China’s Slowing New Normal
MILAN – The world’s
two largest economies, the United States and China, seem to be enduring
secular slowdowns. But there remains considerable uncertainty about
their growth trajectory, with significant implications for asset prices,
risk, and economic policy.
The US seems to be
settling into annual real (inflation-adjusted) growth rates of around
2%, though whether this is at or below the economy’s potential remains a
source of heated debate. Meanwhile, China seems to be headed for the
6-7% growth rate that the government pinpointed last year as the
economy’s “new normal.”
Some observers agree that such a rate can be sustained for the next
decade or so, provided that the government implements a comprehensive
set of reforms in the coming few years. Others, however, expect China’s
GDP growth to continue to trend downward, with the possibility of a hard
landing.
There is certainly
cause for concern. Slow and uncertain growth in Europe – a major trading
partner for both the US and China – is creating headwinds for the US
and China.
Moreover, the US and
China – indeed, the entire global economy – are suffering from weak
aggregate demand, which is creating deflationary pressures. As central
banks attempt to combat these pressures by lowering interest rates, they
are inadvertently causing releveraging (an unsustainable growth
pattern), elevated asset prices (with some risk of a downward
correction, given slow growth), and devaluations (which merely move
demand around the global economy, without increasing it).
For China, which to
some extent still depends on external markets to drive economic growth,
this environment is particularly challenging – especially as currency
depreciation in Europe and Japan erode export demand further. Even
without the crisis in major external markets, however, a large and
complex middle-income economy like China’s could not realistically
expect growth rates above 6-7%.
Yet, in the aftermath
of the global economic crisis, China insisted on maintaining extremely
high growth rates of 9% for two years, by relying on fiscal stimulus,
huge liquidity injections, and a temporary halt in the renminbi’s
appreciation. Had the government signaled the “new normal” earlier,
expectations would have been conditioned differently. This would have
discouraged undue investment in some sectors, reduced non-performing
loans, and contained excessive leverage in the corporate sector, while
avoiding the mispricing of commodities. Growth would still have slowed,
but with far less risk.
In the current
situation, however, China faces serious challenges. Given weak growth in
external demand and an already-large market share for many goods, China
cannot count on export growth to sustain economic performance in the
short run. And, though support for infrastructure investment by China’s
trading partners – especially through the “one belt, one road” policy –
may help to strengthen external markets in the longer term, this is no
substitute for domestic aggregate demand.
Investment can
sustainably drive growth only up to the point when returns decline
dramatically. In the case of public-sector investment, that means that
the present value of the increment to the future GDP path (using a
social discount rate) is greater than the investment itself.
The good news is that
growing discipline seems to be pushing out low-return investment. And
there is every reason to believe that investment will remain high as the
economy’s capital base expands.
But, in order to
boost demand, China will also need increased household consumption and
improved delivery of higher-value services. Recent data suggest that,
notwithstanding recent wage increases, consumption amounts to only about
35% of GDP. With a high household savings rate of around 30% of
disposable income, per capita disposable income amounts to roughly half of per capita
GDP. Expanded social-security programs and a richer menu of saving and
investment options could go a long way toward reducing precautionary
saving and boosting consumption. But what is really needed is a shift in
the distribution of income toward households.
Without a concerted
effort to increase households’ share of total income and raise
consumption’s share of aggregate demand, growth of consumer products and
services on the supply side will remain inadequate. Given that services
are a significant source of incremental employment, their expansion, in
particular, would help to sustain inclusive growth.
Another key challenge concerns China’s slumping property sector, in which construction and prices dropped rapidly last year. If
highly leveraged developers are under stress, they could produce
non-performing loans – and thus considerable risk – in both the
traditional and shadow banking sectors.
Fortunately, Chinese
households’ relatively low leverage means that the kind of balance-sheet
damage that occurred in some advanced countries during the crisis,
leading to a huge drop in demand, is unlikely, even if real-estate
prices continue to decline. It also means
that there remains some space
for expanding consumer credit to boost demand.
That is not the only
source of hope. Wages are rising, deposit insurance will be introduced,
and deposit rates are being liberalized. Internet investment vehicles
are growing. New businesses in the services sector – 3.6 million of
which were started just last year – are generating incremental
employment, thanks partly to a new streamlined licensing framework. And
online platforms are facilitating increased consumption, while expanding
market access and financing for smaller businesses.
China’s leaders
should aim to accelerate and build upon these trends, rather than
pursuing additional fiscal and monetary stimulus. Public investment is
high enough; expanding it now would shift the composition of aggregate
demand in the wrong direction. And, with the corporate sector already overleveraged, a broad-based expansion of credit is not safe.
Any fiscal stimulus
now should focus on improving public services, encouraging consumption,
and increasing household income. Accelerating the expansion of
state-funded social security could bring down household savings over
time. More generally, China must deploy its large balance sheet to
deliver income or benefits that expand what households view as safely
consumable income. Given that private investment responds mainly to
demand, such measures would likely reverse its current downward path.
A further slowdown in
China is a distinct possibility. China’s leaders must do what it takes
to ensure that such a slowdown is not viewed as secular trend – a
perception that could undermine the consumption and investment that the
economy so badly needs.
Michael Spence, a Nobel laureate in economics
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