If nothing else, the annual meeting of the World Economic Forum at the Swiss mountain resort of Davos provides a barometer of fears and hopes for the coming year among international business leaders. At last week’s downbeat event the glass was falling in large part because of concern about a slowing Chinese economy. Just how concerned should the rest of us at lower altitudes be?
On the face of it, the worries of the global elite look overdone. The headline that caught everyone’s attention ahead of Davos was that Chinese GDP growth slipped in 2018 to its lowest since 1990. Yet that disappointment was one that most countries would welcome with open arms since growth remained remarkably high, at 6.6 per cent (down from 6.8 per cent in 2017).
The trouble is that China’s economic statistics, especially for GDP, are notoriously untrustworthy. In a document leaked in 2010 (recounting a private conversation with the then American ambassador in 2007), Li Keqiang, now Premier of the State Council of China, described GDP statistics as “man-made” and therefore unreliable, saying that he preferred to follow at local level electricity consumption, rail cargo and bank lending. The trajectory of national GDP is unnaturally smooth, arousing the suspicion that it projects the economy that Chinese leaders want to portray rather than the reality.
Evidence that can’t be manicured by the government suggests that the economy is doing worse than official figures show. Investors in Chinese stocks are nursing painful losses after a dire year in which the Shanghai stockmarket fell by a quarter, the worst performance in the world (other than the smaller Shenzhen index, which did even worse). The “Aussie” (Australian dollar), which offers insight into the performance of the Chinese economy because of its ravenous investment-driven appetite for resources imported from Australia such as iron ore, is down a tenth on its rate against the US dollar a year ago.
More worrying still, China’s bumpy ride appears to have become a lot bumpier in late 2018, notwithstanding the reported 6.4 per cent growth for the final quarter (compared with the same period in 2017). Asian trading partners in particular have reported a sharp fall in their exports to China in December. The value of Japan’s for example declined by 7 per cent on a year before.
The slowdown in Chinese domestic demand is especially notable in the car market, the biggest in the world. Passenger car sales in 2018 fell by 4 per cent, the first such reverse since 1990. The slump in the car market is affecting foreign carmakers through not only lower exports, but also falling output from the many plants they have set up in China to take advantage of what appeared to be an unending boom.
Weakening growth in retail sales suggests that other components of consumer spending are under pressure. As important, investment growth is flagging; tellingly, Chinese imports of iron ore fell in 2018 for the first time since 2010. The slowdown in investment is overdue since Chinese capital spending is much too high for an economy returning to earth. Investment in 2017 was an extraordinary 42 per cent of GDP, higher than its 36 per cent in 2002, on the eve of a five-year sprint of double-digit annual GDP growth.
In the past, China might have hoped to export its way out of trouble, but that escape-route looks blocked as the tide of globalisation ebbs. Indeed things could get worse since looming over the economy is the threat of much higher American tariffs on $200bn of Chinese goods if the two sides fail to reach an agreement in their trade dispute by the start of March.
The underlying worry is that China is belatedly having to make an adjustment that previously occurred in high-flying Asian countries such as Japan and Korea. For many years rapid catch-up growth is possible through high rates of physical investment. But eventually this approach ceases to work owing to diminishing returns on the now much bigger capital stock.
The danger of excessive investment is all the greater in China because of its increasingly unfavourable demographics. For most of the years of high growth since abandoning Maoist communism and adopting market reforms at the end of the 1970s, China has been in a demographic sweet-spot as far as the economy is concerned. The population has been bulging in the middle as the overall dependency ratio (that of children and older people as a share of the population) has declined owing to plunging birth rates. But now the working-age population is starting to shrink as fertility has remained low despite the recent ending of the one-child policy.
The Chinese government has recognised the need to reorientate, with its strategy to leapfrog advanced economies by achieving a commanding position in ten high-tech industries, including advanced robotics and artificial intelligence, by 2025. The “Made in China 2025” plan has alarmed not just the US—a crucial underlying reason for America’s readiness to pick a trade quarrel with China—but also Germany, which frets about China usurping its lead in sophisticated manufacturing.
But setting a goal is one thing; achieving it is another. The strategy may prove a fruitless endeavour since at the same time, under President Xi Jinping’s increasingly authoritarian leadership the Chinese government has reversed tracks. Instead of further promoting the private sector that has transformed the economy it has been redirecting credit towards the inefficient state-owned enterprises that still hold it back.
Over the past decade the Chinese government has repeatedly surprised sceptics about its capacity to sustain growth through big stimulus packages, starting with the massive boost in response to the global financial crisis amounting to 10 per cent of 2008 GDP. That has caused overall debt (financial, corporate, public and household) to balloon and it now stands at around 300 per cent of GDP, nearly double the burden a decade ago. This means that the Chinese government now has much less freedom of manoeuvre to revive a faltering economy.
In his Theory of Moral Sentiments Adam Smith pointed out that a “man of humanity” would lose more sleep over a “paltry misfortune” like the loss of a little finger than over a remote catastrophe such as an earthquake swallowing up the entire Chinese population. In his parable, the anti-hero would nonetheless “enter into many reasonings concerning the effects which this disaster might produce upon the commerce of Europe, and the trade and business of the world in general”—before having a sound sleep. China’s intensifying slowdown is far removed from Smith’s imaginary disaster. But because of the sheer scale of the Chinese economy after four decades of rapid growth, there will be plenty of lost sleep if the slowdown does indeed take a turn for the worse.