CHINA ECONOMY: Too much of a good thing
The old model that pushed China’s growth has disappeared. Creating a new one will be far from easy
Chinas sheer size and the scarcity of reliable data often make the challenges facing this vast country hard to grasp. Regular travel to the country helps, but even then entrepreneurs, corporate officers and mere observers rely on eureka moments, when the scale of the countrys economic problems suddenly becomes clear.
One such event occurred during a recent tour of a vast, brand-new factory in eastern China, where a major state-owned carmaker was busily assembling ... wind turbines. Why the switch from autos to clean energy? Simple, the plants general manager and chief engineer explains. Everyone else is making turbines. We didnt want to get left out.
Hidden within this simple, honest answer is Chinas economic Achilles heel: overinvestment, inefficient allocation of resources, the might of the public sector, and an obsession with replication over innovation have resulted in an almost chronically unbalanced economy.
From the stockpiling of steel and cement to a surfeit of office blocks, leisure complexes and residential compounds, surplus stocks the result of a political system that promotes officials who overproduce dog China wherever you look. Investment as a share of gross domestic product (GDP) has soared in recent years, from 35% in 2000 to 48% in 2012, according to figures from the CIA World Factbook. Only two countries, both in Africa, boast a higher figure: the Democratic Republic of Congo and the small island state of São Tomé.
By contrast, and despite the repeated beseechings of a government desperate to get its people to spend more, consumption has barely budged. In most countries, at whatever stage of development, retail spending as a share of GDP averages out at 65%. Anything less than 50%, notes Arthur Dong, an expert on Chinas economy and adjunct professor at Columbia Universitys School of International and Public Affairs, usually signifies a nation in distress.
Yet in China the consensus estimate, according to official and external data, is around 35%, a number that Michael Pettis, professor of finance at Guanghua School of Management at Beijings Peking University describes as surreally low and perhaps even the lowest number ever recorded.
And far from improving, or even plateauing, the problem appears to be getting worse. Investment made up 78% of the added growth generated in the second quarter of 2013, when the economy expanded by 7.5%, according to figures from the National Bureau of Statistics (NBS), Chinas official data agency. The same figure a year ago was just 30%. Consumption as a share of net economic growth meanwhile fell 60% year-on-year in the second quarter of 2013.
For years, China was able to gloss over such discrepancies. Surplus stocks were offloaded on world markets by heavily subsidized state-owned enterprises (SOEs). Foreign officials called the process dumping, and blamed China for undercutting domestic firms, but cases brought before the World Trade Organization, mostly by European and North American governments, usually failed.
Even when the financial crisis hit, tempering western consumption of mainland exports, China had an answer, rolling out a $600 billion stimulus package that propped up local SOEs thanks to cheap loans from state banks. Stockpiles continued to grow, but most added production was absorbed internally by an economy on stimulus setting, or by fast-growing emerging markets like Indonesia, Brazil and India.
At some point, of course, the overinvestment and misallocation of capital had to end. Chinas new generation of leaders, led by president Xi Jinping and premier Li Keqiang, have talked earnestly of the need to promote private enterprise and boost consumer spending. Li has sought to direct more state bank lending to private firms, with mixed results. Many SOEs have merely set up subsidiaries masquerading as private enterprises, or have begun lending to one another, circumventing the formal banking sector.
The same is true of retail expenditure. As anyone who talks regularly with senior officials can attest, Chinas political elite has long assumed its economy will make the painful transition from export-based to consumption-based growth with relative ease. So far, there is little sign of this happening. Analysts willing to wear out good shoe leather in search of truth believe retail spending is actually on the wane in many sectors and cities.
Anne Stevenson-Yang, founder of Beijing-based consultancy J Capital Research, regularly notes the discrepancy between the official consumption figures put forward by Beijing and the raw data served up by one-on-one interviews with retailers, wholesalers and industry associations. That data, she says, points to plummeting sales of luxury products, from fashion to wristwatches and autos to liquor in cities including Beijing, Shanghai, Guangzhou and Chengdu. Sales of luxury goods, she believes, fell by up to 30% in Shanghai in the first half of the year.
Anaemic retail growth is disconcerting for Chinas ultra-cautious leaders. Party leaders were until very recently wedded to an export model relying on overinvestment in key sectors from textiles to construction to white goods.
But those drivers, notes Andrew Polk, resident economist in Beijing at The Conference Boards (TCB) China Center for Economics and Business, have recently become less effective at sustaining economic output. In the past, slowing demand for mainland goods in the developed world would have been equalized by rising demand in emerging markets, or within China itself. Now, all three are either posting slowing or sluggish growth, creating a problem that is, believes Polk, beyond Chinas control. Its notable that net mainland exports contracted in the second quarter of 2013 for the first time in two years.
Officials have sought to ease the burden on the export sector by trimming taxes and waiving inspection fees. But this, experts say, will merely help the nations exporters adapt to a new era of weaker demand, rather than boosting the sectors prospects or profits. This presents a double dilemma for Chinas embattled leaders, overseeing an embattled economy struggling with sloughing exports and sluggish consumption.
It will not be easy for China simply to produce its way out of trouble, as it has in the past. Not only is the country struggling to find new buyers for its products, returns on capital have also slipped alarmingly in the nearly five years since Beijing launched its stimulus package.
As recently as 2010, reckons Susannah Kroeber, an analyst at J Capital Research, a unit of Chinas currency invested would have generated a return of around 125%. By mid-2013, thanks to inefficient capital allocation, the mass replication of goods and rising stockpiles, that number had slumped to just 25%. A renminbi invested is generating lower and lower returns across the board, Kroeber says. Adds TCBs Polk: Chinas economy-wide returns on investment have drifted steadily downward over the past several decades, and the deterioration in returns accelerated after the large stimulus push in 2009.
Many now point to a protracted period of uncertainty for the Peoples Republic. Economic growth is almost certainly lower, and slower, than Party officials are willing to admit. The NBS tips China to grow by around 7.5% in 2013, as does the OECD. But Wang Qinwei at London-based Capital Economics puts the figure at 6%, and TCBs Polk at half a percentage point lower.
Others are harsher still with their estimates. In a July op-ed in the New York Times, Paul Krugman warned that Chinas economic model is about to hit its Great Wall, and the only question now is just how bad the crash will be. J Capitals Stevenson-Yang wonders whether China, given slowing exports and spending, has already tipped into recession.
This seems unlikely, though it would be hard either to corroborate, or plausibly to deny, any such claim. Official data is nigh on useless: even Chinese premier Li says he uses NBS data for reference purposes only. Power data is manipulated to suit overall growth projections, critics say, while production figures for cement and metals often disappear entirely for months at a time.
Reliable data would benefit everyone, from global central bankers and CEOs to the Party officials who oversee leading mainland banks and SOEs. For one thing, it would help Beijings new generation of leaders to prepare its people and the world for a protracted period of slower Chinese economic growth.
This wont be easy. Party leaders have long peddled a simple line on growth, where GDP has to remain above 8% to stave off rising unemployment and social unrest. Yet with growth dipping below that magic number for the past five straight quarters, Beijing needs to draw a new line in the sand.
Most economists believe China should welcome the opportunity to usher in a period of slower but more sustainable growth. There would be losers, notably SOEs grown fat and lazy on cheap loans, while the stock of bad loans at Chinas banks would likely also rise. But promoting private enterprises better able to allocate capital efficiently would be a major step forward in rebalancing the economy. Likewise, channelling more state money into social security and a national pension fund, at the expense of propping up uncompetitive exporters, would trim living costs and get people spending again.
Moreover, notes Polk, a slower-growing China would also lead to, and in fact is a pre-requisite for, a much healthier China. In its 2013 Global Economic Outlook, TCB economists tipped Chinas economy to grow by 5.8% a year until end-2018, and by an average of 3.7% in the six years to end-2025.
Peking Universitys Pettis sees the economy growing by between 3% and 4% a year in the decade to 2023, an adjustment period coinciding with the leadership of the current Xi-Li axis. Only a massive privatization process involving the wide-scale selloff of state assets a possibility being quietly mooted in the capital would maintain GDP above that level, Pettis believes.
Party leaders clearly recognize the need to realign a horribly imbalanced economy. Doing so wont be easy, yet the country really has little choice. For three decades, Beijing profited handsomely from a simple economic model that wowed the world and acted as a template for the developing world. That model now lies in ruins. The question is whether Chinas leaders will find a suitable replacement in time.