Michael Pettis is a former investment banker and currently a professor of finance at the Peking University. In the most recent edition of Bloomberg’s Odd Lots podcast, the professor provided a description of China’s debt issues that Canadians can apply to their deliberations ahead of our national election.
Mr. Pettis explained that China is attempting to reorient its economy from investment-oriented to consumption-driven. The investment model was highly effective in generating gross domestic product growth in the 1980s and 1990s because China was under-invested.
The under-invested stage meant that hypothetically, business owners could borrow $100, invest it and create $110 in economic value. In these cases, the aggregate debt level rises, but the capacity to repay debt rises by 10 per cent.
The problem now, according to Mr. Pettis, is that a saturation point has been reached where $100 investments only create $20 in value. At this point, Chinese debt levels are exploding, but the unprofitable nature of recent investment means the economy’s debt burden is rapidly becoming unserviceable.
There are major structural differences between China’s economy and our own. Most importantly, Canada is already a modern, consumption-centric economy. Household debt levels are high, but anything resembling the gargantuan scale of China’s malinvestment is not evident.
Despite these economic distinctions, I don’t think Canadians can afford to fully ignore Mr. Pettis’ warnings for China as the federal election approaches. Sizeable budget deficits are expected no matter who wins on October 21, and the Liberals new spending initiatives are estimated to cost almost $30-billion annually according to the Globe and Mail’s Campbell Clark.
My point is certainly NOT that government spending is bad. In the past, I’ve featured the work of economists like Carlota Perez from the London School of Economics and University College London’s Mariana Mazzucato, who argue that the current era of technological proliferation requires more government intervention and safety nets for displaced workers.
Ideally, government spending should be focused in areas – education and infrastructure are the two most obvious - that provide benefits and financial returns over time frames longer than any private company is willing to wait. But they still, as Mr. Pettis emphasizes, need to eventually generate $110 in economic value for every $100 spent in aggregate or risk a general decline in standards of living. Canadians should keep this in mind as they head to the polls.
-- Scott Barlow, Globe and Mail market strategist
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