What are the prospects for the Chinese economy? Few, if any, economic questions can be more important. I have just attended this year's China Development Forum in Beijing, which brings western business leaders and scholars together with senior Chinese policymakers and academics, with this question very much in my mind.
Outside China, pessimism has been growing about the ability of the colossus to sustain its rapid growth. Worriers are paying particular attention to excessive capacity, investment and debt. I share the view that making the transition to slower and more balanced growth is an extraordinarily hard challenge even by the standards of those China has already met. Yet betting against the success of Chinese policymakers has been a foolish wager. When a superb horse meets a new obstacle, the odds must be on the horse. But even the best horse may fall.
Yang Weimin, a vice-minister in the government, laid out the country's new "guidelines for comprehensively deepening reform" in an invaluable background paper. This notes several new conditions.
First, China is an upper-middle-income country, with gross domestic product per head of $6,700. It is now tackling the rarely achieved task of becoming an advanced economy.
Second, the international environment is less favourable than it used to be, partly because the high-income economies are so structurally weak and partly because the Chinese economy has become so much larger relative to all others.
Third, the economy has itself changed. The potential growth rate has fallen to 7-8 per cent, partly because of a shrinking labour force; excess capacity has become massive even by Chinese standards; financial risks have risen, driven by excessive local authority borrowing, housing bubbles and growth of shadow banking; the country is now more than 50 per cent urbanised but its cities suffer a range of ills, including pollution. Finally, the resource-intensive growth pattern is hitting limits, notably of water, which is not a directly tradeable commodity.
Reform blueprint
The "Decision on Major Issues Concerning Comprehensively Deepening Reforms" agreed last November is the response. It is the blueprint for the next round of reforms. It proposes, notably, substantial institutional and political reform, including a transformation of "imperative and administrative governance" to "governance by law". The market is to play a "decisive" role in resource allocation. The government is, in turn, to be responsible for "macroeconomic regulation, market regulation, public service, social administration and environmental protection". Westerners would recognise all that.
This implies changes in the role of state-owned enterprises. It also implies a shift from positive to negative lists of what new entrants are allowed to do: instead of needing approvals, businesses should be able to do whatever is not prohibited. This might prove revolutionary. Also important are proposed changes to the system of residence permits, which should allow 100 million migrants to become permanent urban residents.
To most outsiders the language of official declarations is mind-numbing. Yet, having listened to Premier Li Keqiang and vice-premier Zhang Gaoli, I found all this at least analytically convincing. They clearly recognise the need for decisive action in response to the challenges faced. What they want to do also makes good sense both on economic and environmental fronts.
Background paper
A background paper on medium-term economic prospects and a presentation by Stephen Roach, now at Yale, show that China has also made real progress in its transition towards a slower, less
resource-intensive and more employment-intensive pattern of economic growth. While the services sector has a significantly smaller share in GDP than in almost all other economies, for the first time it became bigger than industry's in 2013. Before 2008, a percentage point of growth produced fewer than 1 million new urban jobs. Since then each point has produced an average of 1.4 million jobs. Inflation has remained well under control and industrial profitability has held up despite slower growth. In all, the economy seems to have been adjusting to the slowdown driven by a declining ability to exploit untapped resources.
Consumption
Yet China also has a highly unbalanced economy whose most striking feature is the extraordinarily low share of consumption, public and private, and extraordinarily high share of investment (both close to half of GDP). Until last year, in which there was a small reversal, the rise in the investment share had been rapid and almost continuous since the start of the present century.
At present, private consumption is about 35 per cent of GDP, roughly half the share in the US. The extraordinary share of investment has driven growth. But it is also directly related to the growth of excess capacity and the rise in leverage. As the paper on medium-term prospects notes, the outstanding risks to economic performance do indeed lie in the related risks of financial panic, imploding property bubbles, high local government debt and excess capacity. The peril is that a rapid correction would cause a positive feedback loop and so a far sharper than expected economic slowdown. In many important industries, output is already below 75 per cent of capacity. Yet China is far too large to export its way out of this. The question is whether the corrective forces in the economy could overwhelm the ability of the authorities to manage the needed adjustments smoothly.
Some might argue a crash is precisely what is needed. The authorities will disagree and so, which matters not at all, do I. They also have many levers under their control. Nonetheless, the downside risks from financial stress and macroeconomic adjustment have been rising sharply. I plan to assess the scale of the risks and possible responses next week. Copyright The Financial Times Limited 2014
