China may have turned the corner Improving industrial production figures suggest China could be lifting out of the mire.
John Garnaut January 26, 2009 AUSTRALIA was so transfixed by the capitulation of Wall Street in September and October that we missed the equally important collapse of China's economic boom. Maybe we are now so distracted by the proof of China's capitulation — Thursday's gross domestic product numbers — that we're missing the first signs of recovery.
Exports, the first engine of China's three-engine economy, will be blowing smoke for however long it takes the rich world to begin to consume again. But it could be worse. China's (low-cost) exports fell 3 per cent in the year to December while Japan's (high-tech) exports plunged 35 per cent. What matters for GDP growth is net exports — exports minus imports — and China's net exports are growing because imports are collapsing.
Consumption is the second and structurally weakest engine of the Chinese economy. The problem is not that Chinese households save too much, as is often asserted, but that they have too little income in the first place. China under the Communist Party is rigged towards "insiders" so that that there isn't much left for everybody else.
China has to lift consumption by raising household income if its economy is to continue on a high-growth path.
Construction and heavy industry is the third and most powerful engine of China's economy. These developers and steel makers can make and break the Australian economy, at least in the short term, and they were at the front of China's economic train when it crashed.
Steel production fell a stunning 17 per cent in the year to October. Production of other resource-intensive products like cement and aluminium also collapsed, leading electricity generation to fall 10 per cent in the year to November.
On Friday, when Australia was absorbing the shock of Thursday's data showing the Chinese economy had failed to grow at all in the December quarter, China's National Bureau of Statistics released industrial production figures for the year to December. The data had turned from abominable to merely ugly.
The decline in steel production had moderated from negative 17 per cent to negative 10, electricity production improved from minus 10 to minus 8 and cement production was accelerating. It was a far cry from the double digit growth of the previous five years but enough to suggest the bottom in Chinese commodities demand is already behind us.
When steel makers and other materials suppliers had seen prices falling, they frantically liquidated huge stockpiles, sending prices down further and forcing production closures. That process is nearly complete.
The central government has turned on all the fiscal and monetary taps and put its pro-consumer "harmonious society" rhetoric to one side.
Companies have been excused from all manner of regulations — environmental, minimum wage, pensions, insolvency — while local governments and well-connected enterprises have been given the green light and the finance to build almost anything they like.
Some of the trillions in government-endorsed investment will leave a legacy of better transport, cleaner water and more affordable housing.
Some of it will be remembered for corruption and cronyism, building things that nobody needs, destroying what's left of the environment, exacerbating income inequality and making China's economic and social imbalances worse.
But as a short-term macro-economic fix, it seems to be working. The Government's mammoth stimulus package plus the bottoming of the inventory cycle means Chinese commodities demand will be stronger this year than the market expects. It's not out of the question that Chinese construction will lead global reflation.
The challenge will be in two or three years, when the Chinese consumer will be required to fill the export vacuum.
The policy of overcoming existing imbalances by making them bigger requires a credible exit strategy. The risk of a double-dip Chinese recession is real.
"The moment we stabilise the growth scenario, we need to accelerate reform as in state-owned enterprises, local competition, government intervention in resource allocation, liberalisation of trade, prices and private investment," says Wei Ding, head of investment banking at China International Capital Corporation.
"They need to be far more aggressive on these things to help the efficiency of the economy."
At the time of our interview, on Wednesday afternoon, I had thought Ding was criticising his government. Perhaps it was more of a prophecy.
After he spoke, the rivers of money that had been flowing to developers also began to flow towards poor households (150 billion yuan in new year's "red envelopes"), clean fuel refineries (300 billion) and near-universal health care (850 billion).
On Saturday, the 25 Communist Party leaders who make up the Politburo signalled their return to the goals of a "harmonious society". They said China's "crude mode of development" had caused an imbalanced economic structure, feeble levels of innovation and inefficient growth.
"The price of economic growth in resources and the environment has been too great," they said.
China has an abominable unemployment problem and it is by no means out of the mire. But the data and policy statements of recent days makes it easier to imagine how the country might "be the first to recover from the financial crisis", as Premier Wen Jiabao recently suggested.
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