China macroeconomics

8/13/2019 China macroeconomics

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Figure 1: Growth in China is noticeably

higher than in the G7

Source: Datastream

Figure 2: Investment component drives the

extremely powerful growth rate

Source : Datastream

ContactDr. Alessandro Bee

Economist

+41 58 317 9283

[email protected]

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China consumption contribution of GDP growthChina investm ents contribution of GDP growthChina net exports contribution of GDP growth

1 | Macro Focus Economic & Strategy Research

Challenges facing the MiddleKingdom Chinas economic model proved successful in the past, but it is now reaching its limits China announces the right reforms, but implementation poses the biggest risk The untapped potential of urbanisation and capital stock will help to advance this pro-

cess

The need for reform in China

The Chinese economy has been chiefly as-

sociated with unbridled growth in recent

years. But nowadays, the Middle Kingdom is

mostly associated with the reform concept.

Given the marked cooling in Chinas eco-

nomic momentum recently (see Figure 1),

the need to reform its economy has become

progressively more important. Chinas eco-

nomic policies over the last 30 years have

scored big successes in this respect. The

economy has expanded by about 10% p.a.

since 1980. Growth in China has far out-

stripped economic growth in the G7 coun-

tries.

Investments drive growth

Chinas breakneck economic growth was

mainly fuelled by a massive increase in in-

vestment activity (shown in Figure 2).

Whereas investments in the USA currently

contribute less than 20% to growth, in China

the figure is close to 50%. There are good

reasons for this: 1) China has an extremely

high savings rate. On the one hand, this is

explained by its rapidly aging population, to-

gether with the lack of a social safety net.

On the other hand, Chinas underdeveloped

capital markets offer savers few alterna-

tives. The high savings rate also means that

the investment ratio is above 40%. 2) Regu-

lations are used to keep interest rates arti-

ficially low. Figure 3 shows that in recent

years, real interest rates were on average

negative. By keeping capital costs artificially

low, both the banking system and invest-

ments profited from this regime of financial

repression. 3) Despite Chinas one-child pol-

icy, its working age population has in-

creased from 59% to 73% of the total popu-

lation over the last 30 years. 4) But Chinas

progressive urbanisation is far more im-

portant. Whereas in 1980, more than 80%

of the population were employed in the (not

very productive) agricultural sector, this per-

centage has since declined to 50%.

5) Cheap and abundant resources meantthat China was able to expand its manufac-

turing industry and boost its exports. China

benefited from the fact that the last 20

years were characterised by the rapid global-

isation of product markets and that a boom

in US consumption until Lehman Brothers

collapsed created strong demand for Chi-

nas products.

Unsustainable growth model

Chinas growth model has proved very suc-

cessful to date, but it has also created ex-

ternal and internal imbalances, which pose

a threat to its economic stability in the long

term. 1) In terms of foreign trade, the future

Macro FocusEconomic & Strategy Research21 November 2013


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Figure 3: Financial repression in China

negative real interest rates

Source: Datastream

Figure 4: Investments as % of GDP in Chi-

na, Korea and Japan

Source: Datastream

Figure 5: Urbanisation in China, Korea and

Japan

Source: Datastream

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China urban population in % of totalKorea urban population in % of tot alJapan urban population in % of t otal

2 | Macro Focus Economic & Strategy Research

potential of Chinas export markets in the

West has greatly diminished because the

industrialised world continues to suffer the

consequences of the Great Recession.

2) Regarding the domestic economy, China

faces a decline in its working age population

in the coming years, which could potentially

accelerate wage growth. 3) In terms of in-

vestments, there are increasing signs that

the artificial stimulation of investments hasresulted in a misallocation of resources. The

corporate debt bubble and real estate bub-

ble are evidence of this. There is a risk that

investments in future will no longer be able

to boost production to the desired extent.

Chinas reform plans

Chinas leadership recently announced wide-

ranging reforms at the third plenary session

of the 18thCentral Committee of the Com-

munist Party of China. They are designed to

reduce the economys external and internal

imbalances (rebalancing). The central focus

of this rebalancing process is to strengthen

consumption. Setting up a social safety net

is an important aspect of this endeavour.

Strengthening consumption goes hand in

hand with changing the structure of the

economy from the current model of an ex-

port-based manufacturing industry to that of

a domestic-oriented services sector. Since a

large part of Chinas manufacturing industry

is in the hands of quasi-government organi-sations, whereas the services sector is

dominated by privately owned companies,

this also entails the privatisation of the

economy. Also of central importance is fi-

nancial liberalisation, which should spell the

end of financial repression in China. On the

one hand, consumers will have access to

new resources, while on the other hand, the

introduction of market-based capital costs

reduces the risk of bad investments. The re-

form plans recently outlined by the Chineseauthorities address all these key issues;

however, it is the implementation phase

that usually determines whether reforms are

successful. Nonetheless, it must be said

that Chinas leadership has successfully

executed its reform policies over the last 30

years, which gives rise to the hope that this

time will be no different.

Two transition scenarios

There are two potential scenarios for Chi-

nas impending rebalancing. In the optimis-

tic scenario, China manages to maintain the

current economic model for several years

and, as a result, generates high growth

rates. Supported by strong growth rates, the

Chinese government manages to gradually

introduce the pending reforms and the coun-

try makes a smooth transition to the new

economic model. In the pessimistic scenar-

io, the current economic model very quickly

loses traction and momentum rapidly sub-

sides. But as it will almost certainly take a

decade for the reforms to kick in, China will

face a very difficult rebalancing process andrun the risk of a hard landing, i.e. a very se-

vere downturn resulting in a stagnation or

even in a recession.

Intact growth driver

It is therefore of paramount importance

whether the current economic model can de-

liver high growth rates in the coming years

as well. The deteriorating demographics and

dwindling demand from the West are bound

to slow growth. However, one should not

overlook the fact that the level of Chinas

economic development even after the

powerful growth rates recorded in recent

years is still relatively low. Chinas per

capita capital stock is now at the same level

with that of Japan in the early 1970s and

Koreas capital stock in the 1980s. Yet both

countries still managed to record very high

rates of investment in the subsequent peri-

od (Figure 4). The urbanisation picture looks

similar. Chinas urban population is current-

ly at a similar level with that of Korea in the1970s (shown in Figure 5). Koreas urbani-

sation increased to 80% in 2000, which

suggests China still has potential. The un-

tapped potential of urbanisation and capital

stock gives rise to the hope that Chinas

old economic model is still in a position to

generate high growth rates. This suggests

China should manage to rebalance its

economy without encountering serious fric-

tions or a hard landing.


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China macroeconomics