China's re­bal­anc­ing is over­rated

The Pak Banker - - OPINION - Christo­pher Bald­ing

THE op­ti­mists' case for China is fairly straight­for­ward. Yes, the world's se­cond-largest econ­omy is grind­ing to its slow­est pace in decades. But as in­vest­ment and man­u­fac­tur­ing -- tra­di­tion­ally the key driv­ers of Chi­nese growth -- de­cline in im­por­tance, do­mes­tic con­sump­tion and ser­vices are play­ing a big­ger role: For the first time, ser­vices ac­counted for just over 50 per­cent of GDP last year.

This much-de­sired re­bal­anc­ing should move China to­ward a far more sus­tain­able growth model. New econ­omy com­pa­nies in tech­nol­ogy, health-care, fi­nance and retail are more pro­duc­tive and less pol­lut­ing than smoke­stack in­dus­tries. Ro­bust con­sump­tion -rail traf­fic is grow­ing at 10 per­cent as Chi­nese spend more on leisure travel, while mo­bile In­ter­net traf­fic has dou­bled -- is key to wean­ing the econ­omy off its ad­dic­tion to in­vest­ment. As un­pro­duc­tive coal mines and steel fac­to­ries shed work­ers, la­bor-in­ten­sive ser­vices should pick up the slack.

A closer look at the data, how­ever, paints a dif­fer­ent and de­cid­edly gloomier pic­ture. Take travel. While over­all rail traf­fic is up, to­tal pas­sen­ger turnover, which ac­counts for the num­ber of kilo­me­ters trav­eled, grew only 3.1 per­cent in 2015. More­over, it's im­por­tant to re­mem­ber that only 11 per­cent of trips are done by rail. (In­ter­na­tional air travel, which grew 34 per­cent last year, only cov­ers 0.2 per­cent of trips.) The vast ma­jor­ity of travel takes place by road and high­way traf­fic ac­tu­ally de­clined last year. If so many more Chi­nese are go­ing on plea­sure trips, why is ho­tel rev­enue flat?

Sim­i­larly, sales at the 100 big­gest re­tail­ers in China, which one would ex­pect to be thriv­ing if the econ­omy were re­bal­anc­ing, were down 0.1 per­cent in 2015. Lux­ury brands have been hit par­tic­u­larly hard (in part be­cause of the on­go­ing anti-cor­rup­tion cam­paign) and sales of even ba­sic con­sumer durables such as TVs, re­frig­er­a­tors, au­dio equip­ment and wash­ing ma­chines are flat or de­clin­ing.

Ser­vices are cer­tainly grow­ing faster than man­u­fac­tur­ing and real es­tate. But much of that growth comes from two sec­tors. The first, fi­nan­cial ser­vices, got a ma­jor boost in 2015 from the stock-mar­ket boom in the first half of the year and from the con­tin­u­ing flood of lend­ing en­cour­aged by the govern­ment. If one strips out the con­tri­bu­tion made by the sec­tor, con­sump­tion con­tin­ued to slow last year.

The burst­ing of the equity bub­ble is sure to crimp growth, as may a sour­ing of loans, many of which are go­ing to loss-mak­ing heavy in­dus­tries. In­deed, by help­ing keep afloat those state-owned zom­bie com­pa­nies in or­der to boost GDP, Chi­nese banks are fur­ther de­lay­ing the process of re­bal­anc­ing.

The other sec­tor that's done well is lo­gis­tics and trans­porta­tion -- mostly be­cause of an ex­plo­sion in e-com­merce. Con­sumers are jump­ing at the lower prices and greater choices of­fered on­line; Alibaba, its com­peti­tors and down­stream com­pa­nies are ex­pand­ing rapidly. Yet de­spite this new de­mand, the out­put and to­tal sales of con­sumer goods are barely grow­ing. That sug­gests on­line re­tail­ers are sim­ply steal­ing mar­ket share adding to the over­all pie.

The govern­ment knows it needs to do more to pro­mote true re­bal­anc­ing. The of­fi­cial 2016 eco­nomic plan high­lights the need to lower costs and taxes in or­der to stim­u­late spend­ing. More also needs to be done to cre­ate a so­cial-safety net, so Chi­nese don't have to squir­rel away their sav­ings for a rainy day. Red tape needs to be slashed so en­trepreneurs can more eas­ily launch new ser­vice busi­nesses.

The chal­lenges are daunting, how­ever, and will re­quire changes to fi­nan­cial flows, the la­bor mar­ket and busi­ness cul­ture. Banks will have to be freed up to lend more to small and medium-sized com­pa­nies, rather than the in­ef­fi­cient state-owned en­ter­prises that have tra­di­tion­ally been their clients. Work­ers ur­gently need re­train­ing: Many ser­vice-sec­tor jobs, such as those in tech­nol­ogy and fi­nance, de­mand skills that laid-off coal min­ers sim­ply don't have.

Above all, the state will have to learn to fa­cil­i­tate pri­vate en­trepreneur­ship rather than plan the mass pub­lic projects that have his­tor­i­cally driven growth. As many com­pa­nies that have tried to be­come more in­no­va­tive have learned, there's no way to man­date dy­namism and cre­ativ­ity. Be­fore China can truly tran­si­tion to a new growth model, its govern­ment is go­ing to have to get out of the way.

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