Ignacio de la Torre. Professor. IE Business School
25 June 2013
The Asian giant is turning out to have feet of clay that threaten to muddy the walkways of a large part of the planet from Oceania to Africa, not forgetting Latin America.
“Let China sleep, for when she wakes the world will tremble,” Napoleon said in 1800. The Corsican emperor did not know that China already accounted for 50% of the world’s GDP at the time, and it was precisely in the 19th century when the Chinese economy went into decline, a non-stop decline that continued right up to the nineteen eighties. The reforms that China then implemented permitted part of the country to register growth rates which have accelerated over the last two decades.
Thanks to Paul Krugman’s famous article headed “The myths of Asian growth”, we have already taken a look at how a country can afford to have such enormous growth rates when its economy is far from optimized. Thus, China has undergone an economic revolution similar to that of the Soviet Union in the fifties, Japan in the sixties, and the Asian tigers in the eighties. Krugman argued that once the easy phase of growth is over, the only way to maintain the rate of growth is through the total productivity of the factors, and that this type of growth is far more difficult to achieve given that it is based on highly complex causes linked to the very civilization of which marginal productivity growth is demanded (hence the axiom “How many of the great advances of the twentieth century – plane, radio, television, Internet, atomic energy, etc., did not come from the West?”). Krugman concludes that extrapolating future growth rates from past growth rates is the equivalent of junk economics, as evidenced by the cases of Japan and the Soviet Union.
In spite of China’s recent economic growth, the resultants that explained it are now looking far shakier than when the crisis began. Let’s take a closer look: i) the main component of GDP is investment, not exports; ii) the proportion of investment compared to GDP is highly unusual, generating enormous risk of politically motivated overinvestement (the famous “bridges to nowhere); iii) China has lost a great deal of competitiveness as a consequence of its wage inflation, which is very worrying if the elasticity of its exports is high; iv) credit intensity, that is to say, the number of debt units needed to grow a unit of GDP, has gone from one to one some fifteen years ago, to the current ratio of three to one, similar to Spain before the crisis; and v) as a result of this, credit penetration as a percentage of GDP has climbed above 25 points over the last three years. Generally speaking, these brutal credit injections end up fuelling an asset bubble and, in the medium term, financial and economic crises (Minsky’s famous cycles).
Many of these trends first appeared in the fall of 2011 in China’s real estate sector, when housing reached incredible prices vis-a-vis disposable income (in comparative terms, the bubble was between two and three times the size of that reached in the US or Spain just before the crisis). China’s GDP began to slow down in the course of 2012 until the growth rate dipped below 8%, the threshold cited by many analysts as the key for generating the number of jobs needed to tackle rural migration to cities. The immense majority of economists predicted a re-acceleration of China’s GDP during the first quarter of 2013, and as we now know, this did not happen, and China’s GDP is growing at even lower rates - as low as 7.7% according to official statistics. The latest figures (Official PMI and HSBC) indicate that there is no sign of an acceleration in the second quarter in spite of many predictions to the contrary (the exception being the excellent George Magnus, one of the very few who predicted the current crisis, who in a recent essay* states that structural factors could mean that the normal paradigm of Chinese growth is more likely to stand in the region of 5% rather than 8-10%).
The consequences of said deceleration are visible in countries that export key raw materials, given that China had been consuming up to 50% of world supplies of many raw materials such as steel, for example. The latest figures (PMI) for steel exporters like Australia are at their lowest level since 2009 (34, compared to 46 in recession-struck Europe…) which has in turn brought about a drop in interest rates in its central bank. The same thing is happening in other major export economies, such as New Zealand and Canada, translating into weakened labor markets and currencies. Lower growth of China’s structural demand and, in turn, raw materials, is driving down the price of raw materials. This drop in prices will also be associated with an increase in production resulting from enormous investments made in the past on the back of high prices, which will be made still worse by the downward trend. We are also seeing revolutions in terms of energy supply, which could have enormous geopolitical implications (Could anyone have imagined that the US might have a current account surplus by 2020?).
At the end of the nineties a Chinese prime minister addressed the US congress, stating with a proud feeling of continuity into the millennium that “when one looks at the history of China, you should not only focus on what has happened since the second world war – we have only been making mistakes for the last 500 years.”
China has undertaken brave reforms over the last thirty years, which have once again positioned it among the world’s economic giants. However, it now faces some formidable challenges. Personally, I have more faith in Magnus’s theory than the general economic consensus. If I am not very much mistaken, the implications will be very negative not only for Canada, Australia and New Zealand, but also for Latin America and Africa.
*“China, the end of extrapolation”, UBS, November, 2012.