Modern Monetary Theory and China

There is no greater example of the progress human society can make than China. Most of us are familiar with the ascent of China and their accomplishments. The short version is that China has lifted hundreds of millions of people out of poverty and increased GDP per capita from about $250 to nearly $10,000.

There is a vast literature on how this was accomplished, but I wanted to highlight three key elements that reinforce the power of large scale government spending that targets productivity. The role of government is ultimately two-fold : provide security to citizens and increase productivity and wealth of the country. In this regard, China has done a amazing job.

To increase productivity in a sustainable and self reinforcing way is extremely challenging. You must do this in the face of political, economic and historical challenges. China did many things, but let me highlight three.

Iron Rice Bowl

At its inception, the Chinese Communist Party created numerous state owned enterprises that offered guaranteed jobs to hundreds of millions. Though low paid and often unproductive, these jobs created economic activity and circulated money through the economy while producing goods and services. In short everyone could have a job if they wanted one. This initiative helped China achieve 6% annual GDP growth under Mao Zedong. Though Mao is known for the disasters of the Cultural Revolution and The Great Leap forward, he did lead China out of the depths of abject poverty with a Federal Jobs Guarantee.

After Mao, Deng Xiaoping reformed many of these state owned enterprises and reduced the guarantees around jobs. Yet, even in 2006 when I worked in China we sill saw the reality of state owned enterprise job creation. A steel mill that I visited in 2006 employed over 7,000 workers while producing 6 million tonnes of steel a year. A similar plant in France where I also worked employed about 2,000 people to produce the same amount of steel at higher grades. This job creation program was critical to China’s growth and it still exists to varying degrees today.

Issuance of Capital

Thomas Picketty argues that the main problem with inequality is not so much inequality of income, but rather inequality of capital. Owning capital is the critical element to success in society. Without it you are subject to the labour market and economic growth. In his latest book, “Capital and Ideology” he advocates for the issuance of substantial capital to all adults. He proposes something along the lines of 150,000 Euros per person.

China never went quite that far, but they did issue capital in massive amounts. One of the first industries China tried to reform and make profit driven was the textile industry. To do this, Deng Xiaoping issued large amounts of capital to a variety of state, semi-state and private enterprises that allowed them to buy looms and machinery from overseas. He also pushed for these companies to make synthetic textiles as cotton was not produced in China at the time and they did not have the capital to import sufficient foreign cotton. The issuance of large amounts of capital or the printing of money allowed for the build up of productive capacity and the generation of profits that could be invested in further industrialization.

The second massive capital allocation to private individuals was the transfer of residential property from the state to the individual. This is well outlined by China Skinny (a weekly newsletter on economic trends in China)

China’s 2019 GDP per capita of $10,098 pales in comparison to the $65,111 in the US. Similarly, its average 2018 urban wages of around $12,000 are just a fraction of the $63,093 earned a year in the States. So why are so many brands banking on China’s structurally low GDP per capita and poorly-paid consumers to lead the global recovery? If we look under the hood, the economic metrics and drivers in China are unlike those in the West, and only paint part of the picture.

For the average consumer in China, the wages one earns influences spending less than it that it does in most other countries, simply because they have more wealth behind them. In fact, China’s median urban household net worth stood at $198,330 at the end of 2019, versus an estimated $104,000 in the US.

Many readers are likely to be scratching their heads wondering how they can be wealthier based on the GDP and income fundamentals above. Chinese may be known as strong savers (although the youth have been taking on consumer debt like no tomorrow over the past few years), but how could saving that relatively low income create a level of wealth double that of half of American households?

The main reason is property wealth. When China’s housing stock was privatised in the late 1990s, most Chinese families were able to buy their homes and apartments at rates that are a fraction of what they are today. As a result, 96% of urban Chinese own property versus just 64% in the US. Having bought their property for such a low price, their indebtedness is also much lower. 57% of Chinese households ‘officially’ have debt, versus 77% of American households. And Chinese ‘official’ debts account for just 16% of their assets, versus 36% in the US.

A whopping 31% of Chinese households own two apartments and 11% have three or more. When the average apartment costs over $1 million in many districts in Shanghai, for example, it means that there are a large number of very wealthy people in China who are fuelling everything from the global luxury market, to cosmetics, to cars, to milk.

Although consumers are not yet skipping through the shopping isles filling their carts with glee, the overall return to normalcy continues to track well based on spending trajectories. Chinese remain fundamentally wealthy. Parents continue to support their millennial offspring’s consumption habits in and many categories are seeing solid growth. With China’s $205 billion post-COVID fiscal spending focused on economy-building new industries such as technology, mass transport and power infrastructure, the wealth of the country as a whole is likely to continue to grow strongly over the long run, and with it, its importance as a consumer market.

Your perspective on the future is very different when you own capital or own your home (a form of capital). Though the Chinese government sold these state assets to citizens, they did so at a reduced rate with no attempt to profit or even make it financially sustainable for the government. However, the consequences of creating a capital owning class vastly outweighed the costs. No economy can be solely based on physical property and this is why China is putting all of its efforts behind the creation of growth engines based on technology. Put in another way, their efforts are focused entirely on creating higher levels of productivity on the back of a capital foundation with a certain amount of guaranteed jobs. This is modern monetary theory at work.