Economy, Talking Point

The great debate

Does the government still have the tools to keep growth at 6%?


Walking the wire: China tries to balance growth with debt sustainability

Back in March 2009 we here at Week in China wondered if the impact of the global financial crisis would see the Chinese economy grow at less than 8%.

Probably not, we reckoned, because the number was so deeply engrained as a bottom line for policymakers. Civil servants always cited it as sacrosanct and a survey of 73 economists sent the same message that year with GDP predictions that came in at a precisely 8% GDP growth rate too (see WiC8).

For many years eight seemed to be the magic minimum for Chinese planners, even though the economy tended to grow at a much faster rate. One suggestion for how that came about dated back to 1982 when Deng Xiaoping was said to have asked then General Secretary Hu Yaobang how China could quadruple its economy by 2000. Hu said 8% growth a year would do it.

Of course, such statistical certitude couldn’t last forever and change finally came when the growth target was cut below 8% in 2012. Since then it has been reduced at more regular intervals, dropping this year to as low as 6% (after the government set a range of 6-6.5%).

Both the World Bank and the IMF are predicting a figure that falls below the psychologically key level of 6% next year. Last week the National Institution for Finance and Development was the first of the domestic think tanks to break ranks by predicting 5.8% for 2020. Elsewhere the debate is whether China’s economic slowdown is a result of short-term challenges or the sign of a sharper, structural decline.

Blame the trade war for the disappointing numbers?

The commentary on the lower rate started out that way this year, with the pain felt first in the export numbers and the manufacturing sector.

Li Keqiang, the country’s premier, warned in September that it was already getting more difficult to maintain a higher growth rate because the economy was so much larger than in the past. But he also highlighted how ‘external factors’ were hurting the economy, citing the tariff row with Washington and its dampening effect on demand in general. They combined to drag down China’s export sector in the first three quarters of this year, which declined 0.2% year-on-year, compared to 11.2% growth a year earlier, and there were more warnings last week when the Chinese cabinet sought advice from private sector economists, as Li suggested the “external environment” was “complex and severe”.

But won’t the worst be over once the two sides strike a deal?

Despite weeks of speculation, there is still no certainty that a trade deal is about to be reached. According to Bloomberg, China’s vice premier and chief trade negotiator Liu He, however, told attendees at a dinner in Beijing that he was “cautiously optimistic” about reaching a phase one deal with the US.

Even if an agreement is announced, it won’t be a resolution of the underlying issues. What looks more likely is a stopgap solution, allowing tariff relief for some of China’s exporters in exchange for commitments from the Chinese to purchase larger quantities of American farm goods.

Nor will that address the tensions that have been building up around Washington’s blacklists of Chinese tech brands or the brewing row about barring access to US financial markets (see WiC470).

With a presidential election coming up it will be harder for the Trump administration to drop its demands for more fundamental changes to China’s economic practices. And if Trump loses next year’s contest, there is little to suggest that his replacement won’t take a hard line with the Chinese as well. Indeed, it might even get tougher for Beijing if a new president finds it easier to build a coalition of support behind American demands. Taken together, the prospects of the trade war subsiding entirely look pretty remote.

In the meantime, what is Beijing doing to steady the situation?

In the wake of the global financial crisis a decade ago the response was infrastructure investment, with massive spending on roads, railways and bridges (see WiC2).

The response to another slowdown five years ago was to concentrate attention on the construction sector (see WiC316), including a major programme of urban renewal to replace slums with affordable housing.

What’s clear this year is that policymakers don’t want to turn on the spending taps like they did after the global financial crisis, because they are trying to bring down debt levels in key areas of the economy. They’re also more cautious about picking out the property sector as a way of firing up growth, especially in more affluent cities, where home prices have moved beyond affordable levels for many people.

The alternative is a more targeted approach that tries to avoid the negative effects of swamping the economy with stimulus. That’s included measures to make more cash available to companies needing credit, such as reductions in bank reserve ratios, which free up more capital in the financial system. There have also been cuts to the cost of borrowing. On Monday the central bank tweaked another lending rate that reduces short-term funding costs for the banks and then on Wednesday it cut the loan prime rate, which serves as a benchmark for mortgages.

That should be enough to stabilise the economy?

Maybe not, warns Julia Wang, senior economist for Greater China at HSBC, who says that the deterioration this year is a lot sharper than during the slowdown in 2012-15.

Also worrying are signs that disruption in trade-oriented sectors like manufacturing is starting to spill over into the domestic economy. That’s being seen in a flattening off in household incomes, as well as indications that the unemployment rate is rising. The jobless rate has climbed past 5% since the start of this year, according to official data from 31 cities.

The same kind of sentiment is bringing down producer prices at the factory gate and blunting the impact of a major round of tax cuts for companies, because businesses are holding back on reinvesting the savings until there is a better outlook.

Demand dropping at home is more of concern now that domestic consumption contributes so much to the economy – more than 60% of its growth in the first 10 months of this year, according to official data.

The downturn is also evident in deflating prices for consumers, something of a surprise when the headlines this year have been about how inflation has been spiking aggressively. Indeed, the CPI in October was the highest since January 2012 and well above the government’s target. But that has been triggered by the explosive impact of swine flu on pork prices (and the knock-on effect for substitute meats). Take out the food items and core consumer inflation has been much more sluggish.

Taken together these trends mean that more action is needed to boost confidence across the economy, says HSBC’s Wang, with bigger and bolder steps to reinvigorate China’s “animal spirits”. That should include a new round of reforms accelerating urbanisation, more fiscal spending from the central government, further tax cuts and more encouragement for the private sector, she says.

Longer term, China still has room to grow?

The central government has tried to shift some of the focus away from growth alone to a wider range of indicators, realising that an over-concentration on gross domestic product wasn’t always productive. That’s been a harder habit to break for local government officials, who were accustomed to being promoted on the basis of such figures. At a more senior level, stewardship of the economy is also a crucial part of the Communist Party’s claim to leadership, which has been crystallised in policy commitments like creating a ‘moderately prosperous society’ by 2020.

That promise was made in 2010, requiring a doubling of the economy within a decade. Fulfilling it now requires growth of 6.2% next year, Cissy Zhou estimated in the South China Morning Post earlier this month. That looks unlikely in the current circumstances, although she thinks that the authorities still have cards to play, especially via the fourth in the series of national economic censuses, which is being conducted this year. There were recalculations in the growth numbers after each of the previous surveys, Zhou says, and something similar this year would help policymakers announce its ‘moderately prosperous society’ was on schedule.

Of course, doing that wouldn’t do much to dilute the scepticism about some of the economic data or the warnings from those who believe that the economy is feeling the early effects of a structural slowdown, rather than a cyclical one.

Another of the research pieces from HSBC’s economics team this month takes a different view, however, arguing that China hasn’t reached the end of the road in its development model.

When Qu Hongbin, HSBC’s chief China economist, looked at how Japan, South Korea and Taiwan fared when growth started to slow, he found that they dropped out of the high-growth bracket only when GDP per capita (a proxy for productivity levels) reached 50-60% of the country with the most advanced technology at the time (the United States).

Because GDP per capita in China is still less than 30% of the level in the US in purchasing power terms, that should mean there is still room for its economy to grow strongly, he advises. Supporting this stance is another piece of research from HSBC this month outlining that China’s economy is still set to benefit from a productivity boost.

One factor is changes in China’s workforce, it says. While it’s true that the working age population has started to shrink, what’s important is that the people joining the workforce are now much better educated than the ones leaving it.

The Chinese are educating more than a third of the world’s STEM (science, technology, engineering and maths) graduates, for instance, creating the human capital for industrial upgrading and innovation in the years ahead.

Also getting focus is how the benefits of more than a decade’s worth of massive infrastructural investment will boost the economy over the foreseeable future. An example is the electricity grid, which now exceeds those of higher-income countries in areas like efficiency and power loss.

There’s been a step-change in bullet trains as well, where the Chinese account for more than two-thirds of the world’s high-speed rail network. Investment in other types of train lines has been equally extensive – over the last decade, the number of cities with metro lines has more than tripled to 34. This will bring productivity gains in areas like shorter commuting times for passengers. By connecting businesses across different cities, there will be network effects too, powering the emergence of new economic clusters.

Another dividend is coming from investment in IT and communications infrastructure. That is already being witnessed in the world’s largest market of smartphone users, which is spurring transformation of the retail sector and the spread of new consumer services. China has also been catching up quickly with higher-income nations in areas like broadband deployment and it is positioned as a pioneer for 5G (see WiC473) with more than 50 cities expected to switch on the new standard by the end of the year.

All of this means that the Central Economic Work Conference (usually held at the year end) will still be watched closely for clues on how the government is going to set economic policy next year. But even with the GDP numbers looking shakier, the foundations of China’s economy are firm for the years ahead, reckons HSBC’s Qu.

“For China, we believe the key factors for economic development – strong infrastructure and high quality human capital – are in place for it to transition into an innovation and productivity-led growth model, supporting its economic development in the years to come,” he predicts.

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