2016: A Tough Year for China’s Economy
By Sarah Y Tong

2016: A Tough Year for China’s Economy

Mar. 30, 2016  |     |  0 comments


China’s economy has been facing increasing downward pressures in recent years, as its annual growth decelerated considerably from over 10 percent in 20101 to 6.9 percent in 2015. Concerns are rising over the prospects for China’s growth and the implications for China and the world economy. To contemplate China’s future growth prospects, it is essential to examine and understand its recent trajectory.


For over 30 years since the late 1970s, China’s economy expanded at an annual rate of nearly 10 percent. On the demand side, growth was driven most significantly by rapid investment expansion, sustained by high savings. External demand was important. On the supply side, heavy investment facilitated industrialization and urbanization. Meanwhile, domestic reforms and market liberalization enhanced incentives and improved efficiency. Externally, economic opening enabled China to participate in economic globalization and enjoy the benefits of economies of scale, competition, as well as foreign investment and technology.



Source: World Development Indicators, the World Bank.


To some extent, the challenges China is facing in sustaining its growth momentum stem from its past success. For 35 years, China not only considerably outpaced the world economy in growth, it also outperformed its neighbors in the region (Figure 1). As a result, China is now the world’s second largest economy. It is also the world’s top trading nation, and has entered the ranks of upper middle income countries. Naturally, as an economy becomes large and its people relatively rich, growth is bound to slow down. Again from the demand side, as an economy industrializes and modernizes, costs rise and profitable investment opportunities become harder to locate. Meanwhile, room for further trade expansion has become increasingly limited for the world’s top trading country. Meanwhile, although household consumption is bound to become a stronger source for growth, the process is likely to be slow and gradual.


Indeed, the changes in the economy’s composition have already taken place, albeit gradually. The share of gross capital formation, related closely to investment, dropped slightly from 47.3 percent in 2011 to 46.1 percent in 2014. Meanwhile, the share of household consumption rose from 35.9 percent in 2010 to 37.7 percent in 2014. More importantly, of the 6.9 percent GDP growth in 2015, 4.6 percent was attributed to the increase in final consumption (household consumption and government spending combined), compared to 2.5 percent by gross capital formation.


From the supply side, the technological gap between China and the advanced economies has narrowed, and thus the room for productivity gains has shrunk. Without significant technological breakthroughs, the overall rate of return on investment will also decline. Meanwhile, investment growth will also be constrained by China’s production over-capacity in several industries, including steel, cement, and coal. While there are still distortions in the economy, such as inefficiencies in the state-owned sector and the underdeveloped financial sector, further reforms in such areas will be difficult, due to institutional obstacles and possible strong resistance from vested interest groups.


The tasks confronting the Chinese leaders seem daunting, as the country has to deal with multiple issues simultaneously. As China struggles to adjust its economic structure, the country is also facing a much weaker world economy and worsening domestic labor and environmental conditions. It is therefore realistic to expect that China’s growth will taper off from its hyper-growth of the past decades to a slower gear, say around 6.5 percent, as stipulated by the Chinese leaders2.


This growth rate, not slow by any international standard, is in fact quite reasonable, based on several considerations. First, China’s economy is not only large but diverse. That means as factor prices rise in the relatively more developed coastal areas, business activities could relocate to relatively less-developed inland regions. Second, much can be done to develop an integrated domestic market which could provide a much needed cushion for struggling businesses as the external market stagnates. Third, there remains great potential for the development of China’s non-state sectors. As Figure 2 indicates, private businesses have consistently outperformed state-owned enterprises in fixed asset investment in the past decade. More supportive policies could enable them to further drive the overall economy forward. Furthermore, the current leadership, led by a strongman, seems determined to push through reforms on the back of a rigorous anti-corruption campaign.


There are, however, uncertainties and difficulties. For example, to some extent, the leadership's prolonged anti-corruption campaign has resulted in bureaucratic paralysis. Incentives by local governments to promote local development have been weakened. Meanwhile, if growth deceleration persists and unemployment rises, the risk of social unrest increases, undermining social cohesion and political stability. There are also macro-economic risks. For example, local government debt, associated with bad bank loans, is rising. Although China has made progress in the internationalization of its currency, such as RMB’s inclusion in the IMF’s Special Drawing Rights basket of currencies, concerns remain regarding further reforms for China’s financial sector. Indeed, as China’s financial sector becomes more open and integrated with the rest of the world, the management of the system has become increasingly complicated.


Overall, 2016 may prove to be a very difficult year for Xi Jinping and his team, as well as for China. Although economic deceleration is expected and is not necessarily a terrible outcome for China, concerns over the transition are warranted. Indeed, the economy is facing numerous constraints, domestically and externally. However, there is no reason to be overly pessimistic. As a large economy and with strong and determined leaders, China will likely sail through the turbulent tide to a successful soft-landing. This will help lay a strong basis for China’s sustained development and prosperity.





Notes


1. Data used for the analysis in this paper is from CEIC Data Manager, unless specified otherwise.


2. For example, the Government’s Work Report, delivered by Li Keqiang earlier in mid-March, states that “to finish building a moderately prosperous society in all respects and double the 2010 GDP and per capita person income in 2020, the economy needs to grow at an average annual rate of at least 6.5% during the five-year period (2016-2020)”. (Source: Report on the Work of the Government (28 March 2016). Xinhua Net. Retrieved from http://news.xinhuanet.com/english/china/2016-03/17/c_135198880_2.htm)

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