China is now the biggest contributor to global growth and its share market is the world’s 4th largest. China’s rapid growth has resulted in considerable scepticism about its sustainability.
The AMP's Chief Economist and Strategist, Dr Shane Oliver looks at the key issues with China.
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China remains on track for strong long term growth
China is being propelled by very strong structural forces that have decades to run.
These include:
• Strong productivity growth on the back of privatisation, deregulation and the application of new technology.
• Rapid urbanisation which is sustaining investment, contributing to productivity growth and keeping labour costs down via the supply of cheap labour. The argument that China has run out of cheap labour seems weak – its urbanisation rate is still only 40%.
• Huge competitive advantages built around low unit labour costs, scale advantages and good infrastructure.
Average salaries of manufacturing employees are 5% of US and European levels. Unit labour costs are a fraction of those in developed countries. Manufacturing unit labour costs are falling despite rising wages.
Consumer demand is growing strongly and will be boosted by Government policy to re-establish a social safety net (with plans to double the percentage of the workforce covered by pension plans and medical insurance by 2010 to just below 70%).
Consumer spending is coming from a low base. E.g., there are less than 20 cars for every 1000 people which is where the US was in 1918 and this compares to about one car for every two people in Australia and the US. Living space per person is 10% of US and Australian levels.
• China’s rate of investment is likely to remain strong on the back of urbanisation, the low level of capital relative to the population, strong profit growth and a high level of retained earnings and policies to narrow the income gap between the eastern and inland provinces.
With per capita income levels in China still way below rich country levels China’s rapid growth phase has decades to go. This means China’s export penetration into developed country consumer – & increasingly capital goods – markets has a lot further to go and so does the resources boom.
Growth is very strong, but no sign of overheating
There is no doubt that Chinese economic growth, running above 11% so far this year, is a bit too strong.
As a result we are likely to see more attempts to slow it down to 9% to 10%. It is also the case that monetary policy in China is unnecessarily stimulative with the one year benchmark borrowing rate of 7.29% extremely low relative to nominal GDP growth of around 15%. Keeping the Renminbi cheap is leading to economic distortions and adding to the difficulties of monetary management.
Rapid growth is also creating social and environmental tensions. However, there are several points to note about all this. Firstly, the normal signs of overheating are not present.
• Non-food inflation is just 1.1%.
The current account is in surplus and as such China is not reliant on foreign capital inflow.
• While property prices are rising strongly, in aggregate Chinese property prices have been rising at a slower pace than nominal GDP (which is running around 15%).
• Investment running at 26% year on year remains too strong, but retail spending has been accelerating and recent strength in investment growth reflects strength in the inland provinces, both targets of Government policy.
These considerations suggest that while further measures are likely to slow growth down a bit, there is no need to crunch it so policy tightening is likely to remain measured.
Secondly, while Chinese interest rates are low relative to nominal GDP growth it should be borne in mind that China is not yet a fully developed laissez faire economy.
Unlike in most developed countries where interest rates are the key policy lever, China also actively uses a range of approaches including the use of administrative controls (such as restrictions on investment projects or putting pressure on banks to slow loan growth like now).
• In this regard, it should also be borne in mind that loan growth of 18% per annum is not strong in relation to nominal GDP growth of 15%. It has been running at much higher levels relative to GDP growth in rich countries recently including Australia.
Thirdly, while China may speed up the appreciation of the Renminbi, it is unlikely to go too fast given the authorities’ fears that it could stifle exports and make it hard to absorb rural workers. Their approach is likely to remain gradual.
Finally, while China has big environmental problems and problems with product standards (such as the recent furore with product recalls from toxic tooth paste to excessive lead in kid’s toys) this is arguably just a stage in its economic development. Industrial revolution London did not look too flash either and the US had similarly lax product and intellectual property standards in the 1800s –
Charles Dickens was extremely annoyed at seeing pirated copies of his books in Boston book stores!
Will China withstand a US downturn?
The impact of the downturn in the US on China depends on how far the US economy slides. China is well placed to
