Tests for China-centric world economy
Although the global growth climate seems to have improved recently, this is no time for complacency
China remains the world’s most powerful growth engine. Even in the face of its recent downshift from 30 years of 10 percent growth from 1980 to 2010, China has continued to play a disproportionate role in driving the world economy. Since 2010, Chinese GDP growth has averaged 7.5 percent — fully 2.1 times the global average.
This impetus is likely to persist for the foreseeable future. If China holds in the 6 to 7 percent growth range over the next few years — a reasonable prognosis, in my view — it will continue to outdistance the rest of the world by a wide margin. In that case, China will account for slightly more than 30 percent of total global growth in 2019 (as measured on a purchasing power parity basis). That would mean its contribution would be about 67 percent greater than the combined growth of the United States and the European Union, even if the latter two economies increased somewhat more rapidly than expected in 2019 (2.5 percent in the US and 2 percent in the EU in 2019), and China slows to the lower end of expectations (6 percent). Indeed, in the absence of China’s diminishing but still powerful growth assistance, the world economy would be struggling.
While there is currently a general sense of optimism regarding the global economic outlook, recent experience suggests it pays to be mindful of ever-present risks. This is especially true of major advanced economies, which have struggled mightily since the financial crisis and recession of 2008-09. But it is also the case for China, which remains tightly linked to the rest of the world.
Of course, now there is hope that the worst is finally over. The US is a prominent case in point, with newfound optimism particularly evident in the aftermath of two quarters of 3.2 percent GDP growth (in the middle quarters of 2017), followed by the recent enactment of a major multiyear tax cut. But there are three key risks on the downside: First, for a fully-employed US economy, the normalization of monetary policy is now likely to be executed more quickly in the face of a large fiscal stimulus. Second, the unwinding of eight years of unconventional monetary accommodation will reduce the liquidity support to an overvalued US stock market, which is currently trading at a cyclically adjusted price-to-earnings ratio only exceeded in 2000 and 1929 over its long history of more than 135 years. Third, the possibility of a sharp correction in US financial assets — stocks and overvalued bonds alike — poses a serious threat to an asset-dependent real economy that has been artificially supported by the liquidity injections of unconventional monetary stimulus.
There are also reasons to be concerned about the outlook for Europe and Japan — even though recent trends in these areas also look somewhat more encouraging. Impaired productivity growth is a common theme for both economies, and a persistent problem in the United States as well. Since 2010, productivity in the advanced economies has fallen well short of its pre-crisis trend. Without support from productivity, output growth invariably faces stiff headwinds. Recent International Monetary Fund research suggests that about 40 percent of the shortfall in post-crisis output growth in the advanced economies is traceable to a protracted slowdown in total (multifactor) productivity growth.
In a weak productivity climate, any acceleration in GDP growth, such as the modest pickup that appeared to be unfolding in late 2017, is likely to be only transitory, inevitably returning to its underlying sluggish trend. The only way to avoid that “growth fade” is for nations to embrace structural reform imperatives — all the more urgent in light of stiff demographic headwinds throughout the industrial world. The policy recipe is hardly a secret: innovation, technological change, human capital and trade liberalization. In the absence of more efficient economic structures, even the lasting growth dividends of infrastructure and other investment spending activity will be limited.
Japan is the poster child for failed structural reforms. After nearly three “lost decades,” the recent modest pickup in the Japanese economy has sparked optimism that its long nightmare is over. However, with structural reforms stymied by special interest politics — especially Japanese labor market reforms — the “third arrow” of the Abenomics strategy has never been successfully implemented. As a consequence, Japanese growth should fade quickly in 2018.
Europe’s long-dysfunctional monetary union poses a similar challenge to the seemingly encouraging pickup in that region’s economy — especially with productivity growth having been cut in half in the aftermath of the financial crisis of 2007-08 relative to an already sluggish pre-crisis trend of just 1 percent (according to the latest research of the European Commission). Without a meaningful productivity pickup — particularly tough for long-sclerotic European labor markets — a growth fade is also inevitable in Europe.
Nor should the United States be spared the same fate from productivity headwinds that are likely to continue to afflict Japan and Europe. Notwithstanding the unsubstantiated and highly politicized claims of supply-siders, a large body of macroeconomic theory and empirical evidence points to little relationship between corporate tax cuts (like those just enacted) and investment, innovation and productivity. In light of the downside cyclical risks to the US economy noted above, America’s lingering structural headwinds are all the more problematic.
All this poses great challenges to China. Its 30-year growth miracle was a levered play on exports, external demand and globalization. Over the past 10 years, China has learned many tough lessons about excessive dependence on the broader global economy. A crisis-induced collapse of global trade, followed by an anemic recovery, has been critical in driving China’s rebalancing agenda away from external dependence toward internal demand — especially household consumption. But this is a long and arduous process that remains incomplete and, therefore, has yet to insulate China from tough global conditions.
Indeed, while the export share of China’s GDP has come down sharply since 2007, it still stands at 20 percent — double the portion of 1986. Meanwhile, household consumption remains disappointingly weak at less than 40 percent of GDP. By default, such incomplete rebalancing has left export-dependent China with little choice other than to rely on fixed investment to hit its growth targets, with debt-intensive, State-owned enterprises taking the lead in providing this impetus.
The results of the annual Central Economic Work Conference held in December underscore the delicate balancing act of a Chinese policy strategy that is attempting to address a multiplicity of risks, challenges and opportunities — from monetary and fiscal policy coordination and currency flexibility to property market excesses and deleveraging. Meanwhile, the structural reform agenda, which is so critical to China’s own productivity challenges, continues to be dominated by supply-side initiatives, with only minimal emphasis on demand-side support to household consumption.
Not only does China face the possibility of renewed challenges from the global business cycle, but it also must contend with the existential threats of deglobalization and protectionism. A muscular “America First” security approach unveiled by the Trump administration is a potential game-changer. China is no longer viewed as a “responsible stakeholder” by the US in geo-strategic terms, but now lumped together with Russia, is characterized as more of a competitive threat that “… challenge(s) American power, influence and interests, attempting to erode American security and prosperity.” It remains to be seen if this shift in America’s approach to China will usher in broad-based trade sanctions that could well spark a trade war between the world’s two largest economies. At a minimum, the odds of such an outcome are certainly increasing.
Nor should China believe that it can simply turn the other cheek and forge a new type of globalization through its Belt and Road Initiative in an effort to engage the world on different terms. While there can be no mistaking the potential scope of this initiative, the planning, funding and construction lags of Belt and Road do not suggest any immediate impetus to China or to pan-regional growth. Moreover, the Belt and Road routes run through some of the most politically unstable nations in the world: 28 of the 64 Belt and Road participating nations are in Central Asia, the Middle East and North Africa and South Asia, where political stability, as measured by World Bank Governance Indicators, is collectively in the 28th percentile of some 213 countries around the world.
Yes, the global growth climate seems to have improved recently. Conditions are depicted as strong and synchronous, with frothy financial markets providing the icing on the cake. Don’t be fooled — a decade of tough global problems has not miraculously vanished into thin air. And, as always, new problems appear to be on the horizon. This is no time for complacency — especially for China, with its incomplete rebalancing.