The year 2007 was an important milestone in modern economic history. While the U.S. grew well, China contributed more to global GDP growth than the U.S. did. That pattern is likely to continue for the foreseeable future. Roughly speaking, the U.S. economy is about four times the size of China’s. If the U.S. grows at 2% -- which is solid for an advanced economy – and China continues to grow at 10+%, then China will be adding more to global GDP each year than any other country. The same can be said for global trade: China’s imports have risen 28% in the past year, so that it is an increasingly important source of demand for other countries.
The growing importance of China in the global economy is the main reason that we have launched this China Development Blog. There is huge interest in the prospects for China and in what is actually happening on the ground here.
While China has emerged as an economy of nearly equal importance to that of the U.S., it is also important to note that China and the U.S. are closely intertwined. There is broad agreement that the U.S. economy is slowing down in the wake of the sub-prime financial mess. Views on whether the U.S. goes into recession are about 50:50; but what is clear is that there will be a significant slowdown in U.S. growth. How much effect will this have on the global economy? How much on China? One school of thought has it that China and the rest of East Asia are increasingly “de-linked” from the U.S. cycle, hence they will feel little impact.
This de-linking hypothesis is implicitly taken up in our new macro quarterly update. We come out somewhere in the middle, though leaning somewhat to “de-linking.” Last fall we projected 10.4% growth in 2008 for China; now, in the face of weaker prospects for global growth, we mark that down to 9.6%. Thus, we reject the complete de-linking view. The slowdown in the U.S. and the broader global economy will have some effect on China. This was already evident in the fourth quarter of 2007, when net exports essentially contributed little to China’s growth. China’s export growth has been slowing down, its import growth has been picking up, and this will have some effect on China’s growth.
But our 9.6% forecast is also something of a nod to de-linking. If actually achieved, that would be an excellent rate of growth in a slowing world economy. Even in China, growth rates consistently and considerably above 11% are not sustainable and risk inflation. Hence, a modest slowdown may be a good thing for China.
From the point of view of arithmetic China can easily meet our 9.6% projection. In these recent heady years of growth, net exports have contributed 2 to 3 percentage points to growth. China’s domestic demand has contributed about 9 percentage points. So, without the stimulus of net exports, China can grow at 9+%. The problem is not arithmetic, however, but human behavior. The slowdown in China’s exports causes real pain. More than 1,000 shoe factories closed in Guangdong province last year, and in China all of these factories are pretty large. As China’s adjusts to a different global environment, some entrepreneurs will lose their shirts, large numbers of workers will lose their jobs. The risk for China is that other firms and households will respond by being more cautious and cutting back on spending and investment, just as that domestic demand is needed more than ever.
One reason that we remain cautiously optimistic is that many of the drivers of the domestic economy—confidence, profitability, liquidity, and consumption—are strong as China enters 2008. Moreover, the government has lots of fiscal space to stimulate the economy. Recent fiscal policy has been very conservative. In fact, it is ironic that the government has been constrained in dealing with real social issues – such as poor rural health care or lagging rural schools – because overall the economy was in danger of overheating in recent years. Hence, if there is an unexpectedly sharp falloff in domestic demand as the global economy slows, the government could easily increase its spending on social services and infrastructure – meeting real needs and keeping the macro economy on track.
Bottom line: China needs to be agile with its macro policy as the uncertainties of 2008 unfold, but with good management it can continue to grow at 9% and above.
(Also, you may be interested in a live discussion we just had about this report. Read the transcript, but come back here if you want to keep the discussion going ).