China’s economic growth has halved—and it is set to halve again

China announced last week that its economic growth had slowed to 6.2 per cent in the year to the second quarter of 2019, the lowest rate since 1992, and half the rate of the mid-2000s.

The official GDP data tell us next to nothing about how China’s economy is really doing. The figures are manicured to show a trend which lacks any sense of cyclicality or volatility.

Other data, though, allow us to see that the economy slowed through 2018 because of the effects of deleveraging. Shadow banking assets, for example, dropped especially sharply as a share of GDP. From October, the economy lurched sharply lower, necessitating a significant shift in government policy. Credit expansion picked up again, and the government cut taxes, boosted infrastructure spending, and eased regulations for the housing sector and beleaguered automobile sector. The economy stabilised between January and April, weakened again in May. The data suggest the economy perked up again in June, but this may have been temporary.

Donald Trump has wrongly taken ownership of the slowdown, attributing it to the effects of the trade war with the US. The short-run focus, though, is a bit of a sideshow. More important is the structural downshift in China’s growth, and the question of what the government is, or isn’t, going to do about it. The real causes of these economic travails are much more made-in-China. Indeed, the country’s growth is set to halve again in the next few years.

China’s trend or sustainable rate of growth, the product of the growth in the labour force and productivity, has dropped to around 3 per cent. The working age population has been falling since 2012 and will decline for the foreseeable future. Productivity growth has become quite pedestrian. This has certainly been undermined by the political emphasis on ubiquitous Party control, while a more restrained government approach to the private sector, slow implementation of necessary reforms, and insufficient use of the markets are also contributing factors.

The accumulation of debt and need for deleveraging are also sapping China’s capacity for growth. The increasing limitations on the debt-carrying capacity of some of the largest borrowers, such as local governments and state enterprises, are constraining things. Households, among which mortgage and other consumer debt has grown rapidly in the last five years, are now also somewhat constrained.

After the shock of the stock market and Renminbi crises in 2015-16, the government became very serious about wanting to control debt and leverage better. Yet, it is struggling with the tension between economic stability, which requires it to keep targeting elevated and unsustainably high growth rates, currently 6-6.5 per cent, and financial stability, where weaning the economy off its debt addiction would require the authorities to allow growth to slide down to, say, five per cent in the coming year, and still lower thereafter.

The problem then is more politics than economics: the government may simply not want to risk the political consequences of a sharper economic slowdown for fear of the effects on job creation and living standards. As it is, the government has made employment a top priority in every important policy meeting for over a year, and we can see why. The employment components of the manufacturing and non-manufacturing business surveys that are released at the start of every month show that it has been contracting mildly in manufacturing for the last six months, and stagnating in service industries. The employment indices are at a 10 year low, and six month low, respectively.

If you now superimpose the trade war on this economic environment, you can see why China would like it to go away for a while. The status quo is bad enough, but if the US ends up extending tariffs to the half of Chinese imports not yet subjected, the consequences for China would become more serious. Meanwhile about a third of the corporate members of the US and EU Chambers of Commerce have already moved parts of their supply chain operations out of China, and another third intend to do so in the year ahead. The targeting of Chinese tech firms, notably Huawei, is also likely to undermine business confidence.

Slower growth is coming at a bad time politically for both President Trump and President Xi, suggesting that both sides may still strive for some form of compromise deal. With the Communist Party’s centenary in 2021 and the 20th Party Congress the following year, Xi has no room for serious error as far as the economy goes, and will not want further detiorations in the overall relationship with the US. For Trump, getting re-elected in November 2020 is now the only thing that matters. Both sides are likely to ease policies in the next few months.

But deal or no deal, nothing underneath will really change. The tech war between the US and China isn’t going to go away. The mutual targeting of companies is an ominous development. And the contrast between the rules, norms and standards which both sides want to assert will continue to define a frostier relationship. That is of growing significance for an ambitious China beset with significant domestic economic problems. In this context the slippage in the growth rate from 6.4 to 6.2 per cent is of no consequence after all.