The Meaning of China's Economic Slowdown

The Meaning of China's Economic Slowdown

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More than a year ago I, along with several colleagues, published a paper entitled “When Fast Growing Economies Slow Down.” In it we predicted that a significant slowdown in Chinese growth was coming. While it was not possible to be precise about the timing, we warned that the number of years for which China’s GDP would continue to grow at high single-digit rates could likely be counted on the fingers of one hand.

We got considerable pushback from critics in China and elsewhere. We had underestimated China’s enormous growth potential, these commentators warned. We failed to appreciate that the country’s growth model was unique and that it was not possible to extrapolate China’s future from the experience of other fast-growing economies.

Well, the slowdown is here.

Chinese growth in the second quarter slowed to 7.6 percent, down significantly from the double-digit norms of the past. Indeed the official figures may understate the magnitude of the change. The growth of electricity consumption has been falling even faster; at its most recent reading it has fallen to virtually zero. Unless the Chinese steel and aluminum industries have discovered how to make do without electricity, it would appear that their growth has virtually ground to a halt. That producer prices are falling is more evidence of weak demand.

The question is how much of this deceleration is structural, reflecting the fact that no economy can grow by ten percent per annum forever, and how much is cyclical, reflecting the weakness of the global economy. Clearly part of what we are seeing is structural. The Chinese population is aging. Labor force growth is slowing. Workers, especially in the urban centers, are demanding higher wages, which are being granted to ensure social stability and in response to pressure from foreign companies concerned with matters of image, all of which raises production costs. Other lower-cost national producers, in East Asia and elsewhere, are nipping at China’s heels. At the same time, part of the deceleration is cyclical. The tepid recovery in the United States and crisis in Europe augur poorly for Chinese exports, which were up by only 9 percent in the first half of 2012.  When – it is tempting to say “if” – Europe and the U.S. begin to do better, exports and the growth of the Chinese economy should pick up again.

Chinese authorities also have considerable capacity to offset the impact of these weak external conditions on their economy. As in 2009, in the wake of the Lehman Brothers shock, they are encouraging the banks to lend. They have reduced reserve requirements for the banks and cut policy rates for the first time in three years to make credit more freely available to the economy. They are encouraging state-owned enterprises to invest. Again as they did starting in 2009, they are beginning to roll out additional infrastructure projects.

At one level, it is a good thing that Chinese officials have these policy levers to pull, unlike their counterparts in the U.S. and Europe, whose policy room for maneuver is all but exhausted. The policy response prevents China from suffering unnecessary economic damage from events in Europe and the United States. Insofar as growth faster than seven percent is important for social stability, even graver risks are averted.

But at another level, the policy response is only storing up problems for the future. Prior to the current slowdown, the Chinese authorities had committed to restructuring their economy.  Restructuring meant redirecting Chinese output from foreign to domestic markets, which implied a change in the product mix, given differences in Chinese and foreign spending patterns.  Restructuring meant rebalancing domestic spending from investment to consumption. The investment rate would be lowered from a stratospheric 50 percent, given that no economy can productively invest such a large share of its national income for any length of time. There would be no more construction of ghost towns and no more bullet trains running off the rails, in other words. As wages rose, the share of consumption would be allowed to rise from 1/3 of GDP toward the 2/3 that is the international norm. Bank balance sheets would be strengthened by holding financial institutions to stricter reserve requirements and higher lending standards. The result was to be a better balanced, more stable, and less financially vulnerable Chinese economy.

Given the global slowdown and the Chinese policy response, this restructuring agenda is now on hold. The new measures will succeed in keeping high single-digit growth going for a time, as they did in 2009-10. But they will do so by aggravating the economy’s imbalances and storing up problems for the future. This is not good news for those of us concerned with China’s longer run prospects.

Barry Eichengreen is George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley.   

Comments
6
Ann Elsey
January 23, 2013 at 17:20

The situation is not that bad yet, and still there is so money to make here even for foreigners who want to set up company in china.

Flam
August 1, 2012 at 14:41

In response to US and europe crisis China has to restructure their economy to avoid or minimize severe damage and it is evident that they have high gpd growth in 2009-2010 no had expected this that Chinese can do. But it seems their luck is losing their gdp growth falls on gloomy figures which indicates their economy are slowing down and if this problem persists they will become like US and Europe in one of these days. Restructuring is a good plan but I agree on what author says it store up problems in future, imports of chinese goods will be change into domestic for chinese consumption will not be good for them because their economy largely dependent on imports on goods on what we say “made in china”, how come you will sell a good if people has less money to spend you will earn lesser on amount you need to sustain your bussiness that may lead also to closure of bussiness or worst bancruptcy. Investment will change into consumption which indicates that chinese demands grew that must be meet if China failed to give what is needed it will result to imbalances which can result major internal problems in every aspect of what China has. It proves no matter what powerful your country is in terms of economy can be also subjected for slowing down or struck by crisis. This is a big challenge for China for criticizing and throwing malicious statements against US and Europe(West) because if they failed to give solution to their problems chinese would hate china and may result to social unrest and more.

Nick
August 1, 2012 at 10:03

Elites offshore industrial heart of Europe and USA to China and replac wealth generation capacity with funny money shenanigans and bubbles. So-called developed economies implode from the fraud, ergo china’s markets and economy take the hit. What’s so hard about that?

Mr Eichengreen hesitates to say “if the USA and Europe economies recover” which shows that his comments are not as a scientist but as a biased participant.

tom
July 31, 2012 at 20:25

Changing to a domestic consumption driven growth model is far easier said than done. State management of the economy isn’t compatible with domestic consumption driven growth, unless there are vast untapped natural resources, and there’s not anymore. To make more stuff for its domestic consumers, China must boost imports, and to pay for more imports and rising prices of those imports as it must outbid other buyers, China must boost exports. And that is becoming progressively more difficult. To make better stuff from the same resources, China needs more entrepreneurial culture. It’s getting there slowly but mainly in small businesses and It will not be easy for the party to let go of big industry. Expecting the impetus for a structural reform driven by the party to magically produce entrepreneurial domestic consumption led growth is misguided. That restructuring hasn’t been postponed, it was simply idle talk and lip service that fell by the wayside when more substantive issues arose.

duke chan
July 31, 2012 at 13:17

Meaning social unrests, people will overthrow the CCP and John Chan will loose his job as an internet police officer!

Observer
July 31, 2012 at 03:38

What? Bully china economy is cooling down? From the 50 cents bridgage members, I thought china would have 100 gazillions economy by now. What happend? More like smoke and mirror and dreaming, LOL.

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