Global Trends by Martin Khor

Monday 22 December 2008

China’s slowdown a worry for other economies

The theory of “decoupling” of Asia from the world recession is disproved as China’s economy is rapidly slowing, with millions of jobs lost and a review pending on its export-led strategy.

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What a difference a few months make! When the United States’ sub-prime mortgage crisis was evolving, many analysts theorized that Asian economies were “decoupled” from the Western economies, and would continue their strong growth, especially with China pulling the rest along.

Last week, I attended a conference in Beijing during which the mood was grim and gloomy.  Most participants not only presented evidence of a significant slowdown of China’s economy in recent months, but also predicted that the country’s export-led model of development was over and a new development strategy must be found.

It is clear we cannot expect China’s traditional high growth to keep the Asian economies or the world economy afloat.  Instead, China may be hit harder than many other countries.

The conference, organized by the Chinese Academy of Social Sciences, the country’s top policy think tank, was to mark 30 years of success in China’s opening up to the world. By the time it was held, the main topic had turned to the effects of the global economic crisis on China.

In fact, Chinese policy makers and thinkers are going through a re-thinking of their economic and social policies, as the global crisis has hit the country much more seriously than perhaps anyone had predicted.

A large part of China’s high growth (10% per year or higher) and its dramatic increase in foreign reserves (to almost US$2 trillion now) was driven by manufactured exports.

But recent months have seen the closure of export-oriented firms. Around 670,000 small firms have closed this year and 6.7 million jobs vanished, many in Guangdong, due to the global crisis, according to State Council advisor Chen Quansheng.

The Ministry of Human Resources last week reported that 4.85 million jobless migrant workers had returned to their hometowns and villages by the end of November and more than 10 million migrants are now out of work.

The situation may even be worse.  Dr. Geng Xiao, Director of the Brookings-Tsinghua Center in Beijing told me that in his estimate 20 million jobs have been lost as the industries based along the Chinese eastern coast that were producing textiles, shoes, toys, steel and construction materials have closed. 

This reflects the slump in exports as well as in consumer spending.  In November, for the first time in many years, China’s export revenue actually fell.  Industrial output growth slowed to 8% in October.  Total electricity output fell by 7%, an ominous sign as electricity use is the first indicator of the overall state of the economy. 

In the domestic economy, vehicle sales were up by only 7.7% in November while the sales of building materials were 33% down in November and private housing sales in January-November were 20% below the same period a year ago.

Small and medium sized enterprises were already in trouble at the beginning of this year.  Their already profit margins were hit by cost increases caused by rising raw materials prices, the appreciation of the local RMB currency, implementation of new labour laws including minimum wages, new tax and export rebate policies, and shortages of land supply and credit.

By mid-year, economic analysts were already talking about “the end of low-cost textile exports.”  Policy makers were aiming at phasing in higher value-added industries.

Then the financial crisis turned into a real-economy recession in the US and Europe in the past few months.  The fall in consumer demand in the West is transforming the problems into a major crisis in China.

At least four foreign experts at the conference last week predicted that the export-led model is over for China, at least for the next several years as the West’s recession will deepen and last many years, and consumer demand for Chinese imports is going to plunge.

Most explicit on this point was Financial Times columnist Martin Wolf, who said “the old export-led growth model has now hit the buffers and the time for radical change is now.”

Almost all agreed that the way forward is for China to boost its domestic engines of growth, especially through an increase in its consumer expenditure, which last year was only 35% of GNP, probably the lowest such ratio in the world. 

How to get Chinese households to spend more is a complex question, given the rise in unemployment and the economic uncertainty, and the penchant of the Chinese to save for a rainy day.  This is a long-term solution.  In the short run, it is easier to boost government consumer spending, such as through house construction.

In November, the government announced a fiscal stimulus package of more than US$600 billion over two years, including for infrastructure, low-cost housing and schools.  This was hailed around the world as a contribution to boosting world demand. As China’s leaders have said, their country’s biggest contribution to the world economy will be to keep its own economy growing.

But it is unlikely that the fiscal stimulus will be enough to prevent a significant slowdown that will shave many percentage points off the economy’s usual 10-plus percent growth.

The global crisis may in fact cut the growth of China by more percentage points than the loss of GNP growth points in the US, major European countries or Japan.

This will affect other developing countries through reduced demand in China for commodities and intermediate products.  The rapid softening of the prices of commodities is a sign of this.

The “decoupling” thesis is thus being turned around its head.  Things will get worse for developing countries like Malaysia before they finally get better.