China: Changing drivers for competitiveness Global Economic Outlook, Q2 2017
China’s economic growth appears to be stabilizing, but the economy continues to derive its growth from the same sources as before: infrastructure and property investment. Changes in global trade agreements, wages, and demographics might affect the economy.
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China’s economic growth appears to be stabilizing, but the economy continues to derive its growth from the same sources as in recent years: infrastructure and property investment. The problem is that such activity has been fueled by rising debt, much of which might not be easily repaid. Moreover, in recent years, high levels of investment in infrastructure and property have not translated into stronger economic growth—which is what one would normally expect. This raises questions about the efficiency and usefulness of such investments, some of which are resulting in an excess supply of property.
In any event, the Chinese government recently released a slew of data that offers a snapshot of the current state of China’s economy. Here are some details:
- Fixed asset investment increased 8.9 percent in the first two months of 2017 versus a year earlier. This was a modest rate of growth compared with recent years, but quite strong nonetheless. The components, however, are especially interesting. Investment by manufacturers was up only 4.3 percent, yet investment in infrastructure was up a stunning 27.3 percent from a year earlier. This included a 35.8 percent increase in investment in public facilities. Thus, overall investment is largely being driven by infrastructure.
- Investment in real estate increased 8.9 percent from a year earlier. Housing starts were up 10.4 percent, and land sales were up 6.2 percent. The floor space of homes sold was up 25.1 percent from a year earlier, a significant acceleration from last year. This means that the easy government policy toward housing last year continues to have a big positive impact on housing market activity. However, recent tightening of policy could hamper such growth in 2017. The tightening reflects concern about the debt created by this development.
- Chinese industrial production was up 6.3 percent in the first two months of 2017 versus a year earlier, a slight acceleration from last year. This included a 6.9 percent increase in output by manufacturers. There was slow or negative growth for traditional and low-wage industries, but strong growth for more technology-intensive industries. For example, output by steel companies declined 9.1 percent. On the other hand, output by IT equipment makers was up 11.0 percent, while output of telecom equipment was up 14.0 percent.
- Retail sales in the first two months increased 9.5 percent from a year ago in nominal terms. When adjusted for inflation, real retail sales were up 8.1 percent. This is a deceleration from last year. The expiration of tax incentives for automotive purchases led to a decline in auto sales in early 2017. Online sales did well and now account for 11 percent of total retail spending in China.1
In recent years, high levels of investment in infrastructure and property have not translated into stronger economic growth—which is what one would normally expect.
Meanwhile China’s government has reduced its annual economic growth target from 7.0 percent to 6.5 percent. This is essentially the government’s public recognition of reality. In addition, Premier Li Keqiang indicated that the economy faces risk from excessive debt. Specifically, he said, “We must be fully alert to the buildup of risks, including risks related to nonperforming assets, bond defaults, shadow banking, and Internet finance.”2 The decision to downgrade growth targets means that the government wants to limit credit growth in order to reduce the risks that stem from excessive debt. What this will mean in practice is hard to say. China’s leaders face a tough balancing act: not allowing growth to decelerate too rapidly lest unemployment rise substantially, yet not allowing debt to get out of hand.
In January, US President Donald Trump pulled the United States out of the Trans-Pacific Partnership (TPP), a free-trade agreement between the United States, Japan, and 10 other Pacific Rim countries. Since then, China has attempted to organize the Regional Comprehensive Economic Partnership (RCEP), a planned free-trade agreement between China, Japan, South Korea, India, Australia, New Zealand, and the 10 countries of the Association of Southeast Asian Nations. The RCEP is not meant to be as comprehensive as the TPP, in that it is merely about removing tariffs. The TPP, on the other hand, included new rules governing cross-border investment, protection of intellectual property, labor rights, and environmental standards.
Japan is now concerned that China will attempt to lead the RCEP and be the dominant economic player in the region. As such, Japan is joining forces with other Asian countries in an attempt to gain control of the RCEP and shift it toward something deeper involving cross-border investment and trade, potentially luring the United States into the agreement. Whatever the RCEP winds up being, it will liberalize trade in Asia and, in the process, fuel growth in the region. For the United States, lack of free access to this market will be a competitive disadvantage.
China’s leaders face a tough balancing act: not allowing growth to decelerate too rapidly lest unemployment rise substantially, yet not allowing debt to get out of hand.
A new study finds that hourly wages in China’s manufacturing sector are now higher than those in every Latin American country other than Chile and are nearing the level found in some of the Eurozone’s lower-income countries such as Portugal and Greece.3 This is a sea change from just a decade ago, when China’s wages were among the lowest in the world. It means that living standards in China have risen substantially. It also means that China’s competitive advantage no longer stems simply from low labor costs. Rather, it stems from other factors such as the skill level of workers, the degree to which workers use technology, the supply of skilled managers, the transport and power infrastructure, and the legal framework. The study found that the productivity of Chinese manufacturing workers actually increased faster than wages. This means that unit labor costs in China (the labor cost of producing a unit of output) declined over the past decade, thereby increasing China’s competitiveness.
Interestingly, in many other countries—such as Mexico, Brazil, and Portugal—wages have declined in the past decade after accounting for inflation. The case of Mexico is especially interesting. In 2005, average hourly wages in manufacturing in Mexico were about twice that of China. Today, China’s wages are nearly twice that of Mexico. This is one reason that, prior to concerns about the future of the North American Free Trade Agreement, Mexico was rapidly becoming a favored destination for manufacturing investment, especially given its free access to the US market and close physical proximity to the United States.
Looking forward, China’s aging population and declining working-age population mean that wages are likely to continue rising. This will cause a further shift in the composition of Chinese manufacturing, away from low-value-added processes such as apparel and textile production toward higher-value-added processes.
A new study finds that hourly wages in China’s manufacturing sector are now higher than those in every Latin American country other than Chile and are nearing the level found in some of the Eurozone’s lower-income countries such as Portugal and Greece.
Speaking of Chinese demographics, the end of the one-child policy is evidently not yet having the desired effect. Specifically, China ended its long-standing policy of allowing urban families to have only one child. This change was made in order to avert a long-term demographic disaster. While the one-child policy had the desired effect of slowing population growth, it also set the stage for a substantial decline in the working-age population and a rapid rise in the ratio of retirees to workers. Ending the one-child policy was expected, over a period of time, to reduce these imbalances. Yet, since the policy changed 18 months ago, the birth rates clocked in major provinces have barely budged. It appears that, as in many other countries, there are other factors leading women to have fewer children. These include more female education and labor force participation, greater availability of government pensions to support the elderly (which reduces the need to have many children for retirement support), and higher incomes that provide greater opportunities for personal fulfillment. Some Chinese provinces are reported to be examining policy shifts that might encourage people to have more children, including subsidies for child care costs, and paid paternity and maternity leave.