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China's Economic Prospects
The fate of China’s economy is a rather important topic these days, to say the least. I write about it each week in my “Week in Review” column and I have intimate personal experience with China (not a very good one, to be honest), but while I will continue to write my regular musings on the topic in WIR, I thought I’d use this space to quote just some of the thoughts of Professor Shujie Yao of the University of Nottingham (U.K.), as published in the South China Morning Post [Hong Kong…I pay good money to subscribe to this publication, I have to add, and thus have no problem quoting Mr. Shujie as I do.]
The world’s investors sift through the semantics of China’s economic policy pronouncements with increasingly desperate optimism. As the eurozone crisis twists and turns, they seek signs of history repeating; a rerun of the 4 trillion yuan stimulus of 2008 [Ed. roughly about $600 billion in those days by my back of the beer coaster calculation] that maintained impressive Chinese growth as the West slipped into recession – and shielded the global economy from worse ills.
China is well versed in economic miracles, but a government decision to roll out an investment program on the same scale as four years ago would be financial suicide. It is time, then, to face up to the uncomfortable reality: the Chinese economy is slowing abruptly and is likely to continue to do so.
Analysts have rushed to predict the nature of the landing. Hard, soft, bumpy even. But there is little value in labeling the situation with loose terminology given the vast differences of opinion over the definition of a “hard landing.”
Economists tend to define a hard landing in terms of declining gross domestic product growth figures and place it anywhere between growth of 4 percent and 7 percent. [Ed. In my 7/7/12 “Week in Review” column, I personally have settled on 6 percent as still being a “soft landing,” with the important caveat…assuming the 6 percent is a real number.] Perhaps a more simple measure based on the principles of econometrics will suffice.
A soft landing indicates a short-term fall in growth, a fluctuation rather than a trend. A hard landing is reflective of a structural break, an intense downward adjustment that will prevent the Chinese economy from returning to current growth levels for at least the next three years, perhaps ever. Of the two scenarios, the most compelling evidence points to the latter.
That Premier Wen Jiabao has set a growth target of 7.5 percent for this year is highly significant. It marks the first time in a decade that China has aimed for growth of less than 8 percent. This figure demonstrates realism and appears conducive to setting China on a more sustainable path of development, both in terms of raising the living standards of Chinese people and environmental protection.
But there is little evidence to suggest that the decline in growth is a result of progress in rebalancing the economy, away from a low-cost manufacturing, export-driven model to an innovation-led economy powered by domestic consumption….
[China’s] export competitiveness is shrinking. Rising wages, an ageing workforce and higher commodity prices have all taken their toll. This is not to say all Western companies will up sticks, at great expense, in search of another Asian exporter. Ultimately, higher costs will be passed on to consumers. To take up the slack of a weakening export sector, an increase in technological innovation within the private sector and a surge in domestic consumption are required. But this requires long-term strategic planning and in recent weeks Beijing has panicked into searching for ways to revive growth in the short term through yet more investment.
The cracks in the fabric of the Chinese economy are gaping. In recent years, investment recorded an annual increase of 25 percent to achieve 10 percent economic growth. Ordinary people’s livelihoods have suffered as a consequence; 50 percent of GDP has been used for further industrial investment rather than developing a more comprehensive social security system. Chinese society is more divided than it has ever been and tensions between workers and employers, the people and the government can only rise….
The fiscal stimulus in 2008 spawned a swathe of wasteful, highly polluting infrastructure projects often with no long-term return. A repeat is not feasible. The government does have some tools at its disposal. As long as inflation remains under control, it can reduce the bank reserve deposit ratio and cut interest rates, a decision it took recently. The long-term benefits, however will be minimal. [Ed. this week the June CPI came in at just 2.2 percent…giving the government the further flexibility Professor Shujie alludes to.]
Chinese policymakers must fulfill their promises to boost the growth and competitiveness of the private sector by increasing lending and offering tax incentives. The monopolistic environment in which state-owned enterprises operate is in urgent need of radical reform. During the boom times, SOEs enjoy abnormal profits, negating the need to innovate; in the hard times, they are bailed out by central government funds, thus perpetuating the cycle.
China’s sword of Damocles has long been the housing market – and the bubble that encompasses it. The government introduced a raft of policies to curb house price inflation, which seems to have worked in the major cities….
[But] a collapse of the housing market would lead to an accumulation of banks’ non-performing loans and cash-strapped local governments would see revenues, obtained through often legally dubious land sales, plummet.
The Organization for Economic Cooperation and Development forecast Chinese growth at 8.2 percent this year before rebounding to 9.3 percent in 2013. But with the eurozone crisis threatening to incapacitate China’s largest trade partner [Ed. China mentioned the eurozone this week as a major issue], this prediction appears wayward. A gradual decline to 6.5 percent is more realistic. Eternal double-digit growth was, of course, never a possibility. The Chinese people must get ready for three years of hardship. In return, the Western world, which has become dangerously reliant on China to prop up the global economy, must adjust its expectations.
Wall Street History will return in two weeks.