China's slowdown and the global glut
- 30 July 2013
- From the section Business
In case you hadn't noticed, China's economy is going through an enormous gear change.
And, given the monster that China has grown into, its planned "rebalancing" is not something the rest of us can afford to ignore.
In fact, the next few years promise to be quite rocky.
First the back story: China has been following the Asian development strategy pioneered by Japan from the 50s to the 80s, and then pursued by the "Tiger" economies of Korea, Taiwan, Hong Kong and Singapore.
Unfortunately for China, its population is almost seven times those of Japan and the Tigers combined. So its impact on the rest of the world has been far bigger, and its room for manoeuvre more limited.
The strategy involves the government - aided by a coterie of mammoth industrial giants - funnelling a huge chunk of the country's income into investment.
"Investment" here means anything which drives up the country's productive capacity - educating the population, building up manufacturing and heavy industry, and above all constructing new cities, roads, railways, power plants, ports, and so on.
The strategy also typically involves a heavy reliance on exports, which help the country raise the foreign currency it needs to import raw materials and valuable foreign technology.
Dividing up the cake
But gearing the economy towards investment and exports has a flipside - it means the economy caters far less well for the immediate needs of its own population.
In order to pull off an average 10% growth rate over the last three decades, China's government has had to tightly ration the slice of the economic cake that goes on goods and services for its own population.
As Michael Pettis, economics professor at Beijing University, points out, Beijing's priorities can be gleaned from its policies:
- a cheap currency, which keeps exporters competitive, but makes imported consumer goods more expensive
- low interest rates, which are great for borrowers (manufacturers, state-owned industries and property developers), not so great for savers (ordinary Chinese)
- wage rises that have failed to keep up with the value of what the average Chinese worker produces, made possible by an abundant supply of cheap peasant workers migrating to the cities
- the right of local governments to expropriate farmers of their land, for profitable redevelopment
- a residence registration system that deprives migrants of welfare services in the cities where they work
All these things subsidise the state and its industrial development strategy at the expense of Chinese citizens.
And now comes the "rebalancing".
The above policies are all set to be reversed, so that consumer spending by the country's growing middle class can finally take over as the main engine of growth.
The leadership has been touting rebalancing for several years, but it is only with the recent enthronement of President Xi Jinping that Beijing finally seems to be getting to grips with the task.
President Xi has little choice. Exports and investment - the old engines of growth - are broken.
The 2008 financial crisis made clear that the US and Europe could no longer afford to borrow from China in order to buy Chinese-made goods.
Such is China's enormity, it has saturated its export markets.
Beijing responded to the crisis by stepping up investment.
But that approach has also reached its limits - the credit-fuelled construction boom since 2009 threatens to lumber China with far too much housing and infrastructure for its level of development, along with a load of unrepayable debts.
Spend, spend, spend
If China must now rebalance, what does it mean for the rest of us?
There is a long-term and a short-term answer.
The long-term is potentially rosy.
China is already experiencing a consumer boom, with wages and retail sales growing at double-digit rates.
In part this is because, with 50% of the population now urbanised, the demand for cheap industrial labour appears to be outstripping the ready supply of new migrant workers, pushing up wages.
If the consumer boom can be sustained - and property speculators certainly hope so - then China will eventually overtake the US and EU to become the world's biggest export market.
British businesses are already seeing the benefit.
The education and publishing group Pearson is at the forefront of selling English language teaching to middle class urbanites.
Meanwhile, Burberry and other luxury brands have seen their profits goosed by those same wealthy Chinese spendthrifts - at least until Beijing recently began clamping down on conspicuous spending by apparatchiks.
China's rebalancing may also herald the beginning of the reversal in global income inequality, which has risen steadily since the 1980s in part because Western workers have had to compete with cheaper workers in China and elsewhere joining the global economy.
It's not all good news - growing demand for meat by China's wealthy population is likely to push global food prices ever higher, at least until genetic engineering starts delivering on its promise to multiply crop yields.
But the big point is that China's rebalancing is an unavoidable and ultimately healthy development.
The world economy could really do with somebody spending more money right now, instead of engaging in spending cuts. And Chinese consumers may eventually fill that void.
"Eventually" - there's the rub.
Household consumption comprises a mere third of spending in the Chinese economy, a shockingly low figure. In most countries, it is 50%-70%.
Starting from such a low base, it makes the maths of rebalancing look quite ugly in the short-term.
Let us assume that China's rate of investment spending - currently a staggering 48% of economic output - stagnates, while consumer spending grows at 10%-15% each year.
That would equate to sharply slower Chinese growth for the next few years - perhaps 5%-7%.
Why should investment spending not shrink, if China has already over-invested in too many apartments, steel mills and train lines?
What if, in the face of rising wages, higher interest payments and a stronger currency, a string of over-indebted property developers, industrial firms and manufacturers goes bust?
Why should Chinese citizens continue to increase their spending so quickly if many find themselves laid off from the construction, heavy industry and export sectors that need to downsize in a rebalanced economy?
And what if the value of the apartments that they have invested their life savings in starts to fall instead of rise?
Even if things run smoothly, the prospect of China winding down its building boom has huge implications for the rest of the world.
Start with mining. China's construction sector eats up vast amounts of base metals, and has until recently driven up global commodities prices to unprecedented levels.
Rio Tinto - one of the world's biggest miners - estimates that in 2012 China consumed two-thirds of the world's tradable iron ore, 45% of its aluminium and 42% of its copper.
That was up from 12%-13% in 2000.
If China starts to fall back towards its long-term natural share of the market, then that means a lot of iron ore, aluminium and copper with nowhere to go.
Prices of the relevant commodities have been falling. Copper, for example, is down by a fifth since February.
If rebalancing continues, it will make life unpleasant for the world's mining firms - many of which feature highly in the London Stock Exchange's FTSE 100.
It will also be bad news for the countries who have done so well in recent years from exporting those commodities - Brazil, Chile, much of Africa, Russia, Kazakhstan, Canada and Australia.
But it's not just mining.
Here are some of the results you get if you Google "China glut":
- Chinese steel plants are halting production ostensibly for "maintenance", but actually because many are loss-making (China produces about half the world's steel)
- China's capacity for making heavy earth-moving equipment is now running at double annual global demand
- China's giant Rongsheng shipyard, built in 2006, is sitting idle
- Rubber prices are sliding due to falling Chinese demand for truck tyres
What all these have in common is that China's overinvestment has outgrown not only its own economy, but also the world economy.
China stayed afloat after 2008 by busying itself building ever more productive capacity, but to whom will it ultimately sell the resulting production?
The overcapacity is bad for profits, jobs and trade relations in the global industries affected.
That will hurt countries like Japan and Germany which are major players in these industries, though it may be more welcome for a service-oriented economy like the UK.
For example, the cost of the imported raw materials and equipment needed to build a new London airport or new affordable housing may fall substantially.
However the glut emanating from China could pose a more fundamental challenge for the global economy.
China's construction boom since 2009 has been heavy on imports of raw materials, equipment and so on, and almost eliminated its trade surplus - which had stood at 10% of economic output in 2007.
Minerals and fuels accounted for about a third of China's imports in 2011, more than double its share of imports in 2003, according to World Trade Organization data.
Meanwhile, China's trade surplus in manufactured goods has continued to widen, but this has been more than offset by its growing imports of raw materials.
If the construction boom is over, those imports could fall sharply, resulting in a temporary resurgence of China's controversial surpluses.
What's more, Beijing may be sorely tempted to help its export sector, so that it can re-employ laid-off construction workers (not to mention unemployed graduates).
The government has announced new subsidies for exporters - as well as a new round of railway construction - as part of its latest plan to prop up the flagging economy.
Another option might be to let the yuan weaken.
The Chinese currency has recently halted its strengthening as the sharpness of China's slowdown has become apparent and the flow of speculative money into the country has seemingly dried up.
But such moves would only worsen China's trade surpluses.
That would not be helpful at a time when Europe, the US and Japan are also all looking to exports to help their economies recover. If everyone wants to export, who is going to do the importing?
Any renewal of large trade surpluses would have the same effect on global demand as a slow puncture on a tyre.
China's economy comprises 11% of the world's GDP, so - at the extreme - a return to 10% surpluses would represent a drag of roughly 1% on spending in the rest of the world.
Crudely put, less Chinese spending on iron ore and equipment means less spending by Australian mining firms on London's financial services, and less spending by German factory workers on British consumer goods.
To make matters worse, if Beijing has to contend with large numbers of unemployed migrant workers, the leadership - or factions within it - may be tempted to drum up xenophobia as a way of shoring up public support.
For example, as the economy first began to wobble last year, China happily reopened an old dispute with its former coloniser Japan over the Shenkaku / Diaoyu islands, before cooling matters down when anger on the street seemed to be getting out of hand.
In short, the risk is that we could be headed for more years of anaemic global demand, as well as increasingly nasty trade relations.