CHINA has cut its growth target for 2015 to 7%, which would be the slowest expansion in more than two decades. Data this week show it will be a stretch to hit even that. This might not seem much to fret about. Even at its subdued current rate, China's growth is still the envy of most countries. But the slowdown is cause for concern. China is faring worse than many had expected (as recently as 2012, the International Monetary Fund, among others, forecast that annual growth above 8% would continue until 2017). Its deceleration is one of the main reasons for the sell-off of global commodities from iron ore to coal over the past two years. And there are fears it could yet turn uglier. What explains China’s slowdown?
On a basic level, it was inevitable that the Chinese growth rates of the past three decades, which averaged 10% a year, would wane. The law of large numbers (financial, rather than statistical) applies to nations as well as to companies: the bigger an economy gets, the harder it is to keep growing at a fast clip. Growth of 7% this year for China would generate more additional output than a 14% pace did in 2007. Structurally, China’s economy faces headwinds. In the long run, growth is a function of changes in labour, capital and productivity. When all three increase, as they did in China for many years, growth rates are superlative. But they are all slowing now. China’s working-age population peaked in 2012. Investment also looks to have topped out (at 49% of GDP, a level few countries have ever seen). Finally, China’s technological gap with rich countries is narrower than in the past, implying that productivity growth will be lower, too.
More recent trends also explain China’s sharper-than-expected slowdown. The single most important development has been its credit binge. Total debt (including government, household and corporate) has climbed to about 250% of GDP, up 100 percentage points since 2008. This debt allowed China to power its economy through the global financial crisis but also saddled it with a heavy repayment burden. Most worrying, much of the credit flowed to property developers. China’s inventory of unsold homes sits at a record high. The real-estate sector, which previously accounted for some 15% of economic growth, could face outright contraction. New property starts fell by nearly a fifth in the first two months of 2015, compared with the same period a year earlier. From this vantage point, the abruptness of China’s current slowdown looks more cyclical than structural. A period of overheated economic growth tends to be followed by a correction. Not all cycles are created equal, however. Working off a credit overhang can take years. Given that China’s financial system is mostly closed, it has little risk of an acute crisis, but the other side of the coin is that it might need even longer to clean up its bad debts.
Read more: China's government preaches the need to tolerate slower growth
Whereas previous leaders propped up growth whenever it slowed, Xi Jinping, China’s president since 2013, has instead spread the gospel of the “new normal”, by which he means less emphasis on growth and faster structural reform. The central bank has been hesitant to ease monetary policy. Changes to fiscal rules have made it harder for local governments to spend money. With consumer-price inflation running at a five-year low of 1.1% and producer prices deep in deflation, there is a case to be made that China’s economy, restrained by the government, is performing below its potential. The good news is that neither the cyclical nor the policy explanations for China’s slowdown are permanent. As the cycle turns and policy changes, the outlook should improve. But the structural shifts in the Chinese economy are a different story. They will cap any rebounds. Double-digit growth is most certainly a relic of China’s past.
