Wednesday, February 28, 2018

Trump’s America 1st Won’t Hurt China Much

By Xu Bin

China’s surprising 6.9% growth in 2017 has made it clear to me that US President Donald Trump’s America First policy won’t hurt China as much as some may fear. An analysis of the data shows that the Chinese economy has delinked from the global one, no longer powered by external forces such as exports and inward FDI. Instead domestic consumption is the main driving force, pushed along by new technology, a growing services industry and urbanization. It also helps that China has a built-in 3S advantage of scale, scope and the newest ‘s’ factor – speed.

Many were surprised – and sceptical – when the 6.9% growth in real GDP was released on January 18. My concern is that this number may well be an underestimation of the true growth. A breakdown of the data shows that the PPI (which drives companies’ incentive to invest more) improved dramatically towards the end of 2016 and was positive for all of last year (up 6.3%). The PMI (a way to measure whether an economy is growing) was similarly impressive for both the manufacturing (52) and services (55) sectors, and there was a 10.8% growth in exports despite the fact that the Chinese currency was appreciating at about 6%.

There are some who believe these impressive results are either because of a global economic recovery or simply a spill over from the Chinese government’s stimulus policies of 2015-2016. I believe both of those theories are incorrect.  

Signs of delinking

The global economic recovery helped, but it was not the main driver of the 6.9% growth in the Chinese economy last year. In fact the surprisingly good growth, in 2017, in the EU (2.6%), Japan (2.1%) and the US (2.5%) has not had much effect on China. In 2007, net external demand was responsible for 10% of China’s economic growth; in recent years, however, net external demand is no longer essential for China’s economic growth. There is supporting data which shows that there is a decrease in China’s overall reliance on global trade. Both export and import values as a percentage of GDP fell by about 50% between 2008 and 2016. At the same time, there has been a rapid drop in China’s processing exports (where a country uses its own resources to produce goods that will be exported by foreign companies). There has also been a steady downward trend – from a high of 6% in the early 1990s to about 1% in 2017 – in inward FDI as a percentage of GDP. This means that 99% of China’s new capital is from its own savings, not from foreign capital. These are all very obvious signs of delinking.

China has been lucky in its timing. In the 80s and 90s as the country began its reform and opening up, globalisation swept across most of the world. Joining the WTO provided Chinese goods access to overseas markets and protection from trade discrimination, and China benefitted from this. Today it has become fashionable, globally, to protect ourselves and put our own people first; we are no longer in the globalisation era. This will still hurt China, but not by much. That is because one feature of China’s so-called New Era is that the country now depends a lot more on itself and a lot less on other countries.

The stimulus theory

The second theory I want to debunk is the suggestion that China’s 6.9% growth was a delayed result of the stimulus package the government unleashed in 2016 to steady the economy in the aftermath of the stock market crash, currency depreciation and a jittery private sector. The Chinese economy was doing very badly in 2015, so from the beginning of 2016 the government increased the amount of its fiscal spending on investment, pulling it up from 10% to 25%. This expansionary fiscal policy (which also included real estate stimulus) lasted for about a year and definitely had a big impact. But this was, more or less, to offset the drop in the private sector’s investment growth rate. According to official government data (which I believe is conservative in this case), overall private sector investment was close to 0% at one point. Private companies, which usually account for 70% of overall investment, stopped investing. So you needed a lot bigger injection from the government to offset this drop, and even this did not stop the downward trend in overall growth. The government also relied, to a lesser extent, on expansionary monetary policy (increased money supply) but both of these measures have been gradually phased out since late 2016 into early 2017. So we can conclude that the stimulus did not result in an increase in the growth rate, but merely offset the fall in the growth rate due to the drop in investment by the private sector. Their lagged growth-promoting effects would not explain the 6.9% GDP growth in 2017.

Real source of growth

I am convinced that services, [private] consumption, urbanization and new technology are behind China’s 6.9% growth in 2017. As other countries before it, China has made the journey from having an economy dominated by the manufacturing/industrial sector to one where the service sector now dominates, accounting for between 52-55%. Meanwhile, over the past two to three years, consumption (about 65%) has replaced investment (about 40%) as the main contributor of GDP growth. In this new consumption-driven growth model, a lot of the growth is being driven by the new service economy. Four of the world’s top 10 internet companies are Chinese, and technological change has been a big push behind the country’s fast growth. So too has urbanisation: migration to cities means people have access to better education, there is easier sharing of information and they can learn from each other.

Because of the nature of the new technology era – dependence on big data, AI, mobile phones, 4G, 5G – scale, scope and speed (what I call the 3S) have become invaluable. Speed refers to China’s ability to rapidly take a product to market and use the sheer size of its tech friendly consumer base to quickly make adjustments as needed. This is linked to the country’s knack for incremental innovation, sometimes called the poor nation’s innovation. Today the once-admirable German and Japanese approach no longer applies. Gone are the days of perfecting a product before it is released to market.  It’s all about speed and China has that segment of the market cornered.

Meanwhile, China has an even bigger advantage in scale than it had during the manufacturing age. One tangible example is how scale helps it leverage the platform economy. A platform such as Tencent, for example, can afford to charge low fees to watch sporting events because of the sheer number of subscribers. And when it comes to scope, not very many countries can compete with China’s ability to complete an entire production chain in one location, for example a village, greatly minimising cost.

So I am convinced these new economic forces related to China’s structural transition are mainly what drove last year’s 6.9% growth rate. I also think that, because of these new elements, over the next three to five years China’s annual GDP growth rate may be higher than the current trend suggests it should be. As countries get richer, it is normal for their GDP to become lower as growth slows, but China’s path may not be a linear trend, it may deviate. We may see an upward swing; instead of a GDP of about 6.2% it would be about 6.6%.

What could go wrong?

Of course it is possible that this upward swing may be derailed by certain risks such as a debt crisis, the housing bubble bursting or large-scale capital flight. There is a very high potential of a debt crisis because China’s shadow banking sector is so large, 70 – 80 trillion yuan. There is clearly a bubble in the real estate market and, as the stock market crash of 2015 showed, there is very little anyone, including the government, can do to intervene if the financial market takes a nosedive. So the risks are there, they are big, but they are contained and it is less alarming because of the strong economy and the powerful government.

China’s President Xi Jinping made it clear, in October 2017, that his focus is no longer on the old growth model. He is now focused on containing financial risk, encouraging innovation and increasing consumer spending. In other words, the focus is on high-quality growth – and China clearly doesn’t need the US to accomplish that.

Xu Bin is Professor of Economics and Finance, as well as Associate Dean (Research) at China Europe International Business School (CEIBS). His current research focuses on the global and Chinese economy, multinational enterprises in China, as well as trade and finance issues within emerging markets.

An edited version of this article first appeared in Caixin Global on Feb. 27. 

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