China’s challenging transition to
a “new normal” Martin Wolf,
Associate Editor & Chief Economics
Commentator, Financial Times
Nottingham University
29th February 2016
Nottingham
China’s challenging transition to a “new normal”
• China’s economy is “unstable,
unbalanced, uncoordinated and
unsustainable.” Wen Jiabao 2007
• “Things that can’t go on forever don’t.”
Herbert Stein
2
China’s challenging transition to a “new normal”
• China’s growth record
• Obstacles to completing the long journey
• Obstacles to economic rebalancing
• China’s slowdown and the world economy
• Short-term prospects
• Conclusion
3
1. China’s growth record
• China’s growth record is extraordinary
• It has grown even faster than the fast-growing small
east Asian economies
• Relative to the US, its GDP per head (at purchasing
power parity) is where South Korea’s was in the mid1980s.
• In absolute terms, China is as rich as South Korea
was in the early 1990s.
• It would take about three decades for China to match
South Korea’s current prosperity relative to the US
4
1. China’s growth record
AN EXTRAORDINARY CATCH-UP PERFORMANCE
GDP PER HEAD RELATIVE TO THE US
(at purchasing power parity) (Source: IMF)
50.0%
45.0%
40.0%
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
1992
Brazil
5
1995
1998
China
2001
India
2004
Indonesia
2007
2010
Mexico
2013
Russia
2016
2019
Turkey
1. China’s growth record
EVEN BY STANDARDS OF FAST-GROWTH ASIA
GROSS DOMESTIC PRODUCT PER HEAD RELATIVE TO
THE US AFTER GROWTH ACCELERATIONS (at PPP)
(Source: Conference Board)
100.0%
10.0%
1.0%
1
5
9
Japan (1950-)
6
13
17
21
25
Taiwan (1959-)
29
33
37
41
45
49
South Korea (1962-)
53
57
61
China (1978-
65
2. Obstacles to completing the long journey
• Five reasons why might China not complete the
catch-up process successfully
• First, the threat of “regression to the mean”:
– Lant Pritchett and Lawrence Summers: “History teaches that
abnormally rapid growth is rarely persistent, even though
economic forecasts invariably extrapolate recent growth.
Indeed, regression to the mean is the empirically most
salient feature of economic growth.”
– One must not assume that the extraordinary will continue.
– The growth of the population of working age will be far
slower than that of the overall population.
7
2. Obstacles to completing the long journey
• Second, China’s size:
– if China were to achieve the envisaged growth, its economy
would expand five-fold over the next generation
– It would be bigger than North America and Europe, together
– This would put substantial strain on the world’s
environmental and economic “carrying capacity”. We must
envisage massive improvements in resource efficiency,
particularly in relation to carbon emissions
– We must also envisage massive stresses in world markets,
the global monetary and financial systems, global institutions
and international relations
8
2. Obstacles to completing the long journey
CHINA’S OUTPUT OF CO2 NOW LEADS THE WORLD
EMISSIONS OF CO2 (million tonnes)
12000
10000
8000
6000
4000
2000
0
1959
9
1964
1969
1974
1979
1984
1989
China
US
1994
1999
2004
2009
2014
2. Obstacles to completing the long journey
• Third, political evolution:
– Professors Pritchett and Summers argue that “salient
characteristics of China—high levels of state control and
corruption along with high measures of authoritarian rule—
make a discontinuous decline in growth even more likely
than general experience would suggest.”
– According to the World Bank, the country ranks in the fifth
percentile of all countries (from the bottom) in voice and
accountability, in the 66th percentile in government
effectiveness, in the 45th percentile in regulatory quality, in
the 43rd percentile in the rule of law, and in the 47th
percentile in control of corruption.
– The developed countries have far higher rankings.
10
2. Obstacles to completing the long journey
• Fourth, the Lewis turning point:
– Real wages have been rising rapidly since the turn of the
millennium.
– The trend rate of real economic growth has slowed sharply
toward 7 percent (and probably even less, in reality) since
2012.
– Getting smoothly from the old normal of 10 percent growth
and cheap labour to a “new normal” of 6.5 percent growth
(or less) and ever-more expensive labour is proving tricky.
– When a bicycle slows, it takes more effort to keep upright.
11
2. Obstacles to completing the long journey
• Fifth, the unbalanced economy:
– Growth has become far too reliant on investment;
– internal debt has grown unsustainably fast;
– Its national (not just household) savings rate is far too high
to be absorbed productively at home.
– These imbalances make it hard to sustain growth and
equally hard to slow it down sustainably
12
3. Obstacles to economic rebalancing
• The Chinese investment rate is far higher than in
other high-growth economy
• China’s demand is hugely investment-dependent
• It is associated with declining growth of total factor
productivity and so long-term weakness in supply
• The incremental capital output ratio has risen from
about 3.5 in the late 1990s to seven in recent years.
Thus, investment’s contribution to growth has halved.
• The capital output ratio is already higher than in any
G7 country, except Japan
13
3. Obstacles to economic rebalancing
INVESTMENT EXPLODES AS GROWTH SLOWS
GROSS CAPITAL FORMATION
(As a per cent of GDP) (Source: OECD)
50.0
45.0
40.0
35.0
30.0
25.0
20.0
15.0
10.0
1960
1965
1970
1975
1980
Japan
14
1985
1990
South Korea
1995
2000
China
2005
2010
2015
3. Obstacles to economic rebalancing
CHINA’S DEPENDENCE ON INVESTMENT
THE STRUCTURE OF CHINA'S DEMAND
(per cent of GDP) (source: Haver Analytics & Datastream)
100
2
2
3
2
3
34
36
36
40
42
8
9
8
4
4
2
3
2
3
40
40
41
43
46
47
47
46
46
46
14
14
14
13
13
13
14
14
14
14
38
37
36
37
36
37
37
37
38
5
90
80
70
60
17
50
16
16
15
14
40
30
20
47
46
45
43
41
40
10
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Household Consumption
15
Govt Consumption
Investment
Net exports
3. Obstacles to economic rebalancing
SLOWING GROWTH AS INVESTMENT SLOWS
CONTRIBUTIONS TO CHINA'S GROWTH OF DEMAND
(quarterly, year on year) (Source: China National Bureau of Statistics)
15
13
11
9
7
5
3
1
-1
-3
-5
Q1-2010
Q1-2011
Consumption
16
Q1-2012
Q1-2013
Gross Capital Formation
Q1-2014
Net exports
Q1-2015
Real GDP
3. Obstacles to economic rebalancing
INVESTMENT EXPLODES AS GROWTH SLOWS
SOURCES OF CHINA’S SUPPLY
(per cent of GDP)(Source: Conference Board)
15.0
13.0
11.0
9.0
7.0
5.0
3.0
1.0
-1.0
-3.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Labour quality and quantity
17
Capital
TFP
Growth
3. Obstacles to economic rebalancing
THE DEBT EXPLOSION IS ONGOING
CHINA'S DEBT OVER GDP (Source: McKinsey)
300%
39%
250%
68%
200%
150%
100%
20%
8%
7%
24%
132%
72%
83%
50%
0%
23%
2000
18
Government
42%
51%
2007
2015 Q2
Non-financial corporate
Financial
Households
3. Obstacles to economic rebalancing
THE STOCK MARKET CASINO
CHINA'S STOCK MARKET (Shanghai Index)
1200
1000
800
600
400
200
19
09/02/16
09/02/14
09/02/12
09/02/10
09/02/08
09/02/06
09/02/04
09/02/02
09/02/00
09/02/98
09/02/96
0
3. Obstacles to economic rebalancing
• If China’s capital-output ratio is merely to stabilize at
current levels, and the economy is to grow at, say, 6
percent, the investment share in GDP needs to fall by
about 10 percentage points, to 35 per cent of GDP.
• That is where it was during much of the 1990s. It
would also still be high by international standards.
• If that happened quickly, demand would fall by 10 per
cent of GDP
• If it did not happen, there would be continued
explosive growth in debt and much economic waste
20
3. Obstacles to economic rebalancing
• The key, then, is to make the adjustment slowly
• This means a long period when investment grows
more slowly than GDP and consumption grows faster
than GDP
• But household disposable income is only 60 per cent
of GDP and households save about a third of income
• Household consumption can grow faster than GDP if
and only if the share of household disposable
incomes rises or the savings rate falls
• The latter is unlikely in uncertain times
21
3. Obstacles to economic rebalancing
• The former would squeeze profits further and so
undermine the ability of corporations to fund
investment
• That would then need to be funded by even faster
credit creation
• The explosive growth of credit probably does not
threaten an outright financial crisis in China, since
the government is solvent and controls the banks
• But, together with slowing growth and the anticorruption campaign, it does threaten capital flight
22
3. Obstacles to economic rebalancing
• Above all, leverage works in both directions. During a
boom, borrowers obtain higher returns than they
expected.
• During the subsequent bust, both they and the
lenders obtain lower returns than they hoped and
duly reduce their risk-taking.
• This happens even if there are not waves of
bankruptcies. One might describe this condition as
one of pervasive distress.
23
3. Obstacles to economic rebalancing
• Conventional economics does not pay sufficient
attention to such balance-sheet effects.
• Policymakers will want both to prevent and to
promote a further build-up of debt.
24
3.Obstacles to economic rebalancing
• A numerical example:
– Assume that the level of investment needed to support
growth at 6-7 percent a year is 35 percent of GDP.
– Assume a small current account surplus.
– Then the national savings rate also needs to fall to 35
percent of GDP.
– Public and private consumption must rise to 65 per cent of
GDP. Assume public consumption were to rise from 10 to 15
percent and private consumption from 40 to 50 per cent.
– Assume households continue to save 30 percent of
disposable income.
25
3.Obstacles to economic rebalancing
– Then household disposable incomes need to rise by 10
percent of GDP, from 60 to 70 percent
– This would slightly more than reverse the decline in the
share of household disposable income in GDP over the past
15 years. It would also mean that savings in the rest of the
economy – corporate and government – would also roughly
halve relative to GDP.
– At recent rates of adjustment, this will take a quarter of a
century.
– It cannot take less than a decade. So investment must
remain well above 35 per cent of GDP: so debt explodes.
– Or the current account surplus explodes relative to GDP.
26
4. China’s slowdown and the world economy
• China’s slowdown has already helped trigger an end
to the commodity supercycle
• Now it threatens a weaker renminbi
• It also threatens another round of global financial and
economic shocks
27
4. China’s slowdown and the world economy
END OF THE COMMODITY SUPERCYCLE
REAL COMMODIITY PRICES
(Jan 70=100; deflated by export unit values of industrial countries; source - Goldman
Sachs)
160.0
140.0
120.0
100.0
80.0
60.0
40.0
20.0
Jan-70
Jan-74
Jan-78
Jan-82
Jan-86
Jan-90
All Commodities
28
Jan-94
Jan-98
Jan-02
Average of all Commodities
Jan-06
Jan-10
Jan-14
4. China’s slowdown and the world economy
END OF THE COMMODITY SUPERCYCLE
REAL OIL PRICES ($s a barrel, December 2015 prices)
160.0
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
29
Real (2015 prices) - using US CPI
Real average
4. China’s slowdown and the world economy
EXCHANGE RATE DIVERGENCES
REAL EFFECTIVE TRADE-WEIGHTED EXCHANGE
RATES (Source: JP Morgan)
140
130
120
110
100
90
80
70
60
1/1/10
7/1/10
1/1/11
US
30
7/1/11
1/1/12
7/1/12
EUROZONE
1/1/13
7/1/13
JAPAN
1/1/14
UK
7/1/14
1/1/15
CHINA
7/1/15
1/1/16
4. China’s slowdown and the world economy
RESERVES START TO TUMBLE
CHINA'S FOREIGN CURRENCY RESERVES ($bn)
$4,500
$4,000
$3,500
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$0
31
4. China’s slowdown and the world economy
THE RISE AND FALL OF CHINA’S TRADE
CHINA'S TRADE (as a per cent of GDP)
40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0
Q4
2000
Q2
2002
Q4
2003
Q2
2005
China Trade Balance
32
Q4
2006
Q2
2008
Q4
2009
China Exports
Q2
2011
Q4
2012
Q2
2014
China Imports
Q4
2015
5. Short-term prospects
ASIA STILL LEADS THE REST
CONSENSUS FORECASTS FOR 2016
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
China
33
India
Asia Pacific
(excl. Japan)
Russia
Eastern
Europe
Jan-15
Jan-16
Brazil
Latin
America
World
5. Short-term prospects
ASIA STILL LEADS THE REST
CONSENSUS FORECASTS FOR 2017
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
China
34
India
Asia Pacific
(excl. Japan)
Russia
Eastern
Europe
Brazil
Latin
America
World
5. Conclusion
• None of these risks appear in the short term
forecasts
• But these rest on standard assumptions about
continuity
• The problem is that the present path just does not
look sustainable
• But the short-term consequences of moving to
another one look bad for everybody
• How will this end? Nobody knows.
35