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China’s economic slowdown—what to do?

Louis Kuijs's picture

The World Bank released the China Quarterly Update —of which I’m the lead author, full disclosure here-- today at a press launch in our Beijing office. The economic journalists noticed that the Bank’s projection for GDP growth in 2008 is now 9.8 percent, more than 2 percentage points lower than the outcome in 2007. Several journalists asked whether it is not time to stimulate growth by loosening macro economic policies and/or what would be the most appropriate policies to relax.

Somebody living in Dallas or Dusseldorf may find it difficult to understand why a government would want to stimulate the economy when growth falls to 9.8 percent.

The difference in perspective is related to a question that has been raised many times since the sub-prime problems broke out in the US: What will happen to growth in developing countries and emerging markets when the US economy, and the European one as well, slows down considerably? Many developing countries and emerging markets had been growing rapidly in the years preceding the sub-prime problems—much more rapidly than high income countries. But exports to high income countries are important for most of them. So the question was: can developing countries and emerging markets “decouple” from the high income countries?

The answer given by many economists was (as usual) yes and no. Developing countries and emerging markets that, like China, have successfully integrated into the world economy cannot decouple from the global economic cycle because a weaker world economy means lower exports and investment. 

But, at the same time, these countries should be able to continue to grow considerably even as growth in high income countries slows down to low levels. In principle, it is easier for poorer countries to grow fast than for rich countries. With large gaps in productivity compared to “best practice”, poorer countries can catch up, or “converge”, simply by adopting techniques or practices from rich countries. The evidence suggests that this convergence is conditional; that is, that it depends on whether the poor countries pursue good policies conducive to growth.

But once developing countries have a good policy framework in place for sustained rapid growth, the evidence suggests that, even as their exports and investment in the tradable sector come down as the global economy slows down, they can keep growth going at solid rates (one of the points made in the Bank's own Global Development Finance report released last week).

We are too early into the current global downturn to be sure about China. However, developments so far suggest that

(1) China has been affected significantly by the global downturn;
(2) China’s overall growth is holding up well.

Exports have decelerated since the outbreak of the sub prime crisis. And investment in industry has slowed down so far in 2008. However, overall GDP growth was 10.6 percent in the first quarter of 2008. Estimates for the second quarter suggest a similar pace of overall growth. Monthly activity data through May suggest a further moderation but to a still healthy pace.

The team behind this report actually thinks that China should not relax macro economic policies. GDP has grown at double digit rates for 5 years, and averaged 11.8 percent in 2006-07. On our projection, GDP growth would moderate to a pace broadly similar to potential output growth 9-10 percent, the rate of growth that the economy can grow at without running into overheating problems. Given that the authorities still need to make sure that the surge in prices of food, energy, and other raw materials does not spill over in a major way into other prices, we think there is no case for a loosening of the macroeconomic stance.

You can check out the full report, and a summary, and a data slideshow, here. Let me know your views in this blog, or join me and David Dollar in a live online discussion about it in July 1 (details and link to come). UPDATED: The live discussion will take place on July 1 at 9:00 a.m. EST, which is 13:00 GMT and 9:00 p.m. in Beijing). You can send questions in advance through this page and/or join the live discussion there as well.


Based on my 20 years proactive structural simulation of China macro economic control impact on GDP growth and inflation, capital, housing market asset prices stability, China Peoples Bank will contine its credit tighteing to fight its PPI at 8.2 % cotinue under soaring oil, commodities price to slowdwon its economic growth the target of 8 %, cut its money supply to 12 % ( currently 16 %). 9.6 % GDP is overheating, sdespite stock plunged 50 %, housiing price still up 10 %, serious housing price bubbles resulted excessive liquidity and fixed investment, hot money speculation. China will not face serious,US sub-prime crisis, with high saving rate , low default rate. details on

Submitted by Louis on
Warren, I agree that containing inflation remains important. The PBC governor noted earlier this week that monetary policy may need to respond to last weeks fuel price increase to ensure that inflation pressures remain contained.

Submitted by Anonymous on
Chinese government can stop real estate speculation by using non-monetary means. They are not doing a good job at it and has been behind the curve. Stock market has crashed already. Energy inflation can be contained by Yuan appreciation against the Dollar. Food price is already controlled by the government. They need to keep their eye on healthy economic growth, no more interest hikes.

Submitted by Louis on
Anonymous, You think slower growth is the main risk and concern in China and that, because of that, policies against inflation, if they are needed, should not be in the form of an interest rate hike. I agree appreciation is helpful in toning down inflation pressures, especially those coming from in internationally, like those of energy and other raw commodities. I do not have a very strong opinion on whether the bottom line monetary policy stance is tight enough or not tight enough (an I do not think the current bout of inflation was caused by excessively loose monetary policy). However, China's use of unorthodox monetary policy instruments like credit controls create distortions. Thus, I would prefer to see more of the monetary policy action done by interest rates instead of credit controls. Indeed, to me the 16 % yoy or so credit growth in China is not intimidating. But deposit interest rates are sharply negative in real terms, and even lending are still negative in real terms. That does not seem appropriate for an economy that still grows rapidly and where inflationary expectations need to be contained.

Submitted by Anonymous on
Inflation is part of the growing process. As income grows, living cost will increase. You can't have an US income and China cost. Would you want the farmers and workers who represent 80% of the population to have stagnant income forever? 5-6% of inflation should be the norm for China. The important thing is to direct investment where it is needed. Like more investment in agriculture and energy. Crack down on housing speculation. Speculators should not be allowed to have more than two units in China. Don't borrow the monetary policy from US. They have failed in the US and less suited for China. Greenspan and Ben are two of the worst FED chairmens in the history of US.

Submitted by Louis on
Anonymous, You raise 2 interesting issues: 1) is inflation unavoidable when a country grows fast? China actually grew fast for a long time without major inflation. This seems to have been possible because the capacity to produce (supply) rose rapidly along side fast expanding actual activity (demand). China now has inflation, caused by high food and other commodity prices. Blue ear disease notwithstanding, most of the higher food prices are because of higher international food prices, as is the case for industrial raw materials as well. Many people say that the high growth in China and other emerging markets are driving up food and other raw materials. If that is so, then, indeed, high growth leads to high inflation, even if it is in a roundabout way. At the World Bank we are of the view that the main drivers behind the high food prices are high oil prices and bio fuel policies. Is the high oil price not a result of rapid growth? Maybe. 2) What is wrong with having substantial food price driven inflation? I think that is a very good point. Higher food prices tend to benefit farmers. That is not always so everywhere, because traders and middlemen may be the main beneficiaries. However, we have indications that in China at the moment farmers are seeing higher income growth because of higher food prices. That is actually a good thing. The government has been trying for years to increase rural incomes and to reduce the urban rural income gap. Well, higher food prices are a welcome development in this regard. Of course higher prices could become a macroeconomic problem if they lead to spillover and a wage price spiral. There is no large systemic spillover yet in China, and macro policy will continue to focus on preventing such spillover for a while more. But, from a Chinese perspective, apart from this macroeconomic issue, higher food prices should not necessarily have to be a bad thing.

Submitted by Anonymous on
"The PBC governor noted earlier this week that monetary policy may need to respond to last weeks fuel price increase to ensure that inflation pressures remain contained." That is the stupidest thing I have heard for a while. Higher energy prices is equivalent to higher interest rate. It is a tax on consumers and it is more effective than higher interest rate. Higher fuel prices are not caused by too much money in China. They should try to appreciate the Yuan faster rather than increasing interest rate. Looks like Chinese central bankers are no better than Greenspan or Ben.

Submitted by Louis on
I agree that higher fuel prices may not be caused by too much money in China. Sensible central bankers will not try to fight the impact of higher fuel prices on headline inflation, and the PBC is run by sensible central bankers. However, sensible central bankers will try to avoid that higher fuel prices lead to large second round effects that may drive up "core inflation" to too high levels. That is what the PBC is trying to do too. By they way, considering tightening the domestic monetary policy stance does not rule out using the exchange rate at the same time.

Submitted by Anonymous on
The root cause of world wide inflation is cheap Dollar. Why don't you ask US FED to increase interest rate? That will solve all the problems. To balance the cheap Dollar is to raise the Yuan agaist the Dollar. Further tighting in China will kill the real estate market repeating the mistake Bernake did in the US. With both stock market and real estate market crashing the last thing you will worry about is inflation.

Submitted by Louis on
Anonymous, You say "the root cause of world wide inflation is a cheap dollar. Why don't you ask the US FED to increaes interest rates". The value of the US dollar is pretty much market determined. A cheap dollar may boost prices of internationally traded raw materials when expressed in dollars. But countries that want to dampen the impact this has on inflation can let market forces work and let their currencies appreciate against the dollar. The US has an independent monetary policy, oriented on domestic considerations. The US economy is weak, and therefore interest rates are low. That makes sense to me. To me, countries that traditionally have kept their currencies closely follow the dollar would be better off letting go this link now and regain monetary independence rather than hope that the US would boost its currency even if US domestic considerations don't ask for it. You also say: "With both stock market and real estate market crashing the last thing you will worry about is inflation." Two comments: 1) I did not know China's real estate market is crashing. 2) In my view it is difficult and wrong for any central bank to not worry about inflation.

Submitted by Anonymous on
I agree with you on the first part. China has kept the Dollar peg for too long. Yuan appreciation will dampen the economic growth in China and relieve some inflation pressure. I think China central bank is behind the curve. Any more tightening will not be good. I didn't say Chinese real estate is crashing now. I say it will if China keeps tightening monetary policy.

Submitted by Anonymous on

This has been all over the media and blogs this past weekend. Since the report is not specific to East Asia and Pacific, nor does this unit work with the author, our bloggers cannot address this issue properly. But there's a Speak Out live online discussion taking place right now on the main World Bank site, and I'm sure this topic will come up. Check it out or send your questions here: After the discussion is over, you can read the full transcript at that same address.

Submitted by Louis on
Thanks all for stimulating links. On Brooking's Wing Thye Woo's article on how to contain inflation, I find much there to agree with. I think I would be somewhat less concerned about raising interest rates; I fully agree that exchange rate strengthening fits China's current conditions well--it will help tone down price pressures; reduce the current account surplus; and contribute to rebalancing, including towards domestic demand in general and consumption in particular. On food prices, Claudia is right that global food prices are out of our reach; they are out of our reach in 2 ways; both analytically and in the sense that East Asia does not play a major role. However, for an East Asia perspective, have a look at our own Milan Brahmbhatt's blog a while ago on food prices: Milan's blog has a link to a background paper of him and another collegue of ours, Luc Christiaensen, which quotes some of the now famous/notorious results from Don Mitchell's work.

Submitted by Anonymous on
"Maintaining economic growth should be our priority when most of the price rises are caused by production costs," Wang wrote in the official China Securities Journal. "Sound economic growth will equip residents well to fight inflation." Seems like most people are sensible about inflation at the raw material level except the governor of PBC who said he wants to fight inflation because energy price has increased. EU should have lowered interest rate instead of raised it. Lowering interest rate there actually will ease inflation since Dollar will be stronger. They seem to follow the text book step by step.

Submitted by Bellyghost on
It is by no means China will enter into a new era ofwhich inflation plays a high profile in the coming days of it's economic growth. It was the old Chairman Jiang's days when the China government announced to play high in the West Developement Programme and National Industrialisation while Mr. Wu - the exisitng Chairman of China play another role with development of high-tech industries that hopefully can bring China into a new era to compete with world great powers. In the old days, fast and rapid production scheme that resulted in nation-wide out-of-control pullotion and de-cultivation will be gone. The national industrialisation resulted in China becoming the world's biggest factory while this situation will still prevail for some years but it is not the will of the exisitng government. But what we can see is that the rapid developement of China brings a huge problem of resources and minerals that needed for national consumption and this need increase annually that made China's inflation a real problem to tackle with. Fortunately the government itself subjectively subsidize most of the industries that bearly to control the inflation, long can China withstand this situation!?

Submitted by Louis on
Thanks. As mentioned earlier in this discussion, I agree that central banks should not try to keep headline inflation unchanged if oil prices rise. However, sensible central bankers will try to avoid that higher fuel prices lead to large second round effects that may drive up "core inflation" to too high levels. In my understanding that is what the PBC is trying to do and what the governor referred to. I do not think I agree with your view that lower European interest rates will reduce european inflation. Lower ECB interest rates will stimulate demand and weaken the euro exchange rate. Both will put upward pressure on euro-denominated prices. That-- perhaps, only perhaps--a weaker euro-$ rate reduces $ denominated commodity prices is of little consolation to the ECB.

Submitted by Elton on
many export-oriented manufacturers of small-size was bankcrupted already under high cost conditions

Submitted by Anonymous on
I was talking about China real estate market going down in July 2008 just three months ago. It is happening now. The problem with world economy is too many economists don't know what they are talking about and keep chasing their own tails. Central banks should be eliminated.

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