Author: Yu Yongding, CASS
George Orwell once observed: ‘Whoever is winning at the moment will always seem to be invincible’. Not long ago, many in the West declared that China would soon be the number one economy in the world.
But in the past two years, many in the West have begun to see the writing on the wall. Labour unrest, the growing housing bubble, shadow banking, rising local government debt, and overcapacity all point to one thing: the coming collapse of the Chinese economy.
To the disappointment of China bears, the Chinese economy will once again defy dire predictions for 2014. Growth is expected to be near the government target of 7.5 per cent for the year.
Chinese economists are far from upbeat about China’s economic prospects. The consensus is that the Chinese economy has entered the ‘new normal’, characterised by three changes. First, high growth rates have become a thing of the past. Future growth will hover at or below an unimpressive rate of 7 per cent. Second, the government will avoid using expansionary fiscal and monetary policy to stimulate growth as long as the growth rate remains above an unspecified lower bound — probably 7 per cent, even if there is still ammunition left in the government arsenal. Third, further market-orientated reforms will be implemented in a firmer manner even at the expense of growth — up to a limit.
Overcapacity remains the key to the future of the Chinese economy in 2015. Investment and exports have driven the economy over the past two decades. China’s investment consists of three main components: manufacturing, real estate and infrastructure, which, according to Morgan Stanley, accounted for 34, 23 and 18 per cent of fixed asset investment respectively in 2013.
As the single most important driver of economic growth since 1998, China’s real estate investment has maintained a growth rate of more than 20 per cent.
Now, after more than one and a half decades of real estate investment manias, China has built some 700 five star hotels with another 500 under construction, and 470 skyscrapers, with another 332 under construction. Five of the ten tallest skyscrapers under construction in the world are located in China. As a country with per capita income of US$6700, China’s home ownership has surpassed 80 per cent, dwarfing America’s 65 per cent and Germany’s 40 per cent. China’s floor space per person is about 30 square metres. In contrast, Hong Kong’s floor space for the median family is less than 48 square metres, while the average income in Hong Kong is more than US$52,000, more than eight times higher than that in the Mainland.
The government is worried about a real estate bubble and the growing resentment towards skyrocketing house prices, especially for those living in municipal cities. The average young couple in Shanghai must work for 24 years, without spending a single yuan, to save enough money to buy a moderate flat. Following the government’s clamp down, real estate investment growth fell to 12.6 per cent by October in 2014.
The real estate investment slowdown has not only hit growth directly but will also drag down the economy via its impact on manufacturing investment. The government has targeted real estate development as the pillar industry of the economy since early 2000s. A large proportion of economic activity is subject to real estate development.
The steel industry is a case in point. China has built thousands of steel mills with production capacity of one billion tonnes, about half of the global total. With the slowdown of real estate development, the bulk of steel mills immediately went underwater. In 2014, the profit from two tonnes of steel was just enough to buy a lollypop. In 2015, the situation will not change much. The same is true of many other industries in the manufacturing sector. It is difficult to imagine how manufacturing investment growth could speed up to compensate for the impact of the slowing down in real estate investment.
There is room for infrastructure investment. China is trying to build more railways and highways. The so-called New Silk Road strategy will help China to cushion a hard landing caused by overcapacity. But due to the limits of absorption capacity and funding, China is no longer able or willing to re-launch a new RMB4 trillion (US$586 billion) stimulus package for infrastructure investment.
What about exports and consumption? Exports have been a drag on growth for years. China is the world’s largest exporter. The world is too small for China’s exports to keep growing at historical rates. As for consumption, in recent years, household consumption has been increasingly steadily with some ups and downs. But, due to its relatively small share in the economy and consumer inertia, consumption growth cannot suddenly become the engine of growth.
China needs to shift from demand-led to innovation-based growth. Only then can supply automatically lead to demand and Chinese-style overcapacity be overcome. Yet this is no longer simply an economic issue and the change will take time. Even if China embarks on this adjustment, some unfavourable long-term factors — such as an ageing population — will creep in and create large uncertainty for China’s economic future.
In short, after 30 years of breakneck growth, China has reached a new stage. Fraught with serious problems, the Chinese economic juggernaut has to slow. Its high corporate leverage ratio is especially worrying. Local government debt will be compounded by the slowdown.
But China has the extraordinary ability to muddle through and keep the economy going. In 2015, China should be able to hit its 7 per cent growth target. Despite vulnerability in its financial system, it is difficult to envisage how a crisis could play out in 2015. Betting on the coming collapse of the Chinese economy is a dangerous business. This is a lesson at least that China bears should have learned.
Yu Yongding is former Director-General of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. He was Distinguished Visitor to the Reserve Bank of Australia.