China’s economy in transitionThe Chinese government is targeting growth this year of around 7 percent. But most experts expect the world’s second-largest economy to underperform. Even Beijing admits it won’t be able to meet the target. It is a striking figure considering the economy had grown about 10 percent per year until 2011. The slowdown does not seem cyclical but structural.
Economies like Korea, Japan and Taiwan went through similar growth patterns in the early stages of their development. During the 30 years since the 1970s, the three economies grew about 10 percent annually. After a transitional period of a decade, their growth slowed to 5 percent. China is no exception. Its economy began to pick up speed from the 1980s. Until 2010, it grew more than 10 percent. The sizzling double-digit growth began to lose steam. There are obvious signs that the once-unstoppable economy has entered a transitional stage.
Why does an economy go through corrective phases and what are the typical symptoms? When the economy is simplified to consumption, investment and trade, fast growth in the first 30 years of industrialization is fueled by heavy investment. Consumption and exports also surge as byproducts of brisk industrial activity, but growth is not as big as in investments. The benefits of economies of scale spur more investment and result in excess. Competitive and reckless investment end up raising costs and paring return yields, calling for industrial restructuring to resolve overcapacity. While consumption remains stable, the largest reason economies like this slow down is atrophied investment. China’s fixed-asset investment surged more than 25 percent on year in the 2000s. The pace slowed significantly to slightly over 10 percent from 2011. Construction sites commonplace in China over the last decade cannot be found in many areas these days.
During the transitional phase, the financial sector must adapt to a new environment of lowered returns. But because investors cannot forget the riches of the fast growth period, they seek out new and riskier investments by borrowing cheaper loans. The practices resulted in the forming and bursting of bubbles in real estate, stock and high-return investment products in Korea, Japan and Taiwan.
China is following the same formula. Inflating real estate prices, expansion in shadow finance and ballooning debt in local governments have been cited as risks for the Chinese economy since 2011. Local governments, companies and individuals have all gone on debt-financed binges to prolong the illusory riches obtained during the transitional economic stage. The volatility in the Chinese stock market and continued stock investment despite unfavorable underlying economic conditions is typical of a blind chase for higher returns during the transitional period.
The question is how long will the transitional period last for China and how will the economy look when it ends? Considering other fast-growth economies that underwent a transition for about a decade, the current tumultuous period could continue through 2020 for China. Given its current slowing pace, China’s growth could stop at around 5 percent by 2020. In short, the hard times would go on for another four to five years.
How China will look after the transition depends on how well it uses the period to stabilize and strengthen fundamentals and potentials. The ailing and redundant industries must be cleaned up and the economy must instead be retooled based on services and technology-intensive industries. Korea, Japan and Taiwan survived the challenging times well.
But unlike these three, the Chinese economy is under state control. Through government interventions, correction in structural problems could be reined, masked or deferred. They can prevent immediate losses and shocks, but cannot solve the fundamental problems. They also undermine the mechanism of the market. Even after a transition stage of a decade or so, the Chinese economy may not turn out as strong and resilient as other economies that went through a similar phase. It remains unclear if the Chinese economy would be on stable footing for further sustainable growth if it remains under rigid state control in five years.
But President Xi Jinping and his government have been prioritizing liberalization and reform. Since taking office, Xi has been unwavering on his anti-corruption drive. How successful his reform and liberalization agenda is and how well his government survives the challenges and tests of transitional times over the next five years could shape the future Chinese economy.
Translation by the Korea JoongAng Daily staff.
*The author is the chief investment officer of Mirae Asset Global Investments Hong Kong Ltd.
by Kim Byung-ha