There has been a lot of discussion recently about how Chinese subsidies and other government support has led to industrial overcapacity, which can have a negative impact on the manufacturing sector of other economies. If domestic supply exceeds domestic demand, the Chinese-made products that won't be sold in the domestic market will be exported, and foreign producers have trouble competing with these Chinese products.
If I understand their argument correctly, some people attribute this situation largely to government policies that cause weak demand and excess savings in China, with these factors leading directly to the subsidized manufacturing. And it seems as though these people believe a key part of the solution is that China should stimulate domestic demand so that its consumers buy more of the Chinese production.
Finance professor Michael Pettis is leading the charge on this. As he recently put it: "In [persistent surplus economies such as China], weak domestic demand is simply the flip side of policies that result in manufacturing competitiveness. The manufacturing sector is subsidized directly or indirectly by households, which leaves them more competitive and leaves households less able to purchase a substantial share of what they produce."
Others who may be on board with this view are Treasury Secretary Janet Yellen, who recently said this: "I am particularly worried about how China’s enduring macroeconomic imbalances—namely its weak household consumption and business overinvestment, aggravated by large-scale government support in specific industrial sectors—will lead to significant risk to workers and businesses in the United States and the rest of the world. China has long had excess savings, but investment in the real estate sector and government-funded infrastructure had absorbed much of it. Now, we are seeing an increase in business investment in a number of 'new' industries targeted by the PRC’s industrial policy. That includes electric vehicles, lithium-ion batteries, and solar." Along the same lines, Yellen said the following in response to a question at a press conference on what could be done about Chinese overcapacity:
Well, there's supply and then there's also demand. And so we've had conversations with our Chinese counterparts about the demand side of the equation and the fact that China's saving rate is among the highest in the world, and even at this advanced stage of development remains close to 45%. The flip side of a very high saving rate is that consumer spending as a share of GDP is quite low in China relative to other countries at this level of income. So one possible approach would be to boost demand and to see a larger share of GDP accrue to households to bolster their income, or and/or to, for example, bolster retirement security, the ability to afford education for one's children and so forth, which are motives for very high saving, and call that rebalancing. And this is a matter that we have discussed over more than a decade in China and I too have talked to many officials and members of the academic community who think that that needs to be part of the solution. If consumer spending were higher as a share of GDP, there would be less need to have such large investment going into building supply.
While I agree that subsidies and overcapacity can lead to trade conflict, I have doubts about the focus on levels of domestic demand and savings. In particular, I'm skeptical that demand and savings are the most important factors here, and that the solution is for governments to try to influence these factors so as to address the trade problems. As I see it, governments pursue the fiscal and other domestic economic policies that affect demand and savings mainly for domestic political reasons, and while trade might be affected by these policies to a degree, the trade impact is not a significant part of the policy calculation. As a result, even if the trade impact is pointed out by affected countries, the governments pursuing these policies are not likely to make major adjustments. Yes, high or low savings levels can affect trade balances where national economies diverge in these areas, but governments see these as domestic choices that are mostly decided based on national politics. International coordination here is difficult and rare.
As support for the view that domestic demand and savings levels are not the main factors driving overcapacity and the resulting exports, let's look at another example of subsidies that support production which exceeds domestic demand. (And just to be clear, I know it's not a perfect parallel in terms of the nature and amount of the subsidies, but nevertheless I think it illustrates the point.) In the U.S., an area in which we have long seen a high level of subsidies is agriculture. This has led to the U.S. having significant "overcapacity" in certain agricultural products, in the sense that we produce more at home than we can sell here. Just like with Chinese industrial subsidies, U.S. agriculture subsidies support capacity that outpaces domestic demand. And as with Chinese manufacturing of electric vehicles, lithium-ion batteries, and solar products, here we see domestic subsidies going to a sector for which a significant amount will be exported.
Notably, it's pretty clear that U.S. demand is not being repressed, either in general or in agriculture; I don't think anyone would say that the U.S. government is taking actions to limit the demand of U.S. consumers. And foreign economies that are affected by the U.S. exports don't call on the U.S. government to stimulate internal U.S. demand for these products in order to deal with the trade effects they experience.
And on savings, no one is accusing the U.S. of having excess savings.
The lesson I take from this is that you can have sectoral overcapacity and spillovers into global markets even without weak demand or excess savings, and this supports the view that domestic demand and savings are not the right focus when addressing overcapacity issues. Instead, the overcapacity causes that need to be addressed are on the supply side: Governments subsidize and otherwise support domestic industries for political reasons, leading to more supply than domestic demand can handle.
Fortunately, if you want to deal with the trade effects of subsidies and other governmental support, we have international tools that could be used here (with the caveat, of course, that international rules can’t solve every trade conflict). Thus, rather than calling on China to increase demand or reduce savings, it would be more productive for the U.S. to use these tools to push China to scale back the subsidies and other government support.
One response might be that the Chinese subsidies for domestic manufacturing are intended to support jobs, and the Chinese government (at various levels) sees that as crucial for maintaining citizens' support. Failed companies and bankruptcies would not be well received, and therefore trying to address demand/savings issue is the easier course. I understand the difficulties here, but at the same time the trading system imposes obligations that China and everyone else has agreed to live up to. Practically speaking, you are free to ignore those obligation, but if challenged successfully you will have to offer compensation or accept retaliation. And with regard to the people affected if the subsidies were eliminated, there are lots of options to help them that don't violate trade obligations.
As to the demand and savings issues, to me these seem harder to address. What is the "right" level of demand or savings? Do the Chinese consume too little and save too much? Do Americans consume too much and save too little? I'm not sure there are definitive answers to these questions. Domestic policy choices on these issues vary, both by country and over time. Policies are decided by internal debates, and are constantly evolving based on the party in power and the mood of the country. They reflect deep-seated cultural attitudes as well. That makes it difficult to address these issues through international governance and coordination, with coordination a particularly daunting task between China and the U.S. at the moment. As a result, I'm skeptical that either side is going to convince the other one to change much on these issues.
