China’s struggling capacity utilization is signal of effective demand limit
As output increases, there is an effective demand limit which slows down the utilization of capital and labor. Utilization of capital typically slows down before labor.
The circled areas show times in the US when capacity utilization (blue) declined as employment (red) was rising or holding steady. This pattern normally happens before a contraction in the economy. We did not see this pattern before the recession at the end of 2007. Employment actually started to fall before capacity utilization.
So what has been happening with capacity utilization in China? Here are some excerpts in an article yesterday from Xinhuanet.com. (Bold is my emphasis)
“The Chinese economy is also thwarted by some deep-rooted obstacles, including excess capacity in certain industries.”
“Liu Shucheng, an economist and CPPCC member, said that, in 2014, China should remove excess capacity in certain industries, prevent risks of local government debt, calm rocketing home prices in some cities, and reduce enterprises’ production and operation costs.”
“Statistics show, by the end of 2012, capacity utilization of only 70 percent was registered in such sectors as iron and steel, cement, electrolytic aluminum, plate glass and ships. P Li, the CASS vice president, said the problem of excess capacity was related to a GDP incentive mechanism decided by an irrational development strategy, which should be reformed fundamentally.”
“The risk of local government debt, estimated at more than 20 trillion dollars by the end of 2013, is also an obstacle hindering the Chinese economy.
Jia, the Finance Ministry official, said, in order to prevent systemic risks due to lack of capital, it was imperative to set up a mechanism of early warning and emergency response for debt risks.”
“The Chinese economy is in a crucial, painful moment of transformation and structural readjustment,” said Feng, the State Council analyst.
Capacity utilization in China has hit the effective demand wall which comes from their limited domestic demand and from the US economy. As the US economy hits its own effective demand limit this year in 2014, China’s delusions of hope will only become more apparent.
China could have expected more potential output in the US recovery, but potential output in the US is looking much smaller than most have thought. And so expecting continued rapid economic growth in China while having to contract certain industries is not sound logic.
Investing in China is much less profitable than a few years ago. Beware…
Edward:
This is an interesting topic as I just got back from China again. I also saw my second manufacturer who has invested roughly $1billion apices in two separate plants. One was a machining facility and the other a forging facility both of which supply all of the ring bearing forgings to other manufacturers in Asia besides making their own.
On my previous trip I went to a sand cast and machining facility with similar investments in each plant. It made CNN equipment for some of the majors we are familiar with and casted the bases for them.
Neither was at 100% of capacity and both were interested in our business even though we could barely use 5% of their capacity. China has overbuilt and now must find a market.
The effective demand limit with Capacity U is probably around 82. No limit yet, once again, you fail to realize the levels.
So lets say Capacity is 80.3 by January 2015. Still some room to grow over the next few years.
China’s “growth-at-any-cost” policy created enormous waste. It needed a “creative-destruction” process long ago. However, it had to keep its population employed to minimize unrest.
When China’s population ages, which will accelerate from its “one-child” policy and lack of immigration, the average Chinese will live very poorly.
China’s living standards will be much lower than Japan’s, and Japan’s living standards are much lower than the U.S..
It’s sad, the Chinese masses will work so hard for a very low standard of living, because of poor government policies and greedy politicians.
Ain’t nothing gonna grow without demand from those on the earth that can afford to create demand and as Ed has been showing, and we here at AB have been talking about those who can afford to create demand are becoming fewer and fewer.
Peak: Creative destruction? Really that’s your answer?
China needs a “creative-destruction” process to shake out the massive waste in its economy.
For example, in the U.S. creative-destruction process from mostly 2000-02 (which took place in a mild recession), some tech firms failed and others were taken over. The surviving tech firms became much more efficient using fewer inputs to produce more output, and became much more profitable.
Consequently, the U.S. not only leads the world in the Information Revolution, it leads the rest of the world combined (in both revenue and profit).
The entire U.S. economy was shaken out mostly from 2000-02.
PT:
You obviously have not been to China or know its culture. China would not survive the medicine you prescribe by allowing millions of it people to slip into poverty through the destruction of its economy. The US leads as the largest consumer nation globally with China a distant second. Screw the information technology and revenue and profit. It is all about demand and consumption and so far the US is well on the way to destroying such capability since 2001 with its policies of investing in Capital sans Labor. Without a healthy and prosperous population your type will not survive.
John C,
The capacity utilization limit has fallen to below 80%. Most likely below 79%. This error in expectations will come back to bite economists really hard. When it happens, they will find another reason for why capacity utilization did not rise above 80%. But lower effective demand is the reason.
Run, a creative-destruction process makes the economy more efficient and reduces waste. It makes the economy stronger.
After the 2000-02 U.S. creative-destruction process, the U.S. had one of the greatest eras of prosperity from 2002-07, and in a structural bear market that began in 2000, after a spectacular bull market from 1982-00.
After 2002, U.S. producers became much more efficient and resources were freed-up to allow domestic growth to expand, while U.S. consumers were able to go on a spending spree, buying more assets and goods, because of low prices and interest rates.
Efficiency in production is one way to create capital to allow investment.
China creates capital by selling its goods, and lending its dollars, too cheaply, e.g. to the U.S, at the expense of creating low wages and negative externalities, for example. China then employs that capital in poor investments, just to create jobs. Consequently, Chinese work hard for little consumption or slow improvements in living standards. China’s growth to a large extent comes from waste.
In 2000-02, it was proven a quick and massive creative-destruction process can take place in a mild recession with appropriate fiscal and monetary policies.
PT:
You advocating Schumpeter’s creative destruction does not a good policy make. Again, you have no idea of the China culture and the economy. What you prescribe as a cure is akin to Mao claiming the wheat harvest was ok between 1958 and 1960 when millions starved and he subsequently rejected wheat shipments from the US. ~30 million starved to death and an ~ 40 million births aborted. This type of creative genocide is what you would create with your policy if it survived the resulting revolution. Much of China is manual labor and keeping the Labor Pool active and paid manufacturing and building infrastructure is what it is all about. China is not a Service Oriented economy focused on banking and TBTF. Have you ever set foot in China and stayed for weeks at a time to see the real China?
As far as manufacturers becoming more efficient as to the loss of Labor, this is nonsense and I am surprised someone with two degrees in economics from CU would support such. From 2000- 2008 an approximate 5.3 million jobs were lost to overseas ventures not because of Labor efficiency (as everyone knows in manufacturing Direct Labor accounts of <10% of the cost of manufacturing) but due to Overhead with Materials maintaining a similar cost. "Overall, U.S. manufacturing output actually fell by 11 percent during a period when GDP increased by 17 percent." We could have a field day discussing this one; but suffice it to say, the growth in GDP was in the Banking, Insurance, Investment, Real Estate Sectors. Much of the growth in GDP during the 2002 -2008 period was the result of a fraud perpetuated by banks and investment firms cut loose from the tethers of Glass Steagall and the National Banking Act. An earlier experience of similar growth and supposed efficiencies can be seen with a ruling by SCOTUS Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp. which cut the tether on state Usury Laws thereby giving today's loan shark credit cards at 30%. Yes Wall Street and Banking have been supper kind to Labor.
In terms of manufacturing moving around, much of this was accomplished by 2000 and started in the sixties (I suggest you pick up a book by Peter Drucker). What occurred in the period you cite is an action to escape the Overhead of the US and Operating in the US, the benefits of which you enjoy today (for example, clean water without Benzene mixed-in [2005, China's Songhua River - 50 mile slick]). Of course such a slip would be litigated to death in US courts where in China it would be face forward and the lights go out due to a bullet in the head.
Efficiency in Production results in Productivity Gains which are supposed to go to Capital and Labor. Unfortunately Capital has decided to keep pretty much for itself resulting in a stagnation of Wages. Spencer has a nice write-up including charts on this here: http://angrybearblog.strategydemo.com/2009/10/labors-share.html The loss in jobs is high and it will be years before they are recouped resulting in a lost decade of labor productivity in 2000 and 2010.
The “Misunderestimated” President:
Bush inherited the worst stock market crash since the Great Depression and a recession. However, the Bush Administration turned the recession into one of the mildest in U.S. history (which wasn’t a recession based on annual per capita real GDP growth), after the record economic expansion and structural bull market from 1982-00.
Over a five-year period in the mid-2000s, U.S. corporations had a record 20 consecutive quarters of double-digit earnings growth, two million houses a year were built, 16 million autos per year were sold, U.S. real GDP expanded 3% annually, in spite of 6% annual current account deficits (which subtract from GDP).
The U.S. economy was most efficient, while Americans stocked-up on real assets and goods, and capital was built-up. It was one of the greatest periods of U.S. prosperity, the fourth longest economic expansion in U.S. history, and in a structural bear market that began in 2000.
The Bush Administration was adept at minimizing the recession in 2008, including providing a tax cut in early ’08 for the Fed to catch-up easing the money supply, until Lehman failed in Sep ’08, which caused the economy to fall off a cliff. However, appropriate policy adjustments were implemented quickly.
If Bush could’ve been reelected and had his way, the U.S. would’ve completed a recovery in 2010, and we’d be in a strong disinflationary expansion instead of this on-going depression and “train wreck.”
GDP is an incomplete and inaccurate measure of living standards. I stated before:
In the Keynesian consumption function (or identity), Y = C + I + G + NX; trade deficits, or negative net exports (NX), subtract from GDP growth, because consumption (C) is overstated.
For example, in a $10 trillion economy, a 5% one year increase in GDP expands the economy by $500 billion. Also, if imports are greater than exports, e.g. $1 trillion of imports and $600 billion of exports, then net imports are $400 billion in one year, which adds to our trading partners GDPs and subtracts from U.S. GDP. However, the total added to the U.S. economy is $900 billion ($500 billion from GDP growth in one year and $400 billion from net imports in one year), because the U.S. is consuming more than producing in the global economy.
It should be noted, with trade deficits, the U.S. exchanges dollars for foreign goods and foreigners exchange those dollars for U.S. Treasury bonds. However, the U.S. is able to maintain trade deficits in the long-run, mostly, because foreigners lose through changes or differences in inflation, interest rates, and currency exchange rates. For example, over the past few decades, the Japanese yen appreciated from 360 to 100 per dollar, which means Japan received fewer and fewer yen per dollar.
Also, to a lesser extent, many of those foreigners moved to the U.S., and foreign firms began producing in the U.S., because it’s better to use those dollars than exchange them for their currencies. Moreover, those foreigners can raise their standards of living by selling their assets, exchanging their currencies for dollars, and moving to the U.S., or attending a U.S. college, for example. Furthermore, tourism (by foreigners in the U.S.) adds to U.S. exports.
In other news of creative destruction IBM shuttered it’s 2 year old server development lab in Taiwan. ~80 engineers and support staff fired. Maybe $200M in startup costs pi$$ed away when the plan to “build it there so we can sell it there” didn’t work out.
Oh well that’s about 1/10th of what Ginni blew on buying stock from herself last year.
“It was one of the greatest periods of U.S. prosperity . . .”
Tell that to the middle class Americans who lost their homes, lost their jobs and saw their college-educated children unemployed or underemployed.
Smarter trolls, please!
Run, I don’t know how to respond to your comment, because it has nothing to do with economics, including the U.S. and China economies. Also, you’re supporting your statement with irrelevant information. There’s no connection to what you’re saying.
My comments are supported mathematically and empirically with no contradictions.
For example, the trend in U.S. manufacturing has been producing higher quality and more quantity with fewer domestic resources, which raises U.S. living standards:
Although, U.S. manufacturing lost 30% of its workforce over the past 10 years, the U.S. share of world manufacturing output has remained roughly constant at 20%, even with larger U.S. trade deficits, which boosts foreign manufacturing.
The National Association of Manufacturers (NAM)
•The United States is the world’s largest manufacturing economy, producing 21 percent of global manufactured products. China is second at 15 percent and Japan is third at 12 percent.
•U.S. manufacturing produces $1.7 trillion of value each year, or 11.7 percent of U.S. GDP.
•Manufacturing supports an estimated 18.6 million jobs in the U.S.—about one in six private sector jobs…Nearly 12 million Americans (or 9 percent of the workforce) are employed directly in manufacturing.
•In 2009, the average U.S. manufacturing worker earned $74,447 annually, including pay and benefits. The average non-manufacturing worker earned $63,122 annually.
•U.S. manufacturers are the most productive workers in the world—twice as productive as workers in the next 10 leading manufacturing economies.
•U.S. manufacturers perform two-thirds of all R&D in the nation, driving more innovation than any other sector.
Joel, you’re confusing the Bush economic boom of 2002-07, which also caused a global economic boom, with the Obama Depression, which also caused slow global growth.
Here’s a PDF on the state of U.S. manufacturing:
http://www.themanufacturinginstitute.org/~/media/D45D1F9EE65C45B7BD17A8DB15AC00EC.ashx
Never smarten up a chump.
PT: ” My comments are supported mathematically and empirically with no contradictions. ”
Haha. Yeah , the “Bush Boom” was wonderful. And continuous large trade deficits are wonderful. Jeeze.
While it’s true that the cumulative current account deficit , which would now exceed $7 trillion , does not tell the whole story , it does tell you how the story is progressing , and the story is not progressing in a beneficial way for the U.S.
The net international investment position tells us where we stand with all of the factors you mention taken into consideration. And , just like the current account , it has deteriorated steadily since 1980 , roughly in line with the current account. It now stands in excess of NEGATIVE $4 trillion , meaning foreigners now own a net $4 trillion more of our assets than they did in 1980. Another way to phrase this would be to say that we owe $4 trillion to foreigners , should we wish to reclaim those assets. Post- WWII we were always the world’s largest creditor , until Bretton Woods ended and we whipped out the credit card.
http://www.bea.gov/newsreleases/international/intinv/intinvnewsrelease.htm
http://www.clevelandfed.org/research/trends/2008/0808/01intmar-2.gif
I do wish you’d stop trashing this site with your propaganda.
Marko, economics is not propaganda. You, like some others here, just can’t accept the fact Wall Street and Corporate America improved U.S. living standards, substantially, e.g. through lower prices, better jobs, higher productivity, etc.
Income Flows from U.S. Foreign Assets and Liabilities
Federal Reserve Bank of New York
November 14, 2012
Foreign investors placed roughly $1.0 trillion in U.S. assets in 2011, pushing the total value of their claims on the United States to $20.6 trillion. Over the same period, U.S. investors placed $0.5 trillion abroad, bringing total U.S. holdings of foreign assets to $16.4 trillion. One might expect that the large gap of -$4.2 trillion between U.S. assets and liabilities would come with a substantial servicing burden. Yet U.S. income receipts easily exceed payments abroad.
As we explain in this post, a key reason is that foreign investments in the United States are weighted toward interest-bearing assets currently paying a low rate of return while U.S. investments abroad are weighted toward multinationals’ foreign operations and other corporate claims earning a much higher rate of return.
U.S. investors earned a much higher rate of return on multinationals’ foreign operations and similar corporate holdings than did foreign investors here, 10.7 percent versus 5.8 percent, respectively.
The superior U.S. rate of return on FDI, as well as the greater tilt in U.S. foreign investments toward FDI, accounts for the $322 billion income surplus recorded in this category in 2011…The United States has earned a substantial premium on FDI investments at least since the 1960s.
Also, you ignore current account deficits are completely offset by capital account surpluses (for the balance of payments to balance).
I’ve stated before, the U.S. has been a Black Hole in the global economy attracting imports and capital, and even attracting the owners of that capital themselves.
The problem is the U.S. government has been a Black Hole in the U.S. economy, which is why we’re in this depression.
The U.S. government should’ve, at least, “refunded” enough dollars to U.S. taxpayers to spur demand, since U.S. consumers bought foreign goods and foreigners bought U.S. Treasury bonds.
The relative returns on investments held varies according to interest rates , exchange rates , and most importantly , riskiness of the held investments. Our Treasuries , for example , are widely considered the most risk-free of investments , and thus offer a lower yield than others.
So we’ve gone from a net positive 20% of gdp in NIIP to ~20% net negative since the 1970s , and those foreign assets we do hold are more risky , on average. You have to be a real pollyanna to view this as a positive development. Or , you could simply be a supply-side propagandist , defending the Reagan Revolution. Either way , you clutter this site with your junk.
I can see why you never provide links – people might note the qualifying remarks made by your sources that weaken your arguments. Like this :
“It is difficult to project how the U.S. net income balance will evolve going forward. In particular, we can offer no projection for how relative FDI returns might behave. However, any meaningful narrowing in the current U.S. rate-of-return advantage would cause a substantial deterioration in the net income balance. To take one hypothetical situation, if the rate of return on FDI in the United States matched the current rate of return on U.S. FDI holdings abroad, the U.S. income surplus would now be some $135 billion smaller. As for interest-earning assets, it seems safe to assume that interest rates will eventually rise. Given current holdings, each 100 basis point increase in U.S. and foreign interest rates would raise U.S. income receipts by $72 billion, but add $146 billion to outgoing payments, for a net drag on U.S. net income of almost $75 billion. Moreover, the dollar impact on net income from a rise in interest rates will grow over time as the United States continues to borrow substantial amounts from abroad. ”
http://libertystreeteconomics.newyorkfed.org/2012/11/income-flows-from-us-foreign-assets-and-liabilities.html
Marko, you’re just a delusional political hack, who has no understanding of economics.
And, I provide the titles and dates for you to easily cut & paste to find the links. Much of I provide is original work based on mathematical and empirical models
You’re determined to turn a positive into a negative, regardless of reality. U.S. multinationals have a lot of market power, high productivity, and top managers to compete internationally. U.S. multinationals have a very successful track record.
Recall, in the 1980s, some people believed Japan would overtake the U.S.. Japan bought U.S. commercial real estate and other assets and lost big, while Americans won big selling those assets.
It’s possible, the U.S. income surplus could fall $75 billion to around $250 billion a year. However, it’s possible, it could rise $75 billion instead.
China’s economy is most inefficient and it’s way overdue for a “creative-destruction” process:
Connecting the Dots Between China’s Falling Consumption Level and Its Banking Crisis
January 22, 2011
“As countries become more affluent, consumption tends to rise in relationship to GDP…ample evidence of colossally unproductive infrastructure projects in China.
Household consumption has declined over the decade as a share of gross national product from a very low 45 percent at the beginning of the decade to an astonishingly low 36 percent last year.
It now takes $7 of debt to produce $1 of GDP growth…The combination of implicit debt forgiveness and the wide spread between the lending and deposit rate has been a very large transfer of wealth from household depositors to banks and borrowers. This transfer is, effectively, a large hidden tax on household income.”
****
China’s Growth: Too Good to be True?
04 February 2011
“If you think that China’s double-digit growth is too good to be true, it probably is. Here are a couple of reasons why China’s GDP could be smaller than it seems:
1. Environmental damage – He Ping, Chairman of International Fund for China’s Environment, believes that China will have to spend at least 2% of its GDP per year to clean up 30 years of industrial waste.
2. Misallocated investments – If you invest $20, then you’re expecting to get more than $20 in return…sometimes the returns actually turn out to be less than the cost of the investment…Some estimates say that up to 1-2% of China’s current GDP growth can be attributed to this.
If you combine that 2-4% of GDP spent on cleaning up China’s environmental waste and the 1-2% of growth attributed to misallocated investments, that means China’s GDP could be overstated by roughly 5% each year.”
****
China’s employment and compensation costs in manufacturing through 2008
BLS
“China’s hourly compensation costs remain far below those of many of its East Asian neighbors like Japan [$27.80] and Taiwan [$8.68], but are roughly on par with those of others like the Philippines [$1.68].
Inflation in China has been substantial. Consumer prices in urban areas increased an average of 3.3 percent annually from 2005 through 2008. Consumer prices in rural areas increased even more rapidly, at an average annual rate of 3.9 percent.
Yearly compensation per employee (98.46 million in manufacturing)
2008 21,593 yuans ($3,108)
Despite large increases in recent years, hourly compensation costs in China’s manufacturing sector remained only 4 percent of those in the United States in 2008; that year, hourly compensation costs rose to $1.36.”
Sorry, China, There Is No Short Cut To Economic Greatness
Jan. 26, 2010
“The government that magically managed to report 6-8% GDP growth in the midst of the financial crisis, when its exports were down over 25%, tonnage of goods shipped through its railroads was down by double digits, and its electricity consumption was falling like a rock. It is hard to manufacture 8% more widgets with a lot less electricity…China did not suddenly become energy efficient during the financial crisis.
This is a government that will go to great length to maintain appearances to keep its ideology going. After all, it censors what its citizens may or may not read and imprisons the ones that write anti-government articles.
China will do anything to grow its economy, as the alternatives will lead to political unrest…Since China lacks the social safety net of the developed world, unemployed people are not just inconvenienced by the loss of their jobs, they starve (this explains the high savings rate in China) and hungry people don’t complain, they riot.
The Chinese government controls the banks, thus it can make them lend, and it can force state-owned enterprises (a third of the economy) to borrow and to spend. Also, since the rule of law and human and property rights are nascent in its economic and political system, China can spend infrastructure project money very fast – if a school is in the way of a road the government wants to build, it becomes a casualty for the greater good.
China has spent a tremendous amount of money on infrastructure over last decade and there are definitely long-term benefits to having better highways, fast railroads, more hospitals, etc. But government is horrible at allocating large amounts of capital, especially at the speed it was done in China. Political decisions (driven by the goal of full employment) are often uneconomical, and corruption and cronyism result in projects that destroy value.
Infrastructure and real estate projects are where you get your biggest bang for the buck if your goal is to maintain employment, since they require a lot of unskilled labor; and this is where in the past a lot of Chinese money was spent. This also explains why, in 2009, new floor space constructed was up 100% and residential real estate prices surged 25%. And this explains why they keep building skyscrapers even though the adjacent ones are still vacant.
To make things worse, before the financial crisis and enormous stimulus ($586 billion), China was already suffering from what I call late-stage-growth obesity, inefficiencies that are a byproduct of high growth rates sustained for a long period of time. Though Chinese growth in the past was high, in its late stages the quality of growth has been low.
For example, in an echo of past Chinese government asset-allocation decisions, China built the largest shopping mall in the world, the South China Mall, that is 99% vacant, years after construction. China also built a whole city, Ordos, in Inner Mongolia, on spec for million residents who never appeared.
The inefficiencies are also evident in industrial overcapacity. According to Pivot Capital, Chinese excess capacity in cement is greater than the combined consumption by the US, Japan, and India combined. Also, Chinese idle production of steel is greater than the production capacity of Japan and South Korea combined. Similarly disturbing statistics are true for many other industrial commodities. The enormous stimulus amplified problems that already existed to financial-crisis levels.”
Apple’s Sweatshop Problem: 16 Hour Days, ~70 Cents An Hour
Jan 20, 2012
“The Chinese city of Shenzhen…30 years ago, Shenzhen was a little village on a river. Now it’s a city of 13 million people — bigger than New York.
Foxconn…has a factory in Shenzhen that employs 430,000 people.
There are 20 cafeterias at the Foxconn Shenzhen plant. They each serve 10,000 people.
Most of the factory floors are vast rooms filled with 20,000-30,000 workers apiece. The rooms are quiet: There’s no machinery, and there’s no talking allowed. When labor costs so little, there’s no reason to build anything other than by hand.
Assembly lines can only move as fast as their slowest worker, so all the workers are watched (with cameras).
The workers stay in dormitories. In a 12-by-12 cement cube of a room…Normal-sized Americans would not fit in them.
Unions are illegal in China. Anyone found trying to unionize is sent to prison.
Some workers can no longer work because their hands have been destroyed by doing the same thing hundreds of thousands of times over many years (mega-carpal-tunnel).
One former worker had asked her company to pay her overtime, and when her company refused, she went to the labor board. The labor board put her on a black list that was circulated to every company in the area. The workers on the black list are branded “troublemakers” and companies won’t hire them.
One man got his hand crushed in a metal press at Foxconn. Foxconn did not give him medical attention. When the man’s hand healed, it no longer worked. So they fired him. (Fortunately, the man was able to get a new job, at a wood-working plant. The hours are much better there, he says — only 70 hours a week).
A Foxconn worker dies after working a 34-hour shift.
Without Foxconn and other assembly plants, Chinese workers might still be working in rice paddies, making $50 a month instead of $250 a month.”