The sky is not fall­ing on Chi­nese econ­omy de­spite the pan­ick­ing


With the burst­ing of the main­land Chi­nese stock mar­ket bub­ble in July and the slight but un­ex­pected de­pre­ci­a­tion of the yuan, by about 4 per­cent in Au­gust, the world mar­kets have pan­icked and doom­say­ers are com­ing out in droves to pre­dict the im­mi­nent col­lapse of the Chi­nese econ­omy. But the Chi­nese econ­omy should be able to make a smooth tran­si­tion to a “new nor­mal,” with an av­er­age an­nual growth rate of about 7 per­cent over the next few years, based once again on China’s do­mes­tic de­mand.

The cur­rent “cri­sis” was a “cri­sis” of do­mes­tic and in­ter­na­tional con­fi­dence, caused by the slow­down of China’s in­dus­trial sec­tor and eco­nomic events such as the burst­ing of the stock mar­ket bub­ble and the at­tempted re­fine­ment of the for­eign ex­change trad­ing mech­a­nism.

De­spite ev­ery­thing, it is un­likely that the Chi­nese econ­omy will suf­fer a “hard land­ing,” be­cause the large and wide­spread ex­cess pro­duc­tion ca­pac­i­ties in China’s man­u­fac­tur­ing in­dus­tries will en­sure ag­gre­gate sup­ply so long as there is ag­gre­gate de­mand. Thus, the Chi­nese econ­omy is not sup­ply con­strained.

Given the ex­cess man­u­fac­tur­ing ca­pac­i­ties in many in­dus­tries and the ex­cess sup­ply of residential units in al­most all ex­cept the very first-tier cities, pri­vate-sec­tor fixed as­sets in­vest­ment is not likely to be a ro­bust source of in­crease for ag­gre­gate de­mand as it once used to be. Low­er­ing the rate of in­ter­est alone is not go­ing to in­duce ad­di­tional pri­vate-sec­tor fixed in­vest­ment in ei­ther man­u­fac­tur­ing or residential hous­ing. Nor is ex­port likely to be a source of in­crease of ag­gre­gate de­mand, given the rel­a­tively slow re­cov­ery of the U.S. and Euro­pean economies, the con­tin­u­ing rise in wages in China and the sig­nif­i­cant ap­pre­ci­a­tion of the yuan since 2005 (about 25 per­cent). The 4 per­cent de­pre­ci­a­tion of the yuan in Au­gust was too small to have any sig­nif­i­cant im­pact.

More­over, it is re­ally not in the best in­ter­ests of China to de­value the yuan enough to go back to la­bor-in­ten­sive light man­u­fac­tur­ing such as toy-mak­ing, with the low stan­dard of liv­ing that such ac­tiv­i­ties im­ply. It is far more im­por­tant, from China’s point of view, to con­tinue the process of in­ter­na­tion­al­iz­ing the yuan, so that it can be di­rectly used for the in­voic­ing, clear­ing and set­tle­ment of global trans­ac­tions. For this pur­pose, the yuan ex­change rate vis-a-vis the U.S. dol­lar must be kept at a sta­ble level.

Chi­nese house­hold con­sump­tion has been grow­ing about 50 per­cent faster than real gross do­mes­tic prod­uct dur­ing the past few years. But be­cause of its low share in GDP, about 30 per­cent in 2014, it will not suf­fi­ciently boost ag­gre­gate de­mand to make a ma­te­rial dif­fer­ence as yet. To­tal fi­nal con­sump­tion, which in­cludes both house­hold con­sump­tion and gov­ern­ment con­sump­tion, reached 60 per­cent of GDP in the first half of 2015. For house­hold con­sump­tion to be­come a ma­jor driver of ag­gre­gate de­mand, real house­hold dis­pos­able in­come must in­crease sig­nif­i­cantly faster than real GDP. Even then, it will take a while be­fore house­hold dis­pos­able in­come ex­ceeds 50 per­cent of GDP.

Thus, in the short and medium terms, any sig­nif­i­cant growth in ag­gre­gate de­mand must come from in­vest­ment in public in­fra­struc­ture and com­mod­ity con­sump­tion. The gov­ern­ment is ex­pected to take the lead in both. In­creas­ing in­vest­ment in in­fra­struc­ture public and com­mod­ity con­sump­tion to boost ag­gre­gate de­mand at this junc­ture has two ad­di­tional ad­van­tages.

First, given the idle man­u­fac­tur­ing ca­pac­i­ties, the mar­ginal so­cial cost of in­vest­ment in public in­fra­struc­ture and com­mod­ity con­sump­tion is low. Sec­ond, the pro­vi­sion of public goods amounts to a re­dis­tri­bu­tion of real in­come in kind, since, for ex­am­ple, both the rich and the poor breathe the same air and drink the same wa­ter. So, the move can re­duce the de­gree of in­come dis­par­ity in China. The au­thor is a pro­fes­sor of eco­nom­ics at the Chi­nese Univer­sity of Hong Kong.

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