Opinion & Commentary
‘China’s unbalanced economy providing silver lining
Chinese leaders and economists have been saying for a decade that its economy is pulled by two strong horses and one weak donkey. China is much too reliant on unsustainably high levels of (inefficient) investment and exports to produce its world record rates of growth. Consumption has always been the stubborn, old donkey dragging its feet. China’s leaders are justifiably worried that the two strong horses will soon run out of puff and the donkey will remain too slow and weak to step up. The economy is dangerously unbalanced which is proving worrying for the Chinese but a continued boon – in the short-term at least - for Australia.
The problem is that domestic capital is getting less and less bang for its buck. Ten years ago it took only two dollars to produce one dollar worth of output. Now it takes six. The government has constantly reiterated the need to restructure the economy away from an investment led one.
Yet, in the first four months of 2008 investment spending in China increased by around 28 percent. From 2000-2007, it increased between 20-40 percent year on year. In contrast, consumption in 2008 is increasingly by only around 15 percent despite the rise in average income outpacing economic growth. China’s recent but worsening inflation problem, which is now almost 9 percent, will only further hinder domestic consumption in the foreseeable future.
Furthermore, the consumption donkey is in historical terms much weaker today than it has ever been. From 1978 (when reforms began) to 2002, domestic consumption was at about 60 percent of GDP. It is now only around 35 percent of GDP. Most respectable economies see levels of around 70 percent. China’s domestic consumption figure is the lowest of any major economy in the world.
What impact will the devastating earthquake in Sichuan province this month have on the Chinese economy? The province accounts for just over 4 percent of Chinese GDP. According to its official state media, the earthquake is expected to bring down GDP growth by 0.2 percent in 2008 while consumption growth will decline sharply in Sichuan province and surrounding areas for the next few months. Thankfully, the earthquake largely missed major industrial centers but it did hit the major pig producing areas hard, meaning an immediate shortage and rise in prices for pork which remains the staple meat for the Chinese.
However, the earthquake affected regions will undoubtedly now see major injections of state capital as part of urgent reconstruction efforts leading to a minor spike in investment levels and further upward demand for commodities needed for rebuilding. Moreover, official plans for reconstruction are ambitious and some believe that newly reconstructed areas affected by the earthquake will see significant rises in consumption once completed.
This seems unlikely to be significant. The flow-on economic benefits – especially an immediate rise in consumption - following large injections of money into construction projects will eventually cease. Once completed, consumption in these regions is most likely to return to the same levels as it was before the earthquake. Besides, even if there were any upsurge in consumption following the rebuilding of devastated areas, these were not major industrial and population areas. Hence, in the longer term, the earthquake will have little effect on the general trajectory of consumption in the Chinese economy.
While consumption growth remains modest, Chinese leaders are forced to rely on the same old, inefficient investment strategy to produce the bottom-line growth that their political legitimacy so much depends upon. Inefficient to be sure but this does provide a silver lining for Australia, if only in the short to medium term.
As everyone knows China has been largely responsible for driving up the price of almost all hard commodities which has been a tremendous boon for the Australian economy. Since 1983 China has been responsible for 64 percent of the increase in global demand for copper, 54 percent for steel, 70 percent of that for aluminum, and 82 percent for that of zinc. This translates to once-in-a-generation good news for companies like BHP and Rio Tinto.
Around four-fifths of Chinese demand for hard commodities is driven by investment in ‘heavy’ projects such as the construction of factories and other buildings, roads, ports etc. Currently running at about 25 percent in terms of year-on-year growth, these officials have suggested that 10-12 percent would be more appropriate. But as Stephen Roach from Morgan Stanley correctly states, such a reduction would produce a “major global commodity downturn.”
This less reliance on a fixed investment strategy will only be allowed to occur if domestic demand can pick up the slack – which I have argued is not happening quickly enough. Meanwhile, Australia will continue to rake in the dollars.
Dr. Lee is a Visiting Fellow at the Centre for Independent Studies. His paper, ‘Democracy on Hold in China’, was released by CIS in May.
