China’s National People’s Congress, the supposed decision-making body for China’s leaders, has just finished meeting. And the main debate (apart from behind the scenes discussions on who would take over as the new leaders from the retiring leadership) was about the state of the Chinese economy.
Mainstream economics is confused about which way the Chinese economy is going. Some media and economists reckon Chinese growth is slowing fast from its double-digit pace seen in the last few years and indeed is heading towards a crisis or slump brought on by ‘over-investment’, a reversal of a credit-fuelled property bubble and a spiralling of hidden bad debts in the banking system. On the other hand, some economists reckon that economic growth may be slowing, but the Chinese authorities will be able to engineer a ‘soft landing’ through the easing of credit and financing of the writing-off of debt from cash reserves built up over past years.
Behind this debate on the immediate future also lies a debate on whether China can continue to grow fast through investment in industry, infrastructure and more exports or will need to switch to a consumer-led economy that imports more and supplies goods to a ‘rising middle-class’ like advanced capitalist economies supposedly do. Mainstream economics reckons that this cannot be done without developing a more ‘market-based’ economy i.e. capitalism, because the ‘complexity’ of a consumer society can only work under capitalism and not under ‘heavy-handed’ central planning of government and state industries.
In this first part of a look at the Chinese economy, I’ll consider what will happen over, say, the next two years or so. China has experienced truly exponential economic growth over the last decade in particular. And that growth continued apace right through the Great Recession that the major capitalist economies suffered from 2008-9. But now the question is: can that ‘breakneck’ pace continue or is it really breakneck?
Chinese economic growth is clearly slowing down. In the first two months of this year, industrial production grew 11.4% yoy compared to 12.8% in December 2011, while China’s power generation increased 7.1%, the slowest growth rate in a year. Fixed asset investment, the main driver of the Chinese economy, was below historical averages. Fixed asset investment growth actually accelerated to 21.5% yoy up from 18,2% in December, although this acceleration was concentated in unproductive investment in property sectors. The comsumer weakened and passenger car sales fell 4.4% yoy to 2.37m vehicles and total auto sales fell 6% yoy to 2.95m units. Retail sales increased 14.7% yoy in early 2012, down from an 18.1% ypy in December 2011. Overall real GDP growth has slowed from a peak of 11.9% yoy in Q1 2010 to 8.9% in Q4’2011, At the People’s Congress, the Chinese leaders targeted real growth at just 7.5% this year, something not seen since the depth of the Great Recession in Q4’2008.
Yet, by global standards, that’s a growth rate to envy: the US can barely manage 2%; Europe and Japan are flat at best, while even fast-growing India will not achieve that rate of growth this year. But the Chinese economy needs to grow by at least 8% a year in real terms if it is to generate enough jobs to absorb the influx of workers from rural areas into the cities without unemployment rising. So there would appear to be a problem ahead. But remember, a target is just a target: China’s GDP has always grown more than projected. Take a look at the chart below. The yellow line shows how China has conservatively set its target GDP growth for the past decade. Every year, actual GDP growth has been higher and much higher in some cases. For example, in 2007, while the government projected GDP to grow 8%, actual GDP growth came in much higher at 14%!
The main argument presented for expecting that China is heading for a sharp slowdown, or even what is called a ‘hard landing’, is that its fast growth in recent years was based on excessive credit injections by its banks, creating a property bubble that is now bursting. Much of the property bubble was engendered by local authorities borrowing huge hidden amounts from the banks and financing their spending by selling off land to private developers, often literally over the heads of the local villagers.
That property bubble is now bursting. Property prices are falling in most Chinese cities and are down 1.5% yoy. Huge debts have been run up local authorities and developers and hidden in special purpose vehicles off the balance sheets of the banks. The level of the what is called the total social funding of the economy by the banks has reached 180% of GDP. This ‘shadow banking’ is similar to the off-balance sheet mess that the US and European banks got into that led to the financial collapse of 2008. The risk is that China is heading the same way. But is it?
First, the government has succeeded in reining in inflation, mainly caused by higher food and energy prices globally. Inflation is now at its lowest level since 2010.
So the government is now able ease its monetary policy by cutting the reserve requirements imposed on the banks to hold cash at the central bank, so they can lend more or at lower rates and take some of the pressure off borrowers over the rest of the year. Monetary growth is already beginning to turn up. And the new budget announced by the government offers some support to growth, if not as much as the humongous increase in public spending adopted in 2008 to counteract the global economic slump.
Fiscal spending will rise 14% this year with spending on health, education and social security up 19% – hardly austerity. Taxes on small businesses are being cut as is VAT. Local government financing through property sales will be curbed, so the issue of local government bankruptcies remains. But central government has huge reserves to fund such defaults from FX reserves of $3trn and fiscal reserves of CNY500bn in the budget.
Mainstream economics has made much of the news that China ran a deficit on its trade with the rest of the world in the first two months of this year, the first time in a decade or more. Exports are important to China. During the global crisis, mainstream economics predicted the collapse of Chinese economy because exports accounted for 35% of GDP. With the negative demand shock from the West, export-led growth collapsed, and so would China – that was the conclusion they considered only logical. But GDP is driven by net trade (exports minus imports), not just by exports. In fall 2008, net exports were 8% of GDP and today are still about 4%. Private domestic demand has been strong. And easing fiscal policy will boost aggregate demand.
The stories of gloom and doom for China have been around ever since the onset of the global crisis in 2008-9. A new round of doomsday prophecies has been accelerating since summer 2011, when the Eurozone crisis escalated and Washington’s debt-ceiling debacle resulted in the downgrade of the U.S. sovereign credit-rating. Now the argument is that Chinese economy is about to face a “hard landing” because of a bursting property bubble, disproportionate reliance on exports, and excess capacity caused by growth through investment. But since the housing downturn is induced by policy, it can also be reversed by changes in policy, which is precisely what happened in China during the global financial crisis. At worst, China is likely to experience slower growth than in previous years. That’s all.
The big story that came out of the People Congress was the sacking of Bo Xilai as party boss from Chongqing. Bo was a controversial and flamboyant figure ostensibly attacking inequalities and pro-capitalist policies. So what does his removal mean? I’ll deal with this and the long-term prospects for China in part two.