China at the crossroads

It seems more than ever, China is grabbing headlines: there are growth concerns, worries about its financial sector, bubbles in parts of its economy and fears about the effects of tariffs, among other issues. How do we add up all this concern? And where is China actually headed at the moment?

Managing expectations has become critical to China’s outlook. Its unparalleled charge to second place in the global GDP race has created the external expectation that China is a sure bet for hot growth well into the foreseeable future. Its own people feel the same. A trend of surging growth stretched over almost four decades looks and feels pretty permanent, and any shock to that has elicited an immediate, and at times visceral, reaction. 

That’s one of the key reasons the Chinese economy has been on a heavy dose of public support since 2008. Back then, China’s trade intensity measured at close to 70 per cent of GDP. Within about two-and-a-half years, that had sunk to less than 50 per cent, and left alone, would have plunged China into a very deep recession, its first in the big expansion dating back to the early 1980s. So, why were overall GDP growth numbers so smooth? It’s popular to think that the data was just faked, but I’m sorry, it just isn’t easy to hide that much activity. What ironed out the data was a massive dose of stimulus, reported at the time to be close to 13 per cent of China’s GDP, vastly greater than the average OECD stimulus program. What’s sobering is that the trade ratio hasn’t improved in the years since the crash. In fact, it’s even lower: it’s currently running at about 40 per cent. 

What that would clearly imply is that the economy hasn’t taken the public purse off the hook in close to a decade. That’s a long time to be priming the pump for a 1.3 billion-person space. With growth now coming back in both the US and EU markets, the challenge in recent months has been to manage growth – allowing greater organic growth to displace stimulus, permitting governments to dial back their contribution. That might explain some of the ups and downs in recent performance.

Is trade the only game in town? Certainly not – the consumer has been touted as a great hope for a sustainable growth shift that weans the economy off its trade dependence. The potential is strong: China’s savings rate is enormous, reputed to be around 40 per cent. That’s ten times Canada’s in a good year. That kind of over-saving is holding the economy back, and if it were to ease down by, say, 2 per cent a year, it would add tremendously to overall economic growth. The trouble is, the consumer’s share of the overall economy is only 40 per cent, and it has hardly budged in recent years, in spite of the central government’s best efforts. 

So if it’s back to trade at least for the moment, then the tariff spat with the US is not helping in the least. The 10 per cent levy was extended from 10 per cent to half of all of China’s exports to the US, will rise to 25 per cent by the first of next year, and comes at a moment of particular vulnerability. It’ll be painful for the average American, but it hits China harder. 

As such, it is likely that there will be considerable efforts from both sides to resolve the situation, as soon as possible. China is already making overtures toward the CPTPP group, a signal that it is ready to at least talk about contentious issues like IP protection, trade in services, currency management and agricultural protections, among other things. These are among the key grievances that the US has with Chinese trade, so it might just be telegraphing Chinese willingness to move on these issues. It’s hard to predict at this point, but there is heavy mutual incentive to avoid a tariff-induced crisis.

Depending on how things turn out, this could prove not to be globalization’s undoing, but its reinforcing. Given how much is at stake, the world is moving toward the New Year with ‘bated breath. 

In multiple ways, China seems to be at a growth-crossroads. Given the dual needs of internal stability and external demand-and-supply dependencies, there is a lot at stake and a high need to see this delicate period through as smoothly as possible. The long-run story is clear; managing the short-run well is essential.