Mao’s (lack of) family planning skills: how China’s untimely population growth is coming back to haunt the dragon

Famously enough, Deng Xiaoping, when asked about Mao Zedong’s legacy, asserted that the Great Helmsman had done 70% right and 30% wrong. Although Deng was credited for far more precise policies and on-the-spot quotes during his fruitful leadership years, it might be time for current and upcoming Chinese leaders to update this dubious percent distribution due to Mao’s terrible, nation-mortgaging family planning skills. In other words, China’s population exploded too early, and this might well be the main cause of today’s economic ills in the most dynamic world economy in the last 3 decades.

The basic reasoning goes like that: facing a much-anticipated economic growth slowdown, partially due to global economic tensions and instability both in the EU and the US, the Chinese economy badly – according to some analysts, rather desperately – needs to boost internal consumption and, therefore, lower the savings rates of much Chinese citizens, which hover above 50% of total disposable income.

One way to boost consumption would be, obviously enough, to increase total disposable income of Chinese workers and middle-income families, which, by all estimates, is relatively low in comparison with other countries with similar per capita GDP. However, this would probably suppose a death knell for the still developing Chinese economy, transitioning from an export-focused, labor-intensive, low-added value model to a hi-tech, added value model. In other words, raising salaries further – i.e. apart from persistent inflationary pressures – would mean a sudden loss of competitiveness for an economy which still exports its way to growth and which is facing increasing international pressure to keep revaluating its undervalued currency, the yuan. In other words, this is not the way Chinese political and business leaders are keener to follow.

What else can they do, then? Not much, indeed. The Chinese public was already heavily incentivized towards consumption by financial sector regulations that offered them a real negative return on their savings: while inflation was running well above 6% a year, interest rates for saving accounts have been capped below 3%. This also explains why many middle-class Chinese resorted to buying property, thus fueling an investment-led bubble that is now set to deflate, if not to explode, as prices reached unsustainable levels and the value of the investment decreased.

This undervaluing of savings has indeed allowed Chinese banks to fuel their almost uncontrolled lending practices vis-à-vis state-owned enterprises (SOEs), in a Chinese-way variant of the unchecked lending that caused massive leveraging in huge Korean chaebols by the mid-90s and subsequently fueled the massive Asian financial crisis of 1997-1998. Although China’s economy is far less exposed to foreign capital (prone to flee when the going starts getting rough) and strict capital controls make it difficult for local money to suddenly exit the country, the way most profits from undervalued private savings have been reused might not have been the wisest possible.

Sure enough, doling out credit to SOEs – including development companies headed by local and regional party leaders – meant fast profits for both the banks and the local, regional and national politicians behind both the banks and the SOEs. However but not reforming the currently inexistent social security net can have severe consequences for a country that has been unable to solve a legacy problem from the Mao era: China might be reaching a demography-led point of no return.

Let’s go back to the starting point: why do Chinese people save so much if their options are limited and real return on investment is even negative? As argued in a recent blog post on the ills of Chinese SOEs with the rather explicit title The Macroeconomics of Chinese Kleptocracy, poor and even middle-income Chinese want to be sure they will have enough money not to starve when they are old. 

China, a traditionally Confucian society, has always emphasized and relied upon the filial piety paradigm, according to which sons and grandsons would care for the elderly when necessary. Based on that, China could progressively scrap its social security net starting from the end of the Mao era without much initial social or economic backlash: although the one-child policy had already been implemented, the demographic trends still allowed for a massive marginal growth in working-age population – a growth which will be totally over by 2015.

However, current Chinese society is mostly based on inverted pyramid families (not to mention the alarming lack of young females due to culture and policy-led infanticide), in which one can find just one child with up to four grandparents. Obviously enough, current and future elders can no longer rely on filial piety alone to feed them (or pay for their medicaments), so they save as much as they can to compensate for the lack of old-age pensions, efficient public healthcare and other social safety measures that indirectly fuel consumption and discourage excessive saving in most developed countries. As long as future prospects of a more relaxed retirement do not come to reality, most Chinese will keep saving their hearts out.

Should, therefore, the Chinese government hasten to create even a limited version of European, East Asian (think Japan’s or South Korea’s) or U.S.-style welfare states? That should have probably been the answer, but it might be already too late for two reasons: global context, both thanks to structural factors and issues related to the current conjuncture, and demographic pressure.

As previously argued, marginal demographic growth of working-age population is grindingly coming to a halt, thus putting extra pressure on the flows of impoverished rural immigrants willing to work for low wages at export-oriented factories. Added to that, the increasing and otherwise unstoppable technologization and digitalization of China’s manufacturing sector – for instance, Foxconn, the huge electronic component maker, will 'hire' a million mechanical arms between 2012 and 2013 – and the necessary transition to a knowledge-based, greener economy can also severely hurt a country with a big chunk of its population still suffering from poverty or relatively low incomes – even if per capita GDP at purchase-power-parity already stands at $8400 (2011 data; source: CIA World Factbook), China’s income inequality is extremely high, and rising, with a GINI index of  48 (2009 data; source: CIA World Factbook), making it the 27th most unequal country worldwide.

Added to that, while the current number of Chinese over 65 years of age is still relatively low for developed country standards, it is no longer so for a developing country devoid of a social safety net. Moreover, the problem is set to dramatically increase in the coming decades, with a projected XX% of the population over the age of 65 by 2050 – i.e. before China, even if generous growth rates are somehow maintained, reaches an economic development level comparable to that of richer countries.

Unemployment benefits for future out-of-job low-skilled factory workers, old age pensions for a growing mass of elderly people, healthcare benefits for an increasingly restive population of rural immigrants residing in cities without the corresponding urban hukou and other much-needed reforms might pose a very serious, growing economic burden for the Chinese state, especially in the midst of a probable global double-dip recession mostly affecting its key economic partners.

Bad timing? Probably. Bad policy choices? Maybe. In any case, major blame should not be put upon sheer luck or the often-maligned one child policy, which indeed was a desperate measure aimed at stopping undue demographic pressure on a country whose natural resources are already stretched to the maximum. Rather, blame should rest upon Mao Zedong’s belief that the key element for national survival in a time of political unrest lay upon a huge population not only helped fuel China’s Communist chaos, but also created an untimely time bomb whose consequences might be dearly felt in the next few years.

While it is undeniable that China’s explosive birthrates and subsequent rural healthcare improvements in the 50s and the 60s set the basis for the economic surge of the 80s and the 90s – again, this massive marginal growth in working-age population, – the explosive growth it helped create might have also sown the seeds of future demography-led stagnation and crisis.

Obviously enough, only time will tell how events will truly unfold. China’s low public debt and deficit levels, as well as its massive foreign exchange reserves, standing at $3.3 trillion at the end of 2011, give ample maneuverability to the Government in case it decides to do something about China’s most pressing economic problem. However, and independently of the route taken by the future caste of Chinese leaders, in case Deng Xiaoping counted Mao’s family planning policies within his 70% positive decisions, it is about time that his successors recalculate the Mao-era plus/minus ratings and start implementing social-based reforms before it might be truly too late.

The (wicked) rationale behind Spain’s tomato (a.k.a. bailout)

I could not resist starting out by somehow reusing Time’s ingenious header on Spain agreeing to receive up to €100 billion from its European partners: You Say Tomato, I Say Bailout: How Spain Agreed to Be Rescued.

The Men in Black, the troika representatives that so much scare Cristóbal Montoro, Minister of the Treasury, and a still bragging President, Mariano Rajoy, are indeed coming to town. Tough conditions will mostly be imposed on bailed out banks, as Angela Merkel herself asserted on June 12: the Spanish case is different from Greece’s or Portugal's. Technically, however, it should not be too different from the Irish situation, the main difference being that Ireland is a tiny country which could be bailed out and bullied and Spain is too big to fail, i.e. too big to bail out. Despite Dublin's plans to raise the issue during the next meeting of eurozone finance ministers, to be held June 21, the Irish Government's wishes will probably be quashed by the structure of Spain's bailout. We will not delve into that, however, as the scope of this post is quite different: we shall discuss the rationale behind the whole bailout/credit idea, which is only starting to get revealed.

It is also noteworthy that timing of the demand was astutely planned, although it ended up backfiring due to the clumsiness of the Government's PR strategy: just one day before Spain’s much-heralded debut in the football EURO 2012, as the reigning World and European champion vying to restore Spanish pride, and with Rafael Nadal all set to conquer his 7th Roland Garros title. The plan was clear: millions of Spaniards would fall into the government trap and quickly forget the implications of the measure, even downplaying that the President, the same person that was hiding until media and political pressure was too high to overcome, would briefly come out on Sunday morning to assert that the so-called “credit line” was a triumph of his Government and that he was ready to fly to Poland because “the problem had been solved.” Thank you, Mr. President, said most Spaniards… as well as international investors, which rewarded Spanish (and European) transparency with further rises of Spain’s sovereign debt risk premium, pushing interests of 10-year bonds to 6.8% on June 12, a 13-year high or a level never seen since the Eurozone was established (update: the rate climbed up to 7% just two days later).

We could spend a lot of time discussing the not-yet revealed details of the bailout package, with its speculated 3-4% interest rate for a 15-year credit to be satisfied by the Kingdom of Spain (i.e. 3-4 billion euro of extra deficit just in yearly interest payments) which, in its turn, will lend the money to needy banks at a 8.5% interest rate (a prohibitively high rate for troubled banks, meant to force them into selling assets), and the direct policy implications it might have, including VAT rate and other tax increases, extra spending cuts, speeding-up the planned progressive raise of the retirement age, etc. However, I believe that many media outlets have already explained all the kinks about the yet-to-be bailout package itself. Worthy and useful explanations can be found here (in Spanish), here and here.

In any case, no media outlet so far seems to explain the rational argument sustaining this bailout and why it could well be enough -- and why not. To put it shortly, it all hangs on restarting the housing market after the (too) slow bottoming-out process it has been undertaking for the last 4 years.

The key issue here is something which was already pointed out in the aforementioned Time Magazine article: this package will only cover the banks’ losses for 2012 and 2013, but not what is causing those losses. Those losses are caused by enormous quantities of money having been lent to construction industry companies and speculators during the boom years, accepting as collateral the very houses or apartment blocks they were building. Once the market crashes, development companies are struck with unsellable housing units, which are thus absorbed by the banks that find themselves unable to obtain monetary repayment of their loans.

This has been happening since 2008. Banks were reluctant to devaluate all those housing assets in their balances, hopeful to sell them at still overinflated market prices. However, as more and more loans are souring and both individuals and companies default on their payments, institutions whose exposure to the housing boom was higher -- the paradigmatic case is that of Bankia, but the cases of CatalunyaCaixa and CaixaNovaGalicia, among others, should not be forgotten either -- find themselves unable to satisfy the huge capital amounts the Spanish government, in a rare display of realism, recently asked them to set aside to hedge against housing-related credit losses. Then, hell breaks loose: the much-feared bailout ensues.

However, today’s rescue is only a first step. As already mentioned, it will cover short-time losses, but not potentially sour loans maturing later on. There is one key point to consider: although it has been modestly falling in the recent months (for obvious reasons: people are not buying houses and, therefore, not applying for new mortgages, and credit is scarce for businesses), overall private debt in Spain (including both companies and households) is still in excess of €2 trillion, i.e. 200% of Spain's GDP. Plus, government debt will be close to 90% of GDP by the end of 2012, assuming the bailout reaches the mark of €100 billion and counts against overall Spanish debt -- an instance already confirmed by Eurostat. According to the much-discussed IMF report on the Spanish banking sector, direct lending for construction projects still amounted 37% of GDP (or approximately €400 billion) by the end of 2011, slightly down from 42% of GDP in 2009. This figure neither includes the share of loans given to auxiliary companies providing construction-related services (plumbing, materials, etc.) nor the many mortgages held by unemployed or underwater homeowners. In other words, if the economy is not restarted somehow, and soon, a bailout amounting to just 5% of overall private debt will clearly not suffice.

Enter the strategy hidden behind the bailout plan, which is only starting to be revealed in the Spanish press: housing prices are going to continue to fall, and probably quite sharply. Banks hold up to 200,000 unsold housing units, according to IMF estimates. They must start substantially cleaning their balances as soon as possible (i.e. before a fresh round of sour loans appears by 2014 and they need to ask for a second European bailout), and this fresh capital injection, which they are eventually supposed to repay with hefty interest, will help them become more flexible in rating their assets and start writing out bad debt accumulated in their books. The latter has not taken long in materializing: Spanish banks have just accepted discounts of up to 45% in liabilities (news item in Spanish) accumulated by Sacresa, a former residential development giant, which had accumulated up to 1.8 billion euro in debt when it filed for bankrupcy protection almost two years ago. The former will soon be pretty visible: banks will offer plenty of houses and apartments at heavy discounts, be it 25% or even more.

The question is: who is going to buy? Unemployment hovers around 25%, and youth unemployment surpasses the dramatic 50% mark. Household debt is at dangerously high levels for a recession-stricken economy, and many families are still underwater from buying their homes at pre-2008 prices. One bet would point at foreign investors and families wishing to own a second home in sunny, tapas-rich and tourist-friendly Spain. High-end Russian tourism is booming, especially in the Catalonia region. However, the bulk of the empty property the Spanish market has to offer is not truly oriented at high-end foreign investors, and not even to middle-class families. Moreover, given the current state of the world economy, mired in uncertainty, as well as the probable economic slowdown that will even strike countries such as Germany or China, counting just on foreign money would maybe be too risky a bet. In other words, a sudden reversal of international capital and investment flight from Spain is probably not in the works. You can definitely bet on it, but you cannot count on it at all.

A second, more plausible bet would focus on local money, namely undeclared income that now the Government will try to funnel into the banks and housing markets via a (shameless) fiscal amnesty: you just deposit your undeclared income in any bank account, pay a 10% flat tax rate, fill out an online form… and you are done. In a country in which black economy accounts for up to 20% of GDP, such a move can help recapitalize cash-stripped banks and revitalize investment in property after due discounts are applied to already-devaluated prices. At least, that is the plan. A plan, however, that looks more like a bet with not much hedging -- such capitals can also be invested otherwise, or even be funneled away from shaky Spanish banks -- and which is also terribly unfair for law-abiding taxpayers. .

Moreover, a clear, rational objection to this plan can easily be made: the housing market will not be brought again into life unless credit is given to families and private investors. However, lending will be scarce while labor market instability continues: in other words, banks are not ready to accept the risk levels they happily accepted until 2007. Labor market instability will not disappear unless jobs are created, and not destroyed, as it is the case right now. However, fresh jobs will not easily be created because Spain built a whole generation around the construction industry, and now suffers from undereducated youth and long-term unemployment of a big mass of non-qualified workers. Then, is construction the answer? Should we enter a never-ending loop of housing booms and crashes?

Growth through business-friendly policies and a workforce ready for the challenges of today's global, knowledge-based economy should be the obvious way out of a crisis for a developed nation as Spain. But the current debt situation might be too desperate to follow this path, which requires patience and heavy investments. Severe budget cuts in education (which amounted to 4.9% of Spain’s GDP but will be cut to just 3.9%, all in the context of a falling GDP and thus way below of European and OECD averages) and research budgets (including painful statements, such as those by Carmen Vela, Spanish Secretary of State for Research, who asserted that there are too many researchers in Spain and that the focus is rather on quantity than on quality) are sadly showing the way forward: betting on a housing-based stabilization of the financial sector and see what happens next.

Should we be shocked? Sad? Depressed? Yes, Spain is (sadly) different in many aspects, but not as different as we might come to think, at least financially speaking. As this invaluable article argues (written by a fund manager, nonetheless), a big problem lurking behind Spain’s problems and decisions is rather a global malaise: a warped financial system that directs scarce capital to speculative and unproductive uses, and refuses to restructure debt once that debt has gone bad. Bankia, anyone?