Q1. What's the story with Chinese growth?
A. Something interesting does seem to be happening. Back in March, Wen Jiabao said China's growth target for 2012 was just 7.5%. That implied a sizeable change for an economy that had averaged roughly 10% growth for the past three decades and 11% growth for the past ten years. It also meant a drop below the almost magical 8% number that many analysts have seen in the past as providing a floor for Chinese growth.
As a result, many China watchers chose not to buy in to the new projection and kept their forecasts above the old 8% floor. Now, they are scrambling to revise their numbers downwards. In fact, China's economy has been slowing since early 2011. In the first quarter of 2011 the economy grew by almost 10% on the previous year. By the second quarter of 2012 the headline growth rate had slipped to 7.6% from a year earlier, its slowest pace in three years and a fall of more than two percentage points.
Since then, below-consensus economic readings for July and August suggested that activity has continued to ease into the third quarter as well, to the extent that even the official 7.5% growth target is now at risk. As a result, many analysts have started downgrading their forecasts for this year to accept the likelihood of sub-8% growth.
Q2. So, why has growth slowed?
A. At least three distinct factors are at work.
First, until quite recently, Beijing was actively seeking to take the heat out of some key sectors of the economy. In the aftermath of the GFC, Chinese authorities responded with a massive fiscal and monetary stimulus. This was very successful in restoring strong economic growth to an economy that had come close to stalling in the final quarter of 2008 and first quarter of 2009, but it also produced a range of unpleasant side effects, including concerns about overheating and fears about bad loans and an inflating property bubble.
The authorities responded with measures designed to cool the property market in particular. With that sector accounting for around 13% of GDP last year and playing an important role in supporting activity since the GFC, its not a surprise that this tougher policy stance has taken a toll on activity.
Second, China (like the rest of us) is facing a tough external economic environment right now, one where the prospects for global economic growth continue to be depressed not only by the aftermath of the GFC but also by the mess in Europe. The EU is China's largest trading partner and accounts for about 18% of total Chinese exports. In August, Chinese exports to the EU fell sharply compared to the previous year. This deterioration in external conditions has reinforced domestic policy tightening and further depress growth.
Third, China's economy may also be transitioning to a lower pace of potential growth, firstly due to demographic factors through the possible arrival of the so-called Lewisian turning point, but also as a consequence of trying to rebalance the economy away from the investment- and export-led growth model (hitherto extremely successful but now possibly running into diminishing returns) towards a more consumption-based model.
Remember, back in 2007, Wen Jiabao famously warned about the 'Four U's', saying that China's economy was Unsteady, Unbalanced, Uncoordinated and Unsustainable. Correcting those 'U's' was always likely to have implications for the sustainable pace of Chinese growth.
In addition, China's policy response to the downturn has been milder than many forecasters had predicted. In part, this presumably reflects the fact that the authorities meant what they said when they forecast lower growth this year. It also reflects some lingering concerns about the adverse side-effects from the previous stimulus package.
But there is also the role of this year's political transition to take into account. The old consensus view seemed to be that, in such a politically sensitive year, the authorities would be extra-keen to avoid any growth mishaps. The new view seems to be that the upcoming transition has in fact delayed the policy response and seen Beijing get behind the curve. Recent announcements of new infrastructure spending plus some strong readings on bank lending in August suggests that they are now trying to catch up.
Q3. OK, but does all that mean that China's high growth days are over?
A. More on that in a follow-up post.
Photo by Flickr user Sharon Drummond.