Is China’s economic slowdown structural?
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China’s economy has grown at its slowest pace since the second half of 2009, recording 7.8 percent gross domestic product (GDP) growth in the first half of 2012 and 7.6 percent growth in the second quarter.
The slowdown was attributable to weak external demand for China’s exports as well as slowing investment growth, particularly in real estate and its related sectors.
The Chinese government has introduced a series of measures to counter the slowdown, including interest rate cuts and the lowering of bank reserve requirements. There are also increasing calls for stimulus packages to boost spending.
However, to determine what measures are most effective in addressing the current economic slowdown, one must answer the question: Is China’s economic slowdown caused by structural or cyclical factors?
There has been a great deal of debate on this question. Some academics and commentators asserted that cyclical factors played a major role in China’s GDP growth slowdown, noting that continued urbanization and industrialization would allow China to maintain a growth rate of at least 8 percent in decades to come. They believe counter-cyclical policy responses are needed in the current environment.
However, others argue that what’s needed in China are structural reforms aimed at promoting productivity and long-term growth potential rather than short-term counter-cyclical policies or stimulus. Those in favor of structural reforms believe after an average annual growth rate of 10 percent for three decades, economic slowdown is not only inevitable but also desirable.
There are merits in both arguments. We believe there are significant cyclical headwinds underlying China’s recent slowdown, as is the case in many other major economies globally.
However, we also see structural changes taking place in China, which will likely lead to a downward-trended growth potential going forward. Based on our analysis, we estimate around 60 percent of the recent economic slowdown is attributable to cyclical factors and 40 percent is structural in nature.
On addressing the cyclical factors, the government is likely to step up counter-cyclical policies to stabilize growth.
These may include increased public spending on infrastructure — financed by both fiscal budget and bank credit — and further monetary loosening.
While structural factors still account for a smaller portion of the current growth slowdown, they are now more significant than during the financial crisis (2008-2009), when only about 10 percent of the slowdown was due to structural factors.
The issue of structural slowdown needs to be dealt with through in-depth economic and financial reforms that would lay the foundation for long-term sustainable growth.
These policies would include, but not limited to, tax reforms to reduce the burdens of enterprises and households; opening up of the highly regulated industries to private investment to increase efficiency and productivity; expansion of the social safety net to the population so as to reduce precautionary savings; and development of the financial market, particularly the bond market, to reduce reliance on bank financing.
Reforms would be needed to promote and deepen urbanization, which could serve as a major driving force of long-term sustainable growth. A key element of the reforms, in our view, is to abolish the household registration system (hukou), which impedes China’s urbanization and consumption growth. China’s statistics show that over half of the population now lives in the urban areas.
Nevertheless, because a large number of the households living in cities without an urban hukou are excluded from the urban social welfare system, they tend to have a high demand for precautionary savings and are reluctant to consume.
The abolishment of hukou would also promote investment in housing and public infrastructure and that are needed for entrenched urbanization. Such investment would help China to absorb the production capacity that had rapidly expanded in the past.
In addition, one major structural hurdle to growth is the dissipating demographic dividends. China’s working age population has grown steadily since the 1980s and has played a critical role in China’s economic boom in the past few decades by filling jobs in manufacturing and raising the national savings rate.
However, with the aging population and smaller family sizes, China’s working age population is expected to peak in 2010-2015 and fall sharply thereafter. This will spell an end to cheap labor and low-cost manufacturing. It will also lower the savings rate that has been a key driver of investment growth.
Policymakers can no longer rely purely on investment and exports to boost economic growth. Instead, consumption will be key to driving future economic growth.
The writer is vice chairman and chief investment strategist of Goldman Sachs’ Investment Management Division, China.