China’s New Normal
July was not a good economic month in China, except for exports. More bad signs of sluggishness came with the preliminary August manufacturing data. An array of indicators seem to reflect faltering growth, from industrial output and retail sales to electricity production, imports and government revenues.
The new normal is reflected by a sharp decline in credit, weak domestic investment demand and a third consecutive monthly decline in housing sales. Consumer confidence lingers at its lowest in three years, with the outlook for jobs at its worst since February 2009.
What’s going on?
The year 1973 that came after 2008
For years before the global financial crisis 2008/9, Chinese economy enjoyed strong double-digit growth. In the process, it contributed to a sense that “good times” would last indefinitely. That’s when I began to warn government officials, senior executives and think-tanks about the eventual growth deceleration.
The business cycles were strong, but eventually a structural deceleration would ensue.
“Beware of 1973,” I used to say. Then I explained how, after World War II, the advanced economies of the United States, Western Europe and Japan enjoyed their great growth spurts. In part, those good years were driven by reconstruction after the devastating world war and the Marshall Plan. In part, they were fueled by the inherent economic potential of these nations.
But in 1973, it all came to a sudden halt, thanks to the first major energy supply shock. Initially most observers thought that surely over time growth would return to its pre-crisis levels. But that did not happen.
So when I warned Chinese audiences about the year 1973, I was saying that the current growth levels are stunning, but ultimately unsustainable. At some point, deceleration would follow; typically, through a crisis. Despite the expectation that the high growth would materialize, there would be no return to the old days.
What I described then is the current shift to the “new normal.”
“New normal” in the short-term
For months, President Xi Jinping has said that China must adapt to a “new normal.” In the short-term, the new era for China’s economy means slower growth, painful restructuring and conflicting responses from the market in digesting government stimulus.
During the past quarters, Premier Li Keqiang has sought to manage the housing market volatility, while continuing deleveraging in the local government. It is a precarious balancing act.
If deleveraging moves ahead too aggressively, housing sales will suffer. If deleveraging is too slow, it would continue to boost housing markets artificially, which would give rise to new bubbles.
The efforts to tame the volatile housing markets and develeraging in the local government share a common denominator. Both reflect huge economic reforms, which are vital to support China’s shift toward post-industrial society.
So where is the Chinese economy in terms of housing markets, deleveraging and reforms?
Despite the relaxation of curbs in a number of major cities to stimulate demand, the property market downturn is adding pressure on local governments, banks, and developers.
Even as Beijing seeks to ensure infrastructure investment, the great local and regional government (LRG) deleveraging is under way. In mid-2013, the LRG debt amounted to some $1.8 trillion, which accounts for some 20 percent of GDP.
Meanwhile, Beijing is restructuring Chinese public finance. As the reforms are implemented gradually, the debt growth is expected to be about the same as nominal GDP growth (ca 10%) in the next three years. Thereafter, the debt growth should begin to decline.
Structural rebalancing in the long-term
In structural terms, the “new normal” reflects positive long-term trends. After all, recent economic reports suggest that the Chinese economy is finally undergoing true rebalancing. Most obviously, growth rates have decelerated from over 10 percent to some 7-7.5 percent today.
For three decades, China’s growth was fueled by investments and net exports. Today, export growth has slowed from its pre-crisis average of 29 percent to less than 10 percent. As the role of net exports is on decline, manufacturing employment and output have shrunk from the pre-crisis peak of over 10 percent to 2 percent, as a share of the GDP.
While growth levels are decelerating in the first-tier coastal megacities, they remain relatively high in the inland provinces. The mainland’s income distribution is slowly improving, along with regional balance.
Overall, these developments reflect slower global demand in the aftermath of the global crisis, which has intensified efforts in the mainland to reduce the role of foreign demand as a critical growth engine.
On the other hand, these trends reflect the eclipse of China’s demographic transition. As the share of working-age people in the total population has been on decline since 2010, the growth potential of the economy has begun to decelerate as well.
Both trends are reflected in China’s urbanization, whose pace is slowing. With urban population of 53 percent of the total, China is today where America was in the early 1920s. Urbanization continues to hold significant economic potential as long as it spreads across the mainland’s inland provinces and medium-size cities.
Toward “long landing,” with 10 million jobs
In 2014, real GDP growth will be around 7.2-7.5% in annual terms. This outcome does require more support from policymakers.
While “big stimulus packages” are now history, Beijing could deploy temporary increases in fiscal spending, targeted cuts in reserve requirement ratio, new supplementary lending, as well as support for consumption and investment.
Understandably, policymakers hope to keep growth at the 7 percent bottom line. That’s why the People’s Bank of China recently cut the rate at which it withdraws liquidity and pumped 500 billion yuan (over $80 billion) in three-month liquidity into the system.
Nevertheless, major policy easing – read: a “big stimulus” – is not likely, as Finance Minister Lou Jiwei put it. After all, the government’s main goal – new job creation – will be met. As some 9.8 million urban jobs have already been created, the annual target of 10 million will be easily reached well before the year-end.
Despite a lot of anxiety domestically and far more internationally, China has begun its long landing. Structurally, that means transformation to a post-industrial economy. It is a multifaceted structural transition that purely economic reports often fail to understand.
That was the case in 1973, too.