5 Risks to China’s growth story

Economic growth

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Lewis curve WSJ.pngChina’s economic growth has become more and more unbalanced over the past 10 years, as we discussed in chapter 6 of Boom, Gloom and the New Normal. Its domestic consumption is now only around a third of GDP, compared to 50% a decade ago. Instead, the leadership has focused on achieving growth via exports and infrastructure investment.

THE SHORT-CUT HAS BECOME A DEAD-END
This ‘short-cut’ to higher growth is now looking more and more like a dead-end. Exports are falling, as the ageing Western babyboomers cut back their spending. Whilst the surge in bank lending has often led to purely speculative activity, such as the housing market bubble.

Now, not for the first time, China’s leadership are flagging that they may move away from their GDP-driven policies. Bloomberg report premier Wen may announce a GDP target of less than 8% in his National People’s Congress speech on 5 March. The problem is that the move, if it comes, may well be ‘too little, too late’ to put China back on course.

Wen himself recognised the issue 5 years ago, when he described the economy as being “unstable, unbalanced, uncoordinated and unsustainable“. But hard choices were deferred when the financial crisis hit in Q4 2008. Instead, lax lending made the problems worse, not better.

Policymakers discussed a possible new approach at December’s economic work conference, which highlighted that “the country is poised to make some significant policy changes”. As Yi Xianrong of China’s Academy of Social Sciences noted then:

“The country has shown more determination than ever to shy away from any enormous economic stimulus packages in an endeavor to decelerate its fast pace of GDP growth”.

FIVE KEY RISKS TO FUTURE GROWTH
‘Better late than never’ is probably the sensible response to this potential policy change. But unwinding the legacy of the previous past decade will not be easy, and creates 5 major risks:

• China’s current policy saw its share of global exports hit 10.5% in 2011, up from 8.8% in 2007. Replacing this volume, and the jobs it created, will not be easy
• Similarly, its wasteful infrastructure investment, which rose to 48% of GDP in 2011 from 42% in 2007 means money has been spent which cannot be recovered
• China’s new short-cut to help boost consumption is to increase wages by 13% a year. But this will reduce profit margins and jobs
• It is also difficult for any country to manage a smooth transition on such a scale. There is a strong risk that the uncertainty created may reduce future investment spending
• Finally, there is the really big risk, that China may hit the ‘middle income trap’ we described, and simply fail to make the transition required

THE WORLD BANK’S WARNING
This latter risk is not just the blog’s concern. Yesterday, the World Bank and China’s Development Research Center (DRC) published their major China 2030 report which warned explicitly that:

“China’s growth is in danger of decelerating rapidly and without much warning. That is what has occurred with other highflying developing countries, such as Brazil and Mexico, once they reached a certain income level, a phenomenon that economists call the ‘middle-income trap’.”

The chart above, from the Wall Street Journal, highlights the scale of this risk. The blue columns show GDP/capita pre-1970 in countries including China, Thailand, Malaysia, S Korea and Japan. The orange column updates this to the 2007/9 average. Some countries have clearly done very well. Korea, for example, has moved from having a GDP/capita of only 10% of US levels to almost 60% today.

Following Korea’s example will not be easy for China. The blog was a regular visitor to Korea in the 1987-92 period, when a key part of this transition took place. It saw major political change taking place, as ordinary people were allowed to vote for their president in a direct secret ballot. This will not be happening later this year in China, when President Hu is expected to be replaced by Vice President Xi.

Yet as Sir Arthur Lewis’ work has shown, political change of this kind is essential if the economy is to continue to grow. Equally, China’s ‘one child policy’ means it has no choice – it cannot continue to rely on cheap labour, and has to become more capital intensive.

The World Bank/DRC report highlights the key question. Can China manage this transition? Equally, it warns that “A sharp slowdown could deepen problems in the Chinese banking sector and elsewhere, and could prompt a crisis“.

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