Stall warning for China’s soaring economy
The general view is that it is straightforward to move from 10 per cent to, say, 6 per cent growth over the coming decade
Chinese economy faces tricky challenge. Photograph: AFP/AFP/GettyImages
The new Chinese leadership is trying to manage one of the most difficult of economic manoeuvres: slowing down a flying economy.
Recently, difficulties have become more apparent, with the attempt of the authorities to bring “shadow banking” under control.
Yet this is part of a bigger picture: the risk that a slowing economy might even crash. Indeed, the expressed desire of China’s new government to rely on market mechanisms raises the risks.
The general view is that it is straightforward for China to move from 10 per cent to, say, 6 per cent growth over the coming decade. The implicit assumption is that “a rapidly expanding economy is like a speeding train; let up on the throttle and it slows down. It continues to roll along the track as before, just not as rapidly.”
He argues, instead, that China is more like a jumbo jet: “In recent years, a couple of engines have not been working well, and the pilot is now loath to keep straining the remaining good engines. He is allowing the plane to slow down, but if it slows too much, it will fall below stall speed and drop out of the sky.”
Explosive credit growth
Thus, after 2008, net exports ceased to be a driving force for the economy. Investment took up the slack, particularly in 2009. That led to a further jump in the share of spending on investment in gross domestic product, from an already extraordinarily high 42 per cent in 2007 to an absolutely amazing 48 per cent in 2010. The jet fuel driving this investment engine was an explosive growth of credit: loans rose at an annual rate of close to 30 per cent during 2009. The policy was highly successful.
But, with booming net exports a thing of the past, the Chinese authorities now also wish to reduce the reliance on credit-fuelled investment.
The engine that the Chinese economy now has left is consumption, private and public.
In fact, figures for quarterly contributions to the growth of demand suggest that the desired slowdown has gone impressively smoothly, so far. But the challenges of a move to annual growth of 6 per cent remain huge.
First, investment in inventories must fall sharply, since its level depends on the growth of an economy, not on the level of activity.
Think about it: in a stagnant economy, inventory accumulation would normally be zero.
Again, other things equal, an economy growing at 6 per cent would need 60 per cent of the investment in inventories of one growing at 10 per cent.
The immediate impact of this adjustment would be a sharp decline in investment in inventories, before their growth resumed at 6 per cent a year, from the now lower level. Moreover, businesses might well fail to anticipate the economy’s slowdown altogether, particularly after years of far higher economic growth. They would find themselves burdened with rapidly rising inventories and would then be obliged to slash inventories, and so levels of output, even further.
Second, investment in fixed capital must also fall sharply. Investment might have to fall by 40 per cent: all other things equal, in China that would imply a 20 per cent decline in GDP, which would evidently entail a deep (and unexpected) recession.