China’s investment stimulus ensures it will retain its international growth lead in 2013

In the 4^th quarter of 2012 China’s economy speeded up, with GDP growth rising to 7.9%. For 2012 as a whole China’s GDP rose by 7.8%. Internationally this contrasted sharply with the EU and Japan, both of which have passed into new downturns, and the US where economic growth in 2012 was 2.2% – anaemic compared to previous recoveries. China’s industrial production in the year to December rose by 10.3% – compared to 2.9% in the US. China’s annual economic expansion now exceeds the US in dollar as well as percentage terms – China’s GDP in 2012 rose by $982 billion compared to $600 billion for the US.

The scale of changes in the world economy involved can be seen even more clearly if the period since the international financial crisis began is taken. Peak US GDP prior to the financial crisis was in the fourth quarter of 2007. Since then China’s GDP has grown by 52.5%. But in the 4th quarter of 2012 US GDP was only 2.4% above its pre-crisis level.

In the last five years China’s economy has therefore grown more than twenty times as fast as the US while the economies of the EU and Japan have shrunk. In current dollar prices China’s GDP has risen by $4.7 trillion and the US by $1.65 trillion.

In industrial production, the most internationally traded sector, and the one with the fastest productivity growth, the change in the last five years is even more dramatic. On the latest available data EU industrial production is 12% below its pre-crisis peak and Japan’s 22% below. In the US, despite unsubstantiated talk of ‘industrial revival’, in December US industrial output was still over 2% below its peak of more than five years previously. In the five years up to December 2012 US industrial production had fallen by 3%, but China’s industrial production had risen by 80%.

These huge economic shifts pose two questions entering 2013. This year can China maintain the pickup in economic momentum that was clear in the fourth quarter of 2012? Can China maintain this over the medium/longer term with the consequences for further changes in the structure of the world economy flowing from this? Examining the economic processes unfolding at the beginning of 2013 gives the answer ‘yes’ to both questions – and for the same reason.

Turning back to short terms trends, undoubtedly at the beginning of 2012 China’s economic policy makers had underestimated the difficulties in the developed economies. China’s official prediction of a 10% export increase in 2012 could not be achieved without significant growth in developed markets. This did not materialize and exports rose only 7.9%.

As external demand was overestimated there was a delay in launching a program to stimulate domestic demand. Therefore China’s economy slowed. By May 2012 annual fixed asset investment growth had fallen to 20.1%, the lowest for a decade. In August the yearly increase in industrial production declined to 8.9%. In the same month the annual increase in industrial company profit fell to 6.2%.

However, by mid-2012 policy was adjusted appropriately. In late May Premier Wen Jiabao announced an infrastructure centred investment program that grew to $157 billion. Theoretical support to this new stimulus was given by former World Bank Chief Economist and Vice President Lin Yifu – who has now returned to Beijing to be a major influence in China’s economic policy making.

The correctness of these policies was rapidly shown. By December the investment decline reversed, with the annual increase in fixed asset investment rising to 20.6%, and industrial output growth accelerating to 10.3%. Industrial company profits grew – rising to a 22.8% annual increase in November. These trends underlay the GDP growth increase from 7.4% in the third quarter to the fourth quarter’s 7.9%.

In a perfect world doubtless China would have launched its domestic stimulus a few months earlier. But in economics it is impossible, due to the enormous number of variables involved, to make precisely accurate projections, only orders of magnitude can be accurately predicted. In particular policy makers had to take into account that China’s population is extremely inflation adverse. If export demand had been at the level expected, launching a domestic stimulus would have threatened economic overheating with inflationary dangers. In the grand economic scheme of things, with China’s GDP rising at 7.8%, the US at 2.2%, and the EU and Japan not at all, a few months delay is virtually neither here nor there.

Nevertheless there exists a small industry of those claiming China is ‘soon’ to suffer deep economic crisis – the ‘soon’ merely progressively moving forward in time when it doesn’t materialize. A few examples will give the flavor of the genre:

• Gordon Chang in The Coming Collapse of China in 2002 declared ‘A half-decade ago the leaders of the People’s Republic of China had real choices. Today they do not. They have no exit. They have run out of time.’ Actually rather than collapse China was entering a decade of the most rapid growth ever experienced by a major economy in human history.
• Michael Pettis of Beijing University, a frequent predictor of ‘sharp slowdown’ or ‘crisis’ in China, in 2009 reiterated: ‘I continue to stand by my comment [made] last year… that the US would be the first major economy out of the crisis and China one of the last.’ In fact since the peak of the last US business cycle, in the fourth quarter of 2007, China’s GDP has grown by 53% and US GDP by 3%.
• The Economist magazine, in a special supplement in 2002, ‘A Dragon Out of Puff’, predicted: ‘In the coming decade, therefore, China seems set to become more unstable. It will face growing unrest as unemployment mounts.’ And ‘the economy still relies primarily on domestic engines of growth, which are sputtering. Growth over the last five years has relied heavily on massive government spending. As a result, the government’s debt is rising fast. Coupled with the banks’ bad loans and the state’s huge pension liabilities, this is a financial crisis in the making.’ In fact in the next 10 years China underwent the most rapid growth of any major economy in history.

The fact that such predictions are regularly refuted by events does not stop them being put forward. A slight delay in China launching a domestic stimulus in 2012 therefore created a frenzy of speculation in such circles regarding a ‘hard landing’ or ‘crash’ in China’s economy – which as always failed to materialize and instead, as already noted, China’s economy accelerated.

A new ‘theory’ therefore had to be put invented of why China’s economy will substantially slow – that China’s government is allegedly sacrificing the long term interest of its economy for a short term ‘fix’. According to one formulation of this, by Jamil Anderlini and Simon Rabinovitch in the Financial Times: ‘China went into reverse in the second half of 2012 in its efforts to rebalance its economy… Though steady, consumption took a back seat to capital spending as a driver of growth.’

Unfortunately this line of argument makes as little sense as, and will be therefore be just as refuted by events as, the numerous others.

First, taking the long run, modern econometrics shows clearly that as an economy develops it becomes more dependent on investment for growth, not less. As China moves from a developing to a developed economy investment would be expected to play a greater role in its growth.

Second Lin Yifu has rightly stressed that the industrial upgrading of an economy consists of it moving from labor intensive to increasingly investment intensive industries. This is precisely the path China is following with its exports increasingly switching from labour intensive products such as textiles and toys into more capital intensive ones such as ships, construction equipment, smartphones and cars.

Finally, in the purely short term, the present global economy conforms to economic theory showing that investment fluctuates more than consumption, and it is investment downturns which therefore create economic recessions. The latest data shows in developed economies fixed investment is nearly 10% below its peak and has been declining since the first quarter of 2012. China’s ability to counter such threats by an investment stimulus program is therefore a sign of the strength of its economy, not a weakness. It is this ability to control and raise investment which determined that China’s economy continued to grow rapidly, while the sharp decline of investment in the developed economies led to their stagnation or renewed recession.

Consequently, rather than China’s government’s policies sacrificing the long term strength of the economy to short term expedients, the stimulus launched from summer 2012 integrates both short and long term considerations in economic development. This is why the majority of predictions for growth in China’s economy in 2013, from both Chinese and the majority of international experts, are for a further speed up in GDP growth to more than 8% – the World Bank’s 8.4% being fairly typical.

The main dangers to China’s growth in 2013 are therefore not domestic but those from external weakness in developed economies. The latest prediction by the World Bank for growth in 2013 is 1.9% in the US, 0.8% in Japan and -0.1% in the Euro Area. For this reason the World Bank’s overall projection for global growth is a low 2.4% in 2013.

Naturally China, as the world’s second largest economy, and the world’s largest goods exporter, cannot isolate itself from world economic trends. If the world economy slows in 2013 China is likely to slow, and if the world economy accelerates China’s economy is likely to speed up. But whatever the short term ups and downs China will continue to enjoy its 6-7% growth lead over the developed economies.

In regard to the medium term a major turning point in world history is being approached. The IMF projects that, in comparable price levels, that is parity purchasing powers, China will overtake the US to become the world’s largest economy in 2017. At market prices China will overtake the US to become the world’s largest economy a few years later. Exactly when the latter transition will take place depends on the assumption on exchange rates, with 2019-20 being the most central date. To be safe it may be said China will become the world’s largest economy ‘within 10 years’. Given the short time scale, unless China’s economy slows very drastically and very quickly this transition is inevitable.

No one alive has ever lived in a world in which the US was not the largest economy – it gained that position in approximately 1870. It is, among other reasons, because it is mentally difficult for humans to adjust to the new and never experienced that constant theories are put forward that China’s economy must be about the slow substantially. But, for the reasons already outlined, China will maintain its rapid economic growth. That is 2013’s realistic economic perspective.

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An earlier shorter version of this article appeared in China Daily.

John Ross is currently Visiting Professor at Antai College of Economics and Management,Shanghai Jiao Tong University, where he leads research on globalisation and on China and the international financial crisis.
Check out his blog: http://ablog.typepad.com/keytrendsinglobalisation/ , or follow him on twitter @JohnRoss43