Shaping China’s New Normal – Consumption now ‘most exciting’ story

CHINA is undergoing a fundamental change to its economy while it attempts to grapple with longer-term fiscal challenges and potential political tensions.
It is in transition to a services-oriented and consumption-led economy, which will be reflected in a gradual change in China’s imports from the world.

And its growing and costly list of problems — including pollution, environmental degradation and ageing — will lead to creation of new service industries, such as environmental and healthcare services. For China’s trading partners, all these changes pose both challenges and opportunities.

ATI spoke to two professors of economics on the margin of a discussion panel organised by China Daily during the Asian Financial Forum in Hong Kong, seeking their perspective on China’s economy of today and tomorrow.

Both agreed that the days of double-digit, furious growth in China are unlikely to be repeated. What is now quaintly known as the “new normal” will be the norm.

In other words, the world needs to get used to China growing at a lower pace — as China itself also realises that it can grow at less than eight per cent without causing social instability . . .

CHINA IS HEADING into a period of lower growth, says Huang Yiping, Professor of Economics at Peking University and former Greater China economist for Citibank in Hong Kong. “I believe growth could moderate even more in coming years,” he says.

Edward Chen, honorary professor at the University of Hong Kong, concurs. He, too, believes the so-called ‘new normal’ — reflecting a change in China’s growth targets ­— is, indeed, the now “normal” GDP rate for China.

Huang debunks the popular belief that China needs to grow at eight per cent a year to create sufficient jobs and to maintain social stability. He told ATI this thinking was true five years ago, but there has been no problem in maintaining social stability with a lower growth rate.

“If you look at the Chinese economy, growth has been slowing for a couple of years, and there has not yet been a problem of unemployment. That is partly because the services sector is absorbing more labour.”

Most importantly, the labour force is changing, he says. “Fifteen years ago, the Chinese working age population was rising by eight million a year, but that has declined to three million a year. This is why the policymakers have been relatively calm, despite slowing growth.”

Another factor is that China is getting better at income distribution, Huang adds.

Both Huang and Chen say the key short-term issue facing China is over-capacity across the country’s key industrial sectors — including steel, cement, glass and aluminum.

Huang says the level of over-capacity is large — estimated at roughly 35 per cent across these sectors. He says it will take more than a couple of years to absorb this.
China’s demand for raw materials has peaked over the last decade, says Edward Chen, adding that, with lower growth, China’s need for commodities and raw materials will contract from the highs of the past.

The upshot of slower growth will be a drag on some economies, like Australia, which have grown used to a rapidly-growing China and its take-up of raw materials.

Chen says new technologies now incorporated into manufacturing will have an effect in reducing the need for raw materials.
 “The main reason China is facing a lot of difficulties today,” says Huang, “is that its growth has been led by three engines – investment, exports and manufacturing. Two of those engines are slowing down.”
He says labour-intensive manufacturing is experiencing difficulties. It is suffering because of rapidly-rising wage rates and labour shortages — and because of slowing global demand for China’s exports.

The outlook for robust global economic growth, hence strong global trade growth, is not promising, he says.

Outside analysts say these issues are compounded, to an extent, by a paralysis in decision-making on investment in a climate of fear caused by President Xi Jinping’s anti-corruption drive, under way since he took the helm in 2012. Some believe this policy reduced China’s growth in 2014 by up to 0.6 per cent.
Both professors say they have not done any mathematical calculations of the cost to the Chinese economy — but they agree that it is having an impact.
The slowdown has, however, been offset by the sharp drop in oil prices.

Huang says there was no major benefit to the Chinese economy from the oil shock of 2014 because of the impact of the anti-corruption drive. But he also believes that, if the drive continues at its current pace, because the initial shock has already been absorbed, the economic impact will not be as big in the second year.

“There will a levelling of the growth effect. When you have an anti-corruption drive, it takes the growth rate down in the first year. If you continue in the second year, I don’t think it will take the growth rate down further — unless you step it up.”

Therefore, China will likely benefit from lower oil prices from this year.

In Huang’s view, if oil prices stay low, this may add half a percentage point — more or less — to GDP growth.

“(But) benefits like the lower oil price are short-term effects,” he says. “They will not change the trend of growth moderation.”

While there is pessimism, Huang says there are also some positive developments in China. “You are seeing some green shoots in the Chinese economy,” he says. “The economy is rebalancing. Consumption will make up a greater proportion of the economy, and industrial upgrading will continue to rise. The services sectors will also rise more rapidly.”

Huang, who is also Deputy Dean at Peking University’s National School of Development, predicts that consumption is the next big China story in terms of the global economy.

“It won’t be like the US in the near future, even though, in terms of purchasing parity power, China is now larger than the US. In market terms, it is much smaller. Consumption accounts for around 50 per cent of Chinese GDP, compared to 80 per cent in the US.

“The difference is that Chinese consumption can grow by seven or eight per cent a year, compared to two-three per cent in the US. This is why I think consumption is the most exciting story,” says Huang.

China’s services sector is already bigger than its manufacturing industry, says Huang. A rapidly-growing area is in Internet-related services and E-commerce. Chinese online shopping accounts for more than 10 per cent of total retail sales, growing at 40 per cent a year.

Edward Chen says the services sector is growing from a low base. One focus is development of new services — as opposed to traditional services like retailing. The particular focus of the Government is on development of financial services.

Chen says President Xi has anointed Qianhai in Shenzhen as the hub for development of financial services, and gave his imprimateur by paying a visit to the area soon after he took over the leadership.

In a typically cautious Chinese approach, Chen says Beijing has opted to confine development of four key service areas —financial services, logistics, IT support services and, most importantly, financial services — to Qianhai.
“It is called the Hong Kong Qianhai Co-operative Zone,” says Chen, who is also President of the Qianhai Institute for Innovative Research.
Chen says Qianhai (see ATI, August 2012) will be completed by 2020. Banks and businesses have already established a presence at Qianhai, which aims to be a second Hong Kong, replicating all the services that make Hong Kong what it is today.

He says special businesses, like cross border Renminbi lending, have already started.  Some innovative financial products are also already in operation.
Chen expects Qianhai to go down the same path as Shenzhen, which was endorsed by then-President Deng Xiao-ping some two decades ago to become the first special economic zone (SEZ) to lead manufacturing in China. Shenzhen and the Pearl River Delta went on to become the factory of the world.
But, says Chen, Shenzhen graduated from being a manufacturing centre a long time ago as labour-intensive manufacturing gradually moved into interior provinces, away from the Pearl River Delta.

Huang Yiping says industrial upgrading is going on across China’s economy. As an example, the Chinese manufacturers, Xiaomi and Huawei, have been producing cheap mobile handsets, which have become phenomenal successes in some markets (like India). Chinese manufacturers are also producing large electrical machinery and equipment, and construction equipment.

While China is resolving short-term issues, it has to face up to longer-term issues, and front-of-mind is the growing liability of supporting an ageing population — and dealing with health issues caused by degradation of the environment. Huang says some economists estimate that the cost of China’s contingent liabilities – from ageing, pollution and health care – could be as high as 100 per cent of its GDP today.

But, he adds: “I would argue that the impact is not entirely negative. When you try to deal with the environmental protection problem, it will be part of the new economy. The same applies to healthcare — you actually create a new service sector.

“I could accept that, maybe, it could slow growth a little further, but I am not that pessimistic about growth. I think the real question is how the Government can try to absorb this kind of fiscal cost over time. What is the best strategy — to absorb it now or to spread it out over the next 20 to 30 years.”
Huang says the Government recognises the problems and has started to formulate a long-term plan to deal with its contingency liabilities. As yet, its strategy is still unclear.

“China has large State-owned enterprises which, while they can be a liability in terms of efficiency, at least in some areas can be privatised, with the proceeds used to help fund Government liabilities,” he told ATI.

In his opinion, China can resolve most of its economic issues. But what will be harder to manage will be political expectations of an increasingly better-educated population living in an age of social media and the Internet.

“If there is any risk facing China, it is with the country’s political system — especially when it has a rapidly-growing middle class. I think the middle class will demand a lot more rights — and participation in the public decision-making process.” Huang says the question is how authorities cope and adapt to new demands.

Huang — who is working on a research project on China’s overseas direct investment (ODI) with the eminent Australian academic, Peter Drysdale, an emeritus professor at the Australian National University in Canberra — says the leadership in China is aware of potential growing social tensions. “They are trying to deal with this problem.”

But as yet, he says: “We don’t have a clear roadmap from the policymakers. Exactly how they are going to deal with these demands, we don’t know. The Government is talking about a socially harmonised society, a more democratic element, a clean bureaucracy and so on.”