3/12/2019 What’s Causing China’s Economic Slowdown

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Monday, March 11, 2019 - 12:00am

What’s Causing China’s Economic Slowdown
And How Beijing Will Respond
Christopher Balding

CHRISTOPHER BALDING is an Associate Professor at Fulbright University Vietnam.

Last year, China experienced [1] its slowest economic growth in nearly three decades. The trouble
seemed to start in the fall. Wage growth has cooled. Surveys show that companies in the
manufacturing sector have begun shedding jobs. And imports are down, hurting other major
exporting economies.

There’s more than one reason for the slowdown. A rapidly aging population, a falling birth rate, a
tightening Federal Reserve, and a slowing global economy have combined to put the brakes on
China’s economy. Yet Beijing cannot risk a recession. The Chinese government will not allow
growth to slow significantly, even if that means storing up problems for the future.

PERFECT STORM
China’s problems stem primarily from decisions made years—in some case, decades—ago. In the
past, China benefitted from a growing workforce, which boosted GDP both by adding workers and
because younger workers tend to be more productive than older ones. But around 2012, the
working-age population began to shrink, the inevitable result of the one child policy, which was
enacted in 1979. The decline in growth rates owes in part to this demographic winnowing.

Rising wages pose another problem. Chinese wages now match or exceed those of most other
emerging market economies, making China a less attractive destination for foreign companies. On
top of that, high living costs and administrative burdens have reduced the flood of rural peasants
into cities to a trickle. The average disposable rural income in 2018 was 14,617 Yuan a year, low
enough to make moving to the city prohibitive when the average price of an apartment in urban
areas is now 14,678 Yuan per square meter.

Forces that drove Chinese growth in recent years are withering. China once relied on a trade
surplus to boost growth, but today the country’s account is effectively balanced. Investment in fixed
assets, such as factories, machinery, offices, and apartment buildings, was traditionally a major
source of growth. But such investment fell as a share of GDP from 82 percent in 2016 to 71 percent
in 2018, and a further drop is expected in the years ahead, as one in four apartments in China now
sit empty and auto manufacturers are operating at just over 50 percent capacity.

Some of China’s problems come from abroad. For years, the U.S. and Chinese economies have
followed similar paths. Now, however, rising U.S. interest rates combined with slowing Chinese
growth threaten to decouple the two economies. Interest rates on one-year Treasury bonds are now
slightly higher than those on Chinese government debt, meaning that Beijing can no longer count on
capital inflows from investors looking to get returns outside the low interest rate environment of the
United States.

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Since 2008, China has fueled its growth with debt. Now its manner of doing so has hit some stark
limits. The country’s household and national debt have reached levels similar to those in most
developed countries and debt is growing faster than nominal GDP. Those high debt levels make
China an extreme outlier, as the most indebted large emerging-market economy. Most of the debt is
held not by the government but by households and corporations, which pay higher interest rates. So
the cost of servicing the debt now comes to more than 20 percent of GDP. In comparison, other
countries with high debt levels, such as Japan and the United States, have debt servicing costs in
the in the low-to-mid single digits as a percentage of GDP.

When Xi Jinping was reelected as Secretary General of the Chinese Communist Party in October
2017, China was approaching the end of a nearly two-year debt fueled expansion. Throughout 2016
and 2017, Beijing inflated industrial prices, boosting a struggling corporate sector that had taken on
too much debt. Xi began his second term with what is known as new total social financing, the
broadest measure of financing growth in China, growing at an annual rate of 32 percent. But Xi
seems to have recognized the dangers of continued rapid credit growth and taken steps to rein it in.
At the end of last year, new total social financing was shrinking at a rate of 15 percent. But although
Chinese banking regulators may be right to want to restrain credit growth, doing so has added to
China’s economic woes.

DOWN BUT NOT OUT

China’s economy depends on the policies set by the central government to an extent that few other
economies do. The government’s formal [2] and informal signals give firms and people their cues on
everything, from which businesses to start to where to invest. If Beijing were to continue restraining
credit growth, true economic pain could set in.

Yet it appears Beijing has buckled. The credit taps are flowing once again. In January, total social
financing hit an all time high of 4.6 trillion Yuan, a 52 percent jump from January 2018, previously
the second highest month on record. January’s financing is equal to 24 percent of all financing in
2018 and 5 percent of Chinese GDP. Even if Beijing restrains credit growth for the rest of the year,
the sheer size of January’s splurge is likely to keep overall credit growth higher than in 2018.
Although credit growth was more restrained in February, new total social financing for the first two
months of 2019 is still 25 percent higher than the same period in 2018.

China’s decision to boost lending is hardly surprising. In recent years, the Chinese government has
always stepped in to stimulate the economy during hard times, using the “Plunge Protection Team”
to keep stocks buoyant, various bond swap programs to keep banks lending, and stimulus
packages to keep firms building. A government that relies on its economic competence as its
primary claim to legitimacy cannot allow a major downturn. As long as Beijing keeps lending
growing faster than nominal GDP, the economy will likely continue to expand. Beijing seems willing
to trade greater debt for higher growth.

Yet Beijing’s efforts to stimulate consumption are hitting their limits. Chinese households now owe
more money relative to their income than those in many developed countries, including the United
States. That depresses consumption. Some research suggests that Chinese car purchases, for
example, may not return to their previous levels until early in the next decade. Even basic
purchases, such as phones and consumer durables, are stagnating as income growth lags.

Chinese economic activity may not be strong, but as long as credit growth remains robust, there is
little risk of a significant downturn. As the economist Michael Pettis has argued [3], Chinese GDP
has become an output rather than a measure—meaning that the government will do what is
necessary to maintain the growth rate, and so the headline figure reveals little about the true state
of the Chinese economy. Chinese growth may not be healthy or sustainable, but there is little risk
that it will stop.
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When a recession strikes a democratic country, voters can kick out the governing party. In China
voters have no such option, which means that a recession could topple the entire regime. Because
the stakes for the Communist Party are so high, and because the party has the mandate and the
resources to keep going, expect China to keep muddling through.

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Source URL: https://www.foreignaffairs.com/articles/china/2019-03-11/whats-causing-chinas-economic-slowdown

Links
[1] https://www.ft.com/content/9706b890-1ad7-11e9-9e64-d150b3105d21
[2] https://www.bloomberg.com/news/articles/2018-11-09/china-banks-drop-after-regulator-sets-targets-for-private-loans
[3] https://carnegieendowment.org/chinafinancialmarkets/78138

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