Has the world economy’s main engine of growth suddenly become its biggest threat?by Anatole Kaletsky / October 15, 2015 / Leave a comment
The Conservative government’s latest panacea for sluggish economic growth and possible isolation from Europe has been the promise of surging trade with China. But just as George Osborne was kow-towing to Chinese politicians and businessmen on his summer sales trip, the country plunged into financial turmoil which raised an alarming question: has the world economy’s main engine of growth since the 2008 crisis, changed suddenly into the biggest threat to global recovery?
A sensible answer requires us to distinguish between three separate blows that hit China over the summer: economic weakness, financial turmoil, and government blunders in response to these shocks. The true risk from China stems not from any one of these problems, but from the interaction between all three: weak economic data has led to turmoil in financial markets, which has triggered clumsy political reactions, which in turn have provoked additional financial panic, which may now lead to further economic setbacks, giving the vicious circle another twist. It is this self-reinforcing feedback loop that now threatens the global economy.
Were it not for the vicious circle between economic data, financial panic and policy blunders, the Chinese slowdown would in itself be neither surprising nor alarming. China’s growth rate has been declining steadily from a peak of 11 per cent in 2010 to between 6 and 7 per cent this year. This slowdown is not surprising because double-digit growth was bound to become unsustainable as China graduated from extreme poverty and technological backwardness, with insatiable requirements for housing and government-led infrastructure investment, to become a middle-income country whose growth must be powered by consumer spending and private enterprise.
A slowdown from 10 per cent growth to around 7 per cent today and 4 or 5 per cent by the end of the decade has long been predicted by all economists. In fact, a steady slowdown has been the official policy of Xi Jinping’s government, which has recognised that enormous size of today’s Chinese economy makes the turbo-charged growth of the past environmentally unacceptable, as well as mathematically almost impossible. This is because a growth rate of 6 or 7 per cent in today’s $11 trillion Chinese economy contributes more to global economic activity—and absorbs more natural resources—than did the 11 per cent growth rate of the previous decade, which started from a base of only $2.3 trillion in 2005.
Why then has China’s slowdown caused disquiet? China’s weakness has been concentrated in heavy industry, mining, property and exports—and the bad news from these sectors, some which really are collapsing, is much more visible than unexciting reports about services and consumer spending, which remain fairly strong. For example, while construction has plunged by 15 per cent and steel output by 5 per cent from a year ago, retail sales are 11 per cent higher and service output is up by 12 per cent.
Because the declining sectors are smaller than the industries that are still expanding strongly, China’s officially reported growth rate of 7 per cent is closer to the truth than the much lower, sometimes negative, figures bandied about by Western analysts who claim the China economy has already fallen off a cliff. Such claims ignore the strength of consumption and “new economy” services as government fabrication or wishful thinking. Instead they extrapolate from the “hard” evidence of heavy industries such as coal, steel, cement and power generation, which are in suffering from excess capacity and long-term structural decline.
As a result of this bias, many investors have concluded China is falling headlong into recession, with dire implications for financial and social stability—and even perhaps for Communist Party control. Although no such recession is actually on the horizon, the stockmarket collapsed in the summer, followed by a run on the previously-stable Chinese currency, the Renmimbi (RMB).
These financial upheavals, in turn, have inspired a panic-stricken political response: first a failed government attempt to prop up share prices that cost over $200bn; then a half-hearted currency devaluation, which only encouraged Chinese companies and individuals to exchange more RMB for dollars, on fears that a bigger devaluation lay ahead.
These incoherent policy reactions are what really justify anxiety about China’s future. Until this summer, the general assumption about China was that competent technocrats were skilfully the economy, thereby compensating for the political deficiencies of Communist dictatorship. This confidence in Chinese economic management has now disappeared.
This loss of confidence is potentially disastrous because China now faces an extremely challenging economic transition that will require three partly-conflicting objectives to be juggled with extraordinary skill. In the next decade, China must not only create a market-based consumer economy far less reliant on heavy industry and government-controlled investment. It must do this while cleaning up its banks and opening up its financial system. And it must achieve both these objectives while managing an orderly slowdown instead of the economic collapse that has often accompanied industrial restructuring and financial liberalisation in other countries.
To navigate successfully through this trilemma of restructuring industry, liberalising finance and maintaining economic expansion, will require a skilful and pragmatic juggling of priorities. That will be very difficult if Chinese policymakers lose the trust of international investors and, even more importantly, of their own businesses and citizens, leading to a vicious circle of collapsing confidence, capital outflows, policy errors and more capital flight. Such a vicious circle started spinning this summer with the stockmarket and currency fiascos but most probably it will soon stop. If the RMB stabilises and the capital flight out of China dwindles, as appeared to be happening by late September, the financial turbulence in China will be seen as a storm in a teacup, and we can all breathe a sigh of relief.
But if China’s economic management cannot regain credibility, the world economy really will face its greatest threat since the 2008 banking crisis. As we learned in 2008, a self-reinforcing interaction of economic setbacks, policy blunders and financial panic could turn otherwise manageable problems into a Global Financial Crisis—this time Made in China.