Author: Yiping Huang, Peking University
As 2014 fades in the rear-view mirror, the Chinese economy exhibits two sharply conflicting trends: while economic growth continues to decelerate, the stock market is rising steadily. The capital market boom — which started mid-year and accelerated following the People’s Bank of China’s (PBoC) rate cuts in late November — might be supported by expanding liquidity (monetary policy easing) and sentiment (expectations of reform) but certainly not fundamentals (corporate profitability). One major question in 2015 is when and how will China’s current bull market end.
In retrospect, there were three main economic policy issues that emerged last year: the anti-corruption drive, a lower growth target and comprehensive reform. Combined, these represent an important departure from past policy approaches. Even so, many experts argue that the anti-corruption campaign should have been more systemic, the growth target lower and the reform process faster. Chinese authorities identified 2014 as the first year of new economic reform. It may turn out to be a critical year in the transition of the Chinese economy toward a new growth model.
GDP growth in 2014 ended up a touch under the official target of around 7.5 per cent set at the beginning of the year. But this modest growth deceleration appears to have triggered major difficulties in the corporate world.
During the past three decades, two traditional drivers — exports and investment — underpinned China’s strong economic growth. Now both of these drivers have lost their umph. Manufacturing industries that produce investment goods are suffering from high overcapacity rates that average between 30–40 per cent. At the same time, manufacturing firms that make labour-intensive goods are rapidly losing competitiveness due to rising wages and other costs. The latter problem is popularly summarised as the middle-income trap. Industries need to upgrade in order to stay competitive.
The anti-corruption campaign has also had some negative impacts on economic activity. This was reflected by soft spending in high-end markets. More importantly, many officials at different levels of government have become inactive in implementing reform and fiscal policies. For instance, although the government maintains a proactive fiscal policy, fiscal deposits at the PBoC amount to approximately RMB4 trillion at the end of the year.
Far less noticed are the favourable changes taking place in the economy. Despite the downward pressure on growth, there is no sign of a major unemployment problem occurring. This might be due to demographic change. The working age population is now falling by three million a year. It is probably also attributable to a changing economic structure — tertiary industry, for instance, is now bigger than secondary industry. Even income inequality started to decline from a couple of years ago, as evidenced by the Gini coefficient estimates by the National Bureau of Statistics.
Despite significant difficulties in traditional manufacturing industries, the Chinese economy is becoming highly innovatory. The recently US-listed Alibaba is a case in point. Online shopping in China already accounts for more than 10 per cent of total retail sales and continues to grow at 40 per cent a year. China’s express delivery and internet finance services are now world class. Manufacturers of large machinery equipment, electrical machines, cheap mobile phones and other products are rapidly catching up to global leaders.
Economic conditions in China today resemble those of South Korea, Taiwan and Hong Kong 30 years ago. Those economies also faced immense pressures to upgrade their industries. Difficulties in China’s labour-intensive manufacturing are a consequence of past success, while difficulties in capital goods manufacturing are partly exacerbated by past policies supporting investment. But the crucial fact is that innovation is taking place and new industries and products are emerging. This is an explosive change.
Chinese policymakers have decided to lower the growth target further to around 7 per cent in 2015, while inflation is predicted to fall below 2 per cent. This should provide more room for policy easing, although the authorities will likely maintain the current practice of mini-stimulus. Fiscal spending should accelerate through the year, with important reallocations of overhead expenditure on social welfare spending. The PBoC has already lowered the reserve requirement ratio and the market expects it to further reduce policy rates.
Headline macroeconomic data, such as GDP growth and CPI inflation, will probably look unexciting in 2015. But beneath these numbers there should be an important regime change occurring in China’s growth model. New higher value-added services and manufacturing industries — such as the online economy, logistics, and large and small machinery equipment manufacturing — should play greater roles in the economy. The relative importance of traditional labour-intensive and capital goods manufacturing should continue to decline.
The economy also faces important challenges and risks in 2015. These include how to deflate a property bubble, reduce excess manufacturing capacity and lower the financial leverage ratio. None of these tasks are simple. Success or failure in dealing with them and facilitating structural transformation of the Chinese economy depends critically on economic reforms. Two of the most important policy areas will be reform of state-owned enterprises and restructuring of the financial system.
Yiping Huang is a professor of economics at the National School of Development, Peking University, and Editor of China Economic Journal.