China ’s Economic Transition: What’s at Stake

In 2015, India overtook China as the world’s fastest growing economy,[1] a transition that will likely intensify as Beijing embarks on a new development initiative. At the heart of that initiative is a desire to transition the Chinese economy away from exports and investment toward consumption and services. In other words, China seems to wants to model its economy after the West. This consumer-oriented approach will probably come at the expense of the runaway growth global investors have come to expect from the world’s second largest economy.

On the one hand, the transition appears to be under way. China’s GDP growth is slowing significantly, with 2016 marking the slowest rate of expansion in 26 years. However, a closer look at the numbers reveals China could be up to its old tricks again to ensure that expansion doesn’t cool too quickly.

China’s economic growth stabilized at 6.7% annually in the first three quarters of 2016, with the expansion accelerating to 6.8% in the final quarter. The economy relied on traditional “smokestack” industries to keep its growth numbers healthy. In the process, it may have exposed itself to unwanted risks, such as explosive debt and an escalating asset bubble.[2]

ChinaChinese billionaire investor Wang Jianlin has warned that Chinese real estate is the “biggest bubble in history.”[3]

If Beijing truly wants consumer-oriented growth, it’s probably better for it to let go of the wheel and let market forces determine the outcome – at least, more than it is doing now. The country is now home to the world’s largest middle class,[4] one that is demanding many of the same gadgets and luxuries as consumers in advanced industrialized states.

Despite these advantages, the economy is expected to potentially face a “hard landing” as the transition process intensifies. Experts fear that Beijing may be trying to avoid the pain for as long as possible, and is probably resorting to traditional growth drivers to keep optimism elevated.

But evidence of a rough patch is emerging.

For starters, policymakers appear to be struggling to contain the massive capital outflows, as investors look to diversify away from the yuan – a currency that has undergone multiple devaluations in recent years. The government is also attempting to drain overcapacity in its industrial sectors, which benefit from large state subsidies and other favourable incentives. Overcapacity leads to overproduction, which can potentially undermine global stability. However, transitioning millions of workers out of these industries is easier said than done.

Experts say China’s economic transition will likely be a long and painful road. The International Monetary Fund (IMF) expects China’s economy to expand just 6% in 2018, reflecting a prolonged cooldown.

Over the past three decades, growth has slowed from a double-digit annual pace all the way down to its current rate. The People’s Bank of China has adjusted its annual growth target to 6.5% to 7% to account for the slowdown.

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[1] Investopedia (February 9, 2016). “India Overtakes China in GDP Growth.”

[2] Sam Bourgi (January 20, 2017). “China Q4 GDP Expands 6.8%; Full-Year Growth Slowest Since 1990.” Economic Calendar.

[3] Jethro Mullen and Andrew Stevens (September 29, 2016). “Billionaire: Chinese real estate is ‘biggest bubble in history’.” CNN Money.

[4] Telegraph UK (October 14, 2015). “China’s middle class overtakes US as largest in the world.”

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