Faculty & Research
Faculty & Research
Faculty & Research
What’s Behind China’s Slowdown?
Analysing the Chinese economy is not an easy task and, among CEIBS faculty you will find a wide range of views. Read on for a ‘fly on the wall’ perspective of a discussion including CEIBS Professor of Economics Zhu Tian and Professor of Economics & Finance Xu Bin. The two men analysed the slowdown of the Chinese economy from different angles, yet they shared common views that one should distinguish between cyclical and fundamental reasons behind China’s economic slowdown, and that policies should focus on supporting the private sector, which is the fundamental driver of China’s economic growth. Read on for excerpts from their discussion:
I tend to agree with Xu Bin about the role that the US-China trade dispute has played in China. It is very clear that the Chinese government changed its tack from late last year. And not only in terms of macroeconomic policies: they basically called off their deleveraging policy and, also, they realized that they have to pay a lot more attention to the private sector because it is the private sector that has been the driving force of the Chinese economy.
I also agree with Xu Bin that the tax reduction announced in Premier Li’s Work Report to the National Congress in March is very significant. It's about 2% of China's GDP, that's almost 10% of the country’s fiscal revenue. I think this signals that the government is getting serious about helping the private sector to grow, and it is a positive development.
In terms of the broader Chinese economy, I think that there is some confusion or misunderstanding about China’s economic growth among, both Chinese policymakers, or their advisors, and the media — including the Western media. A lot of people fail to distinguish between long-term growth and short-term fluctuations. These two things are very different. In macroeconomics, we teach business cycle theory and then we teach growth theory; and the underlying theoretical frameworks are totally different.
China has been growing so fast over the past 40 years, the fastest in the world. How has China managed to grow so much faster than the rest of the world? That's one question. Another question is: why has China slowed down so significantly in recent years? These are totally different questions, so the answers to these questions should be very different.
For long-term growth, we generally rely on the Solow Model. You look at the supply side: investment (i.e., fixed capital accumulation), human capital accumulation, and productivity growth (or technological progress). And when you look at the slowdown, which is a fluctuation in my view, you use the Keynesian approach. That is, you look at the demand side: investment, consumption, exports, etc.
Significant slowdown of the Chinese economy began in 2012. It is true that because it has been seven years this does not look like a normal cyclical slowdown. But I think it is. And let me tell you why. First of all, if you only look at the Chinese GDP growth rate statistics, the numbers do not fluctuate that much; they are all very similar because there is a set GDP growth target of between 6% and 7%. But in a previously published study, I showed that in 2015 the GDP growth rate was probably overestimated by at least two percentage points because the inflation rate was underestimated due to poor methodology. So, in a sense, there has been fluctuation within the past seven years. Government advisors seemed to have thought that the slowdown wasn’t a demand side issue, but a problem on the supply side. So China engaged in supply side policies to deal with the short-term fluctuation. Their goal was to reduce some capacity to balance the supply and demand. The measures implemented actually strangled both supply and demand. That made the recession even more serious. So sometimes downturns are policy-induced.
When I talk about cycles, I am talking about the difference between the potential growth rate and the actual growth rate. China could have grown a lot faster over the past seven years, but it didn't.
So I am happy about the new policy direction we have been seeing since late last year.
Xu Bin to Zhu Tian: I agree with you that there has been some overreaction. But I think without this overreaction, the Chinese GDP growth rate could have been going down even more than what the data shows.
I always share with my students my view on why China keeps the real GDP growth so stable. In my personal view, the most important variable in macroeconomics is not GDP, it's expectation. If you expect the numbers to go up, they will go up. The worst thing that you can do is create an environment in which the expectation is that the numbers will go down. That’s what China did in the second half of 2015, with the Renminbi, and then we saw a lot of fluctuation. So I think it's deliberate from the Chinese government's side to make the GDP stable.
Zhu Tian: I agree. So that's why I said you cannot tell whether there are fluctuations by looking at the data.
Xu Bin: When India changed the way they calculate their GDP, there was all this criticism. Two years later, who remembers that? I think Prime Minister Modi is doing the right thing: adjusting India’s GDP growth rate to a level higher than China’s, in order for the Indian people to keep up their morale in the economic race between the two countries.
Everyone has expectations, and these are not necessarily rational. That's the core of Keynesian theory, which is called animal spirits. It is a very good concept, but people think it's about the irrational. In fact it's about expectations. People's expectations are the most important determinant.
I have two views about the slowdown of the Chinese economy. One is that there is clearly a fundamental decline in the supply side, the driving force of the economy. I don't put much weight on the so-called aging population theories, I do not think that this is a major factor in the slowdown. My view is that China is becoming more and more advanced, so the room for imitation and catching-up is getting smaller and smaller, so potential GDP growth rate is going down. Another factor is that you require a different quality of labour. In the past, unskilled labour was enough, now you need skilled labour.
My second view is that although China’s GDP growth is going down, five to ten years later it may be going up. The reasoning behind this is simple. I do not believe that, as a country becomes more and more high-income, its potential GDP will be destined to grow less and less. Potential GDP depends on the production function. If entrepreneurs are given more freedom to create, if more Chinese talents return from overseas, imagine how much potential GDP China can achieve. I think that is what should be looked at.
I agree with Zhu Tian that the slowdown has something to do with the overuse of a tightening policy. I think now, especially in terms of the allocation of credit, if you're tightening it in the name of deleveraging, you are hurting private companies the most. If your policies are in favour of China's private sector, China will develop. It's driven by potential GDP, which depends on efficiency and the quality of inputs. And I think that both in terms of efficiency and quality of inputs, down the road, China will have a beautiful run.
So I tell all my EMBA students, "Do not move to other countries. The opportunities are here for you, for your kids, and for your companies."