Does the Chinese economy have enough puff left? – by Mervyn Lewis

photo credit: Christopher Augapfel via Flickr cc

photo credit: Christopher
via Flickr cc

Despite anxieties about how quickly the Federal Reserve may exit from its easy money policies and the ongoing saga of the US budget and debt ceiling, few things matter as much for the world economy as what China does.  China’s growth over the last decade, in combination with that of other emerging economies, has helped underpin the international economy post-crisis and prop up the ailing developed world.

Still, with the IMF in its latest World Economic Outlook lowering China’s forecast growth rate in 2014 to 7.3 per cent per annum and observing ‘strengthening conviction that China will grow more slowly over the medium term than in the recent past’, this growth engine seems to be running out of steam, setting off a chorus of doomsayers quick to declare that China’s export-oriented, high investment growth model was unsustainable all along.  It is time to take stock.

By any account, what China has done can only be described as astonishing.  Starting from a low base three decades ago, China is now the world’s second largest economy, a manufacturing powerhouse and a vast source of global savings.  In that time, China has transformed itself from a rural to a predominantly urban nation, achieving in 30 years what took 200 years in Britain, 100 years in the United States and 50 years in Japan.  Not surprisingly, the ten fastest growing cities in the world are all in China, and as reported in Nature most are growing vertically rather than outwards.  The result is the greatest poverty reduction scheme in history, when those living below $1.25 per day fell from 84 per cent in 1980 to 10 per cent in 2010 (The Economist).

China continues to generate extraordinary economic statistics, consuming 67% of the world’s corn, 63% of iron ore, buying more mobile phones than the rest of the world combined, and is the largest exporter of solar panels.  It has passed the US in steel production (1999), beer consumption (2002), copper consumption (2002), carbon emissions (2006), exports (2007), fixed investment (2009), manufacturing output (2010), total energy consumption of crude oil, natural gas, nuclear power and renewables (2010), car sales (2010) and patents granted to residents (2010).

photo credit: Michael Mandiberg via Flickr cc

photo credit: Michael Mandiberg via Flickr cc

This leads to what The Economist calls ‘the dating game’.  According to the HSBC, in 2050 China will be the world’s largest economy in terms of market exchange rates (i.e. in US dollar terms), followed by the United States, second, and then in third place India, but a long way behind.  But exactly when might the mantle of the number one economy be handed over, or more likely snatched from American hands?  This is the question underlying ‘the dating game’.

The Economist answered its own question by plumping for 2018 as the year when China overtakes the United States.  Angus Maddison opted for 2020, Martin Jacques and PricewaterhouseCoopers 2025, Goldman Sachs 2027, World Bank Chief Economist Justin Lin 2030, and the US National Intelligence Agency, 2036.  Some, however, say never – Larry Summers: ‘our best days as competitors and prosperous citizens still lie ahead’; Michael Mandelbaum: ‘No country now stands ready to replace the United States’; and Joseph Nye: ‘The United States…..will remain more powerful than any single state in the coming decades’.

Admittedly, the case for ‘American exceptionalism’ is strong.  Who would have thought even a few years ago that, thanks to shale oil and fracking technology, the United States would be on track to displace Russia in 2015 as the world’s largest producer of oil and gas?  Yet, by the same token, China sceptics have been wrong before too.  To this end, a number of points can be made. 

First, there are the demographics.  As the Chinese population ages and the ranks of those of working age fall in a relative sense, China no longer needs to grow quite so quickly as the 8% target previously seen as necessary to maintain social cohesion, and its policy makers undoubtedly slowed the economy down accordingly.

Second, China critics point to an unbalanced economy marked by over-investment, empty buildings and countless bridges and roads to nowhere.  Yet the simple fact is that China’s per capita capital stock is only 6-7 per cent of that of the United States.  China’s road density of 40 km per 100 sq km in 2009 trailed the United States’ 65 km per 100 sq km by a considerable margin.  Although China is slightly larger in area than the United States, its 98,000 km of rail lines in 2012 are less than half of the United States’ 228,000 km.  Has China really over-invested?

Third, the power of compound growth remains.  Suppose that China slows its growth from 10% to 7% per annum.  Its economy would double in size every 10 years instead of every eight.  The US would take almost 30 years to do the same if it grows at 2.5% per annum – the  forecast for 2014.

Fourth, the Chinese economy is more than double the size it was a decade ago.  Even at 7% per annum growth, it is adding more to global growth than when it was growing at 10% p.a. (7% of 200 is more than 10% of 100).

Fifth, using 2010 data, in articles published in 2011, Richard Iley and I projected, like The Economist, that the Chinese economy would likely overtake the US economy at end-2018.  In our book Global Finance After the Crisis: The United States, China and the New World Order (2013), published in July this year, the projection was re-calculated but on the current trajectories of the two economies, with the result largely unchanged – the Chinese economy grew faster than we (and others) expected in 2011, and slowed from a higher base.  China may still be on track to become the biggest economy end-2019.  Even with growth scaled back China would appear to be fast closing the gap on the United States.

Such straight-line extrapolations are obviously fraught.  After all, in 1979 Japan was predicted to take the Number One mantle from America.  Will China also falter?  Japan’s population then was one-half of the United States, and it needed to be twice as productive.  As Arvind Subramanian noted in his 2011 book Eclipse, China’s population is four times America’s, and only needs to be one-quarter as productive to exceed US output – a more achievable task. 

Mervyn Lewis photoProfessor Mervyn K. Lewis is Professor of Banking and Finance, in the School of Commerce, UniSA Business School, University of South Australia, City West Campus, Adelaide. Formerly Midland Bank Professor of Money and Banking at the University of Nottingham, he was educated at the University of Adelaide obtaining first class Honours and a PhD.  Professor Lewis is an active researcher, publishing twenty-two books, 70 articles and 90 chapters.  In 1986, he was elected a Fellow of the Academy of the Social Sciences in Australia.

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