China’s economy in the last two months has softened, immediately raising the question of why this occurred and how significant it is. The answer will inevitably affect global conditions as China is the world’s second-largest economy, the main trading partner for numerous economies, and the dominant market for key commodities. This softening was in contrast to the first half year, when China’s economy accelerated – GDP growth reaching 6.9%.
The answer to these key questions is that this softening is easily explained, and for that reason – whilst real – it will not develop a major dynamic. The Chinese authorities have the situation under control because China has strong macroeconomic management mechanisms. Therefore, the slowdown is palpable but will be mild with no serious risk of crisis. If the Chinese authorities consider the slowing is excessive, they have ample means to control the situation.
First, data will be provided, and the explanation of recent trends analysed thereafter.
The increase in China’s industrial value added fell this August to 6.0% – the lowest since December 2016. However, as can be seen from Figure 1, the deceleration was mild. China’s annual average increase in industrial value added in the last year was 6.5%, an acceleration from 6.0% at the beginning of the year, and from a low of 5.6% at the beginning of 2015. Thus, August’s 6.0% is only slightly below trend – a tangible slowdown but also a mild one.
The same trend may be seen in China’s retail sales. Their year on year increase in August was 10.1%, the lowest since February 2017- but again, only slightly below the one-year average of 10.4%. Therefore, the decline in the growth rate of retail sales is noticeable, but only minor.
The figure which has attracted most attention, and which is indeed the key to understanding the real dynamic in China’s economy, is that of fixed urban investment. During the first eight months of the year, compared to the same period in 2016, fixed investment increased by 7.8%. There has been no figure as low as this in the recent period, and therefore the decline in fixed investment is much more substantial than the decline in industrial value added or retail sales. It is also the key to analysing how the Chinese authorities will respond.
China’s Macroeconomic Mechanisms
China differs from most economies in that that there are three mechanisms available to the government to carry out macro-economic control – not just two. In most economies, there are only the two tools of monetary policy and fiscal policy. China, however, also has direct state control over a large part of investment: in the first eight months of 2017, 60.7% of China’s fixed asset investment was private and 39.3% non-private (which is overwhelmingly state) investment.
This key difference between China’s economy and most others is wrongly understood and leads to mistakes in analysis. However, Tom Orlik in the Wall Street Journal characterised it accurately:
‘Most economies can pull two levers to bolster growth: fiscal and monetary. China has a third option. The National Development and Reform Commission can accelerate the flow of investment projects.’
To illustrate this, Figure 3 shows how the Chinese authorities responded to what they considered an excessive economic slowdown at the end of 2015 and beginning of 2016 – China’s GDP growth had fallen from 7.0% in the first quarter of 2015 to 6.7% by the first quarter of 2016. A large state investment package was launched. This reached a year on year peak of increase of state investment of 23.7% in April 2016. The result was that China’s GDP growth increased from 6.7% in the first quarter of 2016 to 6.9% by the 2nd quarter of 2016 – as shown in Figure 4.
With economic growth increasing, private investment (which had fallen to a low of 2.1% year on year increase by July 2016) sped up again, reaching 7.7% in March 2017. The investment stimulus launched by China’s authorities at the beginning of 2016 was therefore effective both in stopping the decline in economic growth and in stimulating private investment. This explains China’s strong economic performance through to the first half of 2017.
However, China’s authorities have slowed this investment accelerator in recent months. The year on year rate of the growth of state investment halved to 11.2% and the growth of private investment slowed slightly to 6.4%. The slight softening of economic performance in the last two months, therefore, is a logical result of this trend.
The fact that the mild slowing of the economy followed logically from the Chinese authorities’ decision to limit the increase in state investment, whilst the programme that was embarked on in early 2016 was highly effective, shows that China’s authorities have the instruments to stabilise the economy if necessary and prevent any serious slowdown.
Regarding perspectives, the softening of the Chinese economy in the last two months is thus palpable, but also rather limited in scope. The softening of the economy is also the logical outcome of decisions taken by the Chinese authorities – indicating no loss of control of the situation. If the slowdown continues, the key variable to watch is whether China’s authorities launch a new increase in state investment.
Immediately, however, the present slowdown is too small to suggest that any major move to stimulate investment will be taken in the short term – significant new data will be available when the 3rd quarter 2017 GDP figures are published in October. But as the present economic softening is easily explainable and the means to reverse any severe downturn are well understood from previous experiences, there is no reason to believe that the authorities have lost control of the situation. It would also be an over-exaggeration to believe that there will be any severe slowdown in China’s economy.
It is, therefore, necessary to avoid the type of ‘manic-depressive’ analyses of China’s economy which appear in some reports. The fundamental target announced by President Xi Jinping is that China’s average growth should not fall below 6.5% until the end of the present 13th Five Year Plan in 2020. This will allow China to complete its target of doubling GDP in 2010-2020. While the economy’s softening in the last two months is real, it is not severe. There is no indication from present data, and from analysing the trends which underlie it, that China’s target for 2020 will not be achieved.
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