And, although growth is slowing on a not-unexpected trajectory, it is, according to the Bank, more balanced and sustainable — the ‘new normal’, as it is called, for the world’s second-largest economy.
The World Bank analysis argues that ‘the slowdown in China’s economy growth means the government is making inroads with structural adjustments and policy efforts to address financial vulnerabilities. Over the medium term, these efforts are helping China gradually shift its growth model from manufacturing to services, from investment to consumption, and from exports to domestic spending’.
The government has put in place polices to slow rapid credit growth, contain shadow banking and limit borrowing by local governments, and these have succeeded in slowing investment growth in areas such as real estate. At the same time, it has tried to prevent growth from slowing down too much, with limited but targeted stimulus measures.
‘In 2015, it remains a priority for China to balance reforms and short-term growth’, says the Bank’s chief economist in China, Chorching Goh, ‘because large-scale, broad-based stimulus measures aimed at supporting growth may conflict with efforts to make the economy more sustainable in the medium run’.
China’s economic structure is changing. There is still massive overcapacity in heavy industries, as Premier Li acknowledges, and decelerating export growth and regulatory tightening of non-traditional lending, like softening real estate prices, are dampeners on economic activity. That’s one reason why the One Belt, One Road idea has such traction, as an instrument for boosting external demand for Chinese investment goods.
At the same, growth in services is robust, especially in advanced services such as banking and insurance. And on average, consumption has grown somewhat faster than investment. These structural changes are critical to keeping the economy on the right track. A better allocation of credit to allow this requires big financial sector reforms. The investment-driven growth model helped China’s economy take off, but reforms are needed to enable the financial system to support sectors that have to be the base for reasonable if more modest growth over the medium term.
Today, the sustainability of Chinese growth is at the front of everybody’s mind. And the challenges facing Chinese policymakers have never appeared more real, as Yiping Huang notes in a recent paper, since historically most other countries have failed to graduate into high-income status after reaching a stage of development that is similar to that in China now. With Chinese growth visibly and persistently slowing the bears are coming out of the woods.
Huang reckons the good news is that China’s growth model is already changing, as the World Bank observes, evidenced by a narrowing current account surplus, rising shares of consumption and service in the economy, improving income distribution and high wage shares in income. But so far, he admits, this has been mainly triggered by changes in the labour market, the so-called Lewis turning point. Liberalisation of financial markets, the land system and energy policy are critical for the transformation to continue. Transformation of the growth model is only the first step toward sustainability of economic growth. A more important step is to promote technological innovation and industrial upgrading. China might have been able to achieve rapid economic growth by exploiting its low cost base in the past. But now costs are already rising rapidly. And the only way to sustain economic grow this for the economy to continuously move up the technological ladder to stay competitive.
In this week’s lead essay, Ross Garnaut cautions that China’s slowing growth trajectory masks weaknesses in the structure of transition to the ‘new normal’. He argues that two separate forces are driving the transition to the new model of lower investment and higher consumption. One is the result of straightforward economic pressures, for example in the labour market. The other is the change in China’s national objectives and policy towards a more equitable distribution of income and less damaging impacts on the domestic and international natural environment.
‘China’s new model of economic growth — now described by the Chinese leadership as the ‘new normal’ — embodies structural change at an immense scale and pace’ Garnaut says. ‘But China has made little progress towards the macroeconomic structural changes that are necessary for the new model’s success. Most of this lies ahead’.
The problem Garnaut identifies is that lower growth rates since 2011 seem to reflect the effects of structural problems inherent in the old model of growth more than the effects of transition to the new model. ‘From 2011 China has been more reliant on increases in the capital stock than any point since 1978, while growth in total factor productivity has — as in many countries — had a declining impact on output since 2008. Growth in total factor productivity in China has been high by international standards through most of the reform period, but by some measures stopped in 2014’. This is a worry for, as Huang points out, the drivers of growth going forward have to be located in innovation and productivity-lifting change. The poor productivity outcomes in recent years must be reversed for China to make a smooth adjustment to the new normal.
China has made a start on the transition to its new model of growth. But is still not clear, despite all the innovative activity in the service sector and internet use, for example, that productivity has traction and, as Garnaut concludes, all the elements of transition still have a way to go.
Peter Drysdale is Editor of the East Asia Forum.
There is, arguably a measurement issue of total factor productivity in terms of inputs, particularly capital (investment). Some investment, for example, does not become capital immediately at the time of investment. Then there is a capital utilisation issue. Given Chinese government’s structural adjustment/transition, some capital has been made idle or obsolete that should probably no longer be included as capital.
While clearly China has probably seen a limit on its labour supply, I remember that Professor Meng Xin mentioned at last year’s China Update that there was still large amount of un-utilised labour in China, that cast some doubt on the argument of China has already at or past the Lewis point. If Professor Meng was correct, then one needs to look at the labour market in China differently and there is an issue for government policy to release idle or un-utilised labour into more productive use.
The more rapid increases in wage may be as much as the so called short supply in labour force as the Chinese government policy to force wage to rise more rapidly to ensure social stability.
Another point regarding structural adjustment, there may, arguably, be a dynamic optimisation issue and whether the Chinese government’s policies such as forced closure of many plants of higher energy use or low efficiency ones, has been optimal or not is a question. For example, an alternative would be to more rapidly accelerate the service sector more as opposed to force a reduction in manufacturing activities.
But in China, the government is all powerful and much more powerful than most western countries’ in terms of its relationship with the other agents in the economy.
Another point is the interpretation of the meaning of the “new normal” by the Chinese leadership. The simplest may be that it means a growth from high to “medium high” or “medium to high”. Whether other adjustments are part of the “now normal” or not is a question, because one may interpret those adjustments as reforms under the “new normal” meant by the Chinese leadership.
Perhaps another way to put the dynamic optimisation in a more abstract form in terms of proportions is as the following:
when there is a structural imbalance: one adjustment is to reduce the excesses components to have the structure more balanced. Alternatively, another adjustment would be achieved through expanding the components that are in shortage, so the structure is moving towards to more balanced.