China's Economic Prospects: Outlook and Policy Challenges

IMGXYZ1231IMGZYXAccording to the World Bank, global economic growth is likely to contract by two percent this year. With export markets shrinking, many have questioned whether China’s domestic economy can supplement lost export revenue to maintain the country’s historically high growth rate.

 

Carnegie invited Louis Kujis, senior economist at the World Bank’s China office, to discuss this issue. Kujis was joined by Carnegie’s Albert Keidel and Uri Dadush.

 

In the short-term, China is faced with a contracting international economy, but a relatively strong domestic one. Kujis warned that the global economy is going to remain gloomy for the remainder of 2009; the United States, China’s largest export market, has experienced a 6.1 percent drop in GDP in the first quarter of 2009, which is about 1.5 percent worse than many expected.  

 

On the domestic side, the government’s fiscal and monetary expansions have kept the economy growing at a relatively high rate of 6 percent year-on-year in the first quarter of 2009. China has a strong macroeconomic situation – high foreign reserves and little debt – which has given the government space to act in a crisis. Even now, after its 4 trillion yuan ($586 billion) stimulus, China has room to increase spending further if necessary. 

 

These two very different pictures have implications for Chinese economic policy. The Chinese Communist Party’s (CCP) current 5-year plan is focused on rebalancing the economy away from what it considers an overdependence on exports. To achieve this rebalancing, China needs to strengthen its service sector, generate greater domestic consumption, and engage in fiscal reform. The current global crisis increases the urgency of these priorities. 

 

Although some analysts are already signaling the bottom of China’s slump at home, Kujis explained that there is reason to be skeptical of CCP projections for eight percent growth in 2009. Most of China’s six percent GDP growth can be attributed to the expansion in government investment. However, growth in consumption during the first quarter was relatively low. This means that as net trade continues to worsen – as is likely to happen – domestic demand may be too weak to make up for the significant drop in trade. Keidel provided a scenario: if China’s trade surplus drops by another third, domestic demand would have to grow by 11 percent in order to achieve 7.6 percent GDP growth for the year. This kind of growth would be difficult to achieve: the World Bank predicts 6.5 percent growth in 2009, and two-thirds of that will come from government investment. 

 

When considering China’s prospects in the coming decade, Kujis argued that no one should expect the 19 percent average annual export growth experienced in the previous decade to continue. The hyper-liquidity of export markets in the pre-crisis heyday is over; global demand is expected to grow at a lower rate. There is still room for China to expand its exports, but at a rate closer to nine percent annually. Assuming no other economic changes, this drop in exports would slice about two percent from China’s annual GDP growth.

 

Along with much of the rest of the world, China will be entering a period of spare capacity in the coming years. The results will be weaker employment growth, less migration, downward pressure on profits and prices, incentives to redirect sales to the domestic market, and a greater proportion of sourcing from domestic companies for inputs – import substitution. 

 

Kujis said that he expected China’s manufacturing sector, despite less global demand, to remain very competitive and continue to gain global market share without major government support. 

 

Keidel expressed concern about the U.S.-China trade relationship; although there may not be a major shift, there is potential – particularly during a recession – for a protectionist reaction to China’s trade surplus. On the other hand, China’s trade surplus is likely to diminish or even reverse during 2009, which would quell protectionist sentiments in the United States. 

 

Both Kujis and Keidel agreed that it is not in China’s best interest to devalue its currency, which should continue to appreciate in the long-term.