A painful decline to slower and slower growth is the best case scenario for China, says Michael Pettis, professor at Pe- king University’s Guanghua School of Management. Forget about a soft landing — even with the implementation of key economic reforms, China is in for a ‘long landing’ if it’s able to rebalance its economy.
This isn’t the most settling idea — Emerging markets have been in turmoil since the beginning of the year, and part of that is because of signs of slowing growth in China.
Last week, Q4 GDP number came in at 7.7%. That’s a slow down from the same quarter the year before when the number came in at 7.8%. During the World Economic Forum in Davos, Ray Dalio, the founder of the largest hedge fund in the world, said China’s economy was a bubble.
Naturally, things would get ugly if it burst. That’s the worst case scenario.
Pettis is saying the best case scenario isn’t great either.
In a recent Bloomberg Brief debate with Cornell Professor Eswar Prasad, Pettis says that Xi Jinping and his government are likely well aware of that.
The reforms they planned during the country’s Third Plenum economic reform meeting are meant to stabilise China’s banking system, and make significant strides toward making China’s economy based on consumption, rather than outside investment.
Pettis says that those reforms will ensure that GDP growth slows, since a significant portions of the GDP growth we’ve been seeing, was based on China’s investment-based economic model.
These reforms, and others — like attempts to protect the environment — will ensure that even as China’s real eco- nomic productivity improves, its GDP growth numbers will drop as the reforms are implemented. For now, most com- mentators argue that by increasing productivity, real reform will ensure a soft landing of GDP growth rates of 7 to 8 per cent during the rest of President Xi Jinping’s administra- tion. A growing minority worries, however, that rapidly rising debt will force China into a hard landing.
Although rising debt increases the probability of a hard landing, for now I expect neither outcome. More likely, I be- lieve, is a “long landing,” during which growth rates will drop by roughly one to two percentage points every year for the rest of this decade. Implementing reforms will protect China from a hard landing. It will however force much lower, albeit healthier, growth rates.
Prasad counters this by saying that reforms will generate a new economic prosperity all their own, and “will improve the allocation of resources, push up productivity, and make growth more balanced. Taken together,” Prasad continues, “they will allow China’s economy to continue growing at 6 to 7 per cent for the next few years.”
Of course, the government has to take on entrenched vested interests on first, in order to ensure that these policies are implemented correctly. He’s talking about everything from big financial institutions that rely on the Central Bank’s capital injections, state owned corporations that want to hold on to their pieces of the market pie, and local/regional governments.
Execution — sometimes that’s the hardest part.
Pettis agrees with that. For China to implement its policies these interests will have to take a back seat, but that’s just the thing — to do what must be done in China, many of the bases of its current economic model must be undone.
That, Pettis argues, will take a big toll on growth in the event that the Chinese government can execute.
The proposed reforms will certainly unleash greater pro- ductivity, but they will also eliminate the mechanisms that had previously turbo-charged economic activity and which showed up in the form of higher reported GDP growth rates. They will cause a sharp deceleration in economic activity even though growth will be more productive than in the past. The fact that growth rates have dropped by almost a third even before the reforms were implemented suggests to me just how much further they must drop.
If you accept this notion, then you may as well accept that this ‘long landing’ has already started happening over the last couple of years. And that we’re already seeing it in the minimal reforms China has implemented over the past three years has already lobbed three percentage points off its GDP growth.