27 October 2016
It is difficult to see China's economy continuing to grow at its current pace as it restructures. Photo: Bloomberg
It is difficult to see China's economy continuing to grow at its current pace as it restructures. Photo: Bloomberg

Why China’s slowdown may be irreversible

It’s a universal economic phenomenon that output and technological upgrading of the tertiary sector lag those of manufacturing.

This may explain why China’s economic downturn, triggered by restructuring and rebalancing, is irreversible.

The growth rate of the mainland economy fell further to 7 percent during the first three months of the year, from 7.4 percent in the last quarter of 2014.

Even that 7 percent growth rate has been overstated, some economists think.

Based on the “Li Keqiang Index”, created by the Economist to measure China’s economy using three indicators — railway cargo volume, electricity consumption and loans disbursed by banks — it is estimated that growth in gross domestic product in fact slowed down to 6.7 percent during the period.

The communist cadres have already set the tone, stressing that slower growth is the “new normal” and that no one should read too much into it, but the slew of stimulus policies being rolled out, one after another, belies Beijing’s superficial calm.

Mainland news portal Sina leaked a report that Premier Li Keqiang exhorted officials of the northeastern provinces, where the worst first-quarter figures have been reported, to ardently rekindle growth.

So even the premier himself feels uneasy with the “new normal”.

From academia to the grassroots, the common mindset in the mainland is still that, having endured the tough days of the present, the economy will turn around and return to the fast lane.

Justin Lin Yifu, a top economist who advises Li, has quietly modified his prediction for economic growth.

Having said earlier that China can sustain an 8 percent annual growth rate throughout the next two decades, Lin now says China “still has the potential” to maintain such a pace.

When discussing China’s economic fundamentals, we can consider two factors – an aging population coupled with a shrinking labor force, and overcapacity brought about by inefficient, excessive investment.

Economic restructuring refers to the transition from an investment-led mode to a consumption-driven one.

The process means the rise of the tertiary sector’s share of GDP while the manufacturing sector may experience downsizing.

China is no exception in this regard, even though half of its GDP still comes from the industrial sector.

Now the challenge is that, as mentioned at the beginning, technological upgrading of the tertiary sector cannot keep pace with that of manufacturing.

Naturally, the more an economy depends on non-manufacturing industries, the slower it may grow.

It’s a fallacy that the Chinese economy will enjoy a robust rebound after its restructuring.

To some extent, the previous decades of phenomenal expansion were built on the dominant status of manufacturing in the economy.

The pattern is a vivid example of German economist Albert Hirschman’s well-known assertion that ultra-high-speed growth is unbalanced growth.

Economic activities in the tertiary sector fall into three categories: activities with stagnant technology, activities with minimal technological upgrading, and activities with progressive improvement in efficiency, technology and output.

Numerous types of services, like tutorial schools and learning centers, personal care services like nail polishing, elderly care and many others — even prostitution — belong to the first two categories.

Five years ago, when China was the only major economy immune to the global headwinds, Barry Eichengreen, an economist at the University of California, Berkeley, examined data after 1957 about all the economies where the growth rate nosedived after a period of rapid expansion.

His conclusion is that the plunge may occur when per capita GDP reaches US$17,000 — a stage when the tertiary sector is about to replace manufacturing — and on average, the growth rate may drop to just half of its peak.

Eichengreen estimated back then that China may reach that watershed in 2015.

He has also warned that if a country has long been manipulating the exchange rate of its currency, it’s vulnerable to a fiercer slide in growth.

Given all this, it’s totally logical and normal if China’s growth rate cools down further by 2-3 percentage points in the coming years.

This article appeared in the Hong Kong Economic Journal on April 20.

Translation by Frank Chen

[Chinese version 中文版]

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Former full-time member of the Hong Kong Government’s Central Policy Unit, former editor-in-chief of the Hong Kong Economic Journal

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