Markets have not been enthused by the numbers coming out of China in recent months. Typical headlines are “China’s production indicators disappoint” or “analysts are worried that rapid expansion is faltering”. Estimates of China’s economic growth this year are slipping from more than 8 per cent to something closer to 7.5 per cent. Those concerned about the country’s longer-term growth challenges, however, tend to be more relaxed about near-term outcomes but preoccupied with the new leadership’s commitment to reforms.Is there a trade-off between reviving the economy and establishing a sustainable basis for longer-term growth? Unfortunately there is. Beijing has run out of good options to further stimulate the economy as a strategy to buy time until western economies rebound.
There are lessons from what happened in the aftermath of China’s post Asian financial crisis stimulus more than a decade ago. At that time China responded with a massive programme comparable to its more recent effort in the aftermath of the global financial/fiscal crisis spurred by the economic collapse in the US and Europe.
China’s confidence in stimulus programmes was unrealistically buoyed by its success in dealing with the Asian crisis which resulted in a soft landing followed by years of sustained and rapid growth. But the lingering consequences of the 2009 stimulus package have not been as benign, with no signs that the resulting high debt levels are moderating and that continued expansionary credit policies are spurring production and real demand.
The contrasting results reflect two fundamental differences between the situation a decade ago and the more recent experience.
First, the earlier effort was supported by strong reform initiatives exemplified by actions to secure World Trade Organisation membership in 2001. In contrast the 2009 stimulus was taken in an absence of any path-breaking reforms that might have strengthened the productive base of the economy.
Second, both stimulus programmes led to an increase in the gross debt of the non-financial sector equivalent to about 40 percentage points of gross domestic product. But the first stimulus did this over four years rather than two in the more recent effort – largely because the first programme was more fiscal-based while the second was driven by credit expansion. As a result Beijing has been dealing with a property bubble which has forced policy makers to tighten restrictions on what had been a key growth driver.
Continued easy monetary policies have made it impossible for China’s debt overhang to fall over the past several years compared with the steady decline after the first stimulus. Thus, the new leadership can no longer rely on traditional fiscal and monetary levers to continue stimulating demand without risking the integrity of its financial position.
If so, what can one expect in terms of short-term growth outcomes in the absence of major policy changes and significant improvement in global conditions? The arithmetic is straight forward. Total consumption which accounts for about half of the economy could grow about 8 per cent annually – somewhat less than in the past given unsettled economic prospects. Growth in real investment will be much less than the historic double-digit rates, averaging perhaps 5-6 per cent annually. And assuming that China’s trade balance is neutral in its contribution to growth rather than negative as it has been more recently, then the short-term growth trajectory would be about 6.5-7 per cent. This should be the norm for market expectations.
Other factors such as efficiency improvements, inventory adjustments and external events could affect near-term outcomes, but these factors are unlikely to affect growth rates by more than half a percentage point either way over the coming year.
Much more important is whether Beijing can act on the structural reforms needed to increase productivity so that even with lower investment rates, growth can be sustained about 8 per cent annually for the remainder of this decade rather than pushed down to the 6-7 per cent range. Many of these measures are being given serious consideration by the new leaders.
Key actions include accelerating the pace and efficiency of the urbanisation process, with liberalising the residency or hukou system being paramount. The leadership must be sincere not just about encouraging more workers to move to cities but also providing them with the necessary services.
This needs to be supported by a major overhaul of the fiscal system to encourage more consumption and put financing of public investment on a more sustainable basis. Local authorities need more revenues to provide mandated social services and the requisite financing could come from additional dividend payments from state enterprises and rolling out the property tax experiments already being piloted.
Continued financial sector reforms including liberalising capital movements and more incentives for private sector expansion will also be critical. A major signalling effect would come from selling off state enterprises that cannot be strategically justified and equalising access and costs for public services between private and state entities.
If the new leadership can act on recent public statements to this effect, then China could grow at 8 per cent for many years to come, otherwise expect 6-7 per cent.