Is 7 per cent China's new normal?

Five signs indicate when China will settle into sustainable growth – which may be at a significantly higher rate than Japan and South Korea experienced.

Graph for Is 7 per cent China's new normal?

A Chinese investor looks at prices of shares and stock indexes at a stock brokerage house in Huaibei city, east China's Anhui province. (AP photo)

Today China announced its much anticipated 2013 GDP figure of 7.7 per cent, exceeding its official growth target of 7.5 per cent despite difficult economic conditions. China bears can retreat to their caves for another year.

Will China be able to grow at 7 per cent for the foreseeable future? It is an important question for the Australian economy, which has become more intertwined with the fortunes of the world’s second largest economy than ever before. 

Since 2012, the Chinese economy has been decelerating considerably from the double-digit growth it has enjoyed for the past three decades. The country is clearly transitioning from its high-speed growth phase to a lower but more sustainable pace of development.

Will China’s growth stabilise at around about 7 per cent, or even lower? International experience, especially that of Japan and South Korea, suggests GDP growth halved after periods of high growth ended.

However, China is still a relatively under-developed country compared to Japan or Korea. Parts of China such Guangdong and Fujian are relatively prosperous, with GDP per capita of more than $US10,000 a year, while the central and western provinces are still playing catch-up.

It is likely that China may settle for a higher rate of growth than Japan and Korea had experienced, given the country’s regional growth disparities. When Japan and Korea ended their high-speed growth phase, they had more or less reached the standard of living of the OECD.

China is still long way away from that. Justin Yifu Lin, the former chief economist of the World Bank, says based on the East Asian experience, China still has the potential to grow at 8 per cent for the next two decades. That may be an optimistic view.

The bigger question is: when and how will China settle into a more sustainable phase of growth? 

Liu Shijin, vice minister of the Development Research Centre of State Council (China’s cabinet), suggests that the economy needs to display the following characteristics before it can be considered to have entered the next phase of sustainable development, according to an essay he penned for China Reform magazine.

  1. A fundamental change in the economic structure from a reliance on export and infrastructure spending to consumption, services industry and domestic demand.
  2. The acceleration of innovation and scaling up on the technological ladder, easing of pressure on the environment and natural resources. Productivity gains to offset increase in cost of production.
  3. Economic growth can provide ample employment opportunity for the country’s workforce.
  4. Risks inherent in fiscal, financial and industrial areas become manageable and gradually reduced.
  5. Stabilisation of companies’ profits after the economy enters the slow-growth phase and expansion of the middle class.

Much ink has been spilled on the need for China to change its current model of development (for example, less investment and more consumption).  However, the most interesting point Liu has raised is whether Chinese companies can survive or remain profitable in a lower growth environment.

Research modelling predicts nearly half of the Chinese companies will be in the red when economic growth dips below 7 per cent, according to Liu’s China Reform article. It’s a worrying result that should not come as a surprise: China’s manufacturing industry operates on a low-margin and high-volume model. Slower economic growth will squeeze companies’ already razor-thin margins.

In comparison, American companies are mostly profitable when US economic growth is hovering around 2 to 3 per cent; Japanese firms make money even when the economy is hardly growing at all.

One of the most crucial questions for the Chinese economy is whether companies can remain profitable when economic growth settles around 7 per cent, nearly a quarter lower than the double-digit growth they became used to.

There are some positive signs that Chinese companies, especially in the coastal provinces like Guangdong, Fujian and Zhejiang, are adjusting to the new reality of slower growth. These provinces account for significant part of China’s economic activity; for example, Guangdong’s GDP is about the same size as that of industrial powerhouse South Korea.

Inefficient companies have exited the marketplace; firms are diversifying from traditional manufacturing to more value-added and high technology sectors; the purchasing managers index, which measures industrial activity, is performing better in the eastern part of China than in the central and western parts.

Encouragingly, the employment situation, which is one of the highest policy priorities for Beijing, is holding up well. Demand for skilled technicians and engineers is growing, with many employers struggling to fill these positions.

However, at the same time, 7 million university graduates are entering the job market every year and many are struggling to find meaningful employment. There seems to be a structural mismatch between the demand and supply of skills.

China is in the middle of managing its transition from a high-growth economy to a more sustainable pace. It will be a while before it can find an equilibrium point. Preliminary evidence suggests 7 per cent is likely to be the new norm.

China Spectator will look at Beijing’s policies to support stable growth tomorrow. 

Follow Peter Cai on Twitter: @peteryuancai

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