Friday, November 28, 2014

Misreading Chinese Rebalancing

NEW HAVEN – The punditocracy has once again succumbed to the “China Crash” syndrome – a malady that seems to afflict economic and political commentators every few years. Never mind the recurring false alarms over the past couple of decades. This time is different, argues the chorus of China skeptics.

Yes, China’s economy has slowed. While the crisis-battered West could only dream of matching the 7.5% annual GDP growth rate that China’s National Bureau of Statistics reported for the second quarter of 2013, it certainly does represent an appreciable slowdown from the 10% growth trend recorded from 1980 to 2010.

But it is not just the slowdown that has the skeptics worked up. There are also concerns over excessive debt and related fears of a fragile banking system; worries about the ever-present property bubble collapsing; and, most important, the presumed lack of meaningful progress on economic rebalancing – the long-awaited shift from a lopsided export- and investment-led growth model to one driven by internal private consumption.

With respect to the last point, recent shifts in the composition of Chinese GDP appear disconcerting at first glance. Consumption (private as well as public) contributed only 3.4 percentage points to economic growth in the first half of this year, and an estimated 2.5 percentage points in the April-June period – a deceleration on a sequential quarterly basis that underscores a cyclical, or temporary, weakening in Chinese consumer demand.

At the same time, the contribution from investment surged from 2.3 percentage points of GDP growth in the first quarter of 2013 to 5.9 percentage points in the second quarter. In other words, rather than shifting from investment-led to consumer-led growth, China appears to be continuing along its investment-led growth track.

For an unbalanced economy that has under-consumed and over-invested for the better part of three decades, this is unnerving. After all, China’s leadership has been talking about rebalancing for years – especially since the enactment of the pro-consumption 12th Five-Year Plan in March 2011. It was one thing when rebalancing failed to occur as the economy was growing rapidly; for the skeptics, it is another matter altogether when rebalancing is stymied in a “slow-growth” climate.

This is superficial thinking, at best. The rebalancing of any economy – a major structural transformation in the sources of output growth – can hardly be expected to occur overnight. It takes strategy, time, and determination to pull it off. China has an ample supply of all three.

The composition of GDP is probably the worst metric to use in assessing early-stage progress on economic rebalancing. Eventually, of course, GDP composition will provide the acid test of whether China has succeeded. But the key word here is “eventually.” It is far too early to expect significant shifts in the major sources of aggregate demand. For now, it is much more important to examine trends in the potential determinants of Chinese consumption.

From this perspective, there is good reason for optimism, especially given accelerated growth in China’s services sector – one of the key building blocks of a consumer-led rebalancing. In the first half of 2013, services output (the tertiary sector) expanded by 8.3% year on year – markedly faster than the combined 7.6% growth of manufacturing and construction (the secondary sector).

Moreover, the gap between growth in services and growth in manufacturing and construction widened over the first two quarters of 2013, following annual gains of 8.1% in both sectors in 2012. These developments – first convergence, and now faster services growth – stand in sharp contrast with earlier trends.

Indeed, from 1980 to 2011, growth in services output averaged 8.9% per year, fully 2.7 percentage points less than the combined growth of 11.6% in manufacturing and construction over the same period. The recent inversion of this relationship suggests that the structure of Chinese growth is starting to tilt toward services.

Why are services so important for China’s rebalancing? For starters, services are far more labor-intensive than the country’s traditional growth sectors. In 2011, Chinese services generated 30% more jobs per unit of output than did manufacturing and construction. This means that the Chinese economy can achieve its all-important labor-absorption objectives – employment, urbanization, and poverty reduction – with much slower GDP growth than in the past. In other words, a 7-8% growth trajectory in an increasingly services-led economy can hit the same labor-absorption targets that required 10% growth under China’s previous model.

That is good news for three reasons. First, services growth is beginning to tap a new source of labor-income generation, the mainstay of consumer demand. Second, greater reliance on services allows China to settle into a lower and more sustainable growth trajectory, tempering the excessive resource- and pollution-intensive activities driven by the hyper-growth of manufacturing and construction. And, third, growth in the embryonic services sector, which currently accounts for just 43% of the country’s GDP, broadens China’s economic base, creating a significant opportunity to reduce income inequality.

Far from crashing, the Chinese economy is at a pivotal point. The wheels of rebalancing are turning. While that is not showing up in the composition of final demand (at least not yet), the shift from manufacturing and construction toward services is a far more meaningful indicator at this stage in the transformation.

So, too, are signs of newfound policy discipline – such as a central bank that seems determined to wean China off excessive credit creation and fiscal authorities that have resisted the timeworn temptation of yet another massive round of spending initiatives to counter a slowdown. Early steps toward interest-rate liberalization and hints of reform of the antiquated hukou (residential permit) system are also encouraging.

Slowly but surely, the next China is coming into focus. China doubters in the West have misread the Chinese economy’s vital signs once again.

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    1. CommentedCristea Nicolae-Marcel

      Ok. When it comes to the "Chinese economic miracle" I ask myself the same question: to which extend the books are cooked?! If in the west 2008 economic crisis just showed how many lies are feeding the imaginary economic system, how bad is the situation in China?
      I think time will tell. This future projections are always wrong. History always tells us the same thing: humans believe they can forth tell what's coming, but they were never right when it happened.There for, from my point of view, China is still an economic mystery of the present and the future.

    2. CommentedNejib Masghouni

      Good article... But I think the author undermines the difficulties China will face because of its political system... How long can the west educated Chinese young bear the political repression especially when coupled with growing corruption ? The situation looks much more complicated than the author expected ....

    3. CommentedStefan Siewert

      How little do we understand about economy! The article is persuading. China probably shows the highest economic dynamic in human history. It has brought more people out of poverty than the 100 billion USD, the West spends yearly on Aid. By promoting a labour-intensive export-led growth model, it is the first developing country, which has succeeded in introducing a new model to the world economy, shifting the global balance of power between labour, state and capital, with the emergence of a low-income sector in developed countries. It has become the manufacturer of the world, closing a 250 years life cycle from the motherland of capitalism, England. During the crisis 2008, it was a significant anchor of the world economy.
      But I am a China doubter as well. There is the law of gravity. The political elite does not have experience with structural change for more than 30 years. There is no political power or institutional landscape, pushing through the demanding and risky and extremely messy political change process. Global markets are reaching the limits of absorbing labour-intensive goods. Reindustrialization of the West has started. We know from the Apple’s IPod that value creation shifts away from the production of material goods. Chinese external and internal growth sources have reached their limits and there is nothing on the horizon to replace the efficiency of the unique combination of a diverse infrastructure, disciplined population, and a division of work between state and private companies. The Lewis point is approaching in 8 years, when population will shrink and the country becomes older before becoming rich. The transformation to a consumer-led and innovative economy is formally correct, but, unfortunately, history is bad in reading textbooks. China never developed according to Western scripts.
      As with England 200 years ago and the USA 100 years ago, there was a lot of historic luck that allowed China to succeed. This happens only ones. China will become a “normal” country, with all the problems we face daily.
      The emergence of China as a game-changer was slow, so is the demise. A Japanese-like scenario of 20 years of stagnation might sound optimistic in a couple of years
      But it might also take a couple of years more. We just do not know.

    4. CommentedCarlos Relano

      China's transition from investment-led growth to consumer-driven economy will not just overturn in 5 to 10 years. It will take decades. Remember that tens of millions or hundreds of millions of the population still works in the manufacturing. Their hard work and low wage is still a very important factor to the economy of the country and to the whole world. The services sector needs to be developed. However, to ensure a better development, it needed to be driven by more consumers. Because, for the most part, services sectors, is still a consumer-driven growth.
      China needs to drive itself into innovation-led growth. To implore this, endowment towards its schools and universities must be prioritize. The most important factor should be the government. It needs to provide a project that will develop hundreds of thousands of jobs. It needs to be similar to Silicon Valley where it is mostly a government-driven and not consumer-driven. Silicon Valley only became consumer-driven when its computers, software and other electronic products became cheaper and affordable to the middle class.