China’s slower growth trajectory

Author: Peter Drysdale, Editor, East Asia Forum

 China’s growth outlook is the focus of analysts and economic policymakers all around the world. Nobody can afford now to ignore the scale of the economy and its impact on the global growth outlook. China already accounts for more than 12 per cent of world output in nominal terms and that share continues to grow steadily.

China’s contribution to global trade and output growth has been far bigger than that of any other economy over recent decades. This year too, though it’s a smaller economy, it is likely to contribute a larger share to global output growth than the United States. Strong growth of heavy industry and infrastructure investment fuelled the huge global commodities boom during the first decade of this century. This was a welcome development, despite the adjustments it inevitably brought in world markets, as the industrial world struggled with a sharp decline in output and slow recovery through the global financial crisis.

There are some who question whether China’s growth was ever quite so rapid as the official data record. The sceptics suggest that there were incentives to over-estimate some elements of growth, and they may have a point in thinking so since meeting state output targets is — how shall we put it — subject to some fungibility. There is still a bunch of China growth-deniers entrenched in centres of strategic analysis in Japan, for example, who want to downplay China’s colossal growth achievement over these years as they hanker after the golden days of Japan’s own remarkable growth achievement and regional dominance.

There may have been fudging of the Chinese economic data and there may have been waste and profligacy in some state-backed investment projects around the edges. But there is no wishing away China’s remarkable growth and the substantial, positive benefits it has brought to hundreds of millions of ordinary Chinese people. China’s economic stature, its newly accumulated economic assets and its transition to middle-income economic status are real. The achievement is also now a reality that Chinese policymakers have to face as they struggle to stay on course in guiding the economy through middle-income to OECD advanced country living standards over the next two decades or so.

With a GDP growth rate that has slipped below the average 10 per cent at which the economy barrelled along for more than three decades, China faces more and more questions about how its leadership and policymaking authorities should manage the next phase of the country’s economic development.

As one of the top analysts of the Chinese economy, Yiping Huang, points out in this week’s lead essay, a central question is whether the current deceleration in growth is cyclical or structural in character. Is growth tapering off because of under-utilised capacity in a weak global economy? Or has the real potential rate of growth of the economy been trimmed as aggregate labour supply has begun to shrink and real wages have begun to climb?

The official government growth target was set at around 7.5 per cent this year. But, when growth slowed to 7.4 per cent during the first quarter, as Huang reports it, ‘the government almost panicked’. Policymakers feared that there could be major problems with unemployment, financial risk (with the bursting of real estate bubbles in some major centres) and investor confidence should growth slip below 7.2 per cent, although the evidence on which these fears were based is weak. As the leading Chinese demographer and economist Cai Feng has written, ‘in the period 2001 to 2011, total urban employment (urban resident employees plus migrant workers) increased by 115 million. Even if this number is cut in half in the next decade, it will still be much higher than the new supply of labour constrained by the decline in the working age population. In the future as in the past, it will be rural-to-urban migrants — not new local entrants to the labour force — who will meet the demand for labour caused by economic growth’.

Huang highlights three problems for the Chinese economy. The first is the slow global recovery and negative effects of previous stimulus policies that generated over-investment and capacity. The second is a growth model that no longer attacks the burning problems of the time, such as over-investment and income inequality. The third is steering a way through the middle-income trap challenge. Only the first of these is cyclical in character. The second two are structural and underline the challenge of maintaining higher growth potential through lifting productivity as the supply of cheap labour dries up.

Chinese exports can no longer, for example, continue to grow at more than 20 per cent a year because of the sheer size of China’s economy. The growing consensus among the experts, as Huang suggests, is that China’s current growth potential lies somewhere between 7 per cent and 7.75 per cent — possibly lower than the lower bound, depending on what can be assumed about the speed of putting in place productivity-enhancing reforms.

Is it still possible for China to achieve medium-to-rapid economic growth in the coming decade as the steam runs out of the export and investment-led growth model? As Huang argues, that will all depend on the policy strategy. Long-term growth cannot occur via fiscal stimulus, which will create more zombie firms, inhibit productivity, profitability and job creation in viable firms and deliver white elephant public investment projects.

The more effective strategy for achieving relatively rapid economic growth is through accelerating economic reform. It’s estimated, for example, that reform of the one-child policy and the hukou system of household registration, combined with improvement in human capital, could raise China’s future growth by 1 to 2 percentage points and that more complete financial reforms could lift growth by 1.4 percentage points. The International Monetary Fund finds that a comprehensive reform program, rigorously implemented, might see Chinese growth fall by 0.2 percentage points in the near term but increase by 2 percentage points by 2020.

Huang concludes that the government has to both accelerate structural reform and tolerate some growth slowdown in the near term, which is what Likonomics is supposed to be all about. The question for China is whether there is the nerve for it.

Peter Drysdale is Editor of the East Asia Forum.

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