On January 22, China released a draft of economic statistics on its economy for the year 2008. At the same time it released GDP growth data for individual quarters that showed it falling to 6.8 percent in the fourth quarter of 2008, down from 9.0 percent in the previous quarter and 13 percent for all of 2007.
Question: Is China’s economy in free fall?
Reply: No, but it is slowing considerably this winter, for a combination of domestic and international reasons, including contractions in trade as a result of the global financial crisis.
Question: What do these data tells us about China’s prospects for either recovery or further decline?
Reply: The way they are announced, as annual data, you can’t tell much at all. The annual statistics for 2008 combine the first nine months of relatively rapid growth and many positive trends with the fourth quarter, which went through dramatic changes. So the annual data for all of 2008 really wash out those many sudden developments at the end of the year. It takes a few tedious calculations, using both annual data and data for earlier quarters, to extract what was really happening in the fourth quarter. China’s dramatic end-year changes were heavily associated with the global financial crisis, but not all were by any means and not all were bad. Taken together, the ups and downs in the fourth quarter paint quite a mixed picture—with many troubling signs, but also with many promising ones. The good signals for recovery in ’09 include strong growth in agriculture, investment, retail sales, and urban household incomes. But we also see weakened trade, declining rural incomes, and low prices coupled with high interest rates. Putting it all together, the scale and nature of the promising signs indicate to me China's economy is not in free fall.
Question: It sounds like the fourth quarter data contradict the annual data officially reported. Is that right?
Reply: Yes, one big surprise was the 5 percent real drop in rural cash incomes (“real” meaning after correcting for the effects of inflation). This is especially unexpected because growth of GDP’s “first” sector, consisting almost entirely of agriculture, was so surprisingly strong. This measure of fourth-quarter farm output showed astounding 7.3 percent growth in real terms. That’s faster than GDP’s “second” major component (industry and construction), which only grew at 6.7 percent in the fourth quarter, a dramatic deceleration. I don’t remember ever seeing this happen before—agriculture growing faster than industry and construction. If rural incomes declined so sharply compared to a year earlier, even when farm output grew so rapidly, it can only mean that rural wage income—from rural family members working off the farm or sending money home from their jobs as migrants—fell even more sharply, sharply enough to bring average rural household income from all sources down by 5 percent.
Question: That sounds like bad news for consumption growth, which many say needs to be the major source of China’s future recovery and expansion. Are there any good signs from the fourth-quarter data that might counterbalance this negative report on rural income?
Reply: Well, falling rural incomes could easily be bad news. The interesting thing, however, is that urban household incomes, which total to a much bigger national number than rural incomes, grew more than 11 percent in the fourth quarter, compared to a year earlier. This was faster growth than it saw in any of 2008’s earlier quarters. So if we are worried about household spending power, this strongly upside figure likely trumps the downside surprise in rural incomes. And even for rural incomes, looking back at earlier quarters’ growth record, they averaged 11 percent through September, so rural households had a good bit of cash coming in earlier in the year. Granted, they had to spend some of it on farm expenses, like costly diesel fuel and fertilizer, but cash income for the year was up 8 percent in real terms, leaving open the possibility that there is a reserve of consumer spending power saved up in rural areas as well. We can’t know for sure until we see more detailed data from China’s regular household surveys.
Question: So you are saying that even with GDP growth slowing so suddenly, to 6.8 percent, it’s not going to continue to nosedive, and there could still be a chance for domestic demand to recover? That kind of optimism seems to contradict the sharp downturn in growth.
Reply: Anything is possible, but I think a continued sharp growth-rate nosedive is unlikely. Fourth-quarter results show that some dimensions of spending were quite strong—although we always have to take the statistical underpinnings of these numbers with a dose of caution. Retail sales growth, in real terms, was 17 percent. Those of us who do a lot of work with China’s economic data know that China’s retail sales statistic is not a high-quality number. It often confounds retail and wholesale, and consumer sales with sales of products for investment purposes. Nevertheless, this is a respectably high figure for this statistic—as high as it has been in any quarter earlier in the year. Another measure of domestic spending is investment growth, which, after bumping along at about 15 percent in real terms for each of the preceding quarters, accelerated to 18 percent real growth in the fourth quarter.
Question: But how can there be so much spending and buying going on when output growth has slowed so dramatically?
Reply: That’s a good question, and the likely answer lies in trends of an obscure economic variable called inventory change—whether the volume of stuff stashed in warehouses is increasing or decreasing. A vice governor of China’s central bank (a U.S.-trained economist) reported in December that China was going through a period of inventory reduction, so there were more goods being sold than were being produced. This recent GDP data release for 2008 doesn’t report inventory changes, but the combination of weak output growth and strong spending growth is consistent with what the vice governor said. The good news is that inventories can’t continue to decline forever. Most run-of-the-mill recessions get a recovery boost when inventory declines go so far that some new output is required—fueling output and employment growth. Renewed inventory growth helped bring China out of its last serious growth slump in 1999–2000, and so it might eventually play the same role in this Chinese growth slump.
Question: You still haven’t said anything about the impact of shrinking world trade on China’s substantial export sector. Wasn’t that responsible for most of the decline in China’s fourth-quarter GDP growth rate?
Reply: The trade data for the fourth quarter by itself are interesting in a twisted kind of way. You would think that in a global financial and economic crisis that China’s very large trade surplus would run into serious trouble. But in the fourth quarter, China’s imports declined by 9 percent while exports continued to expand, by 4 percent. As a result, China’s fourth-quarter trade surplus increased by roughly 50 percent from a year earlier! To an economist, this looks like it ought to be a huge boost to GDP growth, but it wasn’t.
Question: Why was that? And if China had such fast growth in its trade surplus, why was total GDP growth only 6.8 percent, especially with all that other spending going on?
Reply: For one thing, these trade data aren’t corrected for inflation. Oil and other energy prices, as well as prices of many raw materials, dropped precipitously in the fourth quarter. So in real terms, corrected for inflation, China’s import growth may have been significantly faster, and in real terms the trade surplus may have declined. But inflation indicators for trade, especially for China, are a bit devilish to estimate, especially in a hurry. China’s statistical bureau is the only agency that can do a solid job, so we will just have to wait until more data are released later in the year.
Question: But does the continued growth of exports while imports appear to be falling mean that China won’t be hit hard by the world trade slump?
Reply: No, it’s clear to me that China will be hit pretty hard pretty soon. The fact that fourth-quarter imports declined is probably an early warning that quarterly exports will soon decline strongly, too. Indeed, both exports and imports declined in both November and December, so even this fourth-quarter picture of modest export growth is behind the trend. More importantly, the decline in imports, which are heavily used to provide parts and materials for exports, is likely an indication that production of export products has already started to contract. Here are those inventory changes again. It is quite likely that China is meeting some pre-crisis export orders with product already in its warehouses, but isn’t producing much more to add to those warehouses. The strong surplus—that is, net export sales—can continue while output growth is so slow because the exports are being taken from inventories. Once again, this can’t go on forever. The big question is whether world demand for China’s products will weaken so much that it won’t need to replenish its inventories. Once it does need to replenish them, this additional demand will supplement China’s recovery stimulus.
Question: This is a lot to absorb. There’s good news and bad news. What’s your bottom line?
Reply: The big uncertainty is how deep and prolonged the slump in world export demand will be and whether it will trigger protectionism. If China doesn’t experience the sudden evaporation of its trade surplus but rather sees it decline to low levels over the next two years, then China’s domestic demand stimulus should make a difference by the middle of 2009 so China can shift from 6 to 7 percent growth in the first quarter or two of 2009 to low double-digit growth in the second half and 8-to-9-percent growth for all of 2009.
Question: There’s one more thing I’m curious about. Why do you think China releases economic data in year-to-date form—that is first half, then first nine months and then the whole year, rather than reporting each quarter separately? Wouldn’t that be better?
Reply: I think it is very important for Chinese policy makers to have as clear a picture as possible of what is happening right now in their economy. So I am sure that even though they don’t officially report individual quarterly data, they have their internal reports that make it clear what is happening quarter by quarter and month by month. It may be that if they made these statistics public, the natural variability of these data compared to the slow-changing year-to-date data would cause additional concern among the public, requiring explanations and efforts to defend economic policies that otherwise wouldn’t be necessary. In this same vein, even if China does report data for individual quarters and months, it uses year-on-year measures of growth, which doesn’t say much about what is happening right now, because year-on-year data—comparing this period with the same period a year earlier—is an average of all the changes that have gone on for 12 months. The alternative is quarter-to-quarter and month-to-month measures of change, but when we do this, we need to correct for the natural differences between different months or quarters. This “seasonal adjustment” correction process is as much an art as a science, but without it China’s policy makers run the risk of discovering that suddenly things are much different than they thought they were. This happened a lot in the 1980s.