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The headlines grabbed attention: “China’s economy grows at slowest rate in nearly 30 years,” noted the Financial Times in a typical example. China’s GDP growth in the second quarter had slowed to 6.2%, the smallest gain since 1992, back when the country’s economy was first shifting into high gear. But the recent drop was not such a big fall from the 6.4% GDP growth rate of the first quarter, nor from the 6.6% rate for all of 2018. The big picture shows that China’s GDP has been falling for a number of years and the new number is just the latest in a series.
And while some analysts were connecting the sluggish growth figure directly to the current trade spat with the U.S., that’s not the central problem, according to experts from Wharton and Stanford University. Rather, the challenges to China’s economy are deeper, structural, longer term, and have been building for years. They include over-investment, high savings and modest, if growing, consumer spending, high debt and low industrial productivity.
Those are the views of Wharton emeritus management professor Marshall W. Meyer, a longtime China expert, and Richard Dasher, director of the U.S.-Asia Technology Management Center at Stanford. Overcoming those problems requires big shifts in how the country’s economy is organized, an overhaul the government is attempting to execute.
“The tariffs and trade friction with the U.S. is a relatively small part of what is going on,” notes Dasher.
Less Export-dependent
One reason the current head-butting on trade issues between President Trump and China’s President Xi Jinping is not deeply affecting China: Net exports as a percentage of China’s economy have shrunk sharply for years and now are under 1% of total GDP. And Dasher says that China’s exports to the U.S. make up just 5% of total exports. So while China’s U.S. exports fell 7.8% in June, the result is not exactly a death blow to the nation’s $13.6 trillion economy.
More generally, the graph of China’s economic growth has sloped downward since 2009, Meyer notes. The last quarter’s number was related to internal problems. Three of the most important in his view are the following: (1) demographics, “China is getting older” and the workforce is beginning to shrink; (2) “regression to the mean” – countries that grow quickly “almost always encounter … very rapid deceleration in growth at some point;” and (3) “excessive reliance on capital investment,” particularly in infrastructure.
“The tariffs and trade friction with the U.S. is a relatively small part of what is going on.” –Richard Dasher
Added to overspending on infrastructure, China also is boosting consumer and industrial spending by expanding available credit, Dasher says. “They are really very debt-ridden.” He found it interesting that financial markets did not react “too unfavorably” to the very low GDP growth rate “because consumer spending is up over 9% (in part due to recent tax cuts). And industrial investments are higher than GDP growth. The only way you can do that is through extending more credit.” And officials have done that by giving banks a lot of funds to lend out.
Dasher and Meyer offered their comments on the Knowledge@Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)
But the most fundamental — and crucial — issue for China’s economic future is lagging productivity, according to Meyer. Productivity – “the amount of output we get per level of input” – is the most important driver of GDP in the long run for every economy and it has been low in China. In most industrial sectors, “some economists say it has been negative since as early as 2007. And certainly, I would say with a little more certainty since, say, 2012, 2013.”
In the meantime, the country has been piling up debt – by consumers and local governments in particular. “Who’s going to repay that debt? No one knows,” Meyer says. To repay it China will have to increase productivity, which almost certainly means moving up the value chain into “leading-edge industries.” Related to that, China analysts have long said that the nation must move from investment-led growth to consumption-led growth as a way to avoid the so-called middle-income trap.
Racing Towards Innovation
And China has to try to do this rapidly. The list of industries it is hotly pursuing and that fit the bill run from “green energy to artificial intelligence to 5G and beyond,” Meyer explained. China is in a race to get a foothold in industries “where productivity will increase” in time to pay off its mountain of accumulating debt.
While China is pushing hard to restructure its economy, pressures are mounting. There is an increasing gap between the rich and the poor, just as there is in the U.S. “Wages in East Coast Chinese cities are going up drastically while the wage gap between the coast and interior is [becoming] greater and greater,” notes Dasher. “You really have tension inside the country.” Chinese officials may not have to worry about getting re-elected, but they do “have to worry about people seeing them as legitimately improving the quality of life for people.”
This Financial Times article agrees that China’s chief economic problems are domestic and creating social pressure. “Asset prices, particularly housing, have risen so high that many young professionals find themselves priced out of the market in China’s booming cities.”
Taking trade out of the picture for a moment creates more clarity around what are the central differences between the U.S. and China. Some argue that the real competition between China and the U.S. ultimately is not over trade, but rather about who will lead the future in innovation and technology. That idea also helps to explain the related disputes involving U.S. tech sales to Huawei and objections to accepting Huawei into the 5G space in the U.S.
In the U.S., meanwhile, “we complain about our productivity levels which seem to be a 0% to 1% increase a year — my gosh, that’s low,” says Meyer. “Why aren’t we seeing the benefits of automation, etc.? But in China, in most industrial sectors, productivity has been going down.”
The U.S. should “worry a little more – maybe a lot more — about what would happen if Xi were precipitously pushed out of power.” –Marshall Meyer
Despite the productivity advantage, the U.S. does not have a company that can compete with Huawei, Meyer points out, noting that the “strongest Western competitors are Nokia and Ericsson,” both small compared to Huawei. “So the question is why aren’t we in this space? Why are we complaining that the Chinese are unfair, which they may be by U.S. standards but probably not by their standards. Why aren’t we competing?”
The U.S. has to grow “its fundamental industrial capacity” just as China needs to build a more balanced economy. But another key question for Meyer, given that Huawei enjoys significant government aid, is this: How much should the U.S. government help guide the effort for U.S. companies? “There’s a lot of evidence out there that government support has been critical in many of our technologies, even today in Silicon Valley.”
Meyer also thinks the U.S. should realize the risky game it is playing with the trade war. The U.S. should “worry a little more – maybe a lot more — about what would happen if Xi were precipitously pushed out of power. Is this going to be a good thing or not a good thing? And use that to calibrate the amount of pressure we put on China.”
As for the tariffs themselves, Meyer calls them a “a blind alley…. They often end in economic downturns.” And it is worth noting that U.S. exports to China were down 31.4% in June.
A Blunt Instrument
Dasher, meantime, finds the tariffs a “blunt instrument” that are ineffective in solving the problems the U.S. faces with China. “We really need to move back towards a rule-based kind of international system. We need to worry about IT. We need to try to encourage China to join the club of other advanced nations that have intellectual property to protect, and recognize each other’s need to protect intellectual property.”
President Trump, meanwhile, recently said that U.S. tariffs “are having a major effect on companies wanting to leave China for non-tariffed countries.” There appears to be some truth in the claim. Some countries are benefiting from shifts in sourcing as result of the 25% tariffs imposed on many Chinese goods. Those countries range from Vietnam – the biggest winner — to Taiwan, Malaysia, Chile and Argentina, according to a report by Nomura, the Japanese investment bank.
Other reports suggest that Mexico, and even France and Germany have benefited. On balance, however, the impact on third-party countries from the trade disputes will likely be negative, the report noted. Certainly if the disputes slow China’s economy, others will feel the effects because China remains the world’s largest generator of economic growth.
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9 Comments So Far
Stephen Sewalk
This article while interesting is wrong in many aspects.
First you need to believe the $13 trillion GDP, which is highly overstated and may be closer to $10 trillion.
Then you need to believe the 6.2% growth which may very well be 0%.
The challenge of course is both my and the articles numbers may be off as no one really knows the real information.
However, it is a known fact that China exports $2.2 trillion and the US directly imports $480 billion or 20% of total exports. A full blown trade war would highly impact that and so would a Chinese attempt to take over Taiwan which would more than likely result in an American embargo. Also, many items exported to Taiwan, Japan, Korea and elsewhere end up being content added to exports to the US. As a result actual exports and re-exports to the US may well total over $600 billion, 25% of total exports and about 5-6% of total Chinese GDP.
The reality is China is heavily dependent on the US market.
Stephen Sewalk, PhD, JD, MBA, LLM Tax, alum of Stanford, Columbia, London, CU Boulder, Denver and BYU
sajid khan
Stephen Sewalk, your assumptions about Chinese GDP and growth are pulled out of air with no reasoning and how did you calculate your GDP of $10 T and growth rate of zero. China exports to USA of $480B include imports from Japan,S.Korea,Taiwan,Malaysia,etc. The value added by China is probably 50%. Also US companies located in China had revenue of $700B. If these companies exported from US the exports would be much higher.
Frank Lynn
I would speculate China’s GDP growth probably is higher than officially reported. Compare US cities and how people live now versus 30 years ago, there are noticeable improvement but nothing too dramatic. This is what you get with average 3% annual GDP growth. The Chinese cities, on the other hand, are completely unrecognizable compare to 30 years ago. Spending power is also dramatically different. There was almost no mainland Chinese tourists in US 30 years ago
Tom von Alten
The headline is in error; it’s missing a key word. It’s there in the blurb, anyway. “China’s second-quarter economic GROWTH hit a 27-year low.”
Its GROWTH is decreasing. Its GDP is just fine, thanks, and still increasing at a rate that would cause it to DOUBLE in not much more than a decade. (Modulo the accuracy of information we have from them, but leave that challenge for another day.)
The very first paragraph sloshes from literate (“grows” quoted from a typical headline, which I can’t see behind the FT paywall), and “growth” in two sentences, but then the last sentence:
“The big picture shows that China’s GDP has been falling for a number of years and the new number is just the latest in a series.”
Because… you thought it would be boring to keep saying growth over and over? The numbers we have to analyze tell us that China’s GDP has NOT been falling, but rather INCREASING at an EXTRAORDINARY rate. That extraordinary rate, in fact, is unsustainable for all sorts of interesting reasons, which would make an interesting story.
This might be a semantic quibble were it not for the fact that the incorrect framing skews the analysis. This paragraph from the middle of it:
“But the most fundamental — and crucial — issue for China’s economic future is lagging productivity, according to Meyer. Productivity – ‘the amount of output we get per level of input’ – is the most important driver of GDP in the long run for every economy and it has been low in China. In most industrial sectors, ‘some economists say it has been negative since as early as 2007. And certainly, I would say with a little more certainty since, say, 2012, 2013.'”
Their productivity GROWTH notwithstanding, the growth in their GDP over the period in question has been truly phenomenal, even if, as you say Meyer notes, “the graph of China’s economic growth has sloped downward since 2009.”
You seem to be blinded by this single-minded obsession with a derivative measure.
Jim Bozin
I think this article reinforces the current problems with US media and political messages in determining correct int’l policy. Arguing over the numbers only adds to unnecessary debate. We used to hear the adage; perception is “reality”, but in fact, it’s just perception.
Also, as stated, the math has something to do with it. Nothing grows at constant rate forever, aka geometric progression.
US 2 party Govt doesn’t seem to be able to agree on much so thinking it’ll actually solve these problems is folly v China has a central planning body of thousands, that acts long term. eg:All the while B.O. was out proclaiming renewables and global warming, china was nodding its head and out tying up fossil fuel contracts.
Viswanath Kasi
Good article, the key takeaway being the real focus of friction being high tech and emerging innovative technologies. Trade is a collateral damage….. The real battle is of 2 very diametrically opposite forms of governance…once centrally planned and decisively driven, other a government driven by an oligopolic industrial-military establishment.
It is not unimaginable to think of the 2 countries and their governing systems as 2 faces of the same coin. Interdependent and forced to adjust to each other, as also major actors in shaping a global world order.
Erwin Van Moelens
Article is not correct and surely do not take important parameters in mind.What we live now is the effort of US Administration to stop globalization which marketed in 1998 as US foreign policy to control global economy and political changes everywhere. It is not economic fact but clearly political fact. US lost the power to control the global changes in many fields,cannot make a war now to restart a non-pleasant situation,and try with unreliable tools to fight a lost battle anyway. China is the biggest population country and surely want to become the bigest economy too,but not rush on it. US create enemies(sanctions,embargo,dectatorships,etc.) upon the time that China create investments worldwide and new opportunities in trade,in a few words China is the best vehicle in the centrury of globalization,much more by the founder of it, US. China’s GDP grow up 800bUSD in last year, US 500bUSD,all EU zone just 85bUSD. The crucial question is which countries can accept a stable or reducing GDP in their economy?, only countries that leadershoip do not elected, and that happens only in China my friends. If China would have problem then world economy would collapsed within a year.
Muvaffak GOZAYDIN
Please look up to big picture .
China won the commercial war already, whatever everybody says .
China is about to win the technological war too.
HE in China is much better than US. Higher quality every day and also low cost and open to all smart people .
Please count ” college ready ” people in the USA
and also count how many ” college ready ” people in China .
Scale , scale, scale . I have been in China 33 years and 36 years ago twice . Now I see the development. China is the only country in the world living on the same area since first stelled . 4-5.000 years .
Muvaffak GOZAYDIN
In 1955 Japanese products were so cheap , quality horrible .
I started imports from Japan in 1975 quality was good prices were also good not cheap . In 1985 Japanese products became very expensive I swicht to Korea . In 1995 Korea also started becoming expensive . So I swicht to China . So it is time for China also to become expensive then I will move to Vietnam . No country in the world can keep very high growth rate forever .