The 'China slowing' story has dominated the financial markets' gloomy commentary for the past few years, so the recent official GDP growth figure of 6.9% for the year to the September quarter gave commentators another opportunity to find the dark cloud in every silver lining. The figure met the official target of 'around 7%', but it was greeted with widespread scepticism. Last week’s monetary tweak is an acknowledgment that growth is slower than the authorities would like.
What should we make of all this? To put this into perspective, we need to address the specific issues one-by-one:
- Are the GDP figures reliable?
- Isn't 7% a lot slower than China's normal breakneck pace of growth?
- Is 7% growth sustainable?
- Is a smooth transition from double-digit to 7% feasible?
Can we rely on China's GDP measure?
In a narrow sense, GDP figures are bound to be unreliable.
Let's leave aside the natural scepticism generated by the Chinese statistics that are published so promptly and which always meet the official target. Instead, let's just note that even in mature economies, there is a lot of guess-work, approximation, extrapolation, dodgy deflators and uncertain quality-adjustments in every country's GDP figures. But outside China, there is less pressure to meet a target growth-rate.
There is also a long history of incredulity, although nearly all observers accept China has done well since the 1980s and had a stunning burst of growth this century. Recent growth estimates, however, have raised more-than-usual doubts. Anecdotal reports cite manufacturing overcapacity and limp property markets. But ad hoc indices based largely on real production (such as the 'Li Keqiang' index) would not capture the transition from an economy driven by steel and concrete production to one where services (education, schooling, health, travel and so on) play a dominant role: services now account for more than half of recent growth and are notoriously hard to measure in GDP.
Perhaps the best response is to remain agnostic about the quarter-by-quarter figures, and accept that China (like other countries) will have economic cycles during which growth slows temporarily. We should, instead, focus on the underlying growth dynamic.
Is the current underlying trend much lower than usual?
Here is the context. China had a period of double-digit growth in the decade leading up to the 2008 financial crisis. Such growth is unusual, but by no means unprecedented: Japan, South Korea, Taiwan and Singapore have all had such growth spurts. All these countries had extraordinarily high saving and investment. The most important common factor is that they started from a low GDP base, giving them great potential for a quick catch-up. You don't have to invent better ways of doing things; you only have to borrow from rich countries which are ahead on the technological frontier. This is the 'convergence' story referenced in 'The End of Economic Convergence? Not Quite'.
China had other things going for it as well. These included a huge pool of surplus labour in agriculture, which could be shifted into manufacturing and other urban jobs, a transfer that in turn created a great need for urban dwellings and infrastructure.
But these double digit growth spurts could not (and did not) persist in any of these countries. China's point of inflection came in 2008-09, coinciding with the global financial crisis. This slowing was hidden, temporarily, by a policy stimulus far larger than in any other country, which pushed growth back into double digits in 2010 and 2011. This was artificial and unsustainable.
Thus, in underlying terms, the growth inflection should be dated at 2009. The catch-up on urban house construction was showing signs of satiation. The seemingly endless supply of rural labour was looking less limitless (the 'Lewis turning point' was beginning to impinge). A recession-hit global economy was no longer able to take up China's manufacturing surplus, which is why the current account surplus, after peaking at over 10% of GDP in 2008, fell rapidly.
The Chinese authorities recognised this quickly enough, and started talking about growth rates starting with a '7'. For the past three years, this is what the GDP growth figures have shown. This 'new normal' is a lot less than pre-2008 growth, but the big shift in the underlying rate occurred five years ago. It is now an old story, with a good part of the adjustment already made. This new normal would still be enough to double China's GDP every decade. It's also worth noting 7% growth on today's higher GDP represents a bigger increase in physical production than the double-digit annual expansions before 2009, when GDP was much lower.
Let's just accept, then, that whatever the variations in the quarterly figures, the underlying trend growth may well be somewhere around 7%. Is this sustainable?
How long can the new normal last?
Given China's starting point — per-capita income is still only around one-seventh of the US — it still has a lot of potential catching up ('convergence') to do.
On the supply side, there is still potential for shifting surplus agricultural labour into more productive work. Certainly there seems no shortage of investment entrepreneurship. There are plenty of inefficiencies (especially in the state-owned enterprises) to be ironed out, to the benefit of GDP.
On the demand side, dismantling the 'hukou' system restrictions would give all those involved more incentive to demand the urban facilities they are currently denied (housing, health services and education). Whatever the temporary over-building of dwellings or infrastructure, China needs to build perhaps 200 cities the size of Singapore, with all the deep infrastructure and modern dwellings seen in that country.
Certainly, there are challenges. China can't go on stimulating demand by fast credit growth and profligate budgets. But the nature of the transition required seems feasible: the task over the next decade is to shift around 10% of GDP from investment into consumption. Most countries have the opposite problem; the politically far more intractable challenge of stimulating investment and restraining consumption. For this purpose, the Chinese have a singular advantage over Western countries: a command economy which can 'think big', take risks, absorb losses without losing momentum and push through the necessary transformation.
Will it be a bumpy ride?
This leads to the last issue: will this transition be smooth? Even an authoritarian administration has political constraints. And policy-makers will no doubt make some errors. Growth is, intrinsically, a syncopated process, with spurts and reversals. But 7% growth is not such a high bar. Indonesia, hampered by weak micro-economics and poor governance, averaged 7% annually during Suharto's three decades. China, with its imperfect but comparatively superior administration and entrepreneurial dynamism, should be able to do at least as well as that.
Why, then, are seasoned observers like John Garnaut praising the forecasting abilities of the chief growth sceptic Michael Pettis? We'll have to wait longer to see who was most prescient about China's growth path. We are, however, already half-way through the decade in which Michael Pettis said average growth would barely break 3% (see his bet with The Economist). It would take not just a dip in GDP growth but a sustained recession of negative growth for the rest of this decade before that bet pays off.
Eventually China must follow the pattern of those countries which have converged onto the technological frontier, where growth no longer depends on 'catch-up' and the far more difficult task of technological innovation must be faced. But China has many years of convergence before it arrives there.
In the meantime, for all the financial-market alarm about the latest blip in the production managers' index (PMI), the gyrations in equity markets and a minor exchange rate adjustments, China is likely to grow around twice as fast as the mature economies. The current IMF forecast is for numbers starting with a '6'.
With this sort of growth, Australia is still the lucky country, well located to be pulled along on China's coat-tails (see 'How Dependent is Australia on China's Economic Growth'). We might, however, have to do our own transformation: less resources and more food and services. Are we as capable of transition as China?
Image courtesy of Flickr user Matthlas Mendler