China’s Economic Slowdown is Nothing to Worry About

The Chinese economy

He Weiwen

The recent months’ records show a clear downward trend. The growth rate was 10.1% in November, 10.3% in December 2012; 9.9% in January and February and 8.9% in March 2013. Several overseas investment funds started selling short in China’s stock markets, which saw a net funds outflow for 8 weeks in a row by April 17, 2013, totaling $ 2.3 billion. The Shanghai Composite Index ended at 2177.91 on April 26, the last Friday in the month, 4.0% down since the start of 2013, wiping out all the gains from 2012. This concern has been reinforced by the fresh rises in housing prices, and the fast growth of money supply. Yet, China’s economic slowdown should not cause alarm.

Recent concerns have been overreactions. The growth rate of 7.7% itself is no reason to cause alarm and is still within the safe range for the whole year target of 7.5% growth. As China changes its growth model for a better, more environmentally friendly one, it is unlikely that a growth rate well above 8% will ever or even should repeat. The relative decrease in labor age and the rising labor cost bring down potential productivity. As a result, the growth rate target for the whole 12^th five-year plan period is 7.0%, and the first two years (2011-2012) already saw 9.1% and 7.8% respectively. Assuming China maintains the same GDP growth rate of 7.7% for all of 2013, it needs to grow by less than 6.0% annually in 2014 and 2015 to hit the five-year goal.

As far as public debt is concerned, the total government debt volume (central and local governments combined) in China was RMB18 trillion by the end of 2013’s first quarter. While this is 38% of 2012’s GDP, far less than the 60% international tolerance line, it is much lower than the 100% in the US and 220% in Japan. Therefore, the Chinese economy is still stable and growing relatively fast compared to major economies.

A positive feature in the first quarter of 2013 was a more rational, harmonized growth pattern. Home consumption contributed 4.3% to total GDP growth; investment and net exports each contributed 2.3% and 1.1% respectively. It shows a predominant role of domestic demand, and more consumption-driven pattern. Net exports, which contributed negatively for two consecutive years, also had a positive role. Therefore, as China’s economy finds a more desirable mix of the three “driving horses,” it is more sustainable.

Rather than focus on China’s sovereign debt or economic hard landing risks, China’s major concerns rest in three areas: slow progress in industrial structural changes, non-stop expansion of real estate market bubbles, and excessive liquidity.

First, industrial structural changes, or upgrades, are measured by higher productivity. The key indicator of the latter is the value added rate (or the added value as the percentage of total output value). In 2012, the value added rate of Chinese industry was 23%, or $230 out of every thousand-dollar output, even lower than three years ago. This explains why China’s fixed investment maintains high growth. Total fixed investment grew by 20.7%, 0.3% higher than 2012, with industrial investment up 17.4% (output up 9.5%). In other words, the industrial production growth, to a large extent, has been realized predominantly by intensive investment in recent years, instead of advances in productivity. In comparison, the value added rate of Japan and the US in 2011 was 31.8% and 38.4% respectively. As China’s population continues to age, slow progress in productivity improvement will lead to further disadvantages for Chinese productivity. If China wants to move up the ladder of the international division of labor and emerge as a strong world competitor in capital intensive industries, it must devote more resources to innovation and creativity, and hit a 30% value added rate as early as possible.

Second, the most severe regulations by the State Council has not stabilized the housing prices, contributing to a burgeoning real estate bubble as prices keep rising in major cities. Similar to many aspects of Japan’s economy in the early 1990’s, real estate investment was RMB 1313.3 billion in the first quarter of 2013. At 20.2% year-over-year and accounting for 22.6% of total fixed investment, this is reason for concern.

Third, excessive liquidity contributes to inflation. China’s aggregate M2 supply broke RMB 100 trillion, hitting RMB 103.16 trillion by the end of the first quarter of 2013, or 198.6% of its 2012 GDP. Compared to 66.7% in the US, this shows that economic growth still relies heavily on liquidity supply and less on internal structural advancements, which tends to aggravate the potential for inflation.

The only way to solve these lurking problems and secure long-term sustainable growth is through further reform and opening to the world, a message that has been made repeatedly clear by China’s new leadership. Therefore, growth should depend more on market forces, fair competition and innovation. There should be further reforms of investment mechanisms, offering greater access to the private sector and foreign businesses. Additionally, a renewed focus should be placed on alternative energy, railroad transportation, petrol retailing, telecommunication services, banking, and capital markets. Finally, the government’s innovation incentives should apply equally to SOEs and private or foreign business in China. In that way, more capital will move to China’s core economic sectors instead of property markets, allowing economic growth to depend less on liquidity.

American businesses in China actually face new opportunities. China’s domestic demand will play an increasingly important role in driving economic growth, and thus will provide an ever-expanding market for global companies. Continuous initiatives upgrading industry and providing further market access will create inexhaustible opportunities for American industrial and service sectors alike. In fact, the latest Chinese customs data shows that Chinese imports from the US have been increasing at twice the rate of the rest of world. China’s global goods imports grew by 8.4% during the first quarter 2013, while imports from the US grew by 20.1% over the same period.

The American Chamber of Commerce’s 2013 business climate survey shows that 78% of respondents expressed optimistic or slightly optimistic outlooks on China’s economy for the next two years. Now, China’s top risk is the rising cost of labor and continued economic slowdown. There are good reasons to believe that American exports to and investment in China will support stable growth in 2013 and beyond.

He Weiwen is co-director of the China-US/EU Study Center at the China Association of International Trade.