Economics and Business, Politics

What’s up with China’s New Normal?

For a while now, China has been reassuring us all that the slowdown in its growth engine is all part of this conversion into a more consumer-oriented society, rather than the cheap-labor, cheap-goods factory machine that it has become known for. Rocketed by a burgeoning middle-class, there is now a new China in town.  This is a China that will no longer create those ubiquitous “Made in China” labels, this is a China that creates higher value-added goods and this is a China that cannot spit out 10+% growth rates anymore. This is “The New Normal.”

It’s hard to really get a sense of what “New Normal” means as nothing about China has been normal in the past two centuries. But it was predictable that this is what China will eventually have to endure. After all, decades of the One Child Policy would have to have had major effects on the labor supply. And given China’s immense population and how it has fueled their economy, this is a big deal. The laws of supply and demand insist that as the labor supply decreases, wages have to increase. As wages increase, final product price increases. At the new price, less consumers may be willing to pay, and exports decrease.

Beyond the labor market, which is specific to China, there are larger forces at play. The Solow-Swan Model illustrates just this phenomenon. The model predicts that the income levels of poor countries will eventually catch up to the income levels of rich countries, assuming the poor country’s saving rates for physical and human capital grow to mirror that of richer countries. This is called conditional convergence. For three decades now, China has been playing catch up, pulling millions out of poverty and accumulating huge amounts of capital – both physical and human. The catch-up is now ending and China is entering a critical period where they have to shift from export-based manufacturing towards services, entrepreneurship and consumer spending. As evidenced by the stock market’s performance this year, this is not an easy thing to do, but it’s not impossible.

Capital-vs.-Output-per-Worker
From the origin to B, quick growth characteristic of China’s last 10 years of economic performance. B-C is the slowdown for eventual end to the “catch-up”

There are examples where countries have been able to conditionally converge. After World War II, the Japanese economy was completely desolated. When the war ended in 1945, Japan’s real GDP growth rate (in terms of international Geary-Khamis dollars) was -50%, which is a ridiculous amount. That means that the entire economy contracted by half. Yikes. But Japanese did something amazing in the 1950s and 1960s. They hiked up the savings rates through intense industrial development, and as a result, saw a rapid and continuous growth cycle that ended only in 1974. After this period, Japan was considered “converged,” and in correspondence to the model, experienced lower growth rates (3-4% rather than 8-12%).

After periods of high growth fueled by either labor or capital accumulation, there is naturally a slowdown. The fundamentals of a miracle economy based on manufacturing cannot be sustained into the future. You must have technological investment and innovation to grow further. But that doesn’t mean that we are at the brink of disaster, despite the onslaught of media headlines that predict just that. The real question here is whether the Chinese economy will blossom into something closer to a consumer-rich economy or crumple and stay duly wilted in the windowsill, always just trying to get somewhere. If it does stay wilted, then China runs the risk of the “middle-income trap,” the same problem that plagues many Latin American countries.

So, in the end, the Chinese government is going to try to mollify market-fears as much as they can, as they do. Much of the western media is going to make strangely giddy doomsday predictions, as they do. But the real situation is somewhere in the middle of that spectrum because a slowdown of the Chinese economy has been predictable for years, though a bit precipitated due to the financial crisis. However, this painful transition is going to make some big ripples on the economies of other countries. Mongolia, in particular, is going to have to think of a very good plan to make it through this period.

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