China isn’t looking to grow its economy but, rather, is waiting for it to recover. Good luck with that

Andy Xie says Beijing’s stimulus measures are not meant to revive economic growth but only to maintain stability. China seems to think it can wait for good growth numbers to return, like the last time. But this strategy won’t work this time

Andy Xie

Published: 2:00am, 21 Jan 2019

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China’s economy is sailing into strong headwinds in 2019. As household debt mounted, the property market turned downwards last year and auto sales fell for the first time in at least two decades. Property and car sales account for one-fifth of China’s gross domestic product. Although China’s foreign trade rose by 10 per cent last year, its growth rate will slip this year as the global economy softens and the United States’ trade war with China begins to bite. As exports also account for one-fifth of GDP, any slowdown there would hurt the economy. Obviously, with all this negative news, investment will also cool.

To stimulate the economy, Beijing is cutting banks’ reserve requirement ratios and launching infrastructure initiatives. Neither is likely to revive growth. Chinese debt, unofficially 300 per cent of GDP, is too high for any debt-led growth policy to be effective. Currently, infrastructure spending is around one-fifth of GDP. It is hard to see how a few projects can move the needle. It appears the government’s goal is stability, especially in the financial system and the labour market, not growth. As the property market tips over, loan repayments become more sporadic. The goal of the monetary policy is probably to keep lending institutions liquid. This policy could be undermined only by massive capital flight. But as long as the Great Wall of capital control is solid, China will remain stable for the foreseeable future.

However, a growth recession, an unpleasant by-product of the muddled strategy, may last for many years. The property bubble has been around for about 12 years. Excesses of debt and inventory are enormous and would take a long time to digest. Residential properties under construction add up to close to six billion square metres, an inventory that would have taken about four years to digest at the peak of the bubble and would take many more years in a cooling market. In addition, tens of millions of properties could have been held for speculation. When they, too, are put on the market, the inventory overhang might stick around for a decade or longer. How much it would drag on growth is easy to imagine.

Growth and development are not identical. China invests about half of its GDP. Even if the economy doesn’t grow, there will be a lot more assets on the ground in 10 years. People who go back to visit a decade later would see a very different country. This is why stagnation may not be a bad choice for the government.

A woman works at a construction site for a residential skyscraper in Shanghai. Residential properties under construction in China add up to close to six billion square metres. Photo: AFP

As long as there are lots of assets, China could increase the size of the economy with the right reforms. It is just that the right reforms are not politically desirable for the foreseeable future.

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A growth recession is deflationary in the short term. As commodity and property prices fall, many industries have room to cut prices. But China’s economy is fundamentally inflationary. Its labour shortage is very severe. As the labour force continues to contract, things will get worse. The rapid rise in blue-collar wages can’t be absorbed by productivity growth. The latest investment in the internet economy, for example, is increasing demand for blue-collar labour while decreasing economies of scale. This is why any rise in labour costs would feed inflation. And this is why consumption prices are rising sharply in a weakening economy, though official statistics don’t reflecting that. Over the medium term, stagflation may characterise China’s macroeconomy.

China has relied on export and investment for the past four decades. A property bubble is a leveraging tool useful for investing long before demand materialises. China is hoping to sustain a high export growth rate, and just wait for good growth to come back, even though it may be a long wait. It has worked before. But it won’t work this time.

Just how badly is China’s economy doing?

China’s exports per capita stand at about US$1,800, low by East Asian standards. Japan’s figure is about US$6,000 and South Korea’s, above US$10,000. But China’s population is more than 10 times Japan’s and 20 times South Korea’s. If China were to reach Japan’s levels, its total exports would exceed US$8 trillion, similar to the total manufacturing value in the rest of the world. But, obviously, if China were to continue its export model, it would be highly disruptive to the global economy. Furthermore, economies which are rapidly deindustrialising couldn’t pay for rising imports. While analysts suggest China needs to abandon its invest-and-export model, it isn’t likely to change any time soon. This is why trade frictions will stay for a long time to come.

While China’s story in 2019 may be one of a growth recession without blow-ups, the rest of the world may not be so lucky. I wrote about the weakest links in the global financial system last month. In the event of a blow-up, China’s growth recession could turn into something worse. Still, it has the ability to keep capital flight below the trade surplus, which is key to keeping the financial system liquid. Crisis or not, China is likely to remain a large economy with large investment but low growth. While the sentiment will swing wildly through 2019, China will remain pretty much the same.

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China will change only when the global economy experiences a severe and lasting recession that cuts China’s exports dramatically and for good. Only a dollar crisis would do that. The US is printing dollars to finance its profligacy. It will keep doing so until confidence in the dollar collapses. That day isn’t near. Indeed, if a financial crisis erupts elsewhere, the dollar will rise, which would give the US even more room to print money. We are stuck with malaise, but no real outbreak, in 2019.

Andy Xie is an independent economist

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