China’s fastest growing exports are anxiety and skepticism. After years of seeing its collective wealth race ahead at a breakneck clip, the world’s most populous economy is hitting some speed bumps—and raising concerns about how severe its slowdown will be. In the second quarter of 2011, China’s official GDP was 9.5%; in the third quarter, it fell to 9.1%. More worrisome, for some, is the very steep decline in the past year in the growth in China’s money supply. Officially, this is part of a deliberate government strategy to prevent the economy from overheating; from there, the conventional wisdom holds that Beijing’s master planners will succeed in getting inflation under control and easing their economy back to a slightly less torrid pace. A growing chorus, however, is warn- ing that the country’s deceleration could be far more jolting than that; that reduced growth in money supply reflects reduced infrastructure activity and other investment spending, and that further erosion in GDP will soon follow in kind.
If so, Canada will be counting its bruises, too. China buys more than $11 billion a year in Canadian exports, and the effects of a serious slowdown would reach well beyond the immediate hit to Canada-Chinese trade. Slackening Chinese demand would nearly certainly pull down the commodity prices that have boosted Canada’s economy in recent years because the Middle Kingdom accounts for almost half of world demand for iron, steel and coal, and more than a third of the global market for copper, nickel and aluminum. Dwindling Chinese demand for raw materials would hit hardest at the mining and materials sectors (where private and state-owned firms are vested heavily in metals, natural gas and potash), but the tremors would also be felt in British Columbia’s forestry industry (which is trying to build an export market in China), the oil patch (where Chinese buyers are an increasingly large presence) and Prairie farms (canola seeds are one of our major exports to China).
How likely are these risks to materialize? Not very, according to the International Monetary Fund, which predicts China will grow at a 9% clip next year, only slightly below the 10.3% rate it hit in 2010. Others, however, take a dimmer view of the odds. A recent report by Nomura Securities says there is a one in three chance that China will endure a “hard landing”—which Nomura defines as a year of 5% growth or less—before 2014.
Nomura’s analysts point to multiple dangers for the Chinese economy. Among their worries are the country’s massive overinvestment in state-favoured industries and the rapidly aging workforce that has resulted from Beijing’s one-child policy. The Nomura team also argues that China is reaching a turning point where the supply of cheap rural labour willing to move to cities and work in factories is starting to slow, creating conditions in which wages will rapidly accelerate. If so, that will kneecap many of the country’s low-wage export industries. Combine that with the market distortions created by state-owned enterprises and an inflexible exchange rate, and the potential for a downturn is uncomfortably high.
Michael Pettis, an American who teaches finance at Peking University’s Guanghua School of Management, says China is going through a classic pattern in which a developing country sprints ahead for several years, and then suddenly and surprisingly topples into stagnation. The Soviet Union—yes, even the Soviets—managed to achieve rapid growth in the 1950s and 1960s before tumbling into its own self-made economic gulag. Brazil, too, was billed as a “miracle” economy in the late 1960s and early 1970s when it was growing at more than 10%—but then hit a wall that knocked it off course for a couple of decades. Japan is the most recent star-turned-also-ran. After shooting upward through the 1970s and 1980s, its economy slid into recession in the early 1990s and has been mired since in a bog of slow growth and deflation.
Pettis says these abrupt falls from grace reflect the diminishing returns from central planning. A strong, capable government can achieve a lot in the early stages of economic development by helping to mobilize capital and prodding it toward obvious needs. No highways? Let’s build some! No railways? Ditto. But once a nation has closed its biggest infrastructure gaps, further projects become more and more difficult to assess. In the tightly controlled markets typical of a developing nation, without clear pricing signals to guide the way, industrial planners operate in the dark. Unproductive, even counter- productive projects pile up as bureaucrats and executives continue to build what they know best. Growth grinds to a halt.
Pettis thinks China is already on the downward slope. “There is very little doubt among economists in Beijing and elsewhere that we have been misallocating capital for the past three years,” he recently told an audience of investment executives. He says, however, that the over-investment problem extends even further back than that. He recalls that when he arrived in China in 2002, he was struck by the high quality of the country’s roads and rails and airports. Yet building has continued at full throttle since then, to the point where even the country’s second- and third-tier cities are now equipped with modern airports. Notwithstanding all those fresh runways and terminals, Beijing is embarking on an ambitious project to build high-speed rail systems that would make much air traffic unnecessary. “We’re building infrastructure on top of infrastructure,” Pettis says.
A bout of overbuilding doesn’t necessarily have to result in stagnation, of course. But other gauges are also blinking red: China’s housing bubble has been well documented, the shares of its major banks are trading near record lows, and the huge debts run by the country’s local authorities are making it difficult for them to sell bonds. A recent poll showed that nearly half of China’s rich now want to emigrate—a reflection of the country’s deteriorating environment and increasingly wobbly economy. Canadian executives would be well advised to factor a Chinese slowdown into the scenarios they are mulling.
Ian McGugan is a business writer and editor in Toronto and the former editor of MoneySense magazine. E-mail: firstname.lastname@example.org.