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Chinese demand a wobbly bulwark

China's economy requires a minimum annual growth rate of 8% to maintain production levels sufficient to prevent unemployment from increasing, according to a general consensus inside and outside the country. Until recently, collective wisdom held that such a level of growth was likely to be maintained through 2009, easing the threat of social unrest as migrants, newly qualified university students and less-skilled school-leavers struggle to find work, while cushioning the global impact of declining demand for industrial metals and related natural-resource commodities.

No longer. China increasingly appears no more immune than any other country from the effects of the "trilateral recession" the International Monetary Fund forecasts for Japan, the US and the European Union, the first time all three will experience negative economic growth simultaneously in the post-World War II era began.

China's gross domestic product (GDP) grew 9% in the third quarter over the same period last year. That was lower than expected and the fifth consecutive quarter in which growth fell compared with the preceding quarter. Growth in the last three months of 2008 approach 8%, with estimates for 2009 dropping towards 6%, with some analysts suggesting rates under 4%.

The notion that the Chinese economy will pick up by the end of 2009 assumes an international economic recovery. Absent that, GDP may grow by an average of less than 7% over the next two years. Chinese export growth fell in November (by 2.2%) for the first time in decades.

Could domestic Chinese demand take the place of external demand? The World Bank's current estimate of 7.5% overall economic growth in 2009 assumes increased domestic demand. Yet most recent data indicate a slowing rate of increase, though not yet an actual fall, in domestic Chinese demand.

The consequence of declining external demand for Chinese goods is that there is less disposable income for consumption inside the country because fewer people are receiving salaries as exporters close factories. That decreased internal demand provokes additional factory shutdowns, further raising unemployment levels - hence the stimulus plan announced six weeks ago by the Chinese government, which declared that it would spend an amount equivalent to US$586 billion (slightly less than one-fifth of the country's GDP) by the end of 2010.

The official announcement stated that 30% of the total stimulus would come from the central government, while local governments and state companies would pay for the remainder. Western analysts have been trying ever since to determine how much of the total would really be new spending and what difference it would make.

Nearly half the expenditure is projected for infrastructure in transportation and electrical power distribution. Another quarter is targeted at the region that suffered the earthquake this past May, and another a tenth for rural infrastructure. The rest is distributed among technological innovation, environmental protection, and housing and other social welfare, including healthcare.

So in general terms the stimulus program is biased against consumption, which is set to decline due to decreased internal demand, and in favor of investment in infrastructure. Such a program implies depreciation of the yuan against the US dollar despite noises to the contrary coming out of Washington. The tendency towards such a devaluation is exacerbated by the most recent statistics available just this past week, showing negative growth in investment and consumption and significant declines in manufacturing output and electricity consumption (related to industrial production).

Imports also declined precipitously, even taking into account lower commodity prices. This signals two problems. The first is a tentative confirmation that, notwithstanding the World Bank's operating assumptions, demand is not merely contracting but beginning to contract perhaps severely (let us not yet say "collapse"). The other problem is that a fall in imports means China's trade balance is becoming more lop-sided to the surplus side, notwithstanding the contraction of domestic manufacturing.

That in turn means China is beginning to overproduce at a time when what the world economy needs is more consumption. Such a contradiction flags an important clash of perspectives that has yet to be resolved, and on which I shall conclude.

While economists in China tend to focus on the domestic economy and on economic measures necessary to avoid domestic social unrest, minimizing the international connections of those policies, so specialists on the Chinese economy outside the country are focusing principally on the latter while considering the former - domestic - concerns to be subsidiary.

Although such a difference of emphasis is perhaps to be expected and should not in principle be unbridgeable, events look as if they are starting to overtake attempts to work out practical steps for the common benefit. For it is only a few short steps from such a misunderstanding to protectionist countermeasures.

If protectionist steps are taken, then we may look forward to spending the three last quarters of the 21st century wondering how the resulting "Second World Depression" spiraled out of control, much as diplomats and scholars after them spent decades in the 20th century trying to understand how the Great War (or World War I, before its successor erupted to challenge its uniqueness) broke out and continued for so long a time, when all the foreign offices in Europe expected it to be over in a few months at most.

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URL:  http://www.robertcutler.org/blog/2008/12/chinese_demand_a_wobbly_bulwar.html
First published in Asia Times Online, 24 December 2008.

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