By Kenny Lau
The Chinese economy has been slowing down for the past several years in terms of annual GDP growth, but it has also been getting bigger in size. In the new “normal” of more modest economic growth, there is great potential that China as a national economy could further improve the efficiency of resource allocation which could lift growth to some extent, but a downward trend is likely here to stay, according to Huang Yiping, Professor of Economics at Peking University’s National School of Development, who is also a member of the Monetary Policy Committee of People’s Bank of China.
In the five years prior to 2010 with the exception of the period during the global financial crisis in 2008/2009, China had consistently experienced an annual GDP growth of 10 percent or more; during the first half of this year it was 6.7 percent. “It is still a remarkable performance,” says Huang. “But how long will this growth moderation continue? And where will be the bottom? This appears to be an L-shape trajectory, but are we on the vertical or horizontal line?”
“The question is whether this is cyclical…or structural,” he points out. “If cyclical, then we shouldn’t worry too much because economies have cycles, and we could engage more through macroeconomic, fiscal and monetary policies. If structural, then we should focus on reform – including supply-side economic reform – in order to improve efficiency of resource allocation so that growth can continue more sustainably.”
“The challenge is how much we should focus on macroeconomic policy and how much we should focus on supply-side reform,” he adds. “We always say we shouldn’t really stimulate growth again because we don’t want to repeat the mistake of the RMB4 trillion stimulus package. That was a little bit too much. So we now want to focus on reform.”
The government response to China’s slowing economy can be a tricky proposition – a policy challenge of juggling economic growth and reform simultaneously. “Growth and reform can go hand in hand together, but they could also be in opposite directions,” Huang notes. “When economic conditions are stable, you have a more favorable environment for introducing reform. But when growth is stabilized, what is the incentive to push forward tough reform?”
“This is also a battle between the new and old economy,” he says. “We have to realize that the industries which have supported China for the last 10, 20 or even 30 years are no longer able to support Chinese economic growth in the next phase. In China, only two of the three growth engines – export and investment – have worked; the third engine, namely consumption, has been relatively weak.”
Behind China’s world of export and investment was a “gigantic” global factory comprising the labor-intensive manufacturing industries located in the Pearl River Delta and the Yangtze River Delta as well as resources based heavy industries concentrated mainly in the northwestern and northeastern parts of China. They were largely the drivers of China’s export and investment expansion onto the global stage in the last couple of decades, and reasons for China’s economic miracle.
The problem is that these industries are vastly losing their competitiveness because of labor shortage and rising wages in the manufacturing sector and because of overcapacity in the heavy industry, and they are no longer able to support Chinese growth. The question is, then, which industry will take over to carry on the responsibility of driving the economy.
“It is not easy to move up, but we are seeing some new activities such as e-commerce,” Huang says. “Older industries are also rapidly re-inventing themselves; in telecom equipment, larger machinery, and especially the internet economy, it is a very dynamic place. This will be an ongoing process, and it will take quite a while. That’s why we are seeing slowing growth.”
The key to bringing about successful supply-side reform in China is to rapidly develop new, competitive industries and to somehow find a way to eradicate the old, low-productivity industries smoothly, Huang believes. “We are seeing massive efforts by the government to encourage innovation and even for individuals to create their own jobs. The more difficult task today is how we can get rid of the unprofitable institutions.”
“We saw these so-called zombie firms in the US throughout the 1980s, then in Japan throughout the 1990s; today it is becoming an official term in China,” he points out. “Many of these zombie firms are associated with the problem of overcapacity, and getting rid of them will not be easy, largely because of two factors: people and money.”
“When you have a company employing 30 percent of the local workers in one city, there is the question of where they can go if the company is shut down,” he explains. “Secondly, many of these zombie firms have heavy debt. If you close them down, who will shoulder the burden of debt or nonperforming loans? While it is undoubtedly difficult, you need to find a way and you can transform. The story of Detroit vs Pittsburg tells me it is possible.”
At the beginning of 2013, Huang predicted that there would be a massive overcapacity problem in China and was particularly focused on two sectors: restaurants and steelmakers. “It is easier to understand why I thought it would be a problem in the steel industry, but restaurants across China were also about to lose business when the anti-corruption campaign started because we knew the government would not spend as much money on dining.”
“Looking at the economy three years later, I was right on one and wrong on the other: while the steel industry has the problem of overcapacity, restaurants do not because they have quickly transformed themselves. If you own a restaurant and lose money in just one month, I am sure you will try everything you can to improve your business. If you are state-owned, you are probably less worried.”
“It means we need market discipline to get rid of these zombie firms in order to support the economy,” he adds. “A reason why even an active financial sector is less effective in supporting the real economy is because zombie firms take up a lot of financing including loans and bank credit which could otherwise be used elsewhere. In 2007, it took 3.5 units of capital input to produce a unit of new GDP; today, you would need 5.9 units of capital input – almost double the amount in order to generate the same result.”
The high level of leverage is another problem for the Chinese economy, Huang emphasizes. “Leverage is the only word you would hear at any investment conference because the Chinese corporate sector has borrowed too much. And the real worry is the divergence of leverage between the public and private sectors. The private sector does so much better in terms of productivity and profitability. In other words, the bad leverage is rising, and the good leverage is falling.”
“While some people say reform has not been as aggressive as we previously expected, I would argue that the Chinese government has done a lot in terms of macro policy reform including those on the household registration system, the one-child policy, and the financial sector,” he believes. “How we can close down unprofitable companies is something we still need to work out. It looks like the government is picking up pace in pushing ahead with reform.”
The outlook for the Chinese economy should be one of cautious optimism, Huang suggests. “It will continue to grow, but growth rate will continue to go down in the next year or two even as the government steps up its efforts trying to boost the economic growth. The real turning point will come when the new economy becomes big enough to carry the responsibility of supporting growth. I think we’ll be ok if we continue to experience five or six percent GDP growth.”
There also appears to be some “positive” changes at the macro level, he says. “Consumption is up and is becoming the most dynamic component of the Chinese economy; the services sector is very dynamic and will continue to drive us forward. In general, you still find wages on the rise, except in the mining industry. It means the labor market condition is robust. We are indeed seeing a transformation, but no one is sure what China’s new ‘normal’ will mean exactly, except that it will be very different.”
“What you can see is an economy in a historic turning point shifting from a something very small to one of the world’s largest,” he adds. “It used to be very poor but income is rising. It used to be a relatively closed economy but it is much more open in terms of trade and capital markets. China used to only export goods and import capital but a more liberal capital account is changing that trend. Chinese companies and individuals are spending more money overseas.”
The next big story for China is one about the consumer, Huang highlights. “I’m not talking about the luxury goods because it has already happened; I’m talking about the consumer market in the areas of household appliances, telecommunication, transportation, tourism, culture, education, healthcare and financial services when the income of 1.4 billion people doubles. This is a plethora of business opportunities.”