Tag Archives: growth

China’s Slowdown

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Investors worldwide are closely watching the steep decline in China’s stock market.  The Shanghai Stock Exchange Composite Index is down more than 40% since June 2015.

The reason observers are concerned is not because they themselves are invested: China’s stocks are overwhelmingly held by Chinese themselves.  Rather, many are interpreting it as evidence that China’s economy is going down the tubes.

China’s growth rate has indeed slowed down and there are plenty of reasons to believe that the slowdown is not just temporary.  But none of them have much to do with the stock market.

For one thing, market prices are still well above where they were in 2014.  That was a time when many observers were bullish on China, proclaiming that its economy had just surpassed the US to become the world’s largest, on the basis of new PPP-based GDP statistics.  But in fact the slowdown in Chinese growth began four years ago.  According to the official statistics, growth averaged 10% over the three decades 1980-2010, but slowed down to the 7%-8% range in 2012-14.

Indeed, the reason that China’s stock market started to ascend at the end of 2014 is that the People’s Bank of China began to cut interest rates in November, in an appropriate response to the slowdown in economic growth that was already evident.  But the market’s continuing rise took on the character of a credit-fueled bubble in the spring of 2015.  The peak came on June 12, when the China Securities Regulatory Commission tightened margin requirements.

The bubble has now been reversed.  That doesn’t necessarily convey much information about China’s growth prospects.

There are plenty of reasons not to be surprised that China’s growth rate has slowed down and not to expect it to return to 10%.  The human instinct of some forecasters five years ago was simply to extrapolate the preceding three decades.   But casting a wider statistical net would have revealed that a fourth decade at 10% would have been historically unprecedented.

The Middle Kingdom is not exempt from the broader statistical regularities.  Some see the slowdown as a case of the middle-incometrap. Others find that the more relevant statistical pattern is regression to the mean in growth rates.

What are the economic forces behind the tendency for a rapidly growing country to slow down?  There is a wide variety of possible economic interpretations. Six come to mind:

  • One is diminishing return to capital.  China’s investment in steel mills, transportation infrastructure and residential construction became “too much of a good thing.”
  • Another interpretation is the observation that productivity growth is easier when it is a matter of copying the technologies, production processes, and management practices of the Western countries.  When the gap between the economic frontier and the newcomers narrows, the latter countries have to do some of the innovating on their own.
  •  A third explanation is that rural-urban migration has been a big source of China’s growth, but that the surplus labor has finally been used up, wages have risen, and the competitive advantage in labor-intensive manufactures has been lost.  (The “Lewis turning point” has been reached.)
  • A fourth is that the population is ageing.  The working-age population peaked in 2012.  The ratio of retirement-age people to working-age population is rising.  This demographic transition occurs naturally in advanced countries; but the one-child policy accelerated it prematurely in China.
  • A fifth is that urban land prices have been bid up and the “carrying capacity” of the environment has been exhausted.
  • A sixth is that the composition of the economy is shifting away from manufacturing and into services, which is appropriate but which entails slower growth because in all countries there is less scope for productivity growth in services than there is in manufacturing.

Thus a shift from 10 per cent growth in China to a more sustainable long-term 5-7 per cent trend is perfectly natural.  The important question is whether the transition takes the form of a soft landing or a hard landing.  In a soft landing China would continue to grow at the slower-but-sustainable trend rate.  In a hard landing it would suffer a financial crisis and more severe economic recession.

High dependence on investment spending and debt financing can work well during a high-growth phase but then lead to excess capacity and financial crisis when the long-run growth rates slows down.  Precedents include post-1980s Japan and 1997-98 Korea.

Some say that the official statistics seriously overstate GDP and that the true growth rate has already fallen well below the 6.9 per cent that the government has reported for 2015.  It is indeed suspicious that official growth statistics seem in most years to come close to the numbers in plans that had been announced by the government ahead of time.  So the skeptics reasonably turn to more tangible measures.  They point out that energy consumption, freight railway traffic, and output of such industrial products as coal, steel, and cement have slowed sharply.  (These are components of the so-called Keqiang Index.)  But Nicholas Lardy persuasively argues that those statistics are also consistent with the interpretation that the composition of China’s economy has been shifting away from heavy manufacturing and toward services.

The shift away from manufacturing to services is one component of a desirable package of policies to smooth the transition to a sustainable growth rate.  Another is a reduced reliance on investment spending and export demand, and a greater role for household consumption.  Other desirable reforms include increasing the flexibility of land markets and labor markets.  For example labor mobility is still impeded by insecure land rights in the countryside and the hukou system in the cities.  More generally, the markets should continue to play a growing role in the economy.  State-owned enterprises should be reined in.  Reforms are also needed in health care, social security, and the tax system.  And, of course, environmental regulation and the end of the one-child policy.

Chinese economists and leaders know all this. Indeed a very similar list of reforms was the outcome of the Communist Party’s Third Plenum in 2013.  Beijing has taken some steps to implement them over the last two years.  But there is still a long way to go and it is by no means guaranteed that the implementation will be fully successful.  As Shang-Jin Wei of the Asian Development Bank points out, the fate of China’s economy depends a lot more on how well the reforms go than on anything about last year’s stock market bubble and its subsequent reversal.

[This is an extended version of a column that appeared at Project Syndicate.  Comments can be posted there, or at the EconBrowser version.]

 

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Why Has the US Economy Picked Up? Congressional Republicans

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What a difference two months make.   As recently as November, when Republicans scored strong gains in the US congressional elections, the universally accepted explanation was economic performance that was perceived as disappointingly weak.  (As always, “it is the economy, stupid.”)   A substantial share of the American public thought that economic conditions were actually deteriorating last year; many held President Barack Obama responsible and voted against the incumbent party.

Now suddenly everybody has discovered that the US economy is doing well after all.  So much so that Republican leader Mitch McConnell, newly elevated to Senate Majority Leader, has switched from a position that the economy is bad and Obama is to blame, to a position that the economy is good and the Republicans should get the credit.  On January 7, he suggested that recent good economic data could be attributable to “the expectation of a Republican congress.”

But (as many have now pointed out) the improvement in performance began well before the November election.   The brightening also began well before September, the date when polls began to indicate that the opposition party was likely to do unusually well in the vote.

The fact is, job growth was vigorous throughout 2014, averaging 246,000 per month for a year total of three million.  It was enough to bring the unemployment rate down to 5.6% in December 2014 (from 6.7 % in December 2013).   This employment growth represented an acceleration relative to the 185 thousand monthly average of the last three years, 2011-2013.  It looks even better compared to the preceding economic expansion of 2002-2007, when job creation averaged 102 thousand per month, let alone compared to the recession years 2001 or 2008-2009.   It was even as good as the Clinton years!

Similarly, GDP growth began to pick up steam in the spring of 2014, running above the rate of the preceding three years.   It even reached 4.8% in the 2nd and 3rd quarters together, though that is almost certainly temporary.   Europe, in stark contrast, remains in the dumps.  Partly as a result of income growth, the US budget deficit came in better than forecast last year:  2.8 %.  This represents a record improvement relative to 2009, when the budget deficit registered almost 10 per cent of GDP.

Just yesterday, the mystery was why growth was so weak, averaging only 2.1 per cent during the years 2011-13.  There were four kinds of explanations.

The first explanation was the Reinhart-Rogoff principle that recovery from a recession takes longer if the origin was a crash in housing and financial markets.  But there is another principle that the deeper the initial recession, the more rapid the rate of growth per year in the recovery phase.  The point about financial crashes being worse than other recessions is more a statement about the magnitude of the initial decline and the corresponding length of time subsequently necessary to get back to normal, than a prediction about the annual rate of growth during the recovery phase.

The second theory was that the slow recovery was part of a longer-term trend, attributable to secular stagnation or a dearth of new important technological innovations.  It is true that productivity growth and labor force growth have slowed since 1975 and perhaps even since 2000.  But it does not seem wise to explain away three years of weak recovery by means of downward revisions in estimates of the long-run trend in potential GDP.

The third interpretation is that the deep recession of 2008-09 had long-lasting effects via long-term unemployment and depressed investment, and hence on the capital stock and the size and skills of labor force.

The fourth explanation for slow growth during 2011-13, however, seems the simplest: dysfunctional fiscal politics.  These years featured the “fiscal cliff,” debt-ceiling standoffs, flirtation with federal default, a government shutdown, and budget sequesters.  One does not need to assume big Keynesian “multiplier effects” to conclude that the combined effects shaved at least one percentage point from growth each year – especially if one believes that the risk created by such unpredictable behavior discourages firms from hiring workers or undertaking investment.  According to the Economic Policy Uncertainty Index, the debt ceiling crisis of 2011 and government shutdown of 2013 each spiked uncertainty to levels as high as had the terror attacks of 2001 or the Lehman failure of 2008.

Then why stronger performance over the past year?  2014 was the first year, since the Republicans achieved a majority in the House of Representatives in November 2010, that dysfunctional fiscal policy did not actively impede the economic recovery.

The government shutdown of October 2013 was perceived to have turned out politically damaging to Republicans, including by the Republican leadership themselves.  Thus they determined to refrain from such dead-end show-downs in 2014, even though doing so meant over-ruling certain noisy “Tea Party” members.   One could have predicted that a year in which Congress refrained from actively impeding economic growth would be a year when the pace of expansion in output and employment would pick up.  If the new Congress in 2015 refrains from standoffs, sequesters and shutdowns, there is no reason why the economy cannot continue to do well in the new year.

Of course the US economy retains some shortcomings.  Wage growth is still slow.  Median household income has barely begun to recover and remains well below its level of 2000.  The explanation is that most of the income gains have gone to people at the top of the income distribution.   Indeed, of the various possible reasons why the electorate in 2014 did not perceive the economic recovery, the most natural is that the typical American had not shared in the gains.  The irony is that rising inequality is usually thought to play to the Democrats’ electoral advantage.

[A version of this post appeared at Project Syndicate.  Comments can be posted there.]

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The Middle Class Crunch: Bipartisan Program for New Members of Congress

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       On December 3-5, 2014, the Institute of Politics at Harvard University held its biannual Bipartisan Program for Newly Elected Members of Congress.  Most of the congress-people come.   This year I was on a panel on the domestic US economy, titled the “Middle Class Crunch.”    In Part I, presented here, I briefly reviewed recent economic statistics.   Part II, laying out 8 recommended policies, will follow.

       The standard economic statistics indicate that the US economy has been doing well lately, not just relative to the severe 2007-09 recession, but relative also to what most Americans think and relative to how other advanced countries are doing.  This applies to (1) GDP, (2) jobs, (3) the stock market, and (4) the budget.

      (1)  GDP growth has averaged an impressive 4.2% over the last 2 quarters.   It has averaged a more moderate 2.4% over the last 4 quarters, but even that is still above the disappointing 2.1% in 2011-13.  See  Figure 1.

Figure 1. Growth has been gradual since the recession’s end in June 2009, but faster lately

Picture1_billionsofchaintype2009dollar

Source: Macroeconomic Advisers, Nov. 18, 2014; monthly numbers derived from US Bureau of Economic Analysis quarterly series. E

        (2) Employment growth has shown  an unprecedented string of positive numbers. The private sector has added 10.6 million jobs over 56 straight months of job growth, easily the longest streak on record. and has added at least 200,000/mo. for nine consecutive months. See Figure 2.

Figure 2.  Change in private sector employment.

Picture2_privatesectoraddedjobs

     (3) The stock market is setting record highs.

(4) The budget deficit has experienced a record improvement since 2009: a decline of more than 2/3.  (See Figure 3.)   It is now  2.8% of GDP, which is below the average deficit since 1980 (3.2%).

Figure 3. The 2014 federal budget deficit is down to 2.8% of GDP.

Picture3_2014federalbudgetdeficit

      If the economy is doing so well, then why don’t Americans see it that way?   The “middle class” doesn’t feel better off because the gains have accrued to people at the top. Median family income  is still 8 per cent below its pre-recession level and even further below its 2000 peak.  It has barely risen above its 1990 level.  See Figure 4.

Figure 4. Real median household income is barely above its 1990 level.

Picture4_whydoamericansfeelworse

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