Dear booming Chinese economy of the past: Bye-bye, the West shan’t miss you

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John Rapley is a political economist at the University of Cambridge and managing director of Seaford Macro.

After a summer filled with speculation about China’s sinking economy, recent news lifted some of the gloom. In reports that came out mid-September, both factory output and retail sales turned back up. Cue the celebrations that China is back and will lift the world economy, as it did after the 2008 financial crisis.

But just as reports of China’s economic death were premature, so too are reports of its resurrection. The country’s economy is going through a difficult transition and while there are signs it is fumbling its way toward solutions, we won’t be seeing the growth rates of old any time soon.

And we shan’t miss it. The fears of China bringing down the world are exaggerated, and a slumping giant in the East might actually help Western economies.

There’s no mystery about the cause of China’s current malaise. Over the past two generations, the ruling Communist Party transformed the country by exploiting its massive labour force, repressing wages to attract investment, and then steering the vast surpluses that resulted into the investment that built up all those cities and high-speed railways. Nearly half of China’s annual output is reinvested, an astonishing rate that is twice the G7 average.

Reinvested in what? With wages so low, production in Chinese factories was for decades geared towards export markets, an arrangement that suited the rest of the world since they got cheap Chinese products. That helped tamp down inflation in the West, enabling interest rates to stay low and thereby supporting a long boom in asset values.

But it also played a part in the deindustrialization of some Western countries that drove the rise of populist politicians. With China’s big Western trading partners now starting to turn against the openness they once favoured, demand for the country’s goods has waned. Exporting its way out of a slump is no longer an option for China. For its part, the leadership in Beijing wants to increase the country’s autonomy by reducing its dependence on imports.

The resulting decline in trade has slowed the economy. To try and juice growth, the authorities responded with that time-honoured approach we know so well: inflating a property bubble. We all know how that story ends. China is now at an impasse.

On paper, there’s an easy way out of it: shifting away from external markets to raise demand at home. This would both reduce the country’s trade-dependence and provide new demand for Chinese output, restoring its healthy growth rates. If China were to cut its saving rate by just a few percentage points and transfer the money to consumers, the economy could enter a whole new phase of expansion.

But China is finding that transition hard to engineer. Part of the obstacle is ideological. Under President Xi Jinping, a Maoist faction in the ruling Communist Party has gained more influence, and Mr. Xi gives voice to its thinking when he objects to the “welfarism” of a consumption-based model. Moreover, the problem is also practical. Transforming a financial, economic and political model that was built to transfer income from households to businesses, and has done so effectively for decades, into one which reverses the flow’s direction of travel, would require a substantial redesign of the Chinese state. Easier said than done.

While there may be some pain for much of the world if China’s slump persists, it probably won’t do much harm to Western countries. For all the woes in its property sector, the exposure of Western banks remains limited, so the sort of spillover effects that turned the Lehman crash in the United States into a global crisis 15 years ago probably won’t repeat themselves. Equally, being a country that runs a trade surplus, China is not an “engine” of the world in the way the U.S. is. A recession there would reduce demand for other countries’ exports, but not by the rate a similar recession in the U.S. would do.

If anything, China’s slump might support the disinflation of Western economies, making life easier for central banks. That’s because reduced demand in China could produce a glut of unsold goods, which would find their way onto world markets at knock-down prices.

All the same, China’s current travails point to a future global economy that looks different from the one we’ve known. When an economy which accounts for a fifth of global output gets into a slump, it’s inevitable everyone else will worry about its wake. Although China’s GDP is still growing at rates most Western countries can only dream of - in the 5-per-cent range - it is slowing. Moreover, the current rate is flattered somewhat by a massive mountain of debt-fuelled stimulus that is adding little of actual value to output. By some measures, the economy is hardly budging.

Unlike the massive Chinese stimulus that helped lift the world economy out of the 2008 Great Recession, the country will look more insular as it moves into its next stage of development. It won’t turn its back on the world, but it may be less open for business than it’s been.