A Contrarian View on China's Growth: Bull versus Bear (An Abundant World)

BEING A CHINA BULL – CHINA’S POST-CAPITAL FUTURE

December 14, 2012 · by jameswhite · in Being a China Bull, China, Competition, post-capital. ·

Michael Pettis’ questions challenged the China Bull to look at three specific issues; the sustainability of China’s debt, the new focus of investment and improving consumption. My response has looked at these questions from different angles. I remain comfortable that being a China Bull is a defendable, though admittedly uncertain position. Uncertain because it means saying: 

"This time is different."

This phrase has, over decades, led many an economist to an early grave.

The return on capital does not define the economic outlook

My day job and the job of all working in financial markets has been to explain the return on capital for an economy, industry or firm. This is an essential function. Capital markets are about pricing capital and I contribute to that process in a very small way.

The problem comes when the return on capital becomes synonymous with the health of the economy and the welfare of its participants. Yet this is exactly where we’ve collectively arrived. Equity indices have come to reflect the health of an economy. But equity indices are not economic health reports.

Consider the United States. Very simply the United States economy is ordered towards maximising the return on capital. Capital, historically, has been scarce. The U.S. at various times has come to rely on foreign capital for investment including the present. Historically, this focus on capital returns has created positive returns for the wider economy, specifically for households in rising employment and wages. Capital is very important for an economy.

But similarly, maximising returns to capital can lead to perverse welfare outcomes. As I’ve argued in Patently Wrong – Part I and II protecting capital often comes at a cost to the welfare of the broader economy and it’s not clear to me that that’s not always a good outcome for households. Similarly, we live in a period where, despite strong returns to capital and a low cost of capital, the level of investment in the U.S. remains disappointingly low. Maximising returns to capital has led to under-investment, not over-investment in recent times. This is largely because capital is becoming focused in the hands of a smaller, and smaller group – the 1%. 

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