China: How a soft landing feels

There are at least three reasons to believe that a Chinese ‘soft landing’, of the sort that headline data from China suggest has so far been under way, poses a very limited threat to advanced manufacturing economies.

The first is arithmetic. We expect the rate of economic growth to slow to a level seen, during the past 20 years, only at the low point of the recent ‘great recession’ (Fig 1). However, the lower growth rate in 2015 applies to a substantially larger base. In absolute terms (that is, in inflation-adjusted CNY , Chinese growth has been as rapid during the past several years as it was during the 2006-07 boom, and we expect this to remain true in 2015 (Fig 2). This does not mean that China is not decelerating. Of course it is. But when compared with the much more slowly growing advanced economies, real Chinese output and demand has been growing at rates comparable to those of the 2006-07 boom. Chinese demand growth might therefore be expected to be similarly supportive of demand growth in the advanced economies.

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The second reason lies in the nature of the deceleration that is underway in China, which is generally understood to be very largely a deceleration of growth in the economy’s potential output, rather than a necessary adjustment of demand in a highly overheated economy. There is, in principle, no reason why a synchronized deceleration of actual and potential output should deal a major blow to China’s trading partners. At least through the first half of 2014, the data seem to suggest that labor markets have not rolled over, which is generally consistent with a supply-driven explanation of the deceleration to date.

The third reason relates to the economic ‘re-balancing’ that is playing out in China as its trend rate of growth declines. This re-balancing implies a gradual shift from an investment-dominated growth model to one in which household consumption spending plays a much more important role. Although most of the goods and services that households will ultimately be buying will almost certainly be made in China, some will be final consumption goods that advanced economies produce and export. At least by comparison with the commodity exports that were privileged in the iron-, copper-, coal- and cement-intensive infrastructure investment spending, this should provide an additional buffer for advanced manufacturing exporters to China.

 

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A real exchange rate appreciation of roughly 20% in the past half-decade, and roughly twice that in the past decade, should also support final-goods exports to China (Fig 4).

All of this seems plausible, but is it true? China has been decelerating now for roughly three years, and we have enough experience to form at least preliminary judgements. To keep things simple, we have aggregated exports to China and Hong Kong of five major manufacturing powers – the US, the euro area, the UK, Japan and Korea – which (with China) account for a large share of the world’s manufacturing activity and financial assets[1].

In fact, the USD value of exports to China from these five manufacturing powers has decelerated very sharply, with growth falling from nearly 17% per year in 2003-11 to only 0.3% per year from 2011 to date.

This abrupt deceleration was driven, in part, by recent deflationary tendencies in globally traded goods prices. In Figure 6, we adjust for these by constructing an index of inflation-adjusted exports from the ‘G5’ to China using (where available) the local currency value of both exports and export prices. The deceleration in export volumes is less abrupt, from roughly 13% between 2003 and 2011 to about 2.5% after 2011. But it is still far more abrupt than the deceleration of real GDP growth over the periods in question.

This very abrupt deceleration in export demand from the ‘G5’ raises some interesting questions about the nature of the deceleration that is under way in China. It also reinforces the idea that the Chinese growth deceleration may have been an important driver of the comparably abrupt deceleration in global inflationary pressures that occurred at about the same time. And it provides a cautionary note against benign assessments of the effect of the slowdown in China on advanced economies.

 

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