Encouraging first-half GDP numbers augur well for China's economic future

These days, all eyes are sharply focused on Beijing, where China's National Bureau of Statistics is headquartered. The level of world interest in China's economy is such that last week's announcement of second quarter GDP growth has provoked a furious row between the Chinese statisticians responsible for producing the economic data, and economists working for foreign banks - some of them Chinese - who think China's economic growth between April and June was in fact lower.

Prior to 2008, China's economic development was not considered critical enough for global growth and prosperity. After all, the rest of the world had motored on quite happily while Asia was collapsing in 1997 and 1998. But there has been a huge shift since the great global crisis started.

In 2011, according to Purchasing Power Parity (the measure of international comparison preferred by economists, which adjusts for price differentials between countries), China accounted for 14 percent of the global economy, against the United States' 17 percent. And because China is growing three or four times faster than the US, its contribution to global growth matters more than either the US' or Europe's.

The official Chinese second quarter growth result of 7.6 percent is a significant drop from first quarter GDP growth of 8.1 percent, but it still came in above forecasts of as low as 7 percent.

Economists were surprised by figures showing zero growth in year-on-year electricity usage in China, against an industrial output growth of 9.5 percent. Surely, they reasoned, increased industrial output would justify a pick-up in electricity usage? The National Bureau of Statistics countered this by arguing that increased electricity usage was being offset by power savings.

But economists also noted that the growth rate of some other important industrial and economic indicators was either low or negative - like the production of ethylene, an important chemical, which fell by 3 percent in June year-on-year, or railway freight (measured in ton-kilometers), which in the first half of 2012 rose by only 3.1 percent against the same period of 2011.

It is difficult, they say, to reconcile these random but important indicators of economic activity with reported economic growth rates of between 7.5 percent and 8 percent. One economist, from Capital Economics in London, said: "The doubts that swirl around Chinese data are an added source of uncertainty for global investors and for anyone who cares about the state of the world economy. China's statisticians would do well to follow more transparent processes that can be cross-checked by outsiders."

Nevertheless, the Chinese second quarter economic data released last week produced an immediate relief rally in global stock markets, indicating perhaps that global investors had been expecting something worse - or had seen signs of new strength in the data, and were expecting China's economy to pick up speed later in 2012.

There are some encouraging signs. Chinese retail sales grew 12 percent in real terms in June yea-on-year, and although home sales fell 11.2 percent year-on-year in the first half of 2012, they shot up by 41 percent in June over the previous month, indicating that early June's interest rate cut had a big effect on the expectations of Chinese real estate buyers. Meanwhile, growth in investment, a major driver of China's economy that had weakened in recent months, held steady at 20.4 percent.

But the sign of rebalancing in the Chinese economy was probably what impressed the markets last week. Global investors are looking for signs that the Chinese government's efforts to increase domestic consumption and reduce investment and exports as drivers of China's economic growth are working.

In the first half of 2012, retail sales in China came to nearly 40 percent of GDP - up from 35 percent a couple of years earlier. Provided that private Chinese incomes continue to grow at an annual average of about 11 percent and retail sales at about 12 percent or more, private spending will steadily increase in overall importance if the economy overall only grows at an annual rate of 8-9 percent.

If this trend continues, China's demand will gradually depend less on the West, and will become a valuable independent or "autonomous" support of growth in the global economy.

In the three decades up to 2008, US household spending was the main driver of the global economy. The most successful global economic forecasters in the 1990s were the ones who realized that US household spending was the key to global growth, and that it had enormous resilience. After the 1991 slowdown, even when a recession looked inevitable, the US continued growing because its consumers kept spending. The same forecasters have realized that today it is the growth of the huge Chinese middle class that holds the key to sustained future global economic growth.

The markets were also cheered by signs that growth in Chinese credit, an important lead indicator, is picking up. New bank loans grew from 793 billion yuan ($124 billion, 100 billion euros) in May to 920 billion yuan in June, while the broad money supply measure known as M2, which includes bank deposits as well as notes and coins, grew by 13.6 percent, a slight, but significant increase on May's year-on-year growth rate of 13.2 percent.

One of the reasons for the disagreement between China's statisticians and economists is that the Chinese economy is changing fundamentally, making it hard to compare numbers from one year to the next. After decades of outperformance by China's coastal provinces, growth this year in the center and west of China has started to outstrip the eastern part of the country. This shift of economic activity away from the coast to China's center reflects not only the slowdown in real estate price rises and transactions which had mainly occurred in the main eastern cities led by Beijing, Shanghai and Guangzhou, but also the impact of a stronger Chinese exchange rate on China's export performance.

Since the 1980s, foreign investment and exports have driven the outstanding economic performance of China's eastern provinces. But today, the yuan which is stronger by about 30 percent against every other major currency means that every Chinese product sold overseas may send foreign buyers looking for cheaper alternatives - unless the increase in the price of the Chinese product is matched by better quality or other improvements.

There has been a shift of lower-value exports from China to cheaper manufacturing locations like Vietnam, India and Bangladesh. Nike now makes only half of its sneakers in China. Coach and Topform (a major Walmart supplier) have also moved production away from China.

But although Chinese exports are growing more slowly, they still grew 11 percent in June year-on-year, producing a higher than estimated monthly trade balance of $32 billion (26 billion euros). Even in China's textile sector, a move up the value chain is occurring. Annual wage growth of 20 percent or more, as well as higher raw material costs and a stronger yuan, have been largely offset by increases in productivity - defined here as the cost in US dollar terms of one unit of product.

In January 2012, average US dollar import prices for Chinese products showed an increase over January 2010 of 5 percent, while prices for US imports from other developing countries increased over the same period by 7 percent. The conclusion is that China's export industry continues to outperform its emerging market competitors, even from a higher cost base.

It is easy to forget that raw material price increases affect everybody, not just China. And China's years of export dominance have created large, deep production centers in a range of different products, from sneakers to textiles to electronics.

But with the rise in the yuan, and a fall in China's current account surplus to under 3 percent of GDP, it is much harder for the US to complain that China is distorting its economy toward exports by managing its exchange rate. And a Chinese export sector no longer dependent on cheap wages will boost the country's sustainable growth in the longer term.

The success of higher-value manufacturing in China will enable employers to pay higher Chinese wages. This in turn will boost private spending - as it has in other successful export centers like Japan, Germany, northern Italy and parts of the US.

A shift of economic activity from developed east to undeveloped west; a household consumption sector which is growing faster than the rest of the economy; and a less dominant, but still growing export sector - these are all signs of a Chinese economy which is successfully rebalancing.

It seems likely that China's economy bottomed out in April or May. We may see a growth rate nearer to 8.5 percent in the second half of 2012. If so, this would mark the full recovery of the Chinese economy from the shock of 2008. It would be an important step forward to a more sustainable, less volatile Chinese economy. No wonder the markets rallied last week.

The author is a visiting professor at Guanghua School of Management, Peking University.

(China Daily 07/20/2012 page6)