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China Trends #4 - China’s New and Old Engines of Growth

BLOG - 18 December 2019

China’s economic growth this year is believed to be the slowest since 1992. The National Institution for Finance and Development (NIFD), a Beijing-based think tank, recently predicted that China’s economic growth rate would even slow below 6 per cent (to 5.8 per cent) in 2020, from an estimated 6.1 per cent this year. This is below China’s target range of 6 to 6.5 per cent growth for 2019 and indicates further downward pressure on the Chinese economy. Economists in and outside China are therefore pessimistic about the future outlook of China's growth. Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences (CASS), believes that the "downward trend is riskier than many observers seem to realize" for instance.1

Contrary to these bleak predictions, the two authors introduced in this article are still optimistic that the Chinese economy will grow at a reasonable speed if the government focuses on the right economic policies. While Zhang Deyong, a researcher at the Institute of Financial and Economic Strategy of the CASS, places hope on new engines of growth, Li Xunlei, chief economist of Zhongtai Securities and vice chairman of the China Chief Economist Forum, focuses on the traditional drivers of economic growth.Zhang finds in his analysis that the Chinese economy grew fairly well in the first half of 2019, despite the uncertainties in the external environment and the downward pressure on the economy.2 As of May of this year, 5.97 million jobs have been created in urban areas. In addition, production has stabilized and progressed, the service industry maintained a rapid growth; domestic demand continued to expand, and online retail continued to experience rapid growth.3 Zhang says that exports have maintained a rapid growth and that the trade surplus further expanded.

As the Chinese economy moves towards high-quality development, innovation has become the first driving force for development.

The second assertion is spot on; but his estimate of China’s exports sounds optimistic: according to MOFCOM, "In January-September 2019, China’s total import and export value reached US$3351.78 billion, with a decrease of 2.4% year-on-year (the same as below). The exports were US$1825.11 billion, with a decrease of 0.1%, and the imports were US$1526.67 billion, with a decrease of 5%. The trade surplus was US$298.43 billion, increasing by 36.1%."4

As the Chinese economy moves towards high-quality development, innovation has become the first driving force for development, Zhang writes, leading to the vigorous development of the "three new" economies ("三新"经济): new industries, new formats, new business models (新产业、新业态、新商业模式). These new economies are based on innovation, and have been supported in various ways by digitalization, artificial intelligence, big data or online retail. In 2017, the growth value of the "three new" economies was equivalent to 15.7 per cent of GDP growth, 0.4 percent higher than in 2016, and 2.9 percent higher than the current GDP growth rate.

In line with these "three new" economies Zhang sees a continuous emergence of new consumption models. Although the growth rate dropped by 0.5 percent from January to April, the investment in high-tech industries increased by 11.9 per cent year-on-year. Investment in the manufacturing industry focusing on the digital transformation (Industry 4.0) increased by 15 per cent. Zhang highlights that, since the beginning of 2019, the high-tech industry has grown rapidly. In May, the added value of high-tech manufacturing increased by 9.4 per cent.

Zhang therefore argues that China's economic growth is stable and that the long-term positive trend will not change. He believes that continued comprehensive reform and opening-up, as well as continuous systemic institutional innovation will keep the Chinese economy growing. Zhang recommends that China promotes high-quality development, adheres to the supply-side structural reforms, and deepens reforms in key areas. He also warns that China should pay more attention to rules and other institutional openness as well as further ease market access.

Li Xunlei’s analysis starts on a much less optimistic note than Zhang’s. Li uses what he calls the "troika" (三驾马车) architecture to explain China’s recent economic performance: consumption, investment and foreign trade. In the first half of 2019, China's GDP growth rate was 6.3 per cent.5 In terms of total volume, GDP growth was in line with the 6-6.5 per cent proposed by the government’s work report at the beginning of the year.

The reason behind consumers’ lack of optimism is the stagnating disposable income of residents.

However, Li sees in the consumption growth rate a downward trend. In 2018, the total growth rate of retail sales of consumer goods was around 9 per cent, and the average growth rate in the first half of 2019 fell to 8.4 per cent. The total retail sales of consumer goods reached 9.8 per cent in June, but this was mainly driven by the automobile industry.6 Other consumption growth rates, including the service industry, were still weak. The consumer price index of the service industry dropped from three to less than two per cent.

Li believes that the reason behind consumers’ lack of optimism is the stagnating disposable income of residents. Li finds that the trend of income growth is very similar to the trend of growth of total retail sales of consumer goods. However, while in 2018 the per capita disposable income of high-income groups increased by 8.8 per cent, middle-income groups achieved a growth of only 3.2 per cent. If inflation is considered, the income growth of middle-income groups is almost equal to zero. This is the main reason for the slow domestic consumption, in Zhang’s view. In addition, the consumption structure has diverged. The consumption of high-end consumer goods and luxury goods has grown rapidly.

Secondly, regarding investment, the growth rate of manufacturing investment in China's fixed asset investment fell to three per cent during the first half of 2019. This indicates that the slowdown of investment in the manufacturing industry and the lack of domestic demand and rising labor costs are all related, Li explains. Regarding the growth rate of real estate investment, it was 10.9 per cent, which has become the main factor for stabilizing the growth of fixed asset investment. As for the growth rate of infrastructure investment, it was relatively weak, only around 4 per cent. Li believes that it will be unrealistic to stimulate economic growth through infrastructure investment in 2019.

Finally, regarding foreign trade, contrary to Zhang, Li finds that exports were generally weak in 2019, likely due to increased trade friction between China and the United States. In sum, during the first half of the year, these three drivers were tempered. Therefore, even though the current economic downturn is not large, it can maintain a steady downward trend.

Li suggests focusing on solving structural problems in response, such as expanding the proportion of public spending that is allocated to social security. Increasing future social security funds would increase consumer confidence and thus also consumption rates. In terms of taxes and fees, Li sees the necessity to further reduce the financing costs for small and medium-sized enterprises (SMEs) and to implement corresponding supporting policies. According to him, "instead of just shouting slogans, there need to be practical steps" (而不是只是喊口号,需要有实际的举措).

Li notes that in the future, like most developing countries such as the United States or Japan, the Chinese economy will be driven by consumption, but the main force of consumption is the middle and low-income classes, which are currently growing relatively slower than the upper middle class. In consequence, for his next policy recommendations, Li proposes to firstly reduce the actual interest rate level, so that SMEs can reduce the financing cost, which would then increase employment and the income of the middle and low-income groups especially.In addition, it is necessary to achieve balanced social development through public spending in Li’s view.

Increasing future social security funds would increase consumer confidence and thus also consumption rates. 

At present, the level of debt in the residential sector is rising rapidly and the debt level of the corporate sector is almost the highest in the world. There is a need for enterprises and the residents' sector to stabilize their debts, in particular as the population ages further and the debt level in the whole society only rises. Li believes that solely the central government, which has very large available assets, can hedge the rise in the debt ratio of the residents and the corporate sector.

Li finds that Chinese citizens are worried about their future pensions, financing their children's education. This is why they do not dare to consume. The core reason for the high savings rate of Chinese residents is the concern for future social welfare protection. Li suggests using the large state-owned resource to cover the needs of the Chinese economy in the future, such as the social security gap. He argues that profits of State-Owned Enterprises (SOEs) can be turned over, meaning to transfer equity, which is a big advantage of China's SOEs system.

In conclusion, given the various challenges China faces from within and outside, it seems Beijing will have to do both: encourage the new engines of growth as well as tackle the problems that are rooted in the traditional drivers of growth.

 

Click here to download the full publication

 

1Yu Yonding, "China Needs to Arrest Slowing Economic Growth, And it Has the Means to Do So", South China Morning Post, 7 November 2019, https://www.scmp.com/comment/opinion/article/3036521/china-needs-arrest-slowing-economic-growth-and-it-has-means-do-so.

2Zhang Deyong, "Grasp the "Real" and "Potential" of China's Economic Development" 全面把握中国经济发展的"实"与"势," Wisdom China智慧中国, September 2019.

3Online retail sales rose by 16.8% year-on-year over the period January and August (though down from the 28.2% growth the year before), according to data published last month by the National Bureau of Statistics.

4Ministry of Commerce of the People’s Republic of China, "Briefing on China’s Import & Export in September 2019," MOFCOM, 11 October 2019, http://english.mofcom.gov.cn/article/statistic/BriefStatistics/201911/20191102912682.shtml

5Li Xunlei, "How to Treat China's Economic Operation and Policy Trends in 2019 如何看待2019年中国经济运行与政策趋势," Journal of Contemporary Financial Research 当代金融研究 4, 2019, no.13.

6The reason for such a large increase was the June 30 deadline to sell cars built to China-5 emissions standards. The central government had ramped up its anti-pollution drive last year and has aggressively pursued the adoption of the electric cars and its stage-6 emission standards. After the deadline only vehicles meeting new stage-6 standards could be put up for sale. The China-5 emissions cars had been reduced in price and the sales volume therefore rose sharply.

 

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