China: The problems are well known, but the jitters are new
Collapse on China's stock markets, devaluation of the Yuan, and a slump in growth. The news coming out of the People's Republic is causing headaches for investors, economists and politicians alike. There are no grounds for panic, but there is some cause for concern.
Some people are warning about a China crash, but others say the hype is just hysteria. Estimates about China’s economy are almost as volatile as the prices on Chinese stock markets. But we should listen to both sides. A dramatic collapse in growth is still a long way off for China, and slower growth will not necessarily lead to a global catastrophe.
The Bundesbank estimates that GDP in Germany will be around 0.3 percentage points lower if real domestic demand in China is 9% lower than expected within the next two years. But the world is becoming more sensitised to the risks in China. Uncertainties on global stock markets are a clear reflection of this – and rightly so. A hard landing for China – an abrupt and massive collapse in growth – would have significant consequences for the global economy.
Over the past five years, China has been responsible for almost 30% of global growth. Even though €75bn in exports to China make up less than 7% of Germany's total exports, Germany would not have survived the financial crisis so relatively unscathed if not for the hugely dynamic economy in China. A crisis in the world's second-largest economy would also have consequences for the insurance industry.
Direct involvement of European insurers in China is still relatively low, but it is already the fourth-largest insurance market in the world. Rising prosperity and increasing demand for insurance are still important growth drivers. We expect more than 20% of global premium expansion by 2020 to come from China. But if there is a hard landing, we will have to reduce these forecasts significantly. And the greater the worries about China, the less likely it is that central banks in Western countries will be prepared to normalise monetary policies – much to the disappointment of insurers.
In recent decades, China has exhibited a dizzying economic catch-up that was characterised by steadily increasing labour productivity. More and more people migrated from the countryside into the cities, finding work in the industrial and service sectors. This work was more productive than agriculture. Productivity was also boosted by government reforms: public enterprises were privatised, and markets were liberalised. This process is still far from being complete, but productivity hikes from further reforms will be more moderate than in the past.
Transformation brings frictional losses
Investments still contribute just under half of the country's economic output. But now China wants to reduce its dependence on investments – indeed, it must do so – because this model is not sustainable. On the contrary: it results in excessive capacity and misdirected investments. To counter this, the government hopes to boost private consumption – which leads to an increase in salaries and wage costs – and reduce the competitiveness of exports, which is the second pillar of the Chinese model.
That this transformation process will lead to lower growth rates is not just expected, it is deliberate. But that is only part of the story. China's breathtaking rate of economic expansion always had the potential to create upheavals and setbacks. Take the real estate sector for example: massive investments in residential property were a main driver of the boom. In the meantime, it has become known that whole ghost towns remain unoccupied. Or look at the debt in the corporate sector: this is now estimated at more than 170% of Chinese economic output, and too many investments are being financed on credit. And, finally, China has recently experienced a vertiginous stock market boom. None of the problems are new, either for the Chinese government or for the rest of the world.
But what has now changed?
The most important pillar of the economic miracle appears to be wobbling: namely the world's trust in the ability of the Chinese leadership to manage history’s largest economic transformation of a country without triggering any massive disruptions. No Western politician would have been considered capable of making planned interventions in economic affairs at the same time as constantly increasing prosperity and avoiding crises. Yet there was almost limitless faith that this type of Chinese state capitalism would be effective.
No doubt this was due to China's vast currency reserves of more than US$ 3 trillion, which could be used in an emergency to extinguish any crises, and to its success story over recent decades. But the government is now stuck in a dilemma. On the one hand, it wants to give market forces more sway – in other words, to let crises take their course. On the other hand, the government intervenes – as we have seen with the devaluation of the Yuan or the collapse in prices on the stock exchanges – while showing that it does not always have the golden touch. But the more massively the state intervenes, the more doubts that are raised about whether the Chinese economy is sound. And the incidental effects also multiply. The devaluation of the Yuan is good news for exporters, but at the same time it creates problems for Chinese companies.
The Bank of International Settlements (BIS) estimates that Chinese corporate debt denominated in US dollars now amounts to more than US$ 1tn. But there is no reason to panic. I remain convinced that China will still reach its growth target of around 7% this year, and that in the long term it will become the world’s largest economy. Yet there are sufficient grounds for caution. It may be that the price falls on Chinese stock exchanges are, in part, just corrections from a previous bubble. And even the Chinese economy will suffer from both mild and severe setbacks. No clever economic policy can prevent this – not in China, nor in the rest of the world.