Is China’s Economy Really as Dire as it Looks?

By Siobhan Kelly
Asia Editor, Undergraduate Economics Student

China’s incredible economic growth has been at the forefront of economic news for decades. Since opening up to foreign trade and investment and implementing economic reforms in 1979, China has transformed into one of the world’s fastest-growing economies, exploiting its cheap labour source to become known unanimously as ‘the workshop of the world.’ After so many years of prosperity, and with many trying to emulate their success, it seemed China could do no wrong.

On what has been dubbed ‘black Monday,’ however, the view of the world shifted. Following a rapidly inflating bubble that saw share prices rise to unprecedented levels, the Chinese stock market became a breeding ground for buying, selling and excessive profits. Stories spread of people leaving their jobs to become day traders, sometimes using loans taken out against their homes. When this bubble burst thousands of investors were left reeling and people are worried for the future of the world’s second largest economy. But on closer inspection, is the situation as dire as some are fearing?

But on closer inspection, is the situation as dire in China as some are fearing?

Economic growth did slow in the latest quarter to a six-year low of 6.9 pr cent and with China’s status as a driver of global economic growth, many are worried about the effect on the state of the world economy. Much of the media is documenting these troubles as a crisis waiting to happen. A further look into the situation however uncovers that China is simply re-balancing their economy, as many knew they would have to.

For one, the bubble that China’s stock market was experiencing simply had to burst, as many predicted it would. The fact that stock prices were climbing ever higher as the economy was simultaneously slowing should have been a major warning sign. From June 2014 to June 2015 the Shanghai Composite Index rose by 150 per cent. Stock market volatility is also consistently higher in China than it is in rich countries, and as financial markets develop, this volatility will fall. There have been far worse stock market losses and there will be in the future.

China’s astonishing economic growth has primarily been investment led, especially in fixed assets. China accounts for more than 50 percent of global demand for steel, aluminium, copper and a whole list of other commodities. The real question here is whether this mass investment has left behind a suitable setting for a new service sector to flourish, or has it been money wasted, leaving the country with an ever growing pile of debt. This debt has now soared to over 200 percent of GDP, which was clearly not part of a sustained growth plan.

The next step requires a transition. As economists have been advising for years, China must rebalance its economy, shifting the investment driven economy to one that is reliant on the service sector and domestic consumption. This is of course a natural progression; when a country’s per capita income rises, people demand more services like education and entertainment.

China must rebalance its economy, shifting the investment driven economy to one that is reliant on the service sector and domestic consumption.

Putting aside some questionable intervention from the Chinese government, stock market intervention and currency depreciation included, this process is indeed underway. Financial services expanded 16.1 per cent in the third quarter, compared with the same period last year, according to the National Bureau of Statistics. China’s better than expected 6.9 per cent economic growth has been assisted by this strong financial services growth, as well as rising retail sales. This expanding service sector is helping to offset the troubles experienced in the manufacturing industry.

If China’s economic performance is judged on previous indicators, the picture is much gloomier. Looking at steel consumption or electricity use for example, the economy looks to be showing significant weakness. These measures are useful when analyzing an industrial based economy, as has been the case for China for some time. But they do not give the whole story when analyzing today’s China and its new growth drivers. The service sector requires far less power and is much less capital intensive. Thus the supposed ‘weaknesses’ uncovered from these indicators are not a sign of an impending crisis, but rather of a much-needed economic rebalance.

China’s economic performance is gloomy if judged on previous indicators but those do not give the whole story.

The weaker industrial performance of late is of course relevant when looking at the declining demand for global commodities. With China previously being the main source of this demand, many emerging economies are losing exports and prices of commodities have fallen, worsening trade deficits for countries like Australia. But in judging the entire Chinese economy, more relevant data is needed.

With expansion of the service sector as well as increasing domestic consumption underway, these policies and structural changes may be exactly what China needs to recover its previous GDP growth rates. The ramifications of the stock market troubles that occurred this summer cannot be ignored, but much of the hysteria is exaggerated. Thus the situation is not as bad as many have feared.

China is not facing an impending economic crisis, but simply fulfilling a new goal. That goal being one of sustained growth, rather than the rapid, investment led growth that was previously driving their economy. Whether the service sector is strong enough to fulfill this goal is something investors all over the world will be keeping a close eye on.

—–

Featured image courtesy of Phogel, Wikimedia Commons

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s