China struggling to balance growth imperative with structural reform
China’s economy is embarking on a new and critical phase of development as the country attempts to navigate its way beyond growth for growth’s sake to create an economy that serves the needs of its people.
Premier Li Keqiang’s much-heralded policies to shift the economy onto a more sustainable growth path are broadly appropriate on paper, but economic and political realities mean he will struggle to implement them. Li’s approach has been dubbed Likonomics because of its similarities to Abenomics, the economic policies of Shinzo Abe, his counterpart in neighbouring Japan. Like Abenomics it has three arrows that together aim to correct the economic ills of the country. But any similarities end there. While Abenomics aims to end deflation and kickstart Japan’s stagnant economy, Likonomics is the polar opposite: subordinating the holy grail of rapid GDP growth to pressing structural reforms.
The slowdown in China’s economy this year has coincided with the once-a-decade transition of power to a new guard headed by president Xi Jinping and premier Li. China’s leadership had already come to the realization that the country’s old growth model had run out of steam, brought painfully home by the global economic crisis and the resulting credit-fuelled investment boom unleashed by a $4 trillion stimulus package.
Now, with the transition complete and Li – a trained economist – at the controls, the drive is on to rebalance the economy away from the old export-led investment growth model towards domestic consumption. Li’s plan for bringing this about is to withdraw stimulus, introduce structural reforms and deleverage. There is broad agreement that this textbook response is the correct medicine, but the leadership has yet to come up with a coherent reform manifesto that will confront the problems facing the economy head on.
Most pressing are relaxing controls on movement of labour around the country, freeing up and reducing risk in the financial system, and reducing over-reliance on government investment. Rebalancing will entail trading the red-hot economic growth of the past for something more prosaic.
The problem is that economic reality appears to be running ahead of Communist Party preparedness. Growth has in fact been decelerating for nine of the past 10 quarters. It was last in double-digit growth territory in 2010, making it look as if rebalancing is a reactive policy forced upon the government in response to a situation over which it has little or no control. Annual growth slowed to 7.5% in the second quarter from 7.7% in the first quarter, with the largest contribution coming from investment as exports weakened. Full-year 2013 growth is still expected to come in at around 7.5%. Although that appears phenomenal by almost any standard, it must be viewed in a China context where it would be the slowest pace of growth since 1990. The more bearish of forecasts see growth falling below 7%.
The slowdown forced Li to commit to holding growth above an unspecified floor and to blunt the no-stimulus arrow of his plan with a package of tax cuts for small businesses, investment in railways, the information sector, and social housing, and a simplification of customs procedures. That floor, the minimum level of economic expansion Beijing will permit, is thought to be about 7%. Standard Life’s head of global strategy, Andrew Milligan, says it is pretty clear that the growth rate of the Chinese economy has to slow anyway because of the deceleration in working-age population and the inefficiency of a large part of the past and current investment. “Beijing does like to give a very strong signal to local governments and the outside world as to what sort of range of growth they would find acceptable,” Milligan says. “How much of that is just accepting the inevitable reality is a matter of debate. “So there’s a general expectation of slower growth – the World Bank has been talking about only 5% by 2020, for example – and a large part of the debate over the past few months is over the pace of that slowdown.
“Without another major stimulus it would be very difficult for the government to engineer growth rates of 8%-plus again, at the same time as admitting to sizeable bad debts in the shadow banking system and accepting that credit, or Total Social Financing, growth has to slow from above 20% to say 15% to 20%.” Milligan stresses that structural reforms are key because investors want a clearer idea of the direction in which China is going to move for the next few years, but warns that this autumn’s party conferences might well fail to produce the clear guidance desired as the issues are complex. Reforms in areas such as hukou (migrant permits), urbanization, land taxes and local government finances could drive forwards a new phase of economic activity.
There is evidence that the economy might already have bottomed out, or have at least stabilized. Official July trade data show that manufacturing, investment and housing starts have all picked up. Inflation was stable at 2.7%, but product-price deflation persists as manufacturers continue to cut prices to compete, albeit at a slightly slower rate. Power production, one of Li’s favoured alternative indicators of growth, surged 8.1% from 6% in June. And the key trade figures showed a rebound in exports and especially imports. Imports are important because an increase could signal rising domestic demand.
China’s strengthening currency has already dented demand for Chinese goods, helping reduce its reliance on exports. But the gap has been filled by ever growing investment fuelled initially by bank lending and, after the government moved to curb lending, by a burgeoning shadow financing sector that poses substantial risk to the economy.
The State Council has unveiled plans for liberalizing the capital account and exchange rate policy, and allowing private domestic capital access to the financial sector, but little has changed save for removing restrictions on the rates at which state banks can lend. If anything, channelling Chinese savings to where they’re needed – the sectors of the economy with the most promise – is becoming more difficult, according to analysts. “To really spark private consumption China needs to develop a better system of social welfare, but that is likely to prove difficult and costly and can’t be achieved overnight,’ says Rod Wye, Asia Program associate fellow at Chatham House.
“They have been making considerable efforts to improve health care, health insurance and pensions but it’s still pretty rudimentary. And the question is if they do introduce wider and more effective welfare, given the population, that’s going to be mind-bogglingly expensive and where is that money going to come from?’’ The existing basic pension alone, for example, will see the government accumulate liabilities of $10.9 trillion over the next 20 years. Wye concludes: “If the economy shows signs of slowing down too much then that sends jitters through the political leadership. The problem is how to manage that transition in a way that maintains a politically acceptable level of growth while really addressing those structural problems. The two don’t actually sit together very well.’’