25 November 2014
Making sense of China
Speaker: George Magnus
Venue : Ashurst
George Magnus spoke on the topic of “Making sense of China” to a full house at November’s evening meeting following the AGM. His overarching view was that China had reached “the end of extrapolation” - that the period of benign globalisation had been brought to an end via the catalyst of the global financial crisis. A slowing in the acceleration, rather than a reversal, of globalisation was the issue for China going forward.
China has benefited from a period of catch-up of low incomes. Slowdown is now inevitable, according to George, because certain events that had generated growth in the past (the ‘low hanging fruit’) were not repeatable - such as joining the WTO, raising secondary school attendance and transferring labour from low- (agricultural) to high- (city-based) productivity employment.
George then focused on what he called the ‘Four P’s”: politics, property, policy and productivity. First, Politics - something you can’t ignore when considering the outlook for Chinese growth. The new government has run an anti-corruption campaign, with many Party members being affected (both junior members and grandees of the Party have been held to account, the former in mass numbers). The motive? To make the Party more compliant and to re-centralise power.
From a political angle, how has China’s rebalancing progressed so far? The evidence is mixed. For sure there has been an improved allocation of resources such that capital has become more price sensitive, the idea being to make State Owned Enterprises (SOEs) more efficient. Energy subsidies have been removed, and there have been pilot schemes to introduce private capital into non-strategic businesses.
But progress has been slow and moderate thus far. Capital market liberalisation has meant a more flexible currency. Rule of Law - or at least the stricter enforcement of current laws - has been a key aspect of the Fourth Plenum. The one-child policy has been relaxed (though how effective this has been is debatable) and pilot schemes in ‘minor’ cities have been introduced to give more rural migrants ‘urban status’. There remain, however, no formal plans to introduce property rights as they exist in developed countries. Moreover, while these changes are encouraging there has been no attempt to codify the rules more generally, with the risk that China is simply replacing one elite with another - just with different sets of vested interests.
The second ‘P’ was Property. Falling residential investment is hampering economic growth (after all, 16-17% of GDP is related to property), with over-leverage, over-supply, and new regulations governing land sales/the environment meaning that this time is truly different for the housing market, and thereby GDP. George described housing as being the “leading edge” of rebalancing, arguing that falling prices and activity might persist for some time. Indeed, a substantial number of ‘non-core’ cities had the worrying combination of previously fast growing property markets and over-supply, making them especially vulnerable - just like the cities in the US that led the downturn in property more generally post the financial bubble deflating from 2007/08 onwards.
The third of George’s ‘Ps’ stood for policy. The authorities understand the need to put the credit genie back in the bottle, according to George. Rising debt/gdp ratios cannot continue ad infinitum. That said, continued reductions in official interest rates over the next year seem likely, and the “long march” to RMB over-valuation looks to be over. We are “in the foothills” of the third dollar bull market since the Bretton Woods system collapsed. And while a devaluation is not on the cards for China, a 5-8% depreciation can be expected.
Finally, George turned to the issue of Productivity. Heavy industry has led the way in generating growth in the past, but going forward it must come from more varied sources. The labour contribution to productivity has never been that large and is now dwindling (it should continue to do so unless we see improving education); the capital contribution has been sizable in the past but is falling thanks to economic rebalacing; thus it comes down to total factor productivity (as is the case for all countries with ‘middle income’ status) to boost growth which can only be achieved by improving the quality of the institutions governing the country.
In summary, the risks of a speedy slowdown in China could yet prove toxic for the global economy - as such, George argues, we need to be particularly watchful about the pattern and pace of China’s slowing growth rate.
The Society of Business Economists would like to express its thanks to Ashurst for hosting the event.