Monday, January 7, 2008

About Decoupling

In the previous post I argued that the BRIC "wings" of the global economy cannot make up for the looming consumer driven recession in the US and possibly Europe. Others argue that China, and perhaps India, will simply substitute domestic consumption for exports and keep chugging along, i.e. decoupling. Is this supported by the data? No.

GDP per capita at purchasing power parity is as follows (2006 data, CIA Factbook).

The figures speak for themselves, but some further elaboration is perhaps needed:
  • People in poor countries like China and India spend a greater portion of their income for basic necessities like food and fuel, leaving less for discretionary spending. For example, food in China accounts for 30-35% of the CPI index, indicating that the average family spends an equivalent portion of their income for food. By contrast, expense for food at home is only 8% of US CPI.
  • A large part of GDP in China and India comes from FDI (i.e. capital spending by foreigners), geared towards creating manufacturing capacity for exports. This ties in to the previous point: most of the value added to export goods does not come from cheap labor, but from foreign capital in the form of new plant and equipment. Simply put, Chinese cannot afford to purchase the value they add to their export goods.


  1. Does this mean that if the US goes into a recession and hurts Chinese production, the Chinese government may have to cash a few US notes to keep their economy from imploding?

  2. We should consider nominal income level not PPP in the debate of decoupling. From US perspective it matters when a chinese consumer buys a genuine iPod at full price or a imported SUV.

    Different price level in many domestic nontradable services matter to the well being of chinese or indian consumer but not much relevant to the developed world.


  3. Hi Hell,

    I have been enjoying your blog, and I agree on many of your points, but not this instance.

    The GDP per capita comparison paints a picture of US consumer dominance. However, the GDP per capita of EM countries such as India and China are pulled down because a significant portion of their populations earning less than US$500 p.a. This does not mean that everyone in China and India are living on subsistence income.

    Does anyone know how many people in EM countries are earning US$30,000 p.a.? Has the number of high income earners in EM countries increased significantly over the past 10 years?

  4. I have a few questions. In the first place, why do you care whether China is de-coupled or not? The Chinese people are not going to buy very much U.S. exports at this stage of their personal income development. China will not have much effect on the U.S.' ability to cope over the next few years.

    Secondly, in order to manage the next few years of worldwide trade flow change, the Chinese will do three things:

    a. Rapidly increase trade with those areas of the world that are willing to trade raw materials for finished products, including Africa, South America, and the Mid-Eastern oil producers.

    b. Rapidly increase trade in mid-range manufactures such as motorcycles, generators, motors, pumps, solar panels, hot water heaters, stoves - rural and semi-rural consumer durables, and sell them throughout SE and central Asia. There is enormous demand for these items - all that is needed is some consumer credit mechanism to provide demand pump-priming.

    c. Rapidly redirect heavy industry production toward internal infrastructure investments, such as highways, railways, power generation and transmission systems, communications systems, and schools (the stuff we built from about 1920 - 1960).

    The first step will provide raw materials, the second step will sop up capacity for mid-range manufacturing capacity, the third step will sop up heavy industry capacity.

    Finally, your assertion that there's relatively little labor value-add in China's exports is funny. Why in the world do you think the Western manufacturers boxed up their plants and moved them to China? For the scenery?

    No. It's because their products had a significant labor component, and the wage rate disparity was big enough, and durable enough to justify the capital cost of moving the factory to China. The other reason they did it is because they expected the Asian market to be where all the growth is going to be -- that's where all the people are that actually need things.

  5. Anon, it all depends on your viewpoint. Not bad for whom? The median citizen of an EM country or the mean citizen of that country?

    You are correct to point out to Hellasious that he is 'sort of' using Gaussian logic on data which may follow Cauchy/Power Law probabilities, but it is still a matter of perspective.

    Though it may not be as bad for a citizen who makes the mean income/has the median wealth within an EM country, it may still be bad for a citizen who makes the median income/owns the median wealth.

    I guess your point could possibly 'soften' Hellasious' concern (I am assuming it is for the median citizen) if the 'hit' occured in only certain higher income/wealth groups?

  6. "Simply put, Chinese cannot afford to purchase the value they add to their export goods."
    Problem is neither can workers in Europe, Japan or the US. That is why they have had to go so deeply into debt in order to purchase imports from Asia.

    Until such time as workers' income start to rise commensurate with gains in productivity, the world will continue to experience deflationary pressures despite escalating commodity prices.

    Even now, the ECB and the Fed's monetary policies are intended to prevent increases in workers' salaries and benefits (with the exception, of course, of highly paid financial executives and hedge fund operators) as though this were some horrible epidemic to be avoided at all costs. So how do the CBs keep down wage costs while still maintaining sufficient demand at the consumer level? They make sure there is plenty of liquidity to inflate asset prices against which workers in the "ownership" society can borrow their way and, ironically, their financial institutions into bankruptcy.

  7. Hi Thai McGreivy,

    Even if EM countries' income is normally distributed, the top 10% may have a minimum income of US$30k p.a. each. 10% of 3 bn people in Asia is 300m end-consumers in Asia ex Jap, which is not insignificant as compared to the entire US population (of which I think a big chunk does not even earn $30k p.a.).

    Perhaps 10 yrs ago, US accounts for 50% of global end-consumers. Would it be possible that today, US may only account for, say, 25% of global end-consumers?

  8. "n todayĆ¢€™s edition the China Daily discusses a new report by the Chinese Academy of Social Sciences which claims that Chinese consumer spending will hit a two-decade record low this year:

    Despite a rosy picture about income growth, consumption by Chinese residents remained at a low level. It contributed about 36 percent to the country's gross domestic product (GDP) in the first three quarters, according to the report. The 2007 figure would hit a record low against around 60 percent in the period from the country's opening up initiative in 1978 to 2002. The figure had slipped by bigger margins thereafter to reach a low of 50 percent in 2006."

  9. The Chinese people are not going to buy very much U.S. exports at this stage of their personal income development. China will not have much effect on the U.S.' ability to cope over the next few years.

    This misses the whole point. It isn't a question of will the Chinese consumer buy American exports, but are they capable of buying the goods produced in their own country that will not be bought by a recession/depression racked America.

  10. This is B.S.!

    Multiply the population of BRIC times their per capita and you'll see why!

  11. "A large part of GDP in China and India comes from FDI (i.e. capital spending by foreigners), geared towards creating manufacturing capacity for exports"

    This is what many people don't understand about the emerging market boom in China. A staggering % of the domestic consumption is devoted solely to expanding the export machine. All of the new power plants, highways, container ports and the cement plants and steel mills needed to feed them are needed solely to continue the sxpansion of export production.

    This is a fine plan, but what happens when demand for your exports drops?

    and a massive glut of inefficient production capacity goes idle?

    and the various underlying issues which have been glossed over during the good times rear their ugly head in the bad times (pollution, disparity between the coast and the interior, ticking demographic timebomb etc)?

  12. About decoupling:


  13. Contrary to the vast majority of previous Blogs your analysis is very supperficial and does not take in to consideration the POPULATION SIZE, so in absolute terms, The Emerging Markets are indeed a force to reckon with. Not to mention that Credit is still incipient. The mortgage market has just started in Brazil, for instance. The U.S is less and less in important in Global terms, and that is good in the sense that it provides external cushioning to its failing economy. I am sorry to say that but lately I sense more wishfull thinking than pure factual analysis. That is not the way of an Engineer.

  14. I assume people are aware of the recent World Bank revisions to PPP adjusted GDPs, in particular for China and India.

    Down by approx 40%.

    China's nominal GDP is approx $2.5 tril. Its PPP adjusted 'used to be' over $10 tril. Now its PPP number is back to something like 5.5,,contentMDK:21589281~pagePK:34370~piPK:34424~theSitePK:4607,00.html

    My general rule of thumb is that Nominal values express international trade. While PPP adjusted values represent domestic purchasing power. (this rule-of thumb though is with several caveats - #1 = for a given country, intl trade represents what % of GDP?).


  15. Numbers are true as stated...but what happens if the Chinese 'unpeg' the yuan from the dollar? What is their currency truly worth, and furthermore, what will the impact be on commodity prices (e.g. oil) for the Chinese consumer?

  16. BricBrac,
    "This is a fine plan, but what happens when demand for your exports drops?
    and a massive glut of inefficient production capacity goes idle?"

    This scenario only happens if everyone in China and EM countries are living in city slumps or rural villages without electricity, clean water, TV, PC etc.

    I suggest you take a trip like Jim Roger to EM countries and see for yourself how many people in these supposedly poor countries are buying these made-in-China products such as laptops, LCD TVs, cars, new high-rise homes etc.

    So what if US demand is to drop 10 to 20%? At the rate of growth of consumption demands in EM countries, the excess capacity is quickly soaked up.

    You can't see these facts by looking at statistics or listening to Bloomberg talking heads, because a large part of EM statistics does not reflect reality, and many of these talking heads are still living in 20th century mindset.

  17. Will China or won’t China? Well, you’ll all just bloody well have to wait and see won’t you.

    If recession/depression hits the U.S. and hangs in for a decade—and it damn well might, BRIC will go right down the tubes with the rest of them and no alphabet load of acronyms will make the slightest difference.

    The last two major cataclysmic recessions/depressions in the Twentieth Century were seen off by two major World Wars. Let see if capitalism can pull the hat trick this time round.

  18. Some questions that need to be thought through.

    1. In 1830 Country X has a modest population level, mostly rural. A small manufacturing base, and a low per capita income.

    2. By 2007 country X has a large population, mostly urban. A large, sophisticated and advanced manufacturing base, and a high-ish per capita income level.

    Q. Using your knowledge of history explain how country X developed and expanded. Take your time on this, it is quite a complex matter.

    Now. Repeat the above thought exercise for China and India - but please remember that both these countries have millennia of histories behind them - very sophisticated histories at that.

    Might an expanding poplation be a significant factor? Might inexpensive energy be a factor? What other significant factors are there with respect to the change from rural agricultural to urban technological, from a low PC to a high PC? Might social and political situations be factors? Education?

    So. Now tell me how China and India will rapidly (within a decade)absorb their own internal development. Very Sudden Debt???

  19. But:

    Poorer Countries to Offset US Slowdown

    Continued robust expansion in developing countries will help offset a slowdown in the United States this year amid concerns of a possible recession in the world's largest economy, the World Bank said Wednesday.

    This theme will not go away soon and may help keep emerging markets up, at least in the short term.

    Perhaps the scope of the 'recession fears' ought to be extended:

    Marks & Spencer Shares Plunge on Unexpected Holiday Sales Drop