The punditocracy has once again succumbed to the “China Crash” syndrome – a malady that seems to afflict economic and political commentators every few years. Never mind the recurring false alarms over the past couple of decades. This time is different, argues the chorus of China skeptics.
Yes, China’s economy has slowed. While the
crisis-battered West could only dream of matching the 7.5% annual GDP growth
rate that China’s National Bureau of Statistics reported for the second
quarter of 2013, it certainly does represent an appreciable slowdown from the
10% growth trend recorded from 1980 to 2010.
But
it is not just the slowdown that has the skeptics worked up. There are also
concerns over excessive debt and related fears of a fragile banking system;
worries about the ever-present property bubble collapsing; and, most important,
the presumed lack of meaningful progress on economic rebalancing – the
long-awaited shift from a lopsided export- and investment-led growth model to
one driven by internal private consumption.
With
respect to the last point, recent shifts in the composition of Chinese GDP
appear disconcerting at first glance. Consumption (private as well as public)
contributed only 3.4 percentage points to economic growth in the first half of
this year, and an estimated 2.5 percentage points in the April-June period – a
deceleration on a sequential quarterly basis that underscores a cyclical, or
temporary, weakening in Chinese consumer demand.
At
the same time, the contribution from investment surged from 2.3 percentage
points of GDP growth in the first quarter of 2013 to 5.9 percentage points in
the second quarter. In other words, rather than shifting from investment-led to
consumer-led growth, China appears to be continuing along its investment-led
growth track.
For
an unbalanced economy that has under-consumed and over-invested for the better
part of three decades, this is unnerving. After all, China’s leadership has
been talking about rebalancing for years – especially since the enactment of
the pro-consumption 12th Five-Year Plan in March 2011. It was one thing when
rebalancing failed to occur as the economy was growing rapidly; for the
skeptics, it is another matter altogether when rebalancing is stymied in a
“slow-growth” climate.
This
is superficial thinking, at best. The rebalancing of any economy – a major
structural transformation in the sources of output growth – can hardly be
expected to occur overnight. It takes strategy, time, and determination to pull
it off. China has an ample supply of all three.
The
composition of GDP is probably the worst metric to use in assessing early-stage
progress on economic rebalancing. Eventually, of course, GDP composition will
provide the acid test of whether China has succeeded. But the key word here is
“eventually.” It is far too early to expect significant shifts in the major
sources of aggregate demand. For now, it is much more important to examine
trends in the potential determinants of Chinese consumption.
From
this perspective, there is good reason for optimism, especially given
accelerated growth in China’s services sector – one of the key building blocks
of a consumer-led rebalancing. In the first half of 2013, services output (the
tertiary sector) expanded by 8.3% year on year – markedly faster than the
combined 7.6% growth of manufacturing and construction (the secondary sector).
Moreover,
the gap between growth in services and growth in manufacturing and construction
widened over the first two quarters of 2013, following annual gains of 8.1% in
both sectors in 2012. These developments – first convergence, and now faster
services growth – stand in sharp contrast with earlier trends.
Indeed,
from 1980 to 2011, growth in services output averaged 8.9% per year, fully 2.7
percentage points less than the combined growth of 11.6% in
manufacturing and construction over the same period. The recent inversion of
this relationship suggests that the structure of Chinese growth is starting to
tilt toward services.
Why
are services so important for China’s rebalancing? For starters, services are
far more labor-intensive than the country’s traditional growth sectors. In
2011, Chinese services generated 30% more jobs per unit of output than did
manufacturing and construction. This means that the Chinese economy can achieve
its all-important labor-absorption objectives – employment, urbanization, and
poverty reduction – with much slower GDP growth than in the past. In other
words, a 7-8% growth trajectory in an increasingly services-led economy can hit
the same labor-absorption targets that required 10% growth under China’s
previous model.
That
is good news for three reasons. First, services growth is beginning to tap a
new source of labor-income generation, the mainstay of consumer demand. Second,
greater reliance on services allows China to settle into a lower and more
sustainable growth trajectory, tempering the excessive resource- and
pollution-intensive activities driven by the hyper-growth of manufacturing and
construction. And, third, growth in the embryonic services sector, which
currently accounts for just 43% of the country’s GDP, broadens China’s economic
base, creating a significant opportunity to reduce income inequality.
Far
from crashing, the Chinese economy is at a pivotal point. The wheels of
rebalancing are turning. While that is not showing up in the composition of
final demand (at least not yet), the shift from manufacturing and construction
toward services is a far more meaningful indicator at this stage in the
transformation.
So,
too, are signs of newfound policy discipline – such as a central bank that
seems determined to wean China off excessive credit creation and fiscal
authorities that have resisted the timeworn temptation of yet another massive
round of spending initiatives to counter a slowdown. Early steps toward
interest-rate liberalization and hints of reform of the antiquated hukou (residential
permit) system are also encouraging.
Slowly
but surely, the next China is coming into focus. China doubters in the West
have misread the Chinese economy’s vital signs once again.
Stephen S. Roach, former Chairman of Morgan Stanley Asia and the firm's chief economist, is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s
