To hear some pundits tell it, China’s economic miracle—one that lifted 300 million people out of poverty and shifted the world’s geopolitical centre of gravity—is coming to a tumultuous end. The volatile stock market and the renminbi’s “surprise” depreciation are signs of imminent economic collapse, according to this view, as risky investments and high levels of government debt put the brakes on decades of turbo-charged output growth.
Fortunately, there is little reason to believe such dire predictions, or that the market gyrations that have been driving recent headlines represent anything more than short-term volatility. After all, equity-price movements are a poor predictor of the real economy’s performance.
Indeed, when Chinese GDP was growing strongly during 2010-2013, stock prices were falling. More recently, when stock prices began soaring during the first half of 2015, the economy’s slowdown had already begun. As the American economist Paul Samuelson famously quipped, “The stock market has called nine of the last five recessions.”
China’s growth has slowed largely as a result of changes in its fundamentals: less favourable demographics, a shift in emphasis from exports and public investment to the service sector and domestic consumption, and lower demand from advanced economies. But China’s past success also contributed to this slowdown, in the form of higher wages, which narrow the scope for rapid growth based on low-cost labour and technological catch-up.
Additional signs of weakness, including soft data on exports and investment, emerged in the first half of 2015. But other important indicators—like retail sales and housing—show upticks. And, perhaps most important, the country’s labour market remains healthy, creating some 7.2 million new urban jobs—many of them in services—in the first half of 2015. Meanwhile, wage growth remains strong and uninterrupted. China’s growth rate may be lower than 7% this year, but I do not believe that it will end up very far from the government’s target of “about 7%.”
The volatility in equity prices in recent months has more to do with the peculiarities of China’s stock markets than with the country’s underlying economic fundamentals. In more developed economies, such as the US and Europe, many institutional investors—who tend to be focused on long-term fundamentals—help stabilise stock markets. By contrast, the Chinese markets are dominated by retail investors, who are more likely to pursue short-term gains and engage in momentum trading, thereby exacerbating volatility and creating a greater disconnect between equity prices and real economic growth.
Moreover, the firms listed on China’s stock exchanges are not representative of the country’s companies. Majority state-owned firms account for two-thirds of the market value of the country’s exchanges, for example, though they are responsible for no more than one-third of Chinese GDP and an even smaller share of employment.
The rise and fall of the Chinese stock market should also be understood in the context of Chinese households’ limited options for storing savings. The run-up in prices took place at a time when deposit interest rates were officially capped. When the alternatives are few and provide only low returns, the equity market looks more attractive, especially if—as was the case—the country’s major newspapers are running bullish editorials about stock prices.
More recent developments may have contributed to the downward pressure on prices, including discussion about abolishing interest-rate ceilings on deposits (the cap on term deposits of one-year or more was removed on August 25). The greater ease with which wealthy households can move savings out of the country, along with an anticipated increase in interest rates in the US, was likely another contributing factor.
Furthermore, as Harvard’s Jeffrey Frankel has pointed out, regulators increased margin requirements several times this year, making it harder to buy stocks with borrowed money. And, as with all stock markets, shifts in sentiment that are not connected to fundamentals can also drive volatility.
Whether China’s economy can continue to grow rapidly will depend far more on its ability to reform than on how its stock markets perform. If China is to thrive in the long-term, raising its aggregate productivity is key. This means that it will need to overhaul its state-owned firms and the financial sector so that resources can flow to the most productive investment projects. Lowering the tax burden on firms—including the payroll tax—would also be useful.
Reforms that increase the flexibility of the labour market are also in order. While China used to have a relatively flexible labour market in the manufacturing sector, firms’ reallocation of workers based on market needs has become more difficult in recent years. Greater flexibility might not stimulate short-term growth, but it would improve resilience to future negative shocks, whether they originate at home or abroad.
As long as China continues to pursue pro-market reforms, it will remain the largest single-country contributor to global GDP growth over the medium-term—unperturbed by stock-market volatility. If reforms stall, falling stock prices are likely to be the least of China’s worries.
The author is chief economist, Asian Development Bank, and the head of its economic research and regional cooperation department
Copyright: Project Syndicate, 2015