Wednesday, November 26, 2014

China is Okay

NEW HAVEN – Concern is growing that China’s economy could be headed for a hard landing. The Chinese stock market has fallen 20% over the past year, to levels last seen in 2009. Continued softness in recent data – from purchasing managers’ sentiment and industrial output to retail sales and exports – has heightened the anxiety. Long the global economy’s most powerful engine, China, many now fear, is running out of fuel.

These worries are overblown. Yes, China’s economy has slowed. But the slowdown has been contained, and will likely remain so for the foreseeable future. The case for a soft landing remains solid.

The characteristics of a Chinese hard landing are well known from the Great Recession of 2008-2009. China’s annual GDP growth decelerated sharply from its 14.8% peak in the second quarter of 2007 to 6.6% in the first quarter of 2009. Hit by a monstrous external demand shock that sent world trade tumbling by a record 10.5% in 2009, China’s export-led growth quickly went from boom to bust. The rest of an unbalanced Chinese economy followed – especially the labor market, which shed more than 20 million jobs in Guangdong Province alone.

This time, the descent has been far milder. From a peak of 11.9% in the first quarter of 2010, China’s annual GDP growth slowed to 7.6% in the second quarter of 2012 – only about half the outsize 8.2-percentage-point deceleration experienced during the Great Recession.

Barring a disorderly breakup of the eurozone, which seems unlikely, the International Monetary Fund’s baseline forecast of 4% annual growth in world trade for 2012 seems reasonable. That would be subpar relative to the 6.4% growth trend from 1994 to 2011, but nowhere near the collapse recorded during 2008-2009. With the Chinese economy far less threatened by export-led weakening than it was three and a half years ago, a hard landing is unlikely.

To be sure, the economy faces other headwinds, especially from the policy-induced cooling of an overheated housing market. But construction of so-called social housing for lower-income families, reinforced by recent investment announcements in key metropolitan areas such as Tianjin, Chongqing, and Changsha, as well as in Guizhou and Guangdong Provinces, should more than offset the decline. Moreover, unlike the bank-funded initiatives of 3-4 years ago, which led to a worrisome overhang of local-government debt, the central government seems likely to play a much greater role in financing the current round of projects.

Reports of ghost cities, bridges to nowhere, and empty new airports are fueling concern among Western analysts that an unbalanced Chinese economy cannot rebound as it did in the second half of 2009. With fixed investment nearing the unprecedented threshold of 50% of GDP, they fear that another investment-led fiscal stimulus will only hasten the inevitable China-collapse scenario.

But the pessimists’ hype overlooks one of the most important drivers of China’s modernization: the greatest urbanization story the world has ever seen. In 2011, the urban share of the Chinese population surpassed 50% for the first time, reaching 51.3%, compared to less than 20% in 1980. Moreover, according to OECD projections, China’s already burgeoning urban population should expand by more than 300 million by 2030 – an increment almost equal to the current population of the United States. With rural-to-urban migration averaging 15 to 20 million people per year, today’s so-called ghost cities quickly become tomorrow’s thriving metropolitan areas.

Shanghai Pudong is the classic example of how an “empty” urban construction project in the late 1990’s quickly became a fully occupied urban center, with a population today of roughly 5.5 million. A McKinsey study estimates that by 2025 China will have more than 220 cities with populations in excess of one million, versus 125 in 2010, and that 23 mega-cities will have a population of at least five million.

China cannot afford to wait to build its new cities. Instead, investment and construction must be aligned with the future influx of urban dwellers. The “ghost city” critique misses this point entirely.

All of this is part of China’s grand plan. The producer model, which worked brilliantly for 30 years, cannot take China to the promised land of prosperity. The Chinese leadership has long known this, as Premier Wen Jiabao signaled with his famous 2007 “Four ‘Uns’” critique – warning of an “unstable, unbalanced, uncoordinated, and ultimately unsustainable” economy.

Two external shocks – first from the US, and now from Europe – have transformed the Four Uns into an action plan. Overly dependent on external demand from crisis-battered developed economies, China has adopted the pro-consumption 12th Five-Year Plan, which lays out a powerful rebalancing strategy that should drive development for decades.

The investment and construction requirements of large-scale urbanization are a key pillar of this strategy. Urban per capita income is more than triple the average in rural areas. As long as urbanization is coupled with job creation – a strategy underscored by China’s concomitant push into services-led development – labor income and consumer purchasing power will benefit.

Contrary to the China doubters, urbanization is not phony growth. It is an essential ingredient of the “next China,” for it provides China with both cyclical and structural options. When faced with a shortfall of demand – whether owing to an external shock or to an internal adjustment, such as the housing-market correction – China can tweak its urbanization-led investment requirements accordingly. With a large reservoir of surplus savings and a budget deficit of less than 2% of GDP, it has the wherewithal to fund such efforts. There is also ample scope for monetary easing; unlike central banks in the West, the People’s Bank of China has plenty of ammunition in reserve.

A growth slowdown is hardly shocking for an export-led economy. But China is in much better shape than the rest of the world. A powerful rebalancing strategy offers the structural and cyclical support that will allow it to avoid a hard landing.

Read more from our "Roach on China" Focal Point.

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    1. CommentedAnon Nymous

      I'm sorry, I don't find this argument terribly persuasive despite generally agreeing with Mr. Roach's points on future urbanization. The crux of the issue is why cities are being built far in advance of their occupation.

      Mr. Roach declares this to be a necessity without justification, and arguably, contrary to the evidence in two significant ways. First, between technological advances and natural decomposition of even derelict structures, the product that will be consumed will be needlessly inferior to more recent construction. Second- and really an extension of the first point- the very existence of these un(der)utilized edifices is a testament to the extraordinary capacity of China's construction industry. In other words, they could produce whole cities with more efficient techniques and more apt accoutrements in quite short order when warranted in the future. So why aren't they?

      I think the issue Mr. Roach has chosen to elide is that the CCP couldn't afford to work in this manner. They couldn't afford an unemployed and politically restive population, so this was a stop gap measure to inflate growth. The fact the end product may be useful a decade or two in the future doesn't rationalize poor allocation of resources in the present.

      The question of whether the article's title is correct is still undecided. That will largely be determined by the ability of future consumers to service the debts incurred to build the (as yet, still) ghost cities. If they can sustain median income growth at a high clip, then quite possibly so. That's simply not a foregone conclusion.

    2. CommentedErik de Ruijter

      I have lived in Pudong, Shanghai, China for 4.5 years, and over 30% of all apartments is structurally empty. Drive around at night and you can see which ones are occupied - some projects are completely empty like for instance the compound right opposite my house in Tiziano Villas.

    3. CommentedJingyi Li

      The success of Pudong may not indicate the fates of those newly developed urban areas.

      Shanghai Pudong was one of few projects promoted by the central government in 90s. Shanghai also has the best infrastructure, talent, and industrial base in China. Pudong, like other early development zones, has attracted the best companies in China and around the world as well as talents.

      Now every city is building their own "new town". Many of them, esp. those in inlands, don't have a solid economic base. Nor can they compete with Pudong and Shenzhen.

    4. CommentedMilton Kotler

      Stephen Roach has hit the nail on the head. When an urbanizing population of 1.4 billion rests upon an economic foundation of high GDP, huge foreign reserves, #2 global export position; a middle class that outnumbers the U.S. ppulation; unified and decisive government; immense borrowing capacity and monetary independence, it is blind to be pessimistic about China's future.

      I have been in China for 12 years on the ground of urban development. The governemnt is opening the West to investment and urbanization, not to mentiomn the urban growth of Central China. All business in China are looking West, as well as fortifying their Easterly position. Infrastructure. population and enterprise is pouring in. As Roach says, Chinia is Okay!

      Our findamental U.S. problem is a mature domestic market with too small a population to compete with China and India, and a corporate investment policy that rests its presence in foreign markets upon the the obliging disposition other nations.

      The U.S. solution must be demographic, just as it has always historically been. We have to double our population by opening the door wide to immigrants and their entrepreneurial initiaives. Open the door!

      Milton Kotler. KMG

    5. CommentedPaul Mathew Mathew

      This article is utter rubbish.

      Anyone who has any understanding of China knows that exports fell off a cliff in 08 – to fill the hole they went on a massive building binge and now they have massive misallocation of capital because of it.

      The idea obviously was to bridge things until the US and EU recovered – neither have recovered so huge problem for China

      I am skeptical that they can repeat that massive stimulus (or anything approaching that) - you can only build so many million empty apartments and ghost towns....

      The fact that iron ore prices are crashing coupled with other articles that report that there are massive stock piles of ore in China + some companies have walked away from contracts to buy more (Andy Xie has some good stuff on this) – would seem to confirm China is unable to repeat (of course that could change…they may try and to hell with the consequences)

      If it doesn’t that means the last driver of the global economy is gone…

      China is at the end of the day totally reliant on export markets - if they do not come back - and they are not - they are as doomed as the rest of us

    6. CommentedDr Dorel Iosif

      China's fixed assets investment is indeed re-adjusting which in turn causes investment growth to decelerate. Regardless of whether or not one adheres to Keynes or Hayek, the increase in the rate of urbanization does not convince me as long as the propensity to consume is stagnant. The structural changes you mention should include removing barriers in "urban" access to education, re-allocation of resources to projects that rely on increase in human capital, accelerate innovation... all in the context of globalization (largest world's structural change) and decrease in demand (esp. in their trading partner no.1 which is EU27) compounded by raising labour costs (hence reduced exports). Executing growth that exceeds one's economy's absorption capacity is difficult to undo.

      Dr Dorel Iosif, Perth, Australia

    7. CommentedProcyon Mukherjee

      There is undeniably so much to draw lessons from in China, albeit its draconian intent to push an agenda that can hardly be called a democratic approach to reforms; when the other part of the world, that is steeped in democratic intent, is struggling to balance the two apparently contradictory objective functions (growth versus equity), at least we see in China a fast paced, aggressive balancing act that is still able to sustain the growth momentum while taking out rural poverty through rapid urbanization and transfers.

      This leads me to the views of some, who find democratic traditions at odds with the progress to be achieved in the Western world, where democracy is fast being replaced by the power of lobbying, which at best could serve the interests of those who have the dollar-votes to match the proliferation of contradictory interest groups, where doing good to one comes at the cost of the other, while the polity is embroiled in an intellectual bickering with no ends in sight.

      Procyon Mukherjee