China remains one of the most dynamic and important growth centers in the world economy. The country is the single largest contributor to world GDP growth, accounting for almost 40 percent of global growth in 2016. As I argued in a previous post, China’s rise owes much to its post-1990 embrace of an export-led growth strategy and resulting restructuring as the premier assembly/production base for transnational capital’s East Asia-centered cross-border production networks.
China recorded an unprecedented average rate of growth of nearly 10 percent over the years 1978 to 2008. However, the slowdown in international trade and continuing economic difficulties in the advanced capitalist countries some seven years after the end of the Great Recession signals a significant change in the global economic environment. China’s rate of growth has been steadily falling. But Chinese leaders claim that the country has significantly lessened its trade dependence and begun a successful transformation to a more domestically centered economy. They speak confidently of achieving an average rate of growth of 6.5 percent over the next five years. I am dubious that such a transformation is taking place and that the target growth rate can be achieved. If Chinese rates of growth do continue to fall, as I expect, perhaps to the 2-4 percent range, internal class pressures will likely build for a radical change in China’s current social and economic policies. And, given China’s key position in the international economy, its slowdown will likely also have important negative consequences for the growth and political stability of many countries, especially those in East Asia, Latin America, and Sub Saharan Africa.
China’s Growth Trajectory
The chart below shows China’s growth performance since 1961. From 1991 until 2015, the country’s yearly rate of growth never fell below 7.3 percent. In ten of those years, Chinese GDP grew by at least 10 percent. With this record as backdrop, the recent downturn in China’s economy stands out. Not only did the country’s rate of growth fall to 6.9 percent in 2015, a 25 year low, it fell again, to an estimated 6.6 percent in 2016. And, as noted above, the Chinese government has lowered its target growth rate to an average 6.5 percent for the next five years.
Moreover, as the chart below highlights, China’s growth over the last few years has consistently fallen short of consensus forecasts.
Of course, a slowdown in growth would have been hard to avoid, given China’s reliance on international trade and the severity of the Great Recession and weak post-Recession recovery in the advanced capitalist world. Still, at the time of the crisis, it appeared that the Chinese economy would just power through the recession. For example, the economy recorded growth of 9.7 percent in 2008, 9.4 percent in 2009, and 10.6 percent in 2010. (In fact, a significant minority of economists pointed to this performance to argue that China’s trade dependence had been vastly overstated—more on this below.) It is now clear that this was a temporary, stimulus-driven, growth spurt and not sustainable. However, the Chinese government, as well as many analysts, are now claiming that the Chinese economy is finally undergoing a long-delayed rebalancing away from its past reliance on external demand. New policies designed to boost domestic consumption will, they believe, produce a more stable and egalitarian Chinese economy. And while these policies are unlikely to generate the extraordinary growth rates of the past, they will allow the Chinese government to meet its current growth target and the country to continue to anchor world growth.
I disagree with this consensus. As far as I can tell, the Chinese government has not achieved (or even pursued, for that matter) a meaningful rebalancing of the Chinese economy. Thus, I expect the country’s rate of growth to continue to fall well below the target 6.5 percent growth rate. To understand why I disagree with the consensus requires that we first investigate the Chinese growth experience.
The Chinese Growth Experience
The Chinese economy has gone through several major transformations.
Here I focus on post-1990 developments because it is in this period that the Chinese economy gradually becomes enmeshed in transnational capital’s accumulation dynamics and, as a result, a major force in the global economy. The Chinese government’s decision to marketize the country’s economy and then privatize state enterprises came at roughly the same time that transnational capital was aggressively looking to internationalize its operations through the establishment of cross border production networks. The two developments intertwined, and the consequence was that China, with the support of the Chinese state, gradually became the central player in East Asia’s regionally structured production-export networks.
We can see, in the chart below, the steady increase in China’s merchandise exports. The major acceleration took place after 2001, which is when China joined the WTO. In 2015, Chinese exports declined.
The following chart puts this export growth in perspective, by showing the rise in China’s exports relative to the growth of the country’s GDP. The export ratio climbed from 14 percent in 1990, to 21.2 percent in 2000, before reaching its peak in 2006 at a whopping 37.2 percent. By 2015, the ratio had fallen back to a still considerable 22.1 percent.
The next chart shows the movement in China’s current account balance (which is dominated by movements in the trade balance) as a percent of the country’s GDP. The current account ratio rose from a relatively insignificant 0.22 percent in 1995, to 1.7 percent in 2000, before dramatically climbing in the period following China’s 2001 membership in the WTO. The current account ratio went from 2.4 percent in 2002, to 8.4 percent in 2006, before peaking at an extraordinary 9.9 percent in 2007. The current account ratio rose from 2014 (2.6 percent) to 2015 (3 percent) despite the absolute decline in exports, because imports fell by more.
To state the obvious: it takes a lot of investment to produce these trade numbers. Factories have to be built and machinery purchased. Transportation networks–highways, ports, rail lines, airports–have to be built. Urban infrastructure—communication, energy, water, and waste systems as well as worker housing—has to be constructed. We can get some idea of the scale of the Chinese effort by looking the dramatic rise in the ratio of gross fixed capital formation to GDP. As we can see in the chart below, it reached historic highs of 38.9 percent in 2007, before moving to an even higher 45 percent in 2010. In 2015 the ratio stood at 44 percent.
Finally, as we see below, in sharp contrast to the growth in exports and fixed investment, household consumption as a share of GDP steadily declined until the last few years, with the first half of the 1990s and the first half of the 2000s standing out for the steepest declines. The consumption ratio stood at 56.2 percent in 1970, 46.2 percent in 2000, and a low of 36.4 percent in 2006. In 2015 the ratio was 37 percent.
In broad brush, the Chinese state promoted the country’s growth though policies that prioritized the construction of a massive infrastructure for production; the transfer of hundreds of million peasants from farms into cities to serve as wage labor; and the creation of a welcoming environment for export-oriented transnational corporations. The results, in addition to rapid and sustained rates of economic growth and elevation to one of the world’s largest exporters and destinations for foreign direct investment, include socially devastating environmental destruction, world-ranking inequality, and—key to our discussion here–an export-driven economy.
Now, as noted above, the statement that China’s growth has heavily depended on exports was challenged by some economists who pointed to the country’s high rates of growth over the years 2008 to 2010 in the face of the collapse in international economic activity and trade. They defended their position using data designed to measure the contribution of different economic sectors to growth. The table below, which comes from the Asian Development Bank, presents such data for China.
The table provides estimates of the percentage contributions made by consumption (government and private), investment, and net exports to China’s economic growth. As we can see, net exports, except for the year 1990, make a relatively small contribution to Chinese growth. In fact, in 2003 and 2004, when exports were rapidly growing, net exports actually subtracted from growth. To clarify: a negative contribution by net exports during those years does not mean that exports fell, only that the trade surplus narrowed, thereby reducing trade’s contribution to growth. Viewed from this perspective, Chinese growth is overwhelmingly explained by domestic demand—investment and consumption–even during the years 2005 to 2007, when net exports made its biggest recent contribution.
However, focusing on net exports is not a useful way to understand the importance of export activity. The fact is that Chinese imports could be used to support consumption, investment, or export production. Thus, to test the importance of exports, one would have to adjust each of these three sectors by subtracting the value of imports used by that sector. The table above is constructed on the assumption that imports are used only in the export sector, an assumption that cannot help but minimize the contribution of trade to Chinese growth. In addition, given what we know about China’s economic transformation, it seems hard to deny that a significant share of investment, whether in plant and equipment or infrastructure, was also triggered by export activity. Moreover, the country’s export activity, by generating income for a growing share of China’s workforce, had to have increased the country’s private consumption. In short, calculating the contribution of exports to Chinese growth requires far more than a simple examination of the contribution of net exports.
A number of economists, using different methods, have concluded that external demand has played a very significant role in driving Chinese growth. For example, consultants for the McKinsey company, using their own measure of domestic value-added exports, estimated that exports accounted for some 30 percent of Chinese growth over the period 2002 to 2006.
Two Asia Development Bank economists used a different measure to calculate the contribution of external demand to Chinese growth, one that included inflows of foreign direct investment as well as their own estimate of domestic value added exports. Their measure of external demand “grew steadily and maintained a two-digit annual growth rate [from 2000] until the global financial crisis in 2008. The estimates suggest that the weight of [external demand] on the economy increased gradually during this period—in 2001 it accounted for 18.3 percent of GDP growth; by 2004, almost half of the 10.2 percent GDP growth could be attributed to [it]. During 2005–07, the share of external demand dropped slightly, but remained 38 percent–40 percent.”
Yılmaz Akyüz, Special Economic Advisor to the South Center and former Director of UNCTAD’s Division on Globalization and Development Strategies, using detailed input-output tables, concluded that:
despite a high import content ranging between 40 and 50 percent, approximately one-third of Chinese growth before the global crisis was a result of exports, due to their phenomenal growth of some 25 percent per annum. This figure increases to 50 percent if spillovers to consumption and investment are allowed for. The main reason for excessive dependence on foreign markets is under consumption. This is due not so much to a high share of household savings in GDP as to a low share of household income and a high share of profits.
In short, it seems clear that exports and foreign direct investment have played a major role in China’s high speed growth. Therefore, it is to be expected that a global recession and very weak post-crisis global recovery would cause a fall in China’s rate of growth. But that raises these two important questions: by how much and for how long? And not surprisingly, the answers to those questions depends, in part, on the response of the Chinese government.
The Misleading Rebalancing of the Chinese Economy
In a trivial sense, if exports fall, then domestic spending will become more important to growth. However, a meaningful rebalancing must mean more than that. The economy should be transformed in ways that allow for sustainable growth based on domestic demand that is underpinned by and contributes to a rising majority standard of living. That is what I do not see.
The Chinese government’s immediate response to the global recession was a massive stimulus program supported by a highly expansionary monetary policy. In November 2008 the government announced a stimulus package, heavily weighted toward infrastructure spending, equal to $586 billion or about 14 percent of the country’s gdp. Thanks to the government’s control over key state industrial enterprises and the country’s banking system, the spending began one month later and continued throughout 2009.
Two Chinese economists describe the impact of this program on the country’s growth as follows:
Directly after the unveiling of the stimulus package, the year-over-year growth rate of fixed asset investment in China jumped 9 percentage points from 2008:Q4 to 2009:Q1 and accelerated further to 38 percent per year in 2009:Q2. So for the entire year of 2009 the yearly growth rate of fixed investment reached 30.9 percent, almost twice as high as its average pre-crisis growth rate. As a result, gross fixed capital formation contributed a phenomenal 8.06 percentage points to China’s 9.1 percent per year real GDP growth in 2009. In other words, investment alone was responsible for nearly 90% of the robust GDP growth in 2009 when Chinese exports collapsed and shrank by nearly 45 percent. . .
(T)he People’s Bank of China started to expand money supply by the end of 2008. The monetary injection immediately led to sharp increases in credit lending at nearly the same speed and magnitude. Despite positive inflation, the real growth rate of outstanding loan balances increased from 5 percent per year in mid-2008 to 12.49 percent per year in December 2008, and further up to 32.5 percent per year in June 2009, a historical peak during the entire reform era since 1978.
Accompanying this explosion of investment was a change in its composition. Investment by private sector manufacturing firms fell, while investment by key state owned industries tied to the government’s infrastructure program–which targeted the construction of new roads, railway lines, ports, airports, and the like–grew. Local governments pursued their own investment activity, supported by cheap and plentiful loans, promoting construction of new industrial parks, shopping centers, and apartment complexes.
All this investment powered the Chinese economy through the period of global collapse; China’s gdp grew by 9.4 percent in 2009 and 10.6 percent in 2010. However, as to be expected, the effects of the stimulus program gradually weakened, leaving in its wake massive excess capacity in many state owned firms; under-used airports, highways, railways, and shopping centers; and enormous environmental damage. Determined to keep growth up, the government maintained its expansionary monetary policy. However, given the continued weakness in the global economy, little of the money was used for productive investment. Instead businesses, local governments, and wealthy citizens tended to borrow to purchase assets, more specially stocks and housing, producing bubbles in each. The stock market bubble was popped by policy in 2015. The housing bubble is ongoing. Construction of housing has helped offset the decline in state investment in infrastructure. And the wealth effect from the stock and housing bubbles has boosted consumption (by high income families), as we can see in the chart below. But housing construction is too limited and personal consumption is too small a share of the economy to halt the steady slide in the country’s gdp growth rate.
Underpinning and now threatening the Chinese government’s growth strategy has been a rapid and extreme build up in debt. Chinese debt levels soared from 150 percent of gdp in 2009 to approximately 280 percent of gdp in 2016. And the debt build up is accelerating. In other words ever more debt appears needed to produce a slowing gdp. And the debt build-up appears to be running up against its own limits. As the China specialist Michael Pettis wrote in his May 2016 monthly report on the Chinese economy:
in order to achieve current levels of GDP growth, China’s debt is growing at least two-and-a-half times as fast as debt-servicing capacity and is probably growing three or four times as fast. Clearly this isn’t sustainable. And it must become even less sustainable as long as the process continues. If China attempts to maintain GDP growth of 6.5% for the next five years, it won’t be enough for debt to continue growing at the same already-alarming rate relative to GDP growth. In the late stages of overinvestment growth cycles, credit must grow exponentially relative to GDP growth. . . .
If China manages the targeted 6.5% GDP growth over the next five years, in short, so that by the end of 2021 its GDP will be double the 2011 level, its GDP will be nearly 40% larger than it is today. If we assume that it takes 15-16% growth in credit, gradually rising to 20-22% growth in credit, to achieve this GDP growth target, China’s debt will have risen to become between 110% and 170% larger than it is today. This represents an enormously high growth rate on an already high level of debt.
And, as Pettit goes on to say, these projected debt levels “are simply too implausible to take seriously. In my opinion it is, in other words, extremely unlikely that China can follow the targeted GDP growth path because the target can only be met if debt is able to grow to what are effectively impossibly high levels.”
The Chinese government has tried several times over the last years to tighten credit, but each time, worried about the consequences, they have reversed course. George Magnus, writing in the Financial Times, provides a useful summary of this experience:
Total Social Financing, a broad measure of monthly credit creation, is growing at nearly three times the rate of officially recorded money GDP growth, or more if you don’t believe the official GDP data. Curiously, many private companies face tight credit conditions and so rapid credit creation may be largely for the benefit of the cash-flows of already highly indebted real estate sector, local governments and state enterprise sectors.
Some financial policies have been introduced by way of countermeasures, but to little effect. For example, the government clamped down in 2013 on borrowing by local government financing vehicles, only to relax the curbs last year . It also introduced a local government bond debt swap scheme last year to allow expensive bank debt to be swapped for cheaper debt instruments. Banks duly bought more than Rmb3tn of bonds, but traditional lending growth continued regardless.
After encouraging the development of shadow banking between 2009 and 2013, lending restrictions were enforced in 2014, but a fall in financial institutions’ off-balance sheet assets simply showed up in an expansion in the main banking system’s assets. . . .
Instead, all we are likely to see is more credit easing, in the wake of the six initiatives since late 2014 to cut interest rates and banks’ reserve requirements, albeit to no economic effect. The credit binge, then, will continue until it can’t.
The decisive factors will be the already compromised debt servicing capacity of borrowers, and the behavior of banks under the weight of rising non-performing and bad loans and emerging funding difficulties as loan to deposit ratios increase further.
Thus, even while demonstrating a willingness to tolerate deepening imbalances, the Chinese government has been forced to accept ever lower rates of growth. And, there are good reasons to believe that the trade-offs facing the Chinese government are worsening, leaving the government with little choice but to accept a lower growth target. One reason is that China’s housing bubble will, like all bubbles, eventually come to an end. C.P. Chandrasekhar and Jayati Ghosh provide the following overview of developments in China’s housing market:
What exactly is going on in the Chinese housing market? Over the past year, there has been a dramatic rise in prices of residential property in many cities, and especially in some of the large metros. This comes after a period just before, when everyone was talking about the “softening” of the Chinese real estate market as the authorities sought to clamp down on what they believed was speculative activity that was leading to excessively high prices and making housing unaffordable for many ordinary Chinese. But since then – and really from early 2015, as [the chart below shows] – prices seem to have gone completely berserk, increasing at unprecedented rates.
The problem, as in most housing booms, is that house purchases are leveraged (albeit to a lesser extent in China than in other countries because of higher down payment requirements). The extent of debt flowing into housing has increased sharply in the current year. According to Bloomberg, outstanding housing mortgages in China increased by 31 percent just in the first half of 2016, three times more than the increase in overall lending. Loans to households increased to account for as much as 71 percent of total new lending in August 2016, compared to 24 percent in January. And this excludes the shadow banking activities that are also dominantly geared to real estate and construction lending. This means that there is bound to be a knock-on effect on banks and other lenders, once the bubble bursts and house prices start coming down. The Chinese authorities are trying to walk the tightrope to bring stability and greater affordability into the housing market without simultaneously destabilizing finance, but this is a difficult task. Indeed, the problem may be urgent, because in fact in many cities the downslide in house prices has already started – and indeed it is evident that in recent months the trend has got aggravated.
The housing market boom has encouraged new home construction and greater consumption, both of which have helped moderate the decline in Chinese growth rates. Letting the air out of the bubble, even assuming that this can be done in a controlled way, will weaken an important force supporting economic growth.
A second reason for pessimission about Chinese growth is the increasing problem of capital flight. In brief, rich Chinese and foreign investors are now moving money out of China. As the New York Times reports: “In Beijing, confidence has given way to a case of nerves. Local residents often sense trouble coming before foreign investors and are the first to flee before a crisis. Chinese moved a record $675 billion out of the country in 2015, some of it for purchases of foreign real estate.”
And, as Bloomberg News points out, this problem will not be easily managed:
China’s balancing act isn’t getting any easier.
Policy makers are grappling with how to attack excessive borrowing and rein in soaring property prices while maintaining rapid growth. They’re also battling yuan depreciation and capital outflow pressures as U.S. interest rates rise, while on the horizon looms the risk of confrontation with America’s President-elect Donald Trump on trade and Taiwan. . . .
Outflows will exceed $200 billion in the fourth quarter  and rise further in the first quarter, said Pauline Loong, managing director at research firm Asia-Analytica in Hong Kong.
Capital is leaving for more fundamental reasons than rising U.S. rates and a stronger dollar, she said. Drivers include rising expectations of yuan weakness, fears of an abrupt policy U-turn trapping funds in the country, and a lack of profitable investment opportunities at home amid rising costs and slowing growth.
“The real nightmare for Beijing – and for markets – is a vicious cycle of capital outflows triggering bigger devaluations of the yuan that in turn drive bigger and faster outflows,” Loong said. “We expect capital outflows to increase in the coming months as Chinese money seeks to maximize exit quotas in case of more stringent restrictions later on.”
The most effective way to halt a capital outflow is to reduce credit and raise interest rates. However, doing so would likely topple the housing market and threaten the financial health of bank and non-bank lenders and high income borrowers, and push down growth rates. On the other hand, to do nothing means a continuing rundown in reserves and a self-reinforcing currency decline.
A third reason is the enormous excess capacity of key Chinese industries and continuing slow growth in the world economy. The consequences of these interrelated problems are well described by two analysts:
As officials from China and the US meet this week [June 2016], they’re scheduled to talk about everything from the US Federal Reserve’s decision-making process to the disputed South China Sea. But China’s “excess capacity” problem is top of the agenda.
US treasury secretary Jack Lew called the problem “distorting” and “damaging” in remarks in Beijing on Monday (June 6) and said it was critical to global markets that China cut its production.
That’s because some of China’s factories have been pumping out more steel, solar panels, and other goods than the world wants or needs—in order to keep China’s GDP growing and citizens employed.
Widespread labor strikes and a slowing domestic economy have put pressure on local Chinese officials to keep factories going, even as leaders in Beijing have pledged to cut capacity and said they could lay off millions. Most of these factories are state-owned, meaning they’re subsidized by the government, rather than making market-driven decisions.
That means Chinese manufacturers can lower prices of what they make to keep factories busy more easily than private companies. China’s producer price index, which measures wholesale prices they command for their goods, has fallen for 50 months in a row.
The net effect for some industries outside of China has been devastating, marked by mass layoffs and closing factories, as lower-priced Chinese goods flood the market—and that has been no where more apparent than the steel industry.
This is not a sustainable situation. The combination of growing debt with falling producer prices is a deadly one for business stability.
And it is worth mentioning a fourth: the changing labor situation in China. Workers are increasingly fighting and winning wage increases despite Chinese government efforts to the contrary. As a result, as the New York Times explains:
Labor costs in China are now significantly higher than in many other emerging economies. Factory workers in Vietnam earn less than half the salary of a Chinese worker, while those in Bangladesh get paid under a quarter as much.
Rising costs are driving many companies in a variety of sectors to relocate business to a wide range of other countries. In the most recent survey from the American Chamber of Commerce in China, a quarter of respondents said they had either already moved or were planning to move operations out of China, citing rising costs as the top reason. Of those, almost half are moving into other developing countries in Asia, while nearly 40 percent are shifting to the United States, Canada and Mexico.
Many of the factories moving away make the products often found on the shelves of American retailers.
Stella International, a footwear manufacturer headquartered in Hong Kong that makes shoes for Michael Kors, Rockport and other major brands, closed one of its factories in China in February and shifted some of that production to plants in Vietnam and Indonesia. TAL, another Hong Kong-based manufacturer that makes clothing for American brands including Dockers and Brooks Brothers, plans to close one of its Chinese factories this year and move that work to new facilities in Vietnam and Ethiopia.
Other companies with an extensive presence in China may not be closing factories, but are targeting new investments elsewhere.
Taiwan’s Foxconn, best known for making Apple iPhones in Chinese factories, is planning to build as many as 12 new assembly plants in India, creating around one million new jobs there. A pilot operation in the western Indian state of Maharashtra will start churning out mobile phones later this year.
To this point, labor activism largely remains limited to shop-floor struggles aimed at forcing corporations to meet wage, benefit, and safety standards mandated by law. However, capitalist mobility gives the Chinese state little room to maneuver. For now, state repression has kept the insurgency from become a movement. But, a sustained slowdown could trigger more militant activism, and on a wider scale, which would negatively impact foreign investment and production.
What Lies Ahead For The Chinese Economy?
The Chinese government faces enormous challenges. Its strategy of building a powerful export sector is now threatened by stagnation in the advanced capitalist countries. It sought to compensate by directing a massive, wasteful, and environmentally destructive infrastructure program that has largely run its course. It now confronts a growing debt spiral, a housing bubble, and capital flight, as well as industrial over capacity and a growing worker insurgency. There is no simple set of policies that can solve any one of these problems without making another worse. For example, government spending to sustain production will only add to capacity and debt problems as well as increase capital flight. Tightening credit markets will help reduce over capacity and capital flight, but likely collapse the housing market and significantly dampen economic growth.
In making this case for difficult times ahead, I do not mean to suggest that the Chinese economy is on the verge of collapse. Rather I mean to argue that the country’s growth can be expected to slow considerably, perhaps to the 2 to 4 percent range. And for China that likely means an intensification of internal pressures for structural change, especially from workers who have enjoyed few of the gains they helped produce during the country’s many years of high-speed growth.
And, since most of the third world has become ever more export-dependent, and China has been the prime export market for the parts and components produced by Asian countries and the primary commodities sold by many Latin American and Sub Saharan African countries, China’s slowdown can be expected to have a significant negative effect on growth rates in most of the third world. At the same time, unless the slowdown in China’s growth rate triggers a major restructuring of the Chinese economy that disrupts/reorients existing cross border production networks, something that has yet to happen, the effects on US and European economies should be far less. The consequences might be greater for Japan, given its tighter integration with East Asian economies.
In sum, those expecting China, or East Asia more generally, to anchor a resurgent global economy, will be disappointed. Transnational corporations have gone far in creating a world to their liking, but the resulting contradictions and tensions are multiplying rapidly, even in those countries and areas where accumulation dynamics have been the most robust. The need is great for meaningful change in how economies are structured and interconnected.