There is a vigorous debate on the prospects for China's growth. But there is little disagreement that the 'new normal' for China is significantly slower than the 10 per cent-plus growth of the past decade and that there needs to be a rebalancing over time, reducing the role of investment in driving growth. How will these changes play out for China's trading partners?
As the latest IMF Economic Outlook shows, emerging countries have accounted for almost all of world growth over the past four years and China accounts for much of this (see IMF graph below; emerging economies are in red).
China's spectacular growth over the past decade has brought some large structural changes to its trading partners. These are the countries which will be most affected if China slows sharply.
The game-changing transformation in Asian trade has been the development of complex supply chains that split the production process over a range of countries. This has affected the whole of Asia but the close production integration has occurred between China, Hong Kong, Korea, Taiwan, Malaysia, Singapore and Japan.
China represented 4 per cent of Taiwan's exports 10 years ago: the share is now 30 per cent, accounting for 20 per cent of GDP. China's share of Korea's exports went from 12 per cent to 25 per cent over the past decade, now accounting for 12 per cent of GDP. Both Korea and Taiwan are growing slowly and would be highly vulnerable to a sharp slowing in China. The IMF estimates that a 1 per cent fall in China's investment would reduce Taiwan's GDP by nearly 1 per cent. Hong Kong is so closely linked that a sharp slowing on the mainland would produce a recession in Hong Kong.
The links with commodity suppliers such as Indonesia and Australia are of the traditional type, but will be important too. Ten years ago, Australia's exports to China were 12 per cent of total exports; the figure is now 30 per cent.
China accounts for around 40 per cent of world consumption of steel, aluminium and copper and consumes half the world's coal production, though until quite recently it was net self-sufficient in coal. Even now, it accounts for well under 20 per cent of internationally-traded coal. Thus if demand for coal in China slows, the impact might be mainly felt by domestic producers (often high-cost underground mines) rather than foreigners, predominantly cheaper open-cut mining. That said, whatever the cost comparisons, the Chinese authorities may arrange things so that the effect of slower growth falls largely on the foreigners.
On top of the effect on trade volumes, there is the impact on commodity prices. China's huge stimulus in 2009 prevented the 2008 Great Recession from undermining commodity prices at that time. China kept commodity demand growing while the financial chaos postponed the supply-side response which in normal circumstances would have mitigated the commodity price increase. Now the delayed supply response is coming on stream.
Whatever China's growth rate, in time commodity prices will reflect the supply side: the cost of production of the marginal producer. Again, the impact of the changing demand/supply balance will not fall solely on foreigners. If the Chinese authorities accept the logic of using the cheapest supplier, then well-located low-cost suppliers (like Indonesia and Australia) should maintain good volumes, albeit at much lower prices.
The debate about China's growth isn't just about its pace: it's also about the composition. The rebalancing involves less reliance on overseas demand (running an export surplus). As well, domestic demand has to be switched from investment to consumption. Much of the external rebalancing has already occurred, with the current account surplus falling from over 10 per cent of GDP five years ago to less than 3 per cent now. The switch from investment to consumption is likely to be slower, simply because it can't be done quickly while maintaining full employment, which is a paramount political priority. Thus commodity-heavy investment is likely to go on growing, albeit more slowly.
Faster consumption growth might produce a domestic supply response but, just as accelerated demand for coal led to substantial growth in imports, accelerated consumption growth is more likely to spill over into imports. Other Asian agricultural suppliers (Thailand, New Zealand) might do well out of the rebalance towards consumption. Indonesia will lose in terms of slower growth in coal demand, but its two other big exports to China – palm oil and natural rubber – should do well, with China cooking and driving more. And in any case, faster consumption growth will raise the demand for electricity, predominantly generated from coal. A sudden switch from investment to consumption would be unhelpful for Australia's two big exports – metallurgical coal and iron ore – although the switch is likely to be gradual.
The Pettis forecast of 3 per cent growth for China is still an outlier: most conventional forecasters are closer to the official figure of 7.5 per cent. The most compelling case for such a number is that this is what is required to keep unemployment from rising, so the authorities will do what is necessary, in terms of stimulus, to achieve it.
Of course they could make a misjudgment or be distracted by politics. Let's hope not. With Europe still deeply mired, the US facing its fiscal cliff and longer-term budget issues, and Japan performing at its usual lethargic pace, there is not much else to keep world growth going.
Originally published by The Lowy Institute publication The Interpreter. Reproduced with permission.