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There are at least two reasons for predicting that China's economic growth will slow substantially in the next few years. The first has to do with historical precedents and the second with the logic of China's rebalancing.
The historical precedents are clear. Many countries in the past one hundred years have gone through periods of extraordinary growth, powered by very high and rising levels of investment. In every case these countries developed serious imbalances, either internally, if the investment was financed by consumption-constraining policies, or externally, if they were not.
In the early stages, it was always relatively easy to find economically viable investments, but as institutional constraints required the persistence of high levels of investment, and as it became increasingly difficult to ensure that investment was economically viable, in later stages investment was always misallocated and debt grew faster than debt servicing capacity.
This combination of extreme imbalances and high levels of debt, driven by misallocated investment, resulted in a subsequent period of rebalancing that turned out to be far more difficult than even the skeptics had predicted. China's development model has differed from its predecessors only in that the imbalances have exceeded any that we have seen in prior history, and the amount of misallocated investment may have also exceeded all precedents.
For this reason it would be surprising, and an historical anomaly, if China's rebalancing were not a very difficult one. Not only has China pushed the imbalances associated with the investment growth model to extremes that exceed any seen before, but it is becoming increasingly clear that the obstruction to any meaningful adjustment by sectors that have benefitted most from domestic economic distortions will make the adjustment politically very difficult.
This historical argument is buttressed by the arithmetic of rebalancing. It is widely recognized that investment growth must be curtailed sharply, but it isn't at all clear what will replace it as China's growth engine. Given the deep problems in the global economy it is hard to imagine a sharp increase in exports. This leaves us only with consumption, but here the prospects have been very disappointing.
Beijing has managed to boost government consumption recently, but since government expenditures are financed mainly by hidden transfers from the household sector - especially in the form of repressed borrowing costs - any increase in government expenditures today will only mean downward pressure on household income, and with it household consumption, in the future. It is household consumption growth, in other words, that creates the only sustainable source of future growth.
The growth in Chinese household consumption has been quite strong in the past decade. Household consumption has grown by roughly 7% annually, which is faster than in any other large economy in the world. But this rapid growth was attained only because global conditions were optimal and Chinese investment growth was so extraordinarily high that it was able to turbo-charge GDP growth at rates of 10% 11% for much of the past decade.
Global and Chinese conditions are not nearly as good anymore. This means that it will be hard to maintain 7% household consumption growth even in the best-case scenario. But rebalancing in China means by definition that household consumption growth has to outpace GDP growth by at least 3 or 4 percentage points every year for the next decade just to bring Chinese consumptions levels to rates equivalent to the lowest consuming countries in the world.
This is just another way of saying that the growth contribution of investment has to drop so sharply that GDP growth cannot exceed 3% 4% if China is to rebalance. Any higher GDP growth cannot be consistent with even a minimal rebalancing of the Chinese economy unless there is some way to force much greater growth in household consumption i.e. much greater growth in household income in spite of much worse global and Chinese economic conditions.
The arithmetic simply doesn't work. China must rebalance its economy because its over-reliance on investment has become toxic. For China even to maintain GDP growth rates of even 7% to 8% implicitly requires that household consumption grow by 10% 12%, something never before achieved even under much better economic conditions. Without a deus ex machine that turbocharges consumption growth, high GDP growth rates are incompatible with rebalancing.
Source: The Wall Street Journal