China’s Growth: Can Goldilocks Outgrow Bears? by IMF
Prepared by Wojciech Maliszewski and Longmei Zhang
The paper analyzes the recent growth dynamics in China, evaluating both cyclical positions and long-term growth prospects. The analysis shows that financial cycles play a more important role than traditional inflation-based cycles in shaping the dynamics of growth. Currently, the ‘finance-neutral’ gap—our measure of the financial cycle—is large and positive, reflecting imbalances accumulated in the economy since the Global Financial Crisis. A period of slower growth is therefore both likely and needed in the near term to restore the economy to equilibrium. In the medium term, growth will slow as China moves closer to the technology frontier, but a steadfast implementation of reforms can ensure that China follows the path of the “Asia Tigers” and achieves successful convergence to high-income status.
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China’s Growth: Can Goldilocks Outgrow Bears? – Introduction
China’s impressive growth record speaks for itself, and the country’s policymakers have won additional accolades for the timely response to the Global Financial Crisis. The Chinese GDP has been growing at the average rate of nearly 10 percent per year in the past four decades. The well-timed policy relaxation supported growth in the immediate aftermath of the crisis. Several analysts pronounced the arrival of a goldilocks economy in China—not too hot to fuel inflation and not too cold to slip into recession (JPMorgan, 2009)—and some see a continuation of the stable economic growth as the most likely scenario for China.
But the past success is no guarantee of future performance, and fears are rising among China ‘bears’ that the recent deceleration in economic activity is a prelude to a deeper growth slowdown (Xie, 2013). These fears are fed by the observation that the surge in credit-financed investment in response to the Global Financial Crisis (GFC) has pushed credit up to, and even beyond, the point that has typically led to sharp growth slowdowns and banking crises in other countries (Liao and Maliszewski, 2015). The surge has also been linked to a boom in the real estate activity, supporting several sectors of the economy at the expense of growing inventories of unsold houses and a rising leverage in the sector. The spectrum of overinvestment or ‘malinvestment’ looms large, with a possibility of a sharp correction when demand created by the investment boom evaporates and the leverage proves unsustainable.
A key question is how much of China’s slowdown is temporary (cyclical) versus long lasting (structural). Growth fluctuations in developing and emerging markets often follow a pattern of spans of impressive growth followed by long periods of stagnation. The concern is therefore not only about a cyclical growth slowdown typically experienced by mature economies, but a prolonged slump so often experienced in emerging markets. These fears are also fed by the observation that structural ‘imbalances’ in the Chinese economy—exceptionally high investment rates associated by some with ‘forced savings’ (Eckaus, 2014)—have further grown since the GFC, reducing investment efficiency and total factor productivity (TFP) growth.
We contribute to the ongoing growth debate by identifying the cyclical position and assessing the degree of potential output slowdown in China. Our main results are:
- We expect growth to slow down in the near-term. Financial cycles in China play a significant role in shaping growth dynamics, and the economy is now likely near the peak of a powerful cycle propelling the economy since the GFC. An adjustment is therefore both likely and needed to bring the economy closer to equilibrium.
- Potential growth is slowing. This is expected as China makes progress on the long journey of converging to advanced economy income levels. As it moves closer to this technology frontier, growth will continue to slow. However, the pace of convergence, and thus China’s medium-term growth rate, will depend on structural reforms. With success in implementing reforms, China can follow the historical experience of other fast-growing Asian economies.
The paper is organized as follows: we start from key themes in the recent literature on China’s growth performance; we then discuss and motivate the range of methods to estimate potential output and output gap, and present and discuss results; we finish with international comparisons, contrasting the performance of fast growing economies against China’s own. The last section offers broad policy recommendations.
II. ‘Asiaphoria’ Meets ‘The Myth Of Asia’s Miracle’
Time and again economic developments in Asia spark a lively debate on the regional growth performance. A couple of years before the Asian Crisis, several authors examined growth in fastgrowing Asian economies only to reach starkly different conclusions about their prospects. Page (1994) found the growth performance significantly better compared to other regions, attributing the ‘Asian Miracle’ to factor accumulation combined with the efficient allocation reflected in relatively high TFP growth. In “The Myth of Asia’s Miracle,” Krugman (1994) famously debunked this view, drawing a parallel between seemingly uninterrupted industrial growth in the Soviet Union and the rise of Asian economies. He concluded that growth rates in both systems were largely input-driven—based on an extraordinary ‘willingness’ to save and sacrifice current consumption for the sake of future production—with little productivity improvement. In this view, fast-growing Asian economies were bound to slow down, and a naive projection of the past growth rates into the future was likely to overstate real prospects. Young (1995) reached a similar conclusion, documenting the fundamental role played by factor accumulation in explaining the extraordinary postwar growth of Hong Kong SAR, Singapore, South Korea and Taiwan Province of China. With the benefits of the hindsight, both bears and bulls could claim partial victory: tremors of the Asian Crisis were only a couple years ahead, but Singapore—seemingly a prime example of Soviet-style development in Krugman (1994)—is now ahead of the US in terms of income per capita and human development indicators.
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