Journal

China’s Economic Situation and Growth Prospect

Wang Yiming Deputy Director, Development Research Center, State Council.
China is the world’s second largest economy. As China’s economy continues to expand, its spillover effect is increasingly felt and it has drawn more and more attention from the rest of the world. The past 5 years saw a moderation of China’s economic growth, though still at a quite high level. In 2015,GDP growth dropped from 7.3% in 2014 to 6.9%. The international community is closely watching and quite many people have expressed worries. On one hand, the Chinese economy has entered a new normal. The internal and external factors which contributed to high growth in past 30 years and more have both changed. On the other hand, China has the necessary conditions to maintain medium-high growth in terms of both growth potential and progress already made through economic transition. This article analyses the new normal of the Chinese economy. China’s economic trend in 2016 and growth prospects. 
 
 
I . The Chinese economy has entered a new normal
 
 
(1) China’s economic growth is shifting gears
We need to observe China’s economic changes in a longer time horizon to understand China’s current economic situation. After high growth of more than 30 years, the Chinese economy is shifting to a new phase and going through systemic readjustment. The current round of shift and readjustment has the backdrop of deep transformation of the global economy in the wake of the global financial crisis. More importantly, it is a voluntary re-balancing and readjustment China has made after the equilibrium among various variables in the high-growth period has been broken.
 
The new normal of the Chinese economy is visible in the shifting of gears in the first place. Since 2010, China’s economy has been slowing down for more than 5 years despite some ups and downs. GDP growth dropped from 10.6% in 2010 to 6.9% in 2015, down by 3.7 percentage points. If we look at the quarterly figure, then starting from the second quarter of 2010 to the fourth quarter of 2015, such a growth moderation has sustained for 23 quarters already. This is owing to cyclical factors such as changes of the global economy. But more importantly, it is owing to the internal structural problems. Essentially, it is because the old growth model can no longer sustain and systematic readjustment has become a must.
 
In this new normal, there has been fundamental changes in the conditions supporting high growth, namely massive investment in low-cost factors of production and condensed release of potential market demand. In terms of supply conditions, from 2012 to 2015, work-age population between 16 and 59 years decreased by 13 million. Demographic dividend faded rapidly. Hard constraints posed by land, resources and the environment are tightening. Total production cost is rising quickly. In terms of demand conditions, by comparable international experience, when urban residents own more than one unit of housing per household and every 1,000 people own more than 100 cars,the market demand for housing and transportation will change in an obvious way. China crossed these two thresholds in 2013 and 2014 respectively. Investment in housing development and car production dropped from double-digit growth in the past to single-digit growth or even zero growth today. The traditional drivers of growth are weakening. And for a considerable time into the future it will be difficult to foster new growth drivers which can match the housing and car sectors in terms of size and growth effect. It is thus fair to say that economic slowdown reflects internal structural readjustment and shifting driving forces. 
 
(2) Growth moderation conforms with economic law
 
By international comparison, China’s growth moderation over the past period of time is similar to Japan and ROK’s performance following a period of high growth. In 2015, at current price, China’s per capita GDP is slightly over 7,900 US dollars. In PPP terms, the figure will be 11,000 US dollars, similar to the level in Japan and ROK when their high growth period came to an end. From 2011 to 2015, China’s annual growth rate is 7.8%, similar to the growth in the last five years of Japan and ROK’s high-growth period. Japan’s high-speed growth ended in 1974. Before that from 1969 to 1973, Japans’ annual growth rate was 6.5% on average. ROK’s high-speed growth ended around 1998. Between 1993 and 1997,its annual growth rate was 7.4%. By comparison, we can see that China’s growth moderation is a relatively mild process. There has not been a remarkable deceleration.
 
China’s GDP dropped from 7.3% in 2014 to 6.9% in 2015. Some people worry that such a growth rate below 7% might increase the expectation of economic slump and even loss of growth momentum. In fact, 7% poses no particular watershed. A growth rate slightly lower or higher is not the main problem. The key is to look at the quality and efficiency of economic performance. In 2015, China created 13.12 million new jobs in urban area,and its surveyed unemployment rate remained stable at around 5%. Household income grew by 7.4%, 0.5 percent higher than GDP growth. Consumer price was stable on the whole. The economy was operating within a reasonable range. One should notice that China’s growth is in a period of transition. The current growth is not remarkably deviating from most institutions’ forecast of China’s potential growth level. 
 
(3) Economic transition is making positive progress
 
While growth is slowing down, the Chinese economy is shifting to a growth model more driven by domestic demand and consumption. In 2015, consumption grew faster than investment for the first time since 1999, contributing 66.4% to economic growth. And in the past five years as well, its contribution has stayed above 50%. China has the largest number of internet and mobile internet users in the world. In 2015, online retail sales volume grew by 31.6% over previous year,20.9 percentage points faster than social retail sales. The service sector accounted for 50.5% of the economy and there is still big room for growth in the future. This will produce a positive impact on job creation and income distribution. China has built large-scale, high-quality and complete-system infrastructures. For instance, about 20,000 kilometers of high-speed railway are now in operation, the equivalent of 60% of the world’s high-speed rail mileage. Average housing space of urban and rural residents increased by over 10 square meters than 2000, with remarkable improvement of housing conditions. By region, among 31 provinces, 10 provinces have a per capita GDP above 10,000 US dollars, with a total of more than 500 million permanent residents. These changes show that despite the shifting of gears, China’s pace of economic transformation and upgrading has not slowed, and is marching towards a higher level.
 
 
II.               China’s economic trend and forecast
 
 
(1)  External economic environment faces uncertainties
 
In 2016, China’s economy will be affected by the following factors: difficult global economic recovery, slowdown of emerging economies, falling price of commodities, sluggish world trade,the end of quantitative easing in the US and cycle of a stronger US dollar. At the same time, the Chinese economy will also leave its impact on the world economy through its interactive and mutual adjustment with the other economies.
 
In 2016, world economy will continue to linger in the “new mediocre”. Seen from latest reports of international institutions, world economy in 2016 will still suffer from low growth,low inflation and a multitude of risks. Developed economies will continue their mild and uneven recovery, with slightly higher growth rate. This is mainly attributed to economic improvement in the US and UK,low oil prices and a loose financial policy. Emerging markets will witness visible divergence among themselves and their growth on the whole is not optimistic. Affected by a strong dollar and weaker demand, developing countries in Latin America, Middle East and Africa, which used to rely on commodities export, will experience prominent structural problems and their growth might come to a halt. Mild recovery of developed economies means that China can export more,but affected by sluggish world economy, China’s foreign trade growth in 2016 is unlikely to improve substantially.
 
Falling price of commodities will dampen the growth prospect of resources exporting countries. Since 2012, the US dollar has been on a new round of appreciation, which poses a downward pressure on the price of commodities. Given worldwide overcapacity and accelerating scientific and technological innovation, demand for commodities is unlikely to increase substantially. Rather, prices of commodities are likely to go down further. If that happens, it will result in less revenues for resources exporting countries, shrink of imports, and all this will affect China’s bounce in export.
 
The Fed’s end of QE and rate hike will continue to be key factors affecting global economy. With massive capital outflow from emerging economies, the currencies of fragile EMEs and developing countries will further depreciate and debt risks will build up. China, the world’s largest developing economy, is directly affected by capital outflow and changing expectations on the Renminbi exchange rate, as well as indirectly affected by shrinking demand and risk outbreak of other EMEs.
 
(2) China’s economy will bottom out
 
In 2016, downward pressure on China’s economy will continue to unfold. But with investment picking up, the cutting of overcapacity, and shifting growth drivers, China’s economy is likely to bottom out. 
 
Fixed asset investment will reach bottom. Investment growth has always been a key factor for China’s economic growth. In 2015, investment increased by 10%, 5.7 percentage points lower than previous year. In 2016, investment growth will slow down further to single digit level and gradually reach trough. First, investment in housing might reach bottom. In recent two years, investment growth in housing went down dramatically. In 2015, investment only grew by 1.0%, 9.5 percentage points lower than previous year. It is expected that growth in housing sector in 2016 will be zero or even negative and gradually reach bottom. Second, investment growth in manufacturing will go steady. Affected by production overcapacity, in 2015 investment growth in manufacturing was only 8.1%, 5.4 percentage points lower than previous year. It is estimated that growth will slightly moderate again in 2016. Third, investment in infrastructure will readjust from a high level and gradually stablize. In 2015, growth in infrastructure investment was 17.2%, 4.3 percentage points lower than 2015. Constrained by investment return ratio and local financing capacities, in 2016, investment growth in infrastructure will make some downward adjustment, but still higher than the growth of public finance revenue.
 
Second, steps to address production overcapacity will be launched. After experiencing explosive growth in manufacturing sector, absolute production overcapacity and cyclical production overcapacity appear at the same time, as economic growth slows down and demand from domestic and international market weakens. Take iron,steel and coal as an example. In 2014, China’s production capacity for crude steel exceeded 1.1 billion tons. But real output was only 823 million tons, realizing only 74.8% of production capacity. Coal production capacity was 4 billion tons. Coal production capacity under construction was 1.1 billion tons. But real output was only 3.87 billion tons. By January this year,producer’s price index for manufactured products registered 47 months of negative growth and profit of industrial enterprises dropped. This shows that overcapacity is a burden on the overall profitability of industrial enterprises and it is important to make the painful decision to cut overcapacity in a “surgical operation style”. In February 2016, the State Council issued opinions on addressing production overcapacity in coal and steel for renewed development. It signals the actual launch of measures to address overcapacity. It will play an important role in improving market expectation and enhancing market confidence.
 
Third, shifting of growth drivers is accelerating. With rising costs of factors such as labor, land and the environment,the constraints on growth are tightening. The period of high-speed expansion based on old driving forces is over. It is imperative to explore new driving forces through increasing factors productivity and make resources allocation more efficient. To foster new drivers of growth, institutional reform and   innovation in science and technology hold the key. China’s new round of reform will enhance the role of the market in allocating resources, which will make the allocation of economic resources more efficient. China is building an innovation-driven country. In 2015,China’s spending on R&D accounted for 2.1% of GDP, ranking second in the world. The ongoing “mass entrepreneurship and innovation campaign” will energize the whole society for innovation. Innovation in science and technology will boost China’s factor productivity and further increase the potential output of the economy.
 
To summarize, China’s economy is still reaching bottom in 2016. Given the moderation of investment growth, reduction of production overcapacity and accelerating formation of new drivers of growth, the economy is likely to bottom out by 2016,and the yearly growth rate will still be above 6.5%. In the next two years, growth will become more steady and take on an “L”shape on the whole.
 
(3) Demand management and supply side reform will work together
 
China’s slowdown is a result of both structural and cyclical factors. But the deep-seated problem is still structural. At present, structural problems are mainly about the mismatch, lack of balance and coordination of supply and demand. Problems with the supply side are more acute and they include the following. Supply side structural change is falling behind changes in demand structure. There is too much ineffective supply and not enough effective supply. There is too much low-end supply and not enough mid-to-high-end supply. Economic downward trend amidst fluctuation since 2010 shows that the marginal effect created by increasing investment is decreasing, and its role in driving economic growth is weakening. Macro-economic management must pay attention to the effective integration of demand management with supply side reform. While maintaining overall stability of aggregate demand through demand management, it is important to focus on structural reform on the supply side, correct the structural mismatch and distortion in factors allocation, so as to ensure the new equilibrium of the Chinese economy on a higher level.
 
Demand management should be well measured. Such management should not become unbearable for the society, nor cause massive liquidity contraction. Pro-active fiscal policy needs to intensify when appropriate by raising deficit-to-GDP ratio temporarily and increase the size of deficit when circumstances allow, readjust the structure of central and local debts, increase the proportion of central financing for railway, water conservance projects, rural power grid, and environmental progress. Continue to implement structural tax cut and universal lowering of tax, and expand the scale of replacing business tax with VAT. The prudent monetary policy must be appropriately flexible to maintain reasonable increase of new loans and all-system financing aggregates, lower the RRR ratio when appropriate to offset the outflow of foreign exchange reserves. It is also necessary to improve interest corridor mechanism and strengthen expectation guidance and management.
 
Supply-side reform must intensify and focus on effectively addressing production overcapacity, promoting industrial improvement and reorganization, lowering production cost for enterprises, developing strategic emerging industries and modern services sector, increasing supply of public goods and services,and making the supply structure more adaptive and flexible to demand change. At present, it is important to start with cutting production overcapacity and phasing out zombie companies so as to get a clear picture of the real situation. We have to clarify the capacity reduction targets, accelerate the formation and implementation of policy measures on the arrangement for personnel, debt disposal and asset reorganization, remove the various institutional barriers on the exit of companies, and link fiscal and financial support policies with approved targets of local production overcapacity cuts. It is important to actively explore market-based clearance of production capacity, promote the flow of production factors from low-efficiency to high-efficiency fields, and from saturated sectors to sectors with market demand, and raise total factor productivity.
 
 
III. Analysis of China’s growth prospect
 
 
(1) China has the potential to maintain medium-high speed growth
Despite many challenges, the fundamentals ensuring sound long-term growth of the Chinese economy have not changed. The basic features of strong resilience,big potential and ample space of adjustment have not changed. The basis and conditions supporting sustainable economic growth have not changed. The momentum of continued structural readjustment and improvement has not changed. We still have the potential and conditions for maintaining medium-to-high growth.
 
First,domestic market potential continues to unleash. As household income and purchasing power rise, the overall size of domestic market is increasingly expanding. Consumption ratio is on the rise gradually. Consumption will play a more important role. Consumption pattern will become more personal, high-end and service-oriented. Particularly, with the fast expansion of the middle-income population, the share of consumption for services and for development such as tourism, leisure, entertainment, transportation, telecommunication, medical and health care, old-age care, education, training, culture and entertainment will increase. New forms of consumption such as online consumption and information consumption continue to emerge and will become new drivers for sustainable economic development.
 
Second, human capital has huge space for improvement. Smaller family sizes mean much more investment in education. Government spending on education accounts for more than 4% of GDP. Every year seven million plus students graduate from university and more than six million students graduate from middle-level vocational education and skill training. More than 300,000 overseas students return from abroad. More than 34% of the urban population between 25-34 years of age have received higher education, close to the average of OECD countries. This has created the condition for transforming mid-and-low end demographic dividend in the quantity sense to mid-and-high end dividend in the quality sense. 
 
Third, innovation capability in science and technology is rising quickly. In recent years, China has substantially increased its input in science and technology. In 2015, R&D spending totaled 1,422 billion yuan, with corporate spending accounting for 76%. Innovation in science and technology has made great headway. China has made leading progress in high-speed computer, manned space programs, nuclear physics and other fundamental research fields. In high-speed railway, nuclear energy, high-voltage power transmission, mobile telecommunication and household appliances, China is now among the front runners in the world. Among the top 10 internet companies, four of them are Chinese. “Internet+” has changed the traditional production model of companies, deepened the online and offline integration and new industries and business models such as e-commerce, internet finance and sharing economy are emerging and evolving with each passing day.
 
Fourth, urbanization still has a big space of development. In 2015, China’s permanent urban population surpassed 770 million and urbanization rate reached 56.1%. Although this is slightly higher than the world’s average, it is still obviously lower than countries or regions with similar per capita GDP levels. By 2020, China’s urbanization ratio is expected to surpass 60%. Advancement of urbanization will generate huge demand for investment in infrastructure and housing construction. The relocation of agricultural population to cities will also foster huge demand for consumption, thus contributing a strong boost to economic growth.
 
Fifth, there is still a fair amount of space for regional adjustment. Given the significant differences among regions in China, there is a lot of complementarity between factors and industries. It offers a big space of adjustment for economic growth. The industries that have lost comparative advantage in coastal regions may relocate to the interior, thus prolonging the product life cycle. Such a unique space of adjustment continues the low-cost comparative advantage in the process of industrial relocation from region to region, and enables different regions to make the most of their respective comparative advantages at different levels of industrial development.
 
Sixth, there is a big room for deepening reform. This will effectively raise resources allocation efficiency and the contribution of total factor productivity (TFP), and further increases potential economic growth. Compared with the past, the difficulties to press ahead with reform are on the rise, as there exists a more complicated landscape of vested interests. However, as the problems become more visible and pressing along with economic slowdown, the resolve of reform is also being awakened. Streamlining of administration, improving administration and services, deepening SOE reform, developing mixed ownership economy, easing market access and breaking industry monopoly will add to market vitality and social creativity. 
 
(2) China will continue to be the anchor of stability and source of driving force for world economy
 
In 2015, China’s economy grew by 6.9%, ranking among the top among the world’s main economies. According to IMF statistics, in terms of comparable price, China contributed 29.8% to world economic growth in 2015. In the past five years, China’s contribution has stayed between 20% to 30%, serving as the world’s most important engine of growth.
 
As China’s economy grows in size, its interaction with the world economy is increasing unprecedentedly. China’s economic transformation and policy readjustment will naturally cause some spillover effects. But on the whole, China’s economic transition has a positive impact on world economy.
 
In terms of trade, in recent years, China’s share in global trade has not decreased. It remains the most important export markets for many economies. Some people say that China’s economic slowdown has dragged down commodities price in the world. In fact, in 2015, China’s import of crude oil increased by 27.12 million tons. Grain import increased by 13.19 million tons. Soya bean import increased by 10.34 million tons. In the first 11 months of 2015, the US, 27 EU member states, Japan and China together imported 9.15 trillion US dollars of commodities. China’s share is close to 17%, basically the same as its shares in the previous five years.
 
In terms of finance, since capital accounts are not fully open, compared with the extensive trade links, China’s financial links with the rest of the world are not that close. Many international financial institutions are of the view that the holding of renminbi assets by foreign financial institutions in the mainland of China is limited. Thus fluctuation in China’s financial market is unlikely to have significant impact. China’s exchange rate regime reform and the easing stock market volatility on 11 August 2015 have drawn response from the global capital market. This is mainly realized through the channel of expectation, and also closely related to the pessimistic view shaped by a sluggish world economy.
 
All in all, China, an economy of close to 11 trillion US dollars, will continue to play a role as the world’s economic anchor of stability and source of driving force. At the same time, China’s ongoing economic transition will also have an impact on the world economy. Other economies also need to adapt to such changes and work together in response, so as to jointly achieve “strong, sustainable and balanced growth” of the world economy.
 
 
 
Wang Yiming is Deputy Director, Development Research Center, State Council. 

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