The latest growth figures in China – published on Friday – suggest that the country’s economic slowdown has indeed bottomed out. Its economy expanded at an annual rate of 7.8 per cent for the third-quarter of this year, up from a rise of 7.5 per cent in gross domestic product from the previous quarter. The storyline is becoming a bit monotonous and perhaps that is good. However, views over whether this rebound is sustained are mixed. Optimistic bulls predict the small uptick will continue next year yet the less convinced bears factor in a small decline. There are also extreme bears who still predict an imminent collapse or growth falling to an annual rate of 3-4 per cent. Of the latter two arguments, one is implausible and the other illogical.
Those who warn of a collapse precipitated by a financial crisis get one thing right: the debt burden limits Beijing’s capacity to continue expanding credit to prop up demand. But these naysayers have not fully understood the cushion provided by China’s enormous stock of household savings, its $3.66tn of reserves and the nature of its debt (largely domestic and from one state entity to another). The system has the means to fend off a major collapse, as it did more than a decade ago when non-performing loans were taken off the banks’ books in a restructuring that socialised the costs and pushed them on to future generations. With time, rapid growth and inflation have reduced the damaging consequences – but repeated episodes eventually will dampen long-term growth prospects.
Those who foresee a sharp decline, but no collapse, point to the vulnerabilities in China’s macroeconomic-imbalances, as reflected in its unusually low consumption-to-GDP ratio and commensurately high investment ratio. These bears assume that the Chinese economy must be rebalanced within, say, a decade. That would mean the ratio of consumption-to-GDP, currently about 0.35, would have to rise to at least 0.50. If consumption were to continue growing at its current rate of 8-9 per cent annually, the arithmetic indicates that GDP growth would have to fall to 3-4 per cent. This argument, however, makes no sense. If GDP growth actually fell that much, consumption would also fall as corporate profits evaporate, job cuts occur and wages stagnate.
This argument’s fundamental flaw is that it mistakenly makes rebalancing the end rather than the means of the growth process. Pushing for increased consumption for the sake of a more balanced consumption-to-GDP ratio is not sensible. Countries with higher or moderate consumption ratios are not automatically blessed. Some economies such as the US and Greece have ratios exceeding 0.70, double China’s, and France and India have numbers about 0.60. At the same time, financially strong economies such as Singapore and Saudi Arabia have similar or even lower ratios than China.
In addition to not necessarily being a risk, such macro-imbalances are often the result of a successful urbanisation-cum-industrialisation process that leads to rapid growth. China’s growth process closely resembles the earlier Asian successes exemplified by Japan, South Korea and Taiwan, which experienced large macro-imbalances decades ago while growing at double-digit rates. Eventually, as their annual growth rates moderated to the 7-8 per cent range, these macro-imbalances diminished.
Should we, therefore, assume that all is well in the Middle Kingdom? Not really. China’s massive 2008 stimulus programme pushed the economy off its former growth path. This deviation is partly a cyclical problem. But China also faces a structural issue in transitioning from middle to high-income status. No economy can grow at 10 per cent a year all the way to high-income levels so a decline to the 7-8 per cent range is inevitable, as it was for the previous Asian Tigers. Their success, however, was predicated on being able to ratchet up productivity so that they could continue to grow at a fairly rapid rate even as investment levels declined.
The challenge for China is similar, but complicated by its debt burden. Combined with a shrinking labour force and likely disappearance of its trade surplus over the coming years, China’s underlying annual growth rate is actually closer to 6 per cent. Its economy is growing at 7.5 per cent a year only because of the lingering effects of easy credit policies and recent mini-stimulus programmes.
There are many distortions in China’s growth process that repress consumption and lower the returns to investment. Eliminating these distortions would increase growth and reduce macro-imbalances. Liberalising urban residency requirements is the clearest example, as is curbing the excessive infrastructure spending by local authorities, which is the main reason why the productivity of investment has fallen. One does not have to be a bear to expect a rebalancing of the Chinese economy over the coming years – but it should be seen as the outcome, not the cause, of a more efficient growth process.
This is why China-watchers, both bears and bulls, are hoping that November’s Third Plenum reform pronouncements will change the mix of investment in favour of the private sector and services, supporting a more efficient urbanisation process, including more liberal migrant residency policies. Such actions would moderate the excessive growth in infrastructure expenditures in the more remote secondary cities and encourage more concentrated development of urban services in the major cities, which would stimulate consumption. Those looking for rebalancing to show up immediately in the indicators will have to be patient. Ironically, such reforms may actually widen macro-imbalances initially before they moderate as the byproduct of a more efficient growth process.