After slowing substantially over the past year, China’s economy is showing signs of reverting to faster growth. A rise in government-funded investment has helped to offset the considerable weakness in China’s exports to Europe. Interestingly, exports to other geographies have actually improved. In October, overall exports were up 11 percent from a year earlier, far better than had been expected. This, in turn, contributed to a 9.6 percent increase in industrial production in October, offering the prospect of stronger GDP growth in the fourth quarter. In November, a private sector purchasing manager’s index for manufacturing moved into positive territory for the first time since July, indicating the fastest rate of growth in the sector in more than a year. Retail sales growth also accelerated in October, suggesting that the consumer sector is improving as well. Thus, it appears that China is on the mend.
Moreover, consumer price inflation in China has decelerated substantially, with prices up a mere 1.7 percent in October versus a year earlier. Indeed, this was the lowest rate of inflation in 33 months. This means that the central bank has considerable wiggle room should it choose to further ease monetary policy in order to stimulate the economy.
However, although growth is showing signs of revival, China still faces some challenges. For example, foreign direct investment (FDI) into China declined in October for the 11th time in the last 12 months. Slowing growth, global economic weakness, a rising currency, rising wages, and political uncertainty are all likely reasons for the deceleration of inbound investment. For the first 10 months of 2012, inbound FDI was down 3.5 percent from 2011. Outbound investment from China, however, increased substantially. In the first 10 months of 2012, outbound FDI was up 25.8 percent from 2011. This suggests that Chinese companies are actively searching for resources and new opportunities around the world. The higher value of China’s currency means that foreign assets are becoming relatively cheaper. In addition, the recent weakness in commodity prices has probably made commodity production resources cheaper as well.
Challenges for a new leadership
There has been a transition in China’s political leadership, raising questions about the likely path of government policy and the new leadership’s approach to tackling longer-term economic challenges. Interestingly, outgoing Chinese president Hu Jintao recently said that China should plan to double per-capita GDP from 2010 to 2020; this goal may be realistic if Chinese economic growth doesn’t slow down. This will likely require significant reforms aimed at maintaining long-term growth in the face of challenging demographics. Hu hinted at such reforms by calling for the private sector to have “equal access to factors of production.” He also called for China to improve its ability to innovate and for a boost in domestic demand.
For the private sector, “equal access” to production factors is significant.
For the private sector, “equal access” to production factors is significant. Today, state-run businesses enjoy favorable terms of credit, which often limit the amount of credit available to private-sector businesses—especially smaller ones, which must pay very high interest rates in the informal credit sector. Reformers want to free up market interest rates that are now set by the central bank and to allow all borrowers to compete freely for credit. Hu’s evident support for this measure could presage considerable reform of China’s credit markets. Yet doing so will likely have the effect of reducing the profit margins of state-run businesses.
Another issue is the need to shift away from export-led growth toward consumer-led growth. Rising wages are already helping to make this happen. For example, in the past three years, the wages of China’s migrant workers increased by 56 percent. Yet exporters have mostly failed to pass on the increase in their costs to customers; the prices of US imports from China rose only 4 percent over the last three years. Absent huge productivity gains, this pattern cannot be sustained indefinitely because it would ultimately cause profit margins to disappear. Rather, export growth will likely decline, and provided wages continue to increase, consumer spending in China should grow faster. Market-opening reforms could help accelerate this change in China’s economic structure.