China’s rebound—7.1 percent (yoy) growth in the first half and 7.9 percent (yoy) in the second quarter of 2009—proved to be quicker and stronger than even optimists had expected. Massive monetary and fiscal stimulus programs introduced in late 2008 led to this V-shaped recovery. Although the current growth pattern is clearly not sustainable, the government’s target of 8 percent for 2009 is within reach.
The magnitude of China’s rebound becomes even clearer when we look at sequential quarter-on-quarter (qoq) growth rates. By international standards, China’s growth (adjusted for seasonal factors) increased from near zero during the last quarter of 2008 to about 17 percent during the second quarter of 2009.
This remarkable comeback was achieved in spite of a huge negative swing in the contribution of net-exports to GDP growth (from 0.7 percent in the last quarter of 2008 to - 4.7 in the second quarter of 2009). Domestic demand growth, fueled mainly by credit expansion, was extremely strong and more than compensated for the sharp drop in external demand. During the first half of 2009, China accounted for most of Asia’s and even the world’s growth and was significant in improving the near-term outlook for global recovery. However, the staggering contribution of investment to growth during that period in China—well over 80 percent, and more than double its already extremely high rate of 42 percent in recent years—makes it clear that this growth pattern is not sustainable.
Funding Stimulus and How it Worked
The Chinese government engineered the country’s sharp recovery through a huge expansion in bank lending and fiscal stimulus. Domestic credit expansion during the first half of 2009 (RMB 7.4 trillion—about $1.1 trillion) was three times larger than during the same period in 2008. A rough estimate of true fiscal stimulus during the first 7 months (December 2008–June 2009) is RMB 700–800 billion1 —about 20 percent of the total fiscal stimulus budget of RMB 4 trillion allocated through 2010.
The Chinese government engineered the country’s sharp recovery through a huge expansion in bank lending and fiscal stimulus.
In March, China projected a fiscal deficit of 3 percent of GDP for 2009. At this juncture, this projection seems realistic or even on the high side. Since official government debt was relatively modest at the start of the crisis (less than 20 percent of GDP), China retains a substantial margin for additional fiscal stimulus, if needed.
The following picture of the still-evolving program is emerging. Because China’s economic slowdown started in 2007 as a result of government efforts to cool the overheating economy and deflate a potentially dangerous real estate bubble, reviving the slumped urban housing sector was the government’s initial priority. This was done through a combination of fiscal, monetary, and administrative measures aimed at quickly reducing the market’s existing supply overhang. As a result, urban housing prices, which had been falling since late 2007, leveled off and began to rise once again in May or June 2009, rather sharply in some cities. This has already led to a modest resumption of private construction and fears of a new bubble.
In late 2008, governments at all levels began to implement (or accelerate the implementation of) infrastructure projects, including high speed intercity rail, urban subway systems, alternative energy (especially solar and wind), low cost housing, additional airports, urban water supply, and waste water treatment facilities. The initial stimulus program aimed to create construction jobs, restore business confidence, eliminate infrastructure bottlenecks, modernize industrial plants (to protect long-term productivity growth), and replenish raw material stocks.
Beijing is keenly aware that its old growth model has outlived its usefulness.
The initial program also included measures to retrain laid-off workers, minimize lay-offs in the state sector, promote rural household consumption (through price subsidies for a wide range of consumer durables), improve rural and urban safety nets (which should ultimately also promote household consumption), and help unemployed university graduates start their own businesses. China’s stimulus program is probably the largest and most comprehensive in the world, at least relative to the economy’s size.
Some of the stimulus money—nobody knows how much—has undoubtedly been misallocated or used for speculative purposes, contributing to rising real estate prices and soaring stock markets (until July, when equity prices began to fall in response to a sharp reduction in credit expansion). There have also been reports of an increase in corruption and the use of fraudulent methods to inflate land prices for the benefit of local governments, who depend on land leases for fiscal revenues.
Industrial Restructuring, Macroeconomic Rebalancing, and Unemployment
Now that the stimulus program has demonstrated its effectiveness, the government is beginning to pay more attention to industrial restructuring and macroeconomic rebalancing. Beijing is keenly aware that its old growth model, which relied heavily on manufacturing investment and export growth and led to excessive current account surpluses and unnecessarily large foreign exchange reserves, has outlived its usefulness.
Consumption growth in China will have to exceed GDP growth for an extended period. The opposite has to happen in the United States.
In August, the government announced its intention to restructure and consolidate ten major industrial sub-sectors currently plagued by excess capacity, including inter alia steel and non-ferrous metals. To reduce dependence on consumer markets in North America, Europe, and Japan, China is promoting South-South trade and investment. Outward FDI from China, mostly to resource-rich countries and other emerging market economies, may exceed inward FDI for the first time in 2009.
If China’s growth pattern is to become more sustainable, consumption growth will have to exceed GDP growth for an extended period. The opposite has to happen in the United States. The problem with consumption in China is not that its growth rate is low by international standards—China was the world’s fastest growing large consumer market for many years, even in the first quarter of 2009 (charts 3 and 4)—but that the country’s GDP grew even faster. Preliminary data indicates that household consumption growth rose to 10.3 percent (yoy) during the first half of 2009, substantially more than the GDP growth of 7.1 percent in that same period! If household consumption growth can be kept at 9–10 percent, given the likelihood of slower, single digit GDP growth (7–8.5 percent) in the years ahead, China’s national savings rate and its current account surplus as a percentage of GDP will likely go down.
At the end of 2008, China’s employment picture looked very grim. An estimated 23 million workers had been laid off by export industries and their suppliers. Earlier in 2008 and in late 2007, there were massive, but unrecorded, lay-offs in the construction industry as a result of the housing slump. Most laid-off workers were migrants without a permanent urban residence permit (hukou) and so were not covered by official statistics in China. In addition, they generally have little or no access to social safety nets. Recent university graduates also faced serious unemployment rates. Close to one-third (1.7 million) of 2008 graduates were unemployed at the end of the year. At the time of this writing (early September), the employment picture is unclear. Reports of massive unemployment in some regions and sectors conflict with announcements of emerging labor shortages in Guangdong province.
An estimated 23 million workers had been laid off by the end of 2008. Most laid-off workers were migrants who were not covered by official statistics in China.
What Happened to Trade?
During the first six months of 2009, exports were down 22.7 percent (yoy)—less than for most East Asian economies. Current expectations are that the trade surplus for 2009 as a whole will be about one-third smaller than it was in 2008 and that the country’s current account surplus will shrink to about 6 percent of GDP (from 11 percent in 2007 and nearly 10 percent in 2008). Given the fact that China has been a major contributor to global economic imbalances since 2004, this is also good news for rest of the world. However, we cannot be confident that the trend will continue. China’s export lobby remains very strong and the government has yet to reverse its temporary export rebates. These increases, as well as the government’s decision to stop appreciating the RMB against the US$ around the middle of 2008, are clearly inconsistent with China’s longer term structural reform needs.
Growth Prospects and New Developments
Given the unsustainable nature of China’s current stimulus-driven growth pattern, it is difficult to make projections. A second growth dip in late 2009 or 2010 is entirely possible, but, fortunately, there is room for more aggressive fiscal stimulus, if needed. While maintaining growth is essential for social stability, there is little doubt that China is also serious about industrial restructuring and macroeconomic rebalancing. It seems probable that China will be able to grow at 7–8.5 percent in the next few years and that the share of consumption in GDP will increase. The central government is keen to avoid additional excess capacity in manufacturing, but its efforts in this regard may be frustrated by local governments desperate for factory jobs and revenues.
China’s economy is likely to emerge from the crisis stronger than it entered it.
Although the reform path ahead will be difficult and bumpy, China’s economy is likely to emerge from the crisis stronger than it entered it. Success in dealing with the crisis may foster even faster integration in greater China (Hong Kong, Taiwan, China), and may help strengthen the Yuan’s prospects as an international currency in the very long run.
1 All projections in this piece were made by the author, unless otherwise noted.
