China’s Economic Problems In Context

China’s economic problems are at the centre of a fundamental transformation in the global economic cycle. It has already lowered equilibrium prices in commodity markets and will be a drag on economic growth of its trade partners. China’s mid-August 2015 sneeze, when it unexpectedly allowed its currency to depreciate under the garb of FX market reform, has since left financial markets shivering and the US Fed with a cold. Emerging Asian currencies have weakened to keep up their export competitiveness vis. a vis. China in global markets. Given that imports from China account for 20% of the total US imports, a weaker yuan will tend to lower US import prices. This prolongs the time over which US inflation (1.37% in Jan 2016 [1]) approaches the Fed’s target of 2%.

The Chinese Economy In A Major Transformation

In February 2016, China’s foreign exchange reserves fell for the fourth consecutive month, dropping by $28.75B billion to $3.2 trillion. 2015 saw a 6.9% growth rate for the country, it’s slowest pace in a quarter of a century. The Chinese economy is in the throes of a major structural transformation, which will play out over the next decade. Historically, the evolution of China from an agrarian to an industrial economy in the 1980s brought prosperity to the country and enabled it to move to the upper middle-income group.

But there is every sign that the best is already behind us and the inevitability of an economic slowdown has been accepted. The key element of China’s slowdown is ageing demographics. An ageing population not only reduces the availability of cheap migrant rural labor for industries, but also lowers the supply of savings available for investment as older people tend to consume out of their life savings rather than add to them. The share of population in the 15-64 year age bracket peaked at 74.4% in 2011(UN estimates), coinciding with the peak in national investment at 48% of GDP (IMF estimates).

The other structural factor behind China’s economic declaration is the policy of keeping the yuan weak versus the US dollar. While this did boost exports it also led to excess money supply in the domestic economy that was used by banks to lend to investment projects. The high debt levels especially those in the informal sector have become unsustainable and have now come under the regulatory scanner. The first round effect of slower Chinese growth is already being felt via the decline in commodity prices, which have climbed down from $100 per barrel in mid-2014 to sub $50 levels now. This has directly impacted China’s commodity trade partners. See Chart 1 for the importance of China in the exports of its partner countries. The second round effects of China’s structural transformation will be felt over the next decade via related structural transformations in the economies of its partners.

Structural-Change1-DS-Chart1

Chart 1: Percentage of total exports of a country accounted for by ChinaStructural-Change1-DS-Chart2
Chart 2: Volume of food imports by China in mn units

The Silver Lining To China’s Economic Problems

The overwhelming focus of mainstream media on the Chinese economic slowdown as a negative for global growth ignores the positive aspects of structural change. The transition of China away from an export dominant economy will be a positive for world aggregate demand as the ageing population of the upper middle-income country will fuel consumption. A simple example is food. The volume of food imports in 2014 increased by 143% over the comparable period in 2008. This will support soft commodity exporters like New Zealand, Brazil, Ghana and Nigeria. Meanwhile, exporters of hard commodities like Australia, Malaysia, Indonesia, DR Congo and Angola will face structural shifts themselves as the focus of economic activity shifts away from mining and extractive industries.

Janki Sharma is a freelance economist based in Singapore and writes for Macrovue


[1] http://inflationdata.com/Inflation/Inflation_Rate/Monthly_Inflation.aspx