How can China keep on growing while its exports are shrinking?

Getting a clear view on where China’s economy is heading is not easy at the moment, as evidenced by large variations in GDP growth forecasts. One of the confusing developments is that while exports have continued to do badly recently, the domestic economy has exceeded most observers’ expectations by a wide margin.

Working in recent weeks on the World Bank’s new China Quarterly Update, released today, we have been trying to determine how the economy has been doing on balance, what the prospects are, and what this means for economic policy. In this blog, I will summarize our understanding of recent developments and prospects, leaving the upshot for economic policies for a later discussion (keep reading after the jump).

Recent developments—respectable growth in a difficult global environment

China’s economy continued to feel the brunt of the global crisis in the first part of 2009. However, very expansionary fiscal and monetary policy since November 2008 have kept the economy growing respectably.

Much of China’s fiscal stimulus is centered on the government’s infrastructure-oriented “RMB 4 trillion” stimulus plan. The monetary expansion resulted in almost 20 percent of GDP of new bank lending in the first five months, with a major part going to the infrastructure projects. Lending has slowed down in April-May from a frantic pace in the first quarter. However, the massive monetary injection will fuel economic growth in the coming quarters.

Looking at individual sources of demand reveals a diverse picture:

• Government-influenced investment, notably in infrastructure, has soared, boosted by the stimulus package (Figure 2).
• Market-based investment has lagged significantly, particularly in export-oriented manufacturing (textiles, clothes, furniture, computers, and IT), reflecting subdued and uncertain prospects for exports and profits and spare capacity.
• Housing sales have recovered in the first 5 months of 2009. But, in the face of a fairly large stock of buildings that are almost or fully finished, new real estate activity has remained weak so far.
• Consumption has held up well, as sharply lower inflation buoyed real incomes even though nominal income growth has declined.
• After the plunge in late 2008, export volumes have so far remained weak (Figure 3). They were still down an estimated 20 percent on a year ago in April-May and remain the main drag on growth.
• Meanwhile, China’s import volumes have picked up swiftly since March, largely because of stimulus package-induced demand for raw materials (this does not show up in the data denominated in US$ because import prices have fallen sharply on a year ago).

Overall, economic growth remained respectable in the first 5 months of 2009 in a very difficult global environment.

The outlook—continued respectable growth, although a swift return to rapid growth is not likely

Globally, signs of stabilization have emerged, but growth prospects remain subdued. The strong policy stimulus will support China’s growth in a major way this year. However, there is a limit to how much and how long China’s growth can diverge from global growth, given that China’s real economy is relatively integrated in the world economy. Government influenced spending only makes up one-third of domestic demand, and I do not think that the surge in government-influenced investment is going to lead to a rapid, broad-based recovery in China in the current global environment.

One important reason is that prospects for investment in several parts of the market-based economy—particularly in manufacturing—are not that favorable because spare capacity, in China and globally, is putting downward pressure on prices of manufactured goods, and thus on profits. Thus, I think China’s economic growth will probably not speed up to very high single digits until the world economy sees a sustained recovery.

We raised our forecast for GDP growth in 2009 to 7.2 percent because of the larger than expected size and impact of the policy stimulus. We expect growth to pick up somewhat in 2010, but not as much as in many other countries (and also not as much as several other China forecasters). This is largely because, while the global climate is likely to remain weak, the policy stimulus—which was key to growth in 2009—can realistically not be as large next year as this year.  

China has clearly defied the skeptics who said it would stop growing if global demand for its exports falls. However, the policy stimulus that made the current growth possible cannot last for years in a row. While we expect exports to recover if the world economy picks up, global demand is unlikely to be as strong in the coming 10 years as in the previous 10 years.

In a follow-up blog, I would like to discuss why we think China does not need more infrastructure-oriented stimulus, and what are the structural policy changes needed to make the transition to the more consumption-led, service-sector oriented, and labor-intensive growth that would allow China to sustain rapid growth in a changed global climate.