Of late, some experts are predicting that China might take the Japan route to economic stagnation. Their views are influenced by Chinas decision to bring down its GDP growth rate during the 12th Five Year Plan and make consumption, rather than investment, the future driver of growth. For an economy propelled by high investment for several years, it is felt that such a switch can produce catastrophic outcomes as the Chinese economy is not geared for ushering in such change.
How true are these fears
One of the biggest problems in analysing the Chinese economy is its steadfast resistance to be explained by straightforward mainstream neo-classical economic explanations. These explanations hardly explain why China is what it is. They do not accommodate the imperfections that the Chinese economy has and cannot explain why China has been growing at amazingly high rates despite imperfections. Chinas decision to cool down its economy is again an exogenous move, hardly anticipated in the mainstream economic discourse. As a result, the move has set the cat among the pigeons.
Contrary to the doubts expressed, it is unlikely that China will suffer an economic slump, much less an economic disaster. Ironically, the Chinese economys inability to adapt quickly to the proposed structural changes is likely to maintain its current growth pattern and thwart setbacks, rather than creating them.
Despite what Chinese policymakers have decided, Chinas GDP growth is unlikely to come down to 7% or thereabout in the near term. Growth moderation was announced as an objective in the earlier Plan as well. But annual GDP growth remained consistently above the targets set. The Chinese command control was unable to rein in the growth. It is unlikely to be much different this time around as well.
Why Chinas GDP growth is shaped by performances of its provinces. Incentive structures in provinces are fashioned in a manner encouraging implementation of growth-oriented, scale-intensive projects. Success in kick-starting projects contributing to GDP determines career progression of provincial officials. Not only does this incentive structure needs to change for curbing the provincial hunger for high growth, it needs to change while maintaining positive career prospects of the provincial administrations. This is obviously difficult and there is little evidence of China experimenting with new incentive structures till now.
Even a casual glance at Chinas recent economic activity, particularly in the months following the financial crisis, cant avoid noticing the emphasis on new infrastructure. High-speed rail corridors have been the buzzword in China, with bullet trains linking various parts of the country at amazing speed and in little time. The rail infrastructure is powered by massive investments and is a state-sponsored initiative. There is little possibility of the infrastructure expansion being curtailed. China will continue to spend well on railways in the foreseeable future. State-directed bank lending into special purpose vehicles managing infrastructure projects is unlikely to reduce. Infrastructure investment will remain a major determinant of aggregate demand and GDP growth.
Discussions on China often underestimate the pronounced informal character of its economy. Credit expansion and economic growth have released phenomenal liquidity in the economy. Chinese household savings include substantive amounts of idle cash due to the absence of an adequate variety of sophisticated financial instruments for parking the cash. Transactions through plastic money are also relatively less. Large chunks of idle money circulate among informal guanxi business networks, finding their way into diverse commercial activities both in the mainland as well as in neighbouring Hong Kong and Taiwan. These have been going on for years, unsupported by official incentives, thriving purely on networks developed through personal associations over the years. Will the decision to reduce GDP growth be able to limit the robustness of these activities
Finally, exports and exchange rate. China has realised the difficulty of pursuing an export-oriented growth strategy through an artificially pegged exchange rate. While it will gradually distance itself from the peg, as an economy, it is unlikely to transform overnight from a net exporter to a net importer vis--vis the rest of the world. Thousands of manufacturers and migrant labourers depend on Chinas export competitiveness for survival. The transition to an import-intensive, consumption-based framework must factor in alternate occupational opportunities for these communities. Until then, China is expected to free the renminbi only in carefully measured amounts.
Analysts overlook the fact that in spite of the overarching diktat of the Chinese Communist Party in the countrys economic decision-making, Chinas size and complexity can make the central directions difficult to fructify in their entirety. Chinas growth has been driven by horizontal decentralisation, with the provinces maintaining the momentum. More than two decades of free run given to provinces, as well as award of incentives not always consistent with principles of market economy for encouraging exports, has created a high growth economy with certain systemic imperfections, which are the biggest hindrances to Chinas cooling down.
Had the Chinese economy been devoid of imperfections and completely amenable to top-down announcements, it would have taken much less time and effort for the economy to change course. But, with the economy having developed home-grown structural peculiarities, and with domestic stakeholders having significant interests in maintaining high growth on largely the prevailing lines, Chinas GDP growth trajectory is unlikely to experience a major dip in the coming years.
Chinas economic collapse is predicated on the assumption of its ability to cut its own growth. China is unlikely to be successful in doing so. And the lack of success is expected to deter potential catastrophes.
The author is a visiting senior research fellow in the Institute of South Asian Studies in the National University of Singapore. These are his personal views