China’s looming battle with the middle-income trap as growth falters at faster-than-expected rate
Premier Li Keqiang declared in his state-of-the-union address the nation faced “a difficult battle” to keep annual GDP growth at a minimum of 6.5 per cent in the next five years.
The remark on Saturday highlights the struggle China faces to avoid being caught in the “middle-income trap”.
After decades of breakneck expansion, China’s growth is faltering at a rate much faster than expected. Last year’s economic growth of 6.9 per cent was the lowest rate of increase since 1990. The world is now watching just how rapidly China can continue to expand – and just what the government needs to do to keep the nation’s economy ticking over.
The ambitious target of 6.5 per cent GDP growth set in the 13th five-year plan shows that the nation’s leaders are prioritising expansion, even as they look to strike a balance between short-term stimulus and structural reform for sustainable growth.
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By 2020, the country’s plan is to have doubled gross domestic product and per capita income from levels a decade earlier in a push to transform China into a “moderately prosperous society”.
Meeting the goals is central to the political agenda of President and Communist Party chief Xi Jinping. Xi’s envisaging of the “Chinese Dream” is a cornerstone of his policy for the next five years but whether it can be realised or not comes down largely to one factor: growth.
Most economists believe meeting the 6.5 per cent target will be a challenge.
Shen Jianguang, chief economist with Mizuho Securities Asia, said the target was ambitious, while Wang Tao, chief China economist with UBS Securities Asia, said it was “possible but a bit difficult”.
Kamel Mellahi, a professor of strategic management and an expert on China business at the Warwick Business School, agreed it would be very challenging but said it could be achieved “if the government pulls the right triggers and intensifies economic reforms”.
Then there are the risks of sticking to a specific target. Economists say that locking China in to 6.5 per cent growth will increase the risks of a financial crisis. To achieve the target, they say, China will barely be able to slow investment. And that means debt will keep climbing to even more dangerous levels.
Economist Yu Yongding estimated that without fundamental changes in China’s economic structure, by 2020, corporate debt would hit 200 per cent of GDP.
Long-term predictions for China’s GDP growth near 2020 range from 4 to 7 per cent, a wide enough gap to imply vastly different domestic and international policy shifts. But more economists forecast a rate of around 6 per cent.
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The International Monetary Fund is tipping 6.2 per cent in the coming five years, saying China’s economy will be 44 per cent bigger in 2020 than in 2014.
One of the gloomiest outlooks is from Harvard University professors Lawrence Summers and Lant Pritchett, who see growth falling to around 4 per cent.
While the estimates vary there is consensus that China’s continued slowdown is a structural inevitability.
For decades, the country has relied on cheap labour and natural resources to get ahead. But the workforce is set to decline as society ages rapidly – labour costs in China have already risen beyond those of developing economies such as Thailand, Indonesia and Mexico.
Another consensus is that China’s slowdown is a result of the sheer size of the economy. Even if it were to grow at 6 per cent, it would be expanding by roughly 1.5 times the size of the entire economy of Singapore or Malaysia each year.
Economists say that growing anywhere near 6 per cent in the long term would require efficiency and productivity reforms that would undercut growth right now.
Those reforms would certainly involve pain but they are something the authorities should do over the next five years.
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Some analysts, including billionaire investor George Soros, have warned that the Chinese economy is so beset with distortions and weaknesses that it is heading for a hard landing. They criticise the government for doggedly pursuing its pro-growth policy and plans to double the size of the country’s economy, saying slower expansion could help ward off a major crunch. The Economist Intelligence Unit has estimated the risk of a hard landing sometime between 2016 to 2020 at a worryingly high 30 per cent.
Xu Shaoshi, head of the China’s planning agency, said on Saturday that there would be no hard landing.
Nevertheless, Hong Hao, managing director and chief China strategist at Bocom International, said the risk of a hard landing could not be ignored.
This could come from corporate defaults, local government defaults or a burst in the property bubble. “Each of these is being addressed by government policies. But we are racing against time,” Hong said.
The fall-off in growth has raised questions over whether the world’s second-largest economy is settling into a protracted period of subdued growth, known as the “middle income trap”. Fears were reinforced when Finance Minister Lou Jiwei said the country had a 50 per cent chance of heading in that direction in the next five to 10 years.
Mellahi said this could happen if China failed to realise goals for social prosperity and urbanisation and if the economy failed to move into high innovation gear.
However, Wang said even if China grew only 4 per cent a year, it would become a high-income country in less than 10 years, avoiding the trap altogether.
While many economists say it is possible for a previously fast-growing economy to avoid falling back into stagnation, they insist China needs more fundamental reforms, including political liberalisation to introduce the rule of law and democracy. That way, they say, China could succeed in navigating the currents to become a high-value-added economy based on productivity and innovation, transitioning towards a modern, affluent society.
Hong said that as the society became richer, its appreciation of intangibles, such as spiritual needs, democracy and human rights, would grow. “It represents an opportunity to change how to govern the people.”