CHINA’S economy, worth over $9 trillion in 2013, divides opinion. Often it divides it neatly in two: optimists contend with pessimists, apologists with alarmists, bulls with bears. Figures released this month encouraged both camps. China’s economy grew by 7.7% in 2013, a little faster than once feared. But a widely watched index of manufacturing, published by HSBC, a bank, fell for the fourth month in a row.
This binary split in opinion is too crude. To understand China’s economy today, it is more helpful to think in threes. Start, for example, with three forms of growth: in supply, demand and credit. Over the long run, China’s economic might depends on the size of its workforce and its productivity. This combination determines how much stuff China can supply without overstretching itself. Numbers released this week confirm that the supply-side limits on growth are gradually tightening.
The country’s urban workforce, which produces most of its output, is growing more slowly. The age group from which this workforce springs is now shrinking outright. The population of working age shrank by 2.44m in 2013, having already fallen by several million the year before.
This demographic turning-point (dubbed “peak toil”) has contributed to a marked slowdown in China’s potential rate of growth from the double-digit tempo of yesteryear. Whether the economy actually fulfils that (diminished) potential depends on a second kind of growth: that of demand. On the one hand, too little spending on goods and services will result in the underemployment of even a shrinking population (witness Japan). On the other hand, too much results in inflation.
By that yardstick, demand in China is still modest. It was enough to increase GDP by just over the government’s minimum threshold of 7.5%. But the economy did not grow fast enough to generate any inflationary pressure. Consumer prices rose by only 2.5% in the year to December. Prices paid to producers fell, for the 22nd month in a row. The Chinese economy is not overheating in any conventional sense.
China’s excesses take a different form. It is not the growth in demand that worries pessimists, but the growth in credit. The stock of outstanding financing for the private sector grew by about 20% last year, according to the central bank’s broad measure (which includes corporate bonds, equity issuance, and a variety of loans by banks and other lenders) even as nominal GDP grew by only 9.5% (see chart). Some of those loans are now turning ugly.
One credit product, sold exclusively through ICBC, China’s biggest bank, on behalf of China Credit Trust, a non-bank lender, is poised to default at the end of this month. It raised 3 billion yuan (over $490m) for Zhenfu Energy group, an ill-fated coal-mining venture, the vice-chairman of which was arrested for taking deposits without a licence. Zhenfu cannot repay its debts. The big question that remains is whether the product’s buyers, sellers or issuers will bear the loss.
China’s credit is not all this bad. And even the bad lending is not all bad in the same way. In fact credit,
too, can usefully be divided into three categories, according to how it is spent, argues Richard Werner of Southampton University. Some is spent fruitfully, on new capital and infrastructure, increasing the economy’s productive capacity. Because lending of this kind adds to both demand and supply, it should result in higher economic growth without higher inflation.
Another chunk of credit is spent wastefully, either on consumption or on misconceived projects, such as bridges without destinations or coal mines without markets. These loans add nothing to the economy’s productive capacity, but they do add to demand. They make a claim on the economy’s goods and services, without adding anything to its ability to provide them. Credit of this second kind should, then, result in higher inflation, increasing nominal GDP but not real GDP.
The surprising lack of inflation suggests that much of China’s credit is instead of a third kind. It is spent speculatively, on existing assets, real or financial, in the hope they will rise in value. Because these assets already exist, they can be purchased (and repurchased) without adding directly to GDP or straining the economy’s capacity to produce new goods and services. Credit and asset prices can chase each other higher, even as consumer prices remain flat.
Because this third kind of credit adds little to economic growth, curbing it need not, in principle, subtract much from growth. China’s financial authorities have repeatedly stated their desire to shrink overstretched balance-sheets, especially among mid-tier banks, without discouraging the flow of credit to the “real economy”. But although this is entirely feasible in principle, it is a difficult trick to pull off in practice.
Pessimists argue that the government’s efforts to curb leverage will stymie growth this year. But these rigours should be offset by stronger exports and consumer spending, both of which have plenty of room for improvement. Foreign trade subtracted from China’s growth last year. Consumption, which made the biggest contribution to growth in 2012 and 2011, was once again overshadowed last year by China’s traditional engine of demand, investment.
China’s dependence on investment remains a worry. But although its pattern of spending showed little sign of rebalancing last year, it did at least enjoy a rebalancing of incomes and production. Both migrant workers and rural households saw their incomes grow faster than the economy as a whole. Four years ago, the disposable income of the average urbanite was 3.3 times that of his rural counterpart. That ratio has now fallen to 3.0.
Of greater historical resonance was the shift in production. Last year China’s output of services, which contributed 46% of GDP, finally eclipsed the output of its industry (44%). An economy based predominantly on making things for people now gets more out of doing things for them. Indeed, China’s fastest-growing sector last year was wholesaling and retailing, which expanded at a double-digit rate. In the workshop of the world, growing numbers now work in shops. Services are known as “the tertiary sector” (whereas agriculture is “primary” and industry “secondary”). It is this long neglected third piece of China’s economy that will prove the optimists right in 2014.