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Fears of a hard landing for the Chinese economy unfounded

15 Sep 2016 - 14:07
Source: Rob Armstrong / Flickr

Many investors are expecting a hard landing, or even a recession, for the Chinese economy. The official Chinese growth figures are being increasingly distrusted. As a result, many analysts are now compiling their own economic indicators that are said to show the actual level of Chinese economic growth. These include figures about electricity consumption, construction permits issued, car sales figures, railway transportation volumes and so on. They also like to refer to the many vacant cement-producing factories, the overcapacity in the steel industry and the stock market crisis a whole year ago. The analysts feel that the economic data they have found confirms the view they already had of the Chinese economy, namely that it has already entered its hard-landing phase.

However, such indicators must be interpreted with caution. It is certainly clear that Chinese economic growth is no longer at its pre-2010 level. The most recent official figures indicate growth of about 6½ %, a figure that is still solid but that is indeed significantly lower than the fantastic growth figures in previous years.

The type of landing experienced by the Chinese economy in recent years is the result of two major developments. First of all, the previous growth model of a state-led, industrial economy that focuses on exports and investments became unsustainable. It led to an inefficient economy with inadequate improvements in productivity. Systematic reforms were essential in order to continue to be able to deliver jobs and improvements in the standard of living for all Chinese. This brings us to the second major development, namely the transformation of the Chinese economy. The bottom line is that the Chinese economy needs to become a more consumption-driven service economy. In order to stimulate the necessary increase in productivity and efficiency in the service economy, the role of the government is being rolled back in favour of the private sector.

Over the past year, China has already implemented significant steps in its programme of reforms. However, the problem is that too many reforms and adjustments lead to lower economic growth in the short term. This not only reduces improvements in the standard of living but also leads to a rapid rise in unemployment. For instance, the efforts to tackle overcapacity in the steel industry alone have already led to an additional 1.8 million unemployed people in China.

Detrimental impact on the political legitimacy of the Chinese Communist Party
One important factor that is often forgotten in analyses of the financial markets is the role played by the Chinese Communist Party ('the Party'). The Party has no electoral legitimacy but is able to remain in power as long as it ensures that the population's standard of living continues to improve. In fact, since as long ago as 1980 the Party's track record in this field has been impressive, with economic growth averaging 10% a year, real income per head quadrupling and 600 million people being taken out of poverty. In other words, there are not many Chinese at the moment who are worried about economic growth. However, if there is a severe recession then this could lead to increasing social and political tensions that could have a negative impact on the political legitimacy of the Party.

The Chinese rulers will not let it come to this; instead, they will ensure that Chinese economic growth remains on track at all times. The economic growth rate will no longer be 10%; instead, it is more likely to lie in the range of 4-6%. However, do the Chinese authorities actually have the power and authority to guarantee such a sufficient level of growth?

Well, what we mustn't forget is that China is a planned economy where political control is exercised centrally. This means that the pace of the necessary reforms can be continually adjusted and that measures to significantly boost spending can be deployed quickly. The modest level of national debt, the sizeable foreign currency reserves and the adequate degree of monetary leeway mean that for the time being the authorities have enough ammunition to cushion the landing.

It is essential that investors and companies understand the economic and political factors and trends, as this understanding can then be used to make a well-balanced judgment about a country's economy. In short, don't just look at the most recent Chinese car sales figures or electricity consumption figures - you also have to consider the continuity in Chinese policy since 1980.