It is a maxim of today’s financial markets that we cannot trust Chinese economic data because the official statistics distort the truth by painting an overly benign Chinese economic picture, or so the sceptics argue.
Consider this: The Chinese government tells us that the economy is growing at 7% a year. But major macroeconomic indicators, including growth in industrial output, electricity consumption and freight traffic are only growing at 3%-4%, and industrial materials output such as steel and cement is actually contracting. Hence, the sceptics conclude that the official statistics are lying about the true picture.
The irony is that these sceptics all think they know about the structural rebalancing story of the Chinese economy, but yet they seem to fail to recognise it when they see it. The problem is that the traditional major economic indicators that we are all accustomed to tracking do not capture the structural changes in the Chinese economy. So when one only focuses on the old China economy, which has entered a structural decline, of course the traditional macroeconomic data paints a dire economic picture.
The old China economy that relies on exports and industrial expansion has suffered an economic hard- landing due to structural rebalancing towards a new economy that relies on services and household consumption. This can be seen in the fast-growing tertiary sector which overtook the secondary sector in 2013. The structural change also argues that the widely-followed Li Keqiang (LKQ) index (which includes electricity consumption, bank lending and rail cargo volume), that has led so many observers to believe that China’s real growth rate is around 3%, has become irrelevant.
What’s more, industrialisation has been migrating westward, suggesting a redistribution of growth from the rich east to the poor central and west regions. Deepening industrialisation in the inland provinces also generates an inherent growth momentum by tapping unused and cheaper resources.
The industrial migration process also implies a division of labour between the wealthy but more costly eastern part of the country focusing on higher value-added tertiary production and the less-developed and cheaper inland provinces taking over manufacturing and industrial production. This rebalancing process should support a medium-term national economic growth rate much higher than the 3%-4% rates that the pessimists see by focusing on the contraction of the old economy.
Meanwhile, evidence shows that the new economy has been growing briskly. A notable example is the growth of railway passenger traffic, which is related to the booming new sector of domestic tourism and personal travel. It has been growing at double-digit rates, compared to a steady decline in the growth of railway freight traffic which is included in the LKQ index and is related to the old economy of transporting industrial goods and materials.
New forms of consumption, such as online shopping, banking, booking for journeys and movie-going, have been rising at more than 30% a year. These new spending activities are not even included in the traditional official retail sales data.
However, the strength of the new economy has, so far, not been sufficient to offset the contraction in the old economy. Indeed, growth challenges abound. For starters, the shift from heavy industry to consumption implies less output per worker and less control the central government can put in to boost output. Meanwhile, the urgency to improve air and water quality will impede growth. The ongoing anti-corruption campaign will continue to delay decision-making and inhibit aggregate spending.
Finally, China’s working population has started to contract, thanks to the one-child policy. The recent relaxation of this policy to allow two children per couple will take at least 16 years to produce any positive effect on the working population, but there is no guarantee that the new policy will work as it depends on whether the Chinese couples want two children.
In the medium-term, increasing the effective labour force will require moving workers from rural to urban areas. This makes urbanisation a top policy priority. However, to facilitate urbanisation, Beijing needs to dismantle the migration barriers imposed by the household registration, or hukou, system. It will also need land reform to allow farmers to sell their land rights at fair market prices and thus enable and incentivise them to move to the cities. But these are deep-rooted changes that will take a long time to implement.
China also has to deal with a variety of short-term macroeconomic problems, including excess capacity, local government debt and bad bank loans. Fortunately, the authorities have recognised these problems and have started to deal with them.
In a nutshell, we cannot trust China’s economic data because the traditional indicators do not capture the changing structure of the economy. China’s economy will not grow as strongly in the future as it has been, but it will not slow to 3%-4% as soon as the sceptics suggest. The medium-term growth rate will likely be around 6% to 7% a year and the structural rebalancing process will deliver a new growth model of rising consumer spending.
Senior Economist, BNPP IP
This blog was originally published for BNPP IP’s professional investor clients. | 23 December 2015 – 5