Change afoot in China

As many economists have argued, the structure and evolution of China’s economy has a huge impact on the global economy, and its very high rate of investment, with overall saving even higher, especially in the run-up to the global financial crisis, was part of the cause of the imbalances that contributed to that crisis. China’s large current account surpluses which it ran for several years prior to the 2008 meltdown were a consequence of domestic distortions (perhaps necessary for its 30 years of rapid growth) that led to a surplus of savings over investment. These savings were ultimately lent abroad, mainly to the US, fuelling a credit and housing bubble which eventually collapsed leading to recession there and across the world.

As Michael Pettis has argued at length, on his blog and in a recent book, Avoiding the Fall, to sustain its growth in the longer term and make the transition beyond a middle-income to a rich country, the share of consumption in the Chinese economy needs to rise significantly and the share of investment (currently around 50% of GDP) to fall. Growth may slow in the process, but investment will become more productive and wages and consumption for the majority will rise which should head off any mass protest against structural change by the population.

And indeed, growth is currently slowing, one hopes sustainably, driven by a huge construction boom gradually coming to an end. Net exports are also growing at a slower pace and the trade surplus has declined in recent years. A careful liberalisation of the financial sector, which includes the setting of interest rates, should lead to a more efficient allocation of capital (investment).

However there are losers in the China slowdown. As growth becomes less manufacturing-intensive, the demand for commodities has fallen, hitting their major exporters, from Latin America to Africa. Some of these economies have failed to diversify away from commodities to manufacturing and services exports and are consequently suffering.

Rising wages in China may also benefit workers across the world, as Chinese workers represent a sizeable proportion of the global labour force. The increased power of Chinese labour may lead to similar shifts in other countries, as the downward pressure on wages and prices from a hugely increased labour supply eases. This could also lead to higher interest rates in many countries, which in recent years have been at rock-bottom levels.

Of course, the trend of slower growth in China will be from a much higher output base than for example a decade ago when the economy was that much smaller, and will still add significantly to global output.

It remains to be seen how quickly and smoothly the Chinese transition can take place, but given the size of its economy (either the largest or second-largest in the world depending on how you measure it), the global economy will be impacted, for good and ill, and policy makers should be ready to respond.




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