Thursday saw a palpable sense of relief in global markets that China’s rather gentle slowdown is coming to an end.
Gross domestic product (GDP) growth fell 0.2 percentage points to 7.4 percent year on year in the third-quarter — the slowest pace in three years. However, Zhiwei Zhang, China economist at Nomura in Hong Kong, said, “The September data indicates economic momentum has picked up strongly compared with July and August.” He added that the September numbers “reinforce our view that growth will rebound sharply in Q4.”
Industrial production growth accelerated by 0.3 percentage points to 9.2 percent in September. Growth in fixed-asset investment increased to a similar degree to reach an eye-popping 20.5 percent. In response, the Shanghai SE Composite index rose by 1.2 percent to 2,132, with Japan’s Nikkei 225 leaping 2 percent to 8,983.
However, a return to the breakneck pace of the past decade, when Chinese economic growth peaked at 14 percent, would in the long term prove damaging for China and for the global economy and global markets.
Much of China’s high growth over the past two decades has been based on heavy direct investment by the state, or by entities that enjoy strong state support. This includes the stimulus package launched by the government in response to the global downturn of 2008.
This model of growth is, in the long term, unsustainable.
Enormous amounts of money have been spent on infrastructure, including road, rail and ports, and on housing. The best directed of this spending has prepared the ground for broad-based economic growth by making China more competitive. New urban housing, when sited in the right place, has enabled farm workers to move to the city to meet the needs of factories hungry for labor. Better transport has enabled global consumer goods companies to site their factories in the Middle Kingdom in the knowledge that raw materials can be shipped in and finished products shipped out rapidly. This gives China a competitive advantage over competitors such as Indonesia, which have cheap labor but poor infrastructure.
However, much of the state and state-directed investment has been badly directed. This is partly because there has been too much of it. The government has been anxious to keep GDP growth close to or above the 8 percent figure, which it has conventionally regarded as compatible with social stability. Infrastructure investment, which can be turned on and off easily by the government, has been the easiest way of doing this. China has also suffered from cronyism: well-connected businessmen using government connections to get the green light for projects of dubious worth.
The result of this imprudent investment is too much government expenditure on white elephants unlikely to generate enough economic growth to pay for themselves through future tax revenue. Candidates for the most heinous are the year-old and largely vehicle-free 42.5km Qingdao sea bridge, the longest in the world, and the ghost city of Chenggong in the southwest.
There is little point in constantly increasing the supply side of the Chinese economy, including its infrastructure, unless demand rises to a similar degree. To ensure that supply and demand march in unison, the Chinese government needs to boost domestic consumer demand. Thursday’s slew of Chinese data provides some encouragement: retail sales growth accelerated by a full percentage point to 14.2 percent in September. However, the even higher increase in fixed-asset investment, including a 78 percent surge in spending on rail, suggests that there is still work to be done on rebalancing the economy.
“The economic strategies that contributed to China’s economic success in the past have started to cause trouble,” says Yao Wei, China economist at Société Générale in Hong Kong. “To continue running the economy on an investment-driven model will generate more risk and instability than prosperity.”
For those analysts who believe China needs rebalancing, the government’s relaxed response to the drop in GDP growth below 8 percent is encouraging. Beijing has surprised many China-watchers by not responding with a huge stimulus package that would lead to even more unbalanced growth than China presently shows. This relative restraint confirms that the political leaders who have run China for the past ten years are aware of the problem. There is a risk, however, that the new leadership cadre scheduled in March to take over the reins for the next ten years will prefer a business-as-unbalanced-as-usual approach — of growth above 8 percent at any cost — as it nervously tries to shore up popular support.
If the next regime decides instead to attempt a real rebalancing, what would this mean for financial markets? It would be bad for assets that have benefited from the infrastructure boom, including copper, as well as construction equipment and metals companies. It would, however, be good in the long term for global consumer products companies. They see “the great mall of China” — the name sometimes given to the growing Chinese consumer market — as a huge potential source of revenue.
An even more worrying possibility for China is that the autocratic political and economic model which has so effectively catapulted it into the group of middle-income countries is precisely the wrong model to take it any further. Like all autocracies based on ideologies, including the Soviet Union before it, China lacks the top-class universities, such as Harvard, MIT, Caltech and Cambridge, which have done so much to develop both independent thought and entrepreneurship. It also lacks an intellectual property framework strong enough to protect would-be entrepreneurs. Moreover, the preference given, when awarding contracts and bank credit, to state-owned enterprises and well-placed businessmen, means that it lacks a system for allocating resources in response to customer need rather than political clout - the very kernel of the high-income economies of the developed world. China’s Long March from poverty to (extremely uneven) prosperity has been impressive; to make the next march into the ranks of the rich countries it may need a new pair of boots.
