Worldwide: The Monday Briefing - Chinese Rebalancing

Last Updated: 23 February 2015
Article by Ian Stewart

China's growth story is nothing short of spectacular.

Since 1980, its economy has expanded at the average rate of 10% a year - a pace that is unthinkable in the developed world. 

Such rapid growth means the Chinese economy is now 25 times bigger than in 1980 and employs almost twice the number of people. Last year, China overtook the US as the world's largest economy measured on a purchasing-power-parity basis.

Yet the fastest period of China's growth has passed. Last year China grew at the slowest pace in 24 years.

Concern about the pace of China's slowdown and its possible implications for the global economy have unsettled financial markets in recent months.  Most economists believe that the deceleration in Chinese growth will be modest. According to the IMF, China will continue to outpace its developed-world rivals throughout this decade.

Since the financial crisis, China's growth has been unbalanced. Credit and investment have boomed  while consumer spending has lagged. Investment accounted for just under half of Chinese GDP in 2013, the highest share of any major economy, while household consumption accounted for just over a third. By contrast, consumption accounts for roughly two-thirds of the UK economy and investment less than a fifth.

Investment is generally seen as "a good thing". But there is such a thing as over investment – marked by inefficiency and over capacity. 

A good deal of Chinese investment has gone into real estate. Average house prices rose 20% between 2008 and 2013, leading to concerns over a housing bubble. The current slowdown is partly a response to an earlier tightening of monetary policy designed to dampen house prices. Chinese policymakers want to engineer a move to slower growth rates and a switch from investment to consumer spending.

So far, things seem to be going to plan. There are tentative signs that growth is becoming more balanced. Consumer spending's share of GDP has edged up and the boom in investment seems to be cooling. Real wages rose 8% last year proving a further boost to consumer spending. Meanwhile, house prices are trending down. 

Rebalancing is likely to involve a continued appreciation of the Chinese Yuan. It was pegged to the dollar for most of the nineties and noughties but has more recently been on a steadily upward path. An appreciated currency is the natural counterpart to China's strong growth and huge export success. A stronger Yuan will, by making imports cheaper, help bolster consumption. But it will also reduce China's export competitiveness, especially for lower value products. 

A permanent and meaningful increase in spending by consumers can probably only be achieved if consumers reduce their famously high level of savings. China's gross domestic savings account for more than half of China's GDP, higher than in any Western economy and the great majority of emerging economies. In the absence of a comprehensive social security system, high levels of savings are needed to protect families in time of adversity. It may be that to persuade consumers to save less China will need to create a more generous and comprehensive state welfare system.  

Until now China's growth has received a tremendous boost from a growing supply of workers. China's working age population more than tripled between 1950 and 2010.

Aided by globalisation, the opening up of its economy and a rapidly expanding workforce, China has been the source of a massive supply shock which has delivered cheaper products to the rest of the world.

But China's demographic dividend is nearing its end.

According to the United Nations, China's working-age population will shrink by 16% between now and 2050. Its population is also ageing rapidly. The share of the citizens aged over 65 is forecast to rise sharply from 8% in 2010 to just under a quarter by 2050. The rise in the population of older people in China is greater than that facing a number of industrialised nations, including the UK.

Changes to the size and composition of China's population will have a significant effect on labour costs, the demand for and provision of healthcare, and growth.

Chinese policymakers are alive to these challenges. One policy decision which helped shift China's demographics – the one-child policy which, from 1978, restricted the number of children most families could have – has been relaxed. In 2013, the government announced that families would be allowed to have two children if one parent is an only child.

At a time when western politics is often criticised as being overly focused on the short term China's emphasis on long term goals is striking. It is perhaps this difference that makes most economists cautiously optimistic about the outlook for the Chinese economy. 

I end this week's Monday Briefing on a sombre note. It was with great regret that I learned last week of the death of our former colleague, Ravi Komatireddy. Ravi was a fine young economist who, between 2007 and 2011 played a huge role in establishing the Monday Briefing and the CFO Survey. Ravi's plan to embark on an MBA at Kellogg in the US was derailed by a diagnosis of cancer a year ago. He bore the illness with characteristic courage and an absence of fuss. He was an immensely capable and decent person; he will be greatly missed by all who knew him.    

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