In time, breakneck growth in the early stages of industrialisation gives way to slower growth. All industrialised nations experience this change as a manufacturing boom fuelled by cheap labour runs its course.
China has been going through just such a transition. China’s growth rate peaked at just over 14% in 2007. Since then it has slowed. Today China’s trend growth rate seems to be somewhere in the region of 5% to 6% a year.
In recent years the Chinese authorities have played a role in the slowdown by reining in credit growth and investment spending. The dampening effects of tighter domestic policy have, in the last year, been reinforced by trade tensions with the US and higher American interest rates.
The US has imposed tariffs on roughly half of Chinese exports to the US and has threatened to put tariffs on the rest. Meanwhile the lure of higher US interest rates has sucked capital out of China and back to America.
Equity markets were ahead of the game in spotting the slowdown. Chinese stocks have fallen 30% from their January peak.
Growth in Chinese credit, retail sales and infrastructure spending have dropped off in recent months. Car sales have been especially hard hit by the imposition of retaliatory tariffs by the Chinese authorities. Over the summer Chinese car sales were growing at 10% year on year. Now they are contracting by around 10% year on year.
In the year to the third quarter the Chinese economy expanded at the slowest rate in ten years.
The pace of the slowdown has taken the Chinese government by surprise and it has reacted by easing policy.
China’s central bank has cut banks’ reserve ratio requirement three times this year and injected cash into the system, pushing interest rates lower. The renminbi has been allowed to drift lower in an attempt to boost exports. Income tax cuts, due to take effect next January, are designed to boost flagging consumer spending. Local officials have been told to accelerate infrastructure spending.
The general view is that these measures will help China engineer a soft landing. The International Monetary Fund forecasts that China will grow by about 6% a year over the next five years.
This is just over half the growth rate of the 1990s and early 2000s. But by Western standards a 6% growth rate is enviable. And at this rate of growth the Chinese economy would double in size every 12 years. Crucially, a move to lower trend growth could lead to a beneficial rebalancing of the Chinese economy.
Slower Chinese growth would help reduce excess capacity and create a more efficient, market-based allocation of capital. That, in turn, would rein in credit growth and speculative development (it is a sobering thought that, according to a recent estimate, one-fifth of China’s urban housing stock or roughly 50 million apartments is unoccupied).
Investment accounts for 42% of Chinese GDP, twice US levels. Shrinking this outsize share of the economy would create space for consumer spending, especially in welfare- enhancing spending on services such as health and leisure.
In the early stages of industrialisation growth is driven by channelling cheap labour and capital into the economy. Now China’s workforce is shrinking and labour costs are rising fast. China’s advantage as a low-cost manufacturing hub has been eroded. And while cheap and abundant capital fuelled growth it also created excess capacity, propped up lame ducks and added to bank debt.
The Chinese government wants to create a more productive, high-tech economy. They do not lack ambition. The Made in China 2025 strategy, launched in 2015, identifies ten sectors, including robotics and semiconductors, where the government wants Chinese companies to dominate at home and compete globally.
The transition to a lower growth China is not without risks. Economists have long fretted about the risks posed by poor quality lending, inflated asset prices and the accumulation of debt. Economic frailties which are manageable in the good times can be cruelly exposed as growth slows.
Everyone agrees that the days of 10% a year growth for China are over. The real question is whether the transition to slower trend growth can be achieved smoothly. That will require skill on the part of policymakers – and plenty of luck.
PS - I was in Washington last week for Deloitte’s annual conference for US Chief Financial Officers. Last year the mood was upbeat, helped by a gathering US recovery and the hope of tax cuts. This year the mood was more cautious. One revealing polling question showed that the CFOs see protectionism as posing by far the biggest threat to North American growth next year.