Can China be Engine of Growth for Global Economy?

Can China be Engine of Growth for Global Economy?

  • 4 August 2009

“China will be among the first countries to lead the global economic recovery out of this recession,” claims Hans Timmer, the Director of the World Bank’s Economic Forecasting Department. This claim is just one among a growing chorus of economists and investors, who believe that the Chinese economic miracle would self-sustain and become the new engine of growth for the global economy.

Much of this optimism springs from recent upbeat economic figures emanating from China. The country’s GDP growth, according to its National Statistics Bureau, clocked an impressive 7.9% in the second quarter of 2009, which surpassed the expectations of most economists on the country’s economic recovery following late last year’s dramatic slump. Even if the rate of increase slows in coming quarters, many analysts believe China will be able to meet its target of an 8% expansion for 2009.

Contrary to the global trend, the Shanghai stock market’s benchmark index has gained 75% this year, and there has also been an accelerated increase in China’s industrial output, bank lending and commodity imports in the past few months. It is estimated that retail sales in China this year have risen by 16% and the property and automobile markets are also booming. Property sales have reportedly soared by 17.5% in acreage from a year earlier in the first four months of 2009. Further, China has become the world’s largest car market in the world with more than 1.5 million cars sold in April, up 25% from a year earlier.

In fact, the International Monetary Fund forecasts that in three years from 2008 to 2010, China will account for almost three-quarters of the world’s economic growth. Out of the 10 biggest economies of the world, China is the only country that is still registering growth and is expected to soon surpass Japan as the world’s second biggest economy. In a Time article of August 10, 2009 issue entitled: ‘Can China Save the World’, Bill Powell writes: “China’s recovery and growing economic importance have led some to suggest that global institutions such as the Group of Eight (G8)—the US, Canada, France, Germany, Italy, Japan and Russia—are becoming obsolete; that the only dialogue that really matters going forward is the conversation between the ‘G-2’: China and the US.” Even US President Barack Obama seemed to acknowledge this view, while addressing a forum of high officials from both countries on July 27, when he said Washington’s relationship with Beijing would “shape the 21st century.”

This impressive turnaround in China’s economy, following the slump of last year, has largely been attributed to its efforts to reorient the economy to greater reliance on domestic demand rather than exports. In the aftermath of the global financial and economic crisis, Chinese official figures show exports from mainland China slumped by 22.6% in April 2009 from a year earlier. This devastating downturn in a crucial sector of the economy forced the Chinese government to inject a $586 billion stimulus into the economy—about 13% of GDP—which focuses on building the country’s infrastructure and promote domestic consumption. According to Li-Dao-Kui, the chairman of the finance department of the School of Economics and Management of Qinghua University, the growth rate in China’s inland areas (which are not led by exports) exceeded that of the coastal areas in the first quarter of 2009. In the wake of the fall in exports, he mentions, it is domestic consumption and investment in fixed assets that are providing “vigorous support” to Chinese economic growth.

It is important to understand that the US is also interested in encouraging China into focusing more on domestic consumption than on exports. At the first United States-China Strategic and Economic Dialogue (S&ED) in Washington on July 27-28, 2009, the US administration urged Chinese officials to further intensify efforts to open its borders to more foreign goods and to protect troubled Chinese export-driven industry by increasing consumption of its produced goods at home. In other words, the US has been asking China to act more like a major fulcrum in the global economy and less like a cheap exporter of goods.

Economists on both sides support these objectives as they believe it would help restore some of the financial and trade imbalances of recent years that have precipitated the current global economic crisis. However, in order to increase domestic consumption of goods and services, China would have to improve the distribution of wealth among its people so that the Chinese consumer feels richer and more comfortable while spending. For this purpose, China may have to provide its teeming millions a stronger safety net, improved healthcare and pensions, and reduce taxes so that its people have more confidence to spend rather than save. It is important to note here that China is still a relatively poor country with a huge rural population and an annual per capita income of $6,000, compared with $39,000 in the US and $33,400 in the EU.

Economists also suggest that China should not peg its currency to the US dollar at very low levels to support its exporters, but restore it closer to its real market value. It is believed a stronger currency would help Chinese people get more value for their money and give them a better standard of living. In a recent report, the Peterson Institute of International Economics, a Washington-based think-tank, claimed that the renminbi/yuan (Rmb) was undervalued 40% against the US dollar. China, however, seems reluctant to raise the value of its currency, not only because it wants to support its export-oriented industries, but also to preserve the value of its huge foreign currency reserves. It is noteworthy that the country holds $2.2 trillion in dollar reserves and $1.5 trillion in US treasury debts. It has also been proposed that deregulation of China’s service sector would give a boost to this job-intensive sector of the economy and would increase domestic consumption.

However, many economists remain skeptical about the tight-fisted and relatively poor Chinese consumers acquiring the purchasing power to rescue the Chinese economy, let alone the global economy. They point to the lack of adequate healthcare and unemployment benefits, poor rural infrastructure and public services, lack of a proper social security system, and underdeveloped credit markets as unsuitable for a major transformation in the Chinese domestic market anytime soon. They point out that internal consumption accounts for one-third of China’s GDP, compared with around 70% in the US.

In his recent article in Financial Times, the head of Morgan Stanley’s Asia division, Stephen Roach states that the recent spurt in domestic consumption is largely the result of the government’s enormous spending in infrastructure development and a bank-directed credit stimulus. He points out that infrastructure expenditure “accounts for fully 72 percent of China’s recently enacted Rmb 4,000bn ($585bn) stimulus.” However, he fears that a “rash of credit disbursement in the first half of this year (is) a trend that could sow the seeds for a new wave of non-performing loans.” It is noteworthy that recently Chinese regulators raised the alarm when they told banks that the new loans must be used to bolster the economy and not for speculation in equities and real estate. The weakness of the export market is said to have diverted up to 30% of new bank lending in 2009 into equities and other speculative activities, according to Andrew Barber, Asia strategist at US-based investment research firm Research Edge. Therefore, Roach suggests that China should focus more on promoting internal private consumption rather than rely on excessive government spending.

Even Wu Xiaoling, former vice governor of People’s Bank of China, recently warned that the combination of excess production capacity and excessively loose monetary policy (i.e. policy to provide cheap loans) could lead to asset bubbles that could cause more harm than good to the Chinese economy in the future.

As President Obama has been looking for a new technological revolution, like the revolutionary dot com boom that rescued US economy at the turn of the century and in this pursuit has been investing heavily on a new clean and green energy technology, the world has been expectantly looking toward China—particularly its growing middle class—to become a new market for global economic revival. However, it seems too early and naïve to assume that Chinese economy, including its beleaguered export sector and domestic market, would emerge as the new engine of growth for world economy. In conclusion, it still seems too early for this vast country, with its plethora of socio-economic problems, to take on the economic leadership of the world.