Paul Krugman: Hitting China’s Wall

China is running out of "surplus labor":

Hitting China’s Wall, by Paul Krugman, Commentary, NY Times: All economic data are best viewed as a peculiarly boring genre of science fiction, but Chinese data are even more fictional than most. ... Yet the signs are now unmistakable: China is in big trouble. ...

Start with the data, unreliable as they may be. What immediately jumps out ... is the lopsided balance between consumption and investment..., for China ... almost half of G.D.P. is invested.

How is that even possible? ... The story that makes the most sense to me ... rests on an old insight by the economist W. Arthur Lewis, who argued that countries in the early stages of economic development typically have a small modern sector alongside a large traditional sector containing huge amounts of “surplus labor” — underemployed peasants making at best a marginal contribution to overall economic output.

The existence of this surplus labor, in turn, has two effects. First, for a while such countries can invest heavily in new factories, construction, and so on without running into diminishing returns, because they can keep drawing in new labor from the countryside. Second, competition from this reserve army of surplus labor keeps wages low even as the economy grows richer. ...

Now, however,... to put it crudely, it’s running out of surplus peasants. That should be a good thing. Wages are rising; finally, ordinary Chinese are starting to share in the fruits of growth. But it also means that the Chinese economy is suddenly faced with the need for drastic “rebalancing”... Investment is now running into sharply diminishing returns and ... consumer spending must rise dramatically to take its place. The question is whether this can happen fast enough to avoid a nasty slump.

And the answer, increasingly, seems to be no. The need for rebalancing has been obvious for years, but China just kept putting off the necessary changes...

How big a deal is this for the rest of us? ... Western economies are going through their “Minsky moment,” the point when overextended private borrowers all try to pull back at the same time, and in so doing provoke a general slump. China’s new woes are the last thing the rest of us needed.

No doubt many readers are feeling some intellectual whiplash. Just the other day we were afraid of the Chinese. Now we’re afraid for them. But our situation has not improved.