The World Needs a Soft Landing of the Chinese Economy
China often underestimated its actual growth rate and, as a result, the degree by which its actual growth exceeded its potential growth, as well as all the problems associated with overheating
On July 2, 2010, China’s National Bureau of Statistics revised China’s GDP growth in 2009 upwards from 8.7% to 9.1%. However, not many people noticed that the Bureau also quietly revised China’s nominal GDP figures for 2005-2008 a few months ago.
Based on the revised figures and the previously-posted GDP deflators, it can be inferred that the actual GDP growth rate during 2005-2008 should be 11.4%, 12.9%, 14.4% and 10.2%, respectively. These figures are up by 1.0, 1.3, 1.4 and 1.2 percentage points over the numbers previously released. Accordingly, the actual growth rate of per capita GDP during 2005-2008 should be 10.7%, 12.3%, 13.8% and 9.6%, respectively. The actual GDP growth rate of 14.4% in 2007 exceeded the previous peak of 14.2% in 1992. The actual growth rate of per capita GDP in 2007 surpassed the highest level ever achieved, in 1984, since China adopted its reform and opening-up policy.
Like those previous ones, these recent revisions revealed the fact that China often underestimated its actual growth rate and, as a result, the degree by which its actual growth exceeded its potential growth, as well as all the problems associated with overheating. Such underestimation often compromised the Chinese government’s efforts at timely and effective macro-control. Given the revised data, the Chinese economy experienced full-blown overheating – not the so-called “slight speeding” or “partial overheating” – right before the global financial crisis. Of course, double-digit inflation was absent this time because China had permanently switched from shortage economy to surplus economy around the mid-1990s.
It was an unprecedented phenomenon that China’s actual growth rate exceeded its potential growth rate for six consecutive years of 2003-2008. After years of overheating, the Chinese economy was destined to undergo a downward adjustment process even if without the impact of the global financial crisis. Admittedly, the recent crisis’ global reach did make it harder for China to avoid a hard landing in the adjustment process.
In 2009, China’s actual growth rate eventually subsided below the potential growth rate, and the deceleration rate of the economy also decreased to 10.8%, down from 29.2% in 2008. There appeared to be a successful manoeuvre in Beijing to engineer a soft landing. However, this was only a good start and it is up to China to choose between proactive adjustment to continue and reactive adjustment to put a stop to its soft landing.
The best scenario of proactive adjustment is a U-shaped process of maintaining a moderate growth rate of 7-8% during 2010-2012 and then returning to the potential growth rate of about 9% in 2013. The worst scenario of reactive adjustment is a W-shaped process of propping up double-digit growth until 2012 and then unavoidably diving for a second dip below 5% or even 4%.
The decision-makers in Beijing should remember the lessons of reactive adjustment and hard landing in the past. China’s economy experienced full-blown overheating during 1984 and 1985, with actual growth rate significantly higher than the potential one. After attempts at cooling the economy, the growth rate dropped to 8.8% in 1986, down from 13.5% in 1985, which was similar to the recent shrink in the growth rate from 14.4% in 2007 to 10.2% in 2008 and to 9.1% in 2009. However, the adjustment efforts taken then were not seen through to the end, causing the growth rate to rebound to 11.6% in 1987 and 11.3% in 1988. Then, a second dip became unavoidable and China eventually plunged into a hard landing with growth rate as low as 4.1% in 1989 and 3.8% in 1990.
Since China plays a prominent role in the global economy, a second dip of the Chinese economy would mean a second dip of the world. Therefore, a “slow” U-shaped recovery of the Chinese economy should be interpreted as a positive sign indicating that China is moving along the right path. A quick V-shaped recovery is only possible for those countries not severely burdened by flawed development models. Unfortunately China does not belong to this group.
Of course, there are various other possibilities between the U-shaped and W-shaped scenarios. Say, for example, the GDP growth rate is 1% higher than the figure in the U-shaped scenario. In such a case, if speculative capital from overseas can continue to reap fabulous profits by speculating in China’s real estate market and/or the international commodity markets as it did before, the resulting drain on China’s national wealth would probably outstrip the wealth generated by the additional 1% growth.
China’s economy emerged relatively unscathed from 2009 mainly by expanding bank credit by 10.6 trillion yuan, or nearly one third of the year’s GDP, and allowing real estate price to surge by 23.5%. Although excessive investment enabled China to dodge a hard landing last year, it worsened the chronic problem of extensive development. This is like “drinking poison to quench thirst.” Over the past years of the twenty-first century, efficiency improvement accounted for only 20% of China’s labour productivity growth, leaving 80% contributed by capital deepening. The situation in China now is similar to that in South Korea right before the outbreak of the Asian financial crisis and is absolutely not sustainable.
If China fails to launch a new round of institutional reforms to extricate itself – as soon as possible – from the trap of extensive development, and if it continues to rely on excessive capital deepening and borrowing from the future to keep the actual growth rate above the potential rate, it will soon find itself in the throes of a catastrophe similar to the one experienced by South Korea during the Asian financial crisis.
China’s experience shows that whenever double-digit growth rate can be maintained somehow, institutional reforms is bound to encounter insurmountable resistance and suffer from a lack of driving forces. China’s experience during 1987 and 1988 is an excellent case that uncontrollable risks emerged during the process of reform within an overheated economy. Only years of proactive adjustment can provide sufficient impetus and a sufficiently easy-going environment – with controllable risks – for institutional reforms.
The world needs a soft landing of the Chinese economy and 2010-2012 should be the years of proactive adjustment and reform for China and many others.
[Reprinted with permission from The China Europe International Business School.]
