Author: Yiping Huang, Peking University and ANU
The Chinese economy is in the middle of transitioning toward a new, more sustainable, growth model with slower GDP growth and a more balanced economic structure. This is a change that has gone largely unrecognised by most China watchers and market participants.
Chinese growth decelerated steadily during 2012. The authorities took steps to stabilise growth, but these measures failed to have an immediate effect. At the time, many analysts argued that the government authorities were ignoring growth risks due to the imminent leadership transition and were way behind the curve. Investors subsequently expected the new government to boost investment after taking office in early March 2013 and were confident about the likely reacceleration of growth in the ensuing quarters. But the new leadership did not announce any major investment programs at the National People’s Congress. As a result, fears of a hard landing once again regained momentum.
What these analysts fail to appreciate is that the economy is settling around its new growth potential. Policy makers are reluctant to take more aggressive measures to support economic growth primarily due to lessons learned from the stimulus package introduced during the global financial crisis. That package was effective, lifting GDP growth from 6.1 per cent in the first quarter of 2009 to 10.7 per cent in the fourth quarter of the same year. Yet it also caused problems, such as new fiscal burdens, the emergence of potential non-performing loans, overcapacity in some areas of infrastructure, extreme imbalance problems, and inflation and asset bubble risks. From as early as 2010, officials began to reach a consensus view on the need to tolerate slower growth.
This view is in line with the new potential rate of growth estimated by various think tanks, such as the World Bank, the Asian Development Bank, the Development Research Center of the State Council and the Chinese Academy of Social Sciences. Most of these institutions put China’s growth potential at between 6 and 8 per cent for the period 2011–20, compared to above 10 per cent in the decade between 2001 and 2010.
A downward shift of the potential rate of growth is most clearly evidenced by China’s demographic change. The Chinese government used to be obsessed about attaining a minimum of 8 per cent GDP growth. The key rationale was that an 8 per cent growth rate was seen as necessary to support full employment and maintain social stability. However, in the late 1990s, when the 8 per cent growth target was initially proposed, China’s working-age population was increasing by more than 10 million people a year. In 2012, China’s working-age population declined by 3.5 million people.
Alongside the slowdown of growth, China’s economic structure has also been rebalanced.
Current account surpluses fell from 10.8 per cent of GDP in 2007 to 2.6 per cent in 2012. Although they could rebound if the global economy recovers strongly, the rebalancing of China’s external account is more or less done. This change has led many officials and investors to believe that China’s exchange rate is close to its equilibrium. In addition, the share of GDP growth accounted for by consumption increased from one-third in 2007 to more than half in 2012, according to official data. Re-estimation of these data reveals that the share of total consumption in GDP rose from 47.9 per cent in 2007 to 52.1 per cent in 2010, compared with 47 per cent in official statistics. If these estimates are correct, the investment share of GDP should be 43.5 per cent in 2010, instead of 48.5 per cent in the official statistics. A study by David Li and Sean Xu also suggests that the household consumption share of GDP increased from 36 per cent in 2007 to 38.5 per cent in 2011. These all confirm that rebalancing of the Chinese economy toward consumption-led growth is already underway.
In late January 2013, the Chinese National Bureau of Statistics reported a set of gini coefficients for the years for 2003–12. They show a steady deterioration of income distribution from 0.479 in 2003 to 0.491 in 2008 and steady improvement after that, to 0.474 in 2012. These estimates are harshly criticised by many economists because they appear to contradict the general impression of continuously worsening income distribution. A more plausible view is that the observed structural changes after 2007 or 2008 tell a consistent story of rebalancing. More importantly, they are probably driven by one common cause: emerging labour shortages and rapid wage increases.
I have long argued that China’s reform approach can be characterised as asymmetric liberalisation, that is, complete freeing of the product markets while heavy distortions are maintained in factor markets. The generally depressed costs of production have the effect of subsidies for the corporate sector but taxes on households. This was the key mechanism contributing to both strong economic growth and growing structural imbalances during China’s reform period.
This pattern has begun to change over the past several years, starting in the labour market. Rapid wage increases squeeze profit margins, slow economic growth and escalate inflationary pressure. They improve income distribution, since low-income households rely more on labour income, while high-income households depend more on corporate profits and investment returns. Rising wages also redistribute income from the corporate sector to households and, therefore, boost consumption as the share of household income in GDP increases.
China’s new growth model is still in its early stages. So far, we have only seen the first wave of cost shocks — changes in the labour market — which have a significant impact on labour-intensive manufacturing industries. The second wave of cost shocks — a rise in the costs of capital and energy — has just started. This could affect state-owned, highly leveraged and heavy industries more dramatically because they were previously built on a distorted cost structure. Consolidation of heavy industries could lead to the first recession of the Chinese economy since the beginning of its economic reforms.
This will not necessarily lead to a period of stagnant growth, as analysts such as Michael Pettis suggest. While cost normalisation would shrink economic activity in the state sector, it should benefit the non-state sector, which accounts for 80 per cent of total industrial output.
In short, China is turning into a normal rapidly growing emerging market economy, with slower growth, higher inflation, more equal income distribution, more balanced economic structure, accelerated industrial upgrading and more discernible economic cycles. The government still faces a daunting task of turning China into a high-income country in the coming decades. This will require significant additional reform, including liberalising the factor markets, establishing macroeconomic policy frameworks compatible with emerging market economies, and transforming the role of government from directly supporting production and investment to facilitating innovation and upgrading.