Ezrati’s Economic Outlook: China’s Growth Prospects

Of all the fears discussed in the financial community these days, worries over China's expansion loom large. The government in Beijing has revised down its growth expectations to 7% to 8% a year from the old, breakneck pace of 10% to 12%.

Private groups, such as the American Chamber of Commerce in China, have made similar downward adjustments in their expectations. Meanwhile, concerns about a burst Chinese real estate bubble cast doubt on even the reduced growth expectations, not the least because they call to mind America's troubles of 2008-2009. Though there is good reason to anticipate a slowdown in the pace of Chinese growth, it would be a mistake to exaggerate the risks, and especially to do so by drawing easy parallels to America's real estate debacle.

The most immediate reason to look for a growth slowdown is last year's monetary restraint. In 2011, China tightened policy in response to increasing inflationary pressures. Consumer prices for a while rose at an annual rate of almost 7%, up from 3% in 2010. To forestall the inflationary momentum, the country's central bank, the People's Bank of China (PBC), drained liquidity from the system, raising its benchmark lending rate five times for a total of 125 basis points, increasing the reserves required of its banks six times, to 21.5% of deposits, and using guidelines to restrain lending in specific sectors, most notably autos and real estate.

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Now that inflation has quieted, slowing to just over a 3% annual rate at last measure, the PBC has begun to ease monetary conditions again. But it will still take time for the economy to respond. In the meantime, growth will drag as legacy of last year's restraint.

More fundamentally, growth should slow because Beijing has begun to shift from exports as its sole engine of economic expansion. Until recently, China had looked to exports alone to propel rapid rates of growth and employment, but the 2008-2009 collapse of world trade awakened Beijing to just how vulnerable such a strategy is. Europe's slowdown and likely recession this year have driven that point home again.

Additionally, and still more fundamentally, China realizes that it can only push export growth so far. Over the last 20 years, the country has brought its share of global exports from next to nothing to a remarkable 12%. It would be unrealistic to expect that percentage to rise to 24% over the next 20 years.

Yet something like that would be necessary to sustain the old, faster pace of growth. All this reasoning has led Beijing to adopt a broader-based internal development effort as a supplement to (not a substitute for) exports as a growth engine. Since internal development by nature proceeds at a more gradual pace than export-led growth, tempered growth expectations are an obvious conclusion.

Superimposed on all this is the bursting of the country's real estate bubble. Building activity has dropped. Prices are in decline. No doubt the ongoing adjustment will put a lid on overall growth rates. But it would be a mistake to exaggerate these effects. Compared to the United States in 2008, China is much less leveraged. By law, buyers there must put at least 20% down on their first home and 50% down on their second home. Any leverage in China lies with the provincial and city governments that have worked with developers.

Though no one should dismiss this debt overhang, it remains much more manageable than subprime was in America. Unlike this country's disaster, the extent and disposition of debt in China are known, removing an uncertainty that caused liquidity to dry up so thoroughly in the U.S. during its crisis. What is more, the still huge migration into China's cities promises to absorb any housing inventory overhang a lot faster than will occur with America's inventory.

Even if matters were to get out of hand, there is every reason to expect the government to take quick action to re-establish a growth rate of at least 7% a year. The authorities in Beijing are well aware of the need for rapid job creation. Without it, they risk severe social discord, even rioting, as occurred in 2008-2009. The prospect of a shortfall now would surely bring on a stimulus program very quickly, just as it did in 2008, to spark at least a minimal growth pace. Though probably not necessary, such a potential gives added reason to look for at least the official 7% to 8% projections and to remember that even this slowed pace is three times that expected for the United States.