With the world’s rich countries still hung over from the financial crisis, the global economy has come to depend on emerging markets to drive growth. Increasingly, machinery exporters, energy suppliers, and raw-materials producers alike look to China and other fast-growing developing countries as the key source of incremental demand.
But Chinese officials warn that their economy is poised to slow. In late February, Premier Wen Jiabao announced that the target for annual GDP growth over the next five years is 7%. This represents a significant deceleration from the 11% rate averaged over the five years through 2010.
Should we take this 7% target seriously? After all, the comparable target for the last five years was just 7.5%, and the Chinese authorities showed no inclination to rein in the economy when the growth rate overshot. On the contrary, they aggressively ramped up bank lending when global demand weakened in 2008. And they were notoriously reluctant to allow the renminbi to appreciate as a way of restraining export growth.
Of course, it is difficult to be too critical of past Chinese policies. The country’s growth has been nothing short of miraculous. Post-2008 policies enabled China largely to avoid the global recession. And there is something refreshing about officials who actually promise less than they deliver.
So are China’s leaders again underestimating their economy’s growth capacity? Or might their forecasts of slower growth just be another Machiavellian ploy to deflect foreign pressure to revalue the renminbi?
There is reason to think not – that this time Chinese officials are convinced that a slowdown is coming.
China has been able to grow so rapidly by shifting large numbers of underemployed workers from agriculture to manufacturing. It has an extraordinarily high investment rate, on the order of 45% of GDP. And it has stimulated export demand by maintaining what is, by any measure, an undervalued currency.
But, in response to foreign and domestic pressure, China will have to rebalance its economy, placing less weight on manufacturing and exports and more on services and domestic spending. At some point Chinese workers will start demanding higher wages and shorter workweeks. More consumption will mean less investment. All of this implies slower growth.
Chinese officials are well aware that these changes are coming. Indeed, they acknowledged as much in the latest Five-Year Plan, unveiled earlier this month.
So what is at issue is not whether Chinese growth will slow, but when. In recent work, Kwanho Shin of Korea University and I studied 39 episodes in which fast-growing economies with per capita incomes of at least $10,000 experienced sharp and persistent economic slowdowns. We found that fast-growing economies slow when their per capita incomes reach $16,500, measured in 2005 US prices. Were China to continue growing by 10% per year, it would breach this threshold just three years from now, in 2014.
There is no iron law of slowdowns, of course. Not all fast-growing countries slow when they reach the same per capita income levels. And slowdowns come sooner in countries with a high ratio of elderly people to active labor-force participants, which is increasingly the case in China, owing to increased life expectancy and the one-child policy implemented in the 1970’s.
Slowdowns are also more likely in countries where the manufacturing sector’s share of employment exceeds 20%, since it then becomes necessary to shift workers into services, where productivity growth is slower. This, too, is now China’s situation, reflecting past success in expanding its manufacturing base.
Most strikingly, slowdowns come earlier in economies with undervalued currencies. One reason is that countries relying on undervalued exchange rates are more vulnerable to external shocks. Moreover, while currency undervaluation may work well as a mechanism for boosting growth in the early stages of development, when a country relies on shifting its labor force from agriculture to assembly-based manufacturing, it may work less well later, when growth becomes more innovation-intensive.
Finally, maintenance of an undervalued currency may cause imbalances and excesses in export-oriented manufacturing to build up, as happened in Korea in the 1990’s, and through that channel make a growth deceleration more likely.
For all these reasons, a significant slowdown in Chinese growth is imminent. The question is whether the world is ready, and whether other countries following in China’s footsteps will step up and provide the world with the economic dynamism for which we have come to depend on the People’s Republic.
By Barry Eichengreen, professor of Economics and Political Science at the University of California, Berkeley. His latest book is Exorbitant Privilege: The Rise and Fall of the Dollar.