Guest Post: China's Broken Growth Model
Submitted by Zarathustra of Also Sprach Analyst blog,
Even now, after the Chinese economy has consistently disappointed everyone, we still get the impression from market participants that it will all be fine in the end, because the Chinese government know what they are doing, and all they need is to let the floodgate of money open. Whenever a bad data point comes out, the market interprets that as more easing ahead, and it will most certainly save the economy.
If only running the Chinese economy is that easy.
People in Asia seemed to have mostly underestimated the severity and the length of the Euro Crisis, and thus the impact on Asia, including China. China’s this year’s trade growth target is 10% compared with last year. We only have 3 months left for the year, so it is fair to say that this target is not achievable this year, even though trade growth with other Asian countries remain relatively robust.
By itself, the poor trade performance only reflects the rebalancing of the economy, both for China itself and for the global economy as a whole. Trade deficit in the US is now lower than before the financial crisis, and Euro area current account is in high surplus than it was, driven by the collapse of imports of peripheral countries. On top of this structural shift to rebalance, cyclically as the global economy slows, global trade collapses with the economy. Although some measures to support export have been announced, it will be ludicrous to suggest that these measures can boost external demand. So it makes sense that China’s growth cannot be driven by trade.
As part of the rebalancing of the economy, the burden of driving growth now lies on domestic demand of course. And within domestic demand, much has been talked about the rebalancing from investment to consumption. Very few people actually argue that there is no need to rebalance, and the government has been talking about rebalancing for a long time, so they are hopefully taking this seriously. The key point of debate has never been whether China should rebalance, but how this rebalancing can carry out.
To rebalance the economy so that the contribution to the GDP from consumption increases and the contribution to the GDP from investment decreases, growth of consumption has to be faster than growth of investment (which should be self-evident). For a long time, most have argued that consumption growth will pick-up strongly while investment growth will be stable or slowing very slightly. However, measures of consumption like retail sales hardly grew faster than fixed asset investment, and it is now clear that once investment growth slows, once the real estate market cools, consumption growth slows with it.
So it is clear, consumption is not so much of a growth driver (yet). To put the goal of rebalancing aside for the sake of generating GDP growth, there is only one thing left, which is investment.
However, China is already having a little problem of over-investment. At China’s income level, China probably should not be able to afford that many subways, that many airports, etc. On top of that, with slowing exports and sluggish domestic consumption, fixed asset investment in manufacturing are one of the biggest drag of investment growth. That makes very good sense, of course, because investment into new productive capacity is burning money if a company has reasonable confidence that the demand for their products does not exist, which is more or less what the situation looks like right now. Not to mention the fact that corporate sector is now highly leveraged, both in terms of bank loans and perhaps in terms of the explosive growth of shadow banking system. That means that corporate sector needs to deleverage.
That leaves the government the only sector of the economy to be the driver of growth, and investment is probably the only thing that the government actually has control. So it is not surprising at all that when all the private sector economists call for stimulus from Beijing, they are basically referring to investment, like infrastructure, etc. While on the monetary side, faith on PBOC’s ability to ease monetary condition remains extremely high (we beg to differ).
Every growth engine of the Chinese economy is failing, and there is only one thing which can sustain these failing engines for longer, which is government stimulus, and whether the government is actually willing to deploy massive stimulus that is questionable.
Markets are all addicted to governments’ and central banks’ stimulus, as if they can solve all the problems. In China’s case (and perhaps in many other cases as well), it sounds as it were the only hope.
And this is not particularly confidence-inspiring if government is the only hope.