The Global Economy and China: the view from a mountain top
“In my view, China’s very high rates of saving and of investment in infrastructure, plant and equipment, Rand D, and human capital should be seen more as a source of strength, than of weakness. There has, of course, been overinvestment in some sectors, such as heavy industry and housing in some regions, but China’s GDP and infrastructure stock per capita is still just a fraction of that of the most advanced countries, and the country’s potential to catch-up remains largely unexploited.” Uri Dadush.
The last few months and days have not been short of news for global economy watchers. The economics aristocracy composed of finance ministers, central bank governors, and Nobel laureates meeting last week in Davos, a Swiss mountain resort, had plenty to talk about. Topping the bill of the global outlook program were momentous issues such as the effects of the oil price collapse, the risk of an implosion in Europe, and, last but not least, the effects on the world of China’s slowdown.
While the mood of delegates was subdued, appropriately reflecting the disappointing global growth outcome for 2014, around 2.5%, most economists in attendance predicted a better year in 2015. Many felt that the IMF’s latest forecast, growth of around 3% was too pessimistic, as it did not give sufficient weight to the beneficial effects of lower oil prices, the blossoming US recovery, and continued robust growth in many emerging markets. In an impressive speech, Li Keqiang, the Chinese Premier, gave credence to the optimists – laying out a path for slower but still-rapid growth in China, growth that was more sustainable and based on domestic demand and rising living standards. He emphatically excluded the possibility of an imminent Chinese economic crisis.
There is a strong interdependence between China, which is the large economy most reliant on international trade, and the rest of the world. Focusing on the issues that most preoccupied delegates at Davos, China will derive a large benefit from the fall of oil prices, and this positive effect is likely to be significantly larger than the negative effect of continued slow growth in Europe, which is China’s largest trading partner. On the other hand, if the slowdown in China is gradual and it is accompanied by increased reliance on domestic demand, the negative effect on the rest of the world should be quite small.
There is no question that the 50% fall in oil prices is very good news for oil importers and for consumers everywhere, and China should be among the large beneficiaries since its net oil imports in 2013 amounted to around 3% of GDP. In 2015, world demand will be significantly higher and inflation lower than if oil prices had not fallen. However, many governments– cash-strapped after 6 years of crisis- including governments in Europe, will decide to shore up their finances by cutting energy subsidies or raising taxes on oil products. These policies will moderate but not eliminate the positive effect of lower oil prices on global demand and on China, especially if lower oil prices are allowed to flow through to Chinese consumers and users of energy, as is happening in the United States, for example.
In Europe, which is the slowest growing part of the world, policy-makers are worried about deflation, a big topic at Davos. However, moderate deflation is not the real problem, only a symptom of deeper maladies such as lack of confidence, a poor business climate, inflexible labor markets, excessive fiscal conservatism in Germany, lack of competitiveness in the periphery, and so on. Nor can the European Central Bank’s new program to buy large amounts of government bonds – so called quantitative easing – solve the twin problems of low growth and deflation by itself. To solve its problems, Europe will have to deepen its structural and fiscal reforms as well as strengthen the institutions which underpin the Euro. The political revolution in Greece will probably not lead to Greece defaulting and exiting the Euro, as a compromise will probably be found, but it is a warning of what the future has in store if the underlying problems are not dealt with.
Few issues have caused more anguish than the possibility that the deceleration of China, the world’s second largest economy at market exchange rates, could herald a hard-landing. Not surprisingly, the pronouncements of experts such as Yifu Lin, the former Chief Economist of the World Bank (and once my boss) were carefully listened to at Davos. In my view, China’s very high rates of saving and of investment in infrastructure, plant and equipment, Rand D, and human capital should be seen more as a source of strength, than of weakness. There has, of course, been overinvestment in some sectors, such as heavy industry and housing in some regions, but China’s GDP and infrastructure stock per capita is still just a fraction of that of the most advanced countries, and the country’s potential to catch-up remains largely unexploited. Moreover, as many have argued, a huge economy like China cannot continue to grow at 10% a year indefinitely, nor can it rely disproportionately on exports, so it needs to reorient itself gradually towards domestic consumption. China also has – unlike most other countries – both the fiscal and monetary policy space to undertake countercyclical polices such as public investment in infrastructure should the need arise. In China, these investments are likely to generate adequate returns in the long-run.
It is likely, furthermore, that the negative effect of China’s growth deceleration on the rest of the world is overestimated. China’s slower growth will, of course, translate arithmetically into significantly slower global economic growth because China is now a big part of the world economy. But what is important in an economic sense is the change in the net demand of China on the rest of the world, and that number (equal to the change in China’s current account balance over a year assuming that all the change originates in China) is small in the context of the global economy, typically in the range of plus or minus 1/10 of 1% of world GDP. Moreover, insofar as China’s growth becomes more domestic demand driven – as has happened in recent years - that impulse is more likely to be a plus than a minus. Granted, slower growth in China will have a big negative impact on exporters of commodities such as metals and oil, but increased domestic demand in China will also help foreign producers of consumer products. China is now bigger market for the Apple iPhone than the United States.
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