Should we worry about China? Is growth in the key ‘emerging economy’ over, with dangerous reverberations across the globe, or are the latest changes to both its growth and its exchange rate just ripples not to worry about? All this depends on what the causes of such changes are. And traditional analysis seems to be looking in the wrong place, confusing causes with symptoms.
With much of the world economy still sick from the latest financial crisis, and aggregate demand lacking in many countries due to cuts to investment and spending, it is not surprising that exports in countries like China (and even Germany) are now stalling. Furthermore, the massive fall in global commodity prices has caused deflation, which the Rmb has reacted to. And China’s debt/GDP ratio has risen not due to a rise in the numerator, but due to fall in the nominal value of the denominator, falling prices.
Indeed, most attention today is on the devaluation of the Rmb. Is this caused by a simple market response to what was an overvalued Rmb (less worrying)? Or is it China’s strategic response to its need to increase exports in an ailing economy, suffering deflation and falling demand (more worrying)?
To answer this question we should first look at some basic facts. The official growth rate in China in the first half of 2015 was 7%, exactly the government’s target. So far, no reason to really worry. But the real question is where has this past growth come from. Chinese growth has not been driven by exports in recent years but by investment in both assets and traditional infrastructure. Between 2004-2014 investment made up more than half of growth each year. Yet in the first half of 2015, fixed asset investment in China has grown at its lowest level since 2000. This is mainly caused by the cut back in property investment due to the over-supply of real-estate, with many unsold flats. And when property investment falls so does the demand for all the construction materials, causing a more general industrial overcapacity (not just in property). So falling export figures (what the media has looked at) should not be a worry—falling investment should be.
So what should the reaction be of China’s policy makers? Should they implement stimulus packages through public spending and investment—of the kind that some EU countries are considering for their faltering economies, or should they implement “structural reforms”? If the latter, what type? China seems to be set for the latter, but not the biased ones in the EU, which focus only on ‘labour market rigidities’, or cuts to public sector wages. They understand structural reforms in the sense of the need to change the sectorial composition of the economy—what Pasinetti, Italy’s most important economist of recent decades, called ‘structural change’ (a concept missing in today’s EU debate). Such structural change would prioritise consumption and services, over traditional industries (those suffering over-capacity). This would include more investment in areas like healthcare, tourism, IT, and education.
In the short-run this sectorial ‘rebalancing’ may cause a fall in growth, precisely because past growth has been driven by construction and investment in more traditional industries. But in the long run this can help to rebalance the economy, render it more dynamic and allow the kind of innovation that benefited traditional industries also affect services in different areas.
Another area that is disregarded by traditional analysis is the immense investments that China is making in what will very likely be the next big thing after the Internet: the green technology revolution. The last 5-year plan included spending $1.7 trillion dollars in 5 new sectors, which include renewable energy, environmentally friendly technologies, and new generation IT. This is done out of necessity due to the very high levels of pollution but its also being done as a result of vision—similar to Germany’s Energiewende policy that understands green not only in terms of renewable energy but also as a total re-direction for the economy: green products and green lifestyle.
China continues to be the number one investor in renewable energy outside of China—mainly through the investments of its strategic public China Development Bank (a Chinese version of the German KfW). As private finance continues to finance other types of finance in the west (due to over ‘financialization’ of many economies), China’s banking systems is financing the ‘real economy’ in many countries, including infrastructure in countries like the UK.
Thus on the one hand internally China is pulling back on investment internally, rebalancing towards services and consumption, but externally it is continuing its investment driven strategy, in both underdeveloped areas like Africa, and in overly financialized areas of Europe. Of course such investments also have a rate of return that when brought back to China can be used to finance priority areas.
These issues raise different questions for China than the ones that traditional analysis seems to be worried about today. The first question regards internal change, and the other external change. Internally it is essential not only to understand whether market friendliness is accompanied by democracy friendliness—key to the future of ‘inclusive’ growth in China. But also to understand whether China’s greater emphasis on services and consumption will be innovation-led, as have been the recent investments in more traditional industries including telecoms and renewable energy. Huawei, number one in the world for Telecommunications, and Yingli Solar one of China’s leading renewable energy companies, are a result of the kind of patient and long term committed capital that the China Development Bank has provided its key sectors, with loans to innovative companies in the billions. Mixed with an exponential rise in R&D spending, and a strong pull on the demand side for new technologies via the 5-year plan, this has increased China’s status amongst most innovative nations. As it ‘rebalances’ towards the service industries, it is essential that this innovation vision be applied to these areas as well. If so, China’s rise to one of the world’s most innovative nations may continue.
The second question regards whether China will implement changes to its own institutions and organizations, so that they can adapt flexibly, in a more decentralised way, to changing national and international circumstances. To avoid the rigidities of the ex-Soviet system, this requires building a dynamic and decentralized system of innovation, across many different agencies, as Japan did in the 80s. Currently, instead, many Chinese investments are still being driven top down through a strong China Development Bank.
And of course a key issue for China, will be whether the rest of the world gets its act together. If counties like Brazil allow political crises to turn into economic crises, and if the Eurozone crisis continues to patter away, forcing austerity and hence sluggish growth onto one country after another, then China’s problems may deepen. And here, the attention should come back to our own inability, in the EU, to react in a flexible dynamic way to what continues to be a political and economic tragedy of epic proportion.
Tags: China, Crisis, Green, Patient Finance, Smart Growth, Sustainable