The decade of Xi Jinping
November 25, 2012
Gavyn Davies
The transfer of power in China from the outgoing regime led by Hu Jintao to the incoming leadership of Xi Jiping has occurred without a hitch. This is a mark of increased political maturity in China.
In fact, the hand-over has been described by Citigroup economists as the first complete and orderly transition of power in the 91 year history of the Chinese Communist Party.
During President Hu’s decade, China’s real GDP per capita rose at 9.9 per cent per annum. China accounted for 24 per cent of the entire growth in the global economy, and Chinese annual consumption of many basic commodities now stands at around half of the world total. Perhaps the most important question in the world economy today is whether China’s economic miracle can continue in the decade of Xi Jinping. The IMF forecasts shown in the graph above suggest that the miracle will persist, but many western economists disagree.
China’s re-emergence as a global economic powerhouse is by now fairly well understood. Following the Deng Xiaoping reforms after 1978, and the opening of the economy to domestic and international markets, China has engaged in a process of economic catch-up similar to that which Japan and Korea achieved in earlier decades.
The question for the next decade is whether this growth process will prove to be self-limiting. The experience of other Asian economies suggests that, one day, this will indeed happen. The supply of under-employed labour in rural areas will be drained, the growth of manufacturing will peak, and the ability to import superior technology from other economies will run out of rope. A slowdown in growth is therefore inevitable. The only questions are when, and by how much?
The recent pattern of growth in the economy has caused some economists to become very pessimistic about the answers to these questions. Although the Hu administration was able to maintain the growth rate of real GDP, it did so after 2008 only by boosting the ratio of fixed investment in the economy to compensate for the declining share of net trade and the sluggish performance of household consumption. Fixed investment is now around 50 per cent of GDP, with consumption standing at only 35 per cent.
These are very unusual figures by any international standards, markedly exceeding the investment shares in countries like Japan and Korea during their economic miracles. There are certainly reasons for concern. In a recent paper for Lombard Street Research, Charles Dumas points out that the additional output achieved per unit of extra investment has been falling in recent years, suggesting that returns on capital are falling. He thinks that there has been substantial over-investment and estimates that the desirable share of fixed investment in GDP is only around 33-34 per cent.
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If this downward adjustment in fixed investment happened too rapidly, it would certainly cause a deep recession. It would also cause recessions in some western economies which have become heavily dependent on exporting capital goods to China. As the accompanying graph from a recent IMF study shows, a drop of 2.5 per cent in the level of fixed investment in China would reduce global GDP growth by around 0.2 per cent, with German GDP being hit by 0.6 per cent. If Charles Dumas is right about the scale of the adjustment needed, the eventual impact on global GDP would be much larger than the graph shows.
Other economists, however, point out that China’s capital stock still remains extremely low relative to developed economies like the US (eg in terms of the housing stock per family, etc), and argue that it does not matter very much if this investment is brought forward relative to the growth of consumption. These economists argue that this sort of “pre-investment” will not create any problems, especially if funded by the government sector rather than by the creation of excessive private leverage and debt. The houses, railways and roads will still be there, and will be fully utilised in future years.
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What can we learn from the experience of other economies at similar stages in their growth process? The most informative research paper which I have been able to find on this question was written in 2011 by Barry Eichengreen and colleagues. This paper identifies all of the growth slowdowns which have occurred since 1957 in economies which have attained a middling level of GDP per capita (over $10,000 per annum in 2005 prices according to the Penn World tables).
The key result of this study is that major growth slowdowns are triggered, on average, when per capita GDP reaches $16,700 per annum, or on an alternative measure when it reaches 58 per cent of the per capita GDP of the lead economy (ie the US). When these levels of income are reached by a developing economy, it tends to experience a growth slowdown of at least 3.5 percentage points. Both Japan (in 1970 and 1992) and Korea (in 1997) suffered growth slowdowns larger than this when their income levels exceeded the critical levels.
China has not yet reached either of the key levels identified by Eichengreen. On my estimates, the level of per capita GDP will exceed $16,700 only in 2016, and the ratio of Chinese to US GDP will not approach the 58 per cent level before the 2020s.
Based on this analysis, the development process in China might still have a long way to go before a major slowdown becomes inevitable. This is presumably one key reason why the IMF’s medium term forecasts for China still show real GDP rising at a healthy rate of about 8.5 per cent per annum up to 2017.However, the Eichengreen study does add some specific warnings about the future for China. Apart from levels of GDP per capita, the study concludes that several other variables which impact the probability of a major growth slowdown are flashing warning signals in China, including the low share of consumption in GDP, the ageing of the population and the undervalued real exchange rate. Because of this, Eichengreen’s estimates show that, in the absence of corrective policy action, the probability of a major Chinese slowdown at some point in the next few years is already running at over 70 per cent.
The test for the decade of Xi Jinping is whether policy can head off all or some of the impending slowdown. The good news is that the incoming administration is extremely well aware of the challenge of excess investment, and will act to mitigate its worst effects. China has faced greater economic challenges in the past three decades, and has succeeded in overcoming them. It can do so again.
