China’s economic slowdown—what to do?

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.