site near the central business district in Beijing on August 27, 2009. (Liu Jin/AFP/Getty Images)

Paul Krugman has taken a break from picking on inflation truthers to write an important column today about China titled "Hitting China's Wall" about the slowdown in the economic data.

The basic story that Krugman tells is this: China  has experienced, for the last few decades, a virtually unlimited ability to spend on consumption thanks to the massive supply of rural surplus labor. China has an extraordinarily unbalanced economy that's comprised of almost entirely investment, and very little consumption.

Now things are changing. There's not much useful investment left, and the surplus labor is disappearing.

The existence of this surplus labor, in turn, has two effects. First, for a while such countries can invest heavily in new factories, construction, and so on without running into diminishing returns, because they can keep drawing in new labor from the countryside. Second, competition from this reserve army of surplus labor keeps wages low even as the economy grows richer. Indeed, the main thing holding down Chinese consumption seems to be that Chinese families never see much of the income being generated by the country’s economic growth. Some of that income flows to a politically connected elite; but much of it simply stays bottled up in businesses, many of them state-owned enterprises.

It’s all very peculiar by our standards, but it worked for several decades. Now, however, China has hit the “Lewis point” — to put it crudely, it’s running out of surplus peasants.

That should be a good thing. Wages are rising; finally, ordinary Chinese are starting to share in the fruits of growth. But it also means that the Chinese economy is suddenly faced with the need for drastic “rebalancing” — the jargon phrase of the moment. Investment is now running into sharply diminishing returns and is going to drop drastically no matter what the government does; consumer spending must rise dramatically to take its place. The question is whether this can happen fast enough to avoid a nasty slump.

For a really detailed dive into what China is facing, this IMF report from earlier this year really goes deep on some of these issues

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Original Source URL: 
http://www.businessinsider.com/krugman-why-china-has-hit-the-wall-2013-7

http://www.globalpost.com/dispatch/news/business/130719/chinas-economy-has-hit-the-great-wall