China's eco­nomic sneeze might be in­fec­tious

The Pak Banker - - OPINION - Linda Yueh

Ac­cord­ing to a mod­ern ver­sion of Met­ter­nich's say­ing, when the US sneezes, the rest of the world catches a cold. Does the same now ap­ply to the world's sec­ond-largest econ­omy?

If China im­plodes, could it drag down the global econ­omy with it? China's stock mar­ket has fallen by about a third since the mid­dle of July, and it has de­val­ued its cur­rency - not once but twice, send­ing shock waves through fi­nan­cial mar­kets.

De­spite the seem­ing panic, so far prices have only fallen back to the same lev­els as at the end of March. In any case, fewer than one in 10 Chi­nese house­holds in­vest in stocks and shares, and on av­er­age the stock mar­ket ac­counts for less than 15 per cent of house­hold wealth. So the tens of mil­lions of small Chi­nese in­vestors who play the stock mar­ket have mostly been bet­ting rel­a­tively small amounts and haven't lost their shirts. And yet the cur­rent sit­u­a­tion is wor­ry­ing.

China's ex­ports have plum­meted by more than 8 per cent in the past year, par­tially thanks to the ren­minbi be­ing pegged to a ris­ing dol­lar. A wide­spread loss of con­fi­dence could be very harm­ful for the econ­omy, which is why the gov­ern­ment has stepped in with some heavy-handed mea­sures to sta­bilise the mar­ket, of which cur­rency de­val­u­a­tion is only the latest ex­am­ple. The mea­sure is par­tially a sym­bolic re­sponse to the IMF stat­ing that China wasn't ready to be a global re­serve cur­rency: a ges­ture to show that the ren­minbi is be­com­ing more flex­i­ble. The im­me­di­ate ef­fect, though, has been to com­pound the global mar­kets' wor­ries about Chi­nese growth - and to add a new one.

Will China go so far as to launch a cur­rency war to boost its growth? China's econ­omy is at a cross­roads. The gov­ern­ment says that slow­ing growth is con­sis­tent with its plan to re­struc­ture the econ­omy.

Oth­ers worry that the slow­est growth rate for 20 years is a sign of a pro­longed struc­tural slow­down. Af­ter three decades of rapid growth, China is now ap­proach­ing the so­called "mid­dle-in­come coun­try trap": a dra­matic slow­ing of an econ­omy af­ter it has reached up­per mid­dle-in­come sta­tus, which at present is around $14,000 per capita.

History is lit­tered with ex­am­ples of coun­tries such as Ar­gentina, where growth slows so much that they never join the ranks of the rich. The Or­gan­i­sa­tion for Eco­nomic Co­op­er­a­tion and De­vel­op­ment es­ti­mates that only a dozen or so coun­tries, such as South Korea and states in south­ern Europe in­clud­ing Spain and Italy, have es­caped this trap in the post-war pe­riod.

Some dis­pute whether such a trap ex­ists, but it's not a risk that Chi­nese pol­i­cy­mak­ers are will­ing to take. Its lead­ers view the slow­ing econ­omy not as one that is los­ing mo­men­tum, but one mak­ing a nec­es­sary tran­si­tion to a more sus­tain­able path - re­ly­ing more on the do­mes­tic con­sumer and less on the for­eign one. The 2008 fi­nan­cial cri­sis showed the down­side of be­ing an ex­port-ori­ented econ­omy when mil­lions of work­ers lost their jobs as global de­mand slumped. China is al­ready the world's largest ex­porter and isn't ex­pect­ing to gain more mar­ket share.

Ex­ports will no longer be the growth driver. With its own newly formed mid­dle-class, China now has its own con­sump­tion base to serve. Con­sump­tion as a share of na­tional out­put has in­creased in re­cent years from 35 per cent to about 50 per cent. For most ad­vanced coun­tries, con­sump­tion is around half- to twothirds of na­tional out­put.

So the well-known Chi­nese saver is now be­com­ing more of a spender. China, of­ten re­ferred to as the fac­tory of the world, is also re­bal­anc­ing away from man­u­fac­tur­ing. Ser­vices have risen quickly to be­come the largest part of the econ­omy, de­mand be­ing driven by the fast-grow­ing ur­ban pop­u­la­tion. For China to em­u­late its neigh­bours Ja­pan and South Korea, and break out of the mid­dlein­come trap, it will have to raise pro­duc­tiv­ity and in­no­va­tion. Tech­no­log­i­cal progress and glob­ally com­pet­i­tive com­pa­nies are the hall­mark of pros­per­ous na­tions. China has a few, but most sec­tors op­er­ate within rather than at the edge of the tech­no­log­i­cal fron­tier.

To achieve this, re­form of le­gal and reg­u­la­tory in­sti­tu­tions, as well as scal­ing back the in­ef­fi­cient state-owned sec­tor, are all needed. This takes time, es­pe­cially as vested in­ter­ests and cul­ture must also change. With an age­ing pop­u­la­tion, achiev­ing more out­put from ex­ist­ing work­ers be­comes an im­per­a­tive. With­out it, the econ­omy will con­tinue to slow and its well-known high level of debt - much of which is owed by lo­cal gov­ern­ments - will be­come un­sus­tain­able. That could trig­ger a bust. China's slow­down is al­ready be­ing felt around the world, con­tribut­ing to a slump in com­mod­ity prices.

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