Thu, Nov 03, 2016 page8

• Is China’s economy on a precipice?

  • By Stephen Roach
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  Is the Chinese economy about to implode? With its debt overhangs and property bubbles, its zombie state-owned enterprises and struggling banks, China is increasingly portrayed as the next disaster in a crisis-prone world.

  I remain convinced that such fears are overblown, and that China has the strategy, wherewithal, and commitment to achieve a dramatic structural transformation into a services-based consumer society while successfully dodging daunting cyclical headwinds. However, I certainly recognize that this is now a minority opinion.

  For example, US Secretary of the Treasury Jack Lew continues to express the rather puzzling view that the US “can’t be the only engine in the world economy.”

  Actually, it is not: The Chinese economy is on track to contribute well over four times as much to global growth as the US this year. However, maybe Lew is already assuming the worst for China in his assessment of the world economy.

  So what if the China doubters are right? What if China’s economy does indeed come crashing down, with its growth rate plunging into low single digits, or even negative territory, as would be the case in most crisis economies? China would suffer, of course, but so would an already-shaky global economy. With all the hand-wringing over the Chinese economy, it is worth considering this thought experiment in detail.

  First, without China, the world economy would already be in recession. China’s growth rate this year appears set to hit 6.7 percent — considerably higher than most forecasters have been expecting.

  According to the IMF — the official arbiter of global economic metrics — the Chinese economy accounts for 17.3 percent of world GDP (measured on a purchasing-power-parity basis).

  A 6.7 percent increase in Chinese real GDP thus translates into about 1.2 percentage points of world growth. Absent China, that contribution would need to be subtracted from the IMF’s downwardly revised 3.1 percent estimate for world GDP growth this year, dragging it down to 1.9 percent — well below the 2.5 percent threshold commonly associated with global recessions.

  Of course, that is just the direct effect of a world without China. Then there are cross-border linkages with other major economies.

  The so-called resource economies — namely Australia, New Zealand, Canada, Russia and Brazil — would be hit especially hard. As a resource-intensive growth juggernaut, China has transformed these economies, which collectively account for nearly 9 percent of world GDP. While all of them argue that they have diversified economic structures that are not overly dependent on Chinese commodity demand, currency markets say otherwise: Whenever China’s growth expectations are revised — upward or downward — their exchange rates move in tandem.

  The IMF currently projects that these five economies will contract by a combined 0.7 percent this year, reflecting ongoing recessions in Russia and Brazil and modest growth in the other three. Needless to say, in a China implosion scenario, this baseline estimate would be revised downward significantly.

  The same would be the case for China’s Asian trading partners — most of which remain export-dependent economies, with the Chinese market their largest source of external demand. That is true not only of smaller Asian developing economies such as Indonesia, the Philippines and Thailand, but also of the larger and more developed economies in the region, such as Taiwan, Japan and South Korea. Collectively, these six China-dependent Asian economies make up another 11 percent of world GDP. A China implosion could easily knock at least 1 percentage point off their combined growth rate.

  The US is also a case in point. China is the US’ third-largest and most rapidly growing export market. In a China-implosion scenario, that export demand would all but dry up — knocking about 0.2 to 0.3 percentage points off already subpar US economic growth of about 1.6 percent this year.

  Finally, there is Europe to consider. Growth in Germany, long the engine of an otherwise sclerotic continental economy, remains heavily dependent on exports. That is due increasingly to the importance of China — now Germany’s third-largest export market, after the EU and the US. In a China implosion scenario, German economic growth could also be significantly lower, dragging down the rest of a German-led Europe.

  Interestingly, in its update of the World Economic Outlook, released last month, the IMF devotes an entire chapter to what it calls a China spillover analysis — a model-based assessment of the global impacts of a China slowdown.

  Consistent with the arguments above, the IMF focuses on linkages to commodity exporters, Asian exporters, and what they call “systemic advanced economies” — Germany, Japan and the US — that would be most exposed to a Chinese downturn. By their reckoning, the impact on Asia would be the largest, followed closely by the resource economies; the sensitivity of the three developed economies is estimated to be about half that of China’s non-Japan Asian trading partners.

  The IMF research suggests that China’s global spillovers would add about another 25 percent to the direct effects of China’s growth shortfall. That means that if Chinese economic growth vanished into thin air, in accordance with our thought experiment, the sum of the direct effects — 1.2 percentage points of global growth — and indirect spillovers — about another 0.3 percentage points — would essentially halve the current baseline estimate of this year’s global growth, from 3.1 percent to 1.6 percent.

  While that would be far short of the record 0.1 percent global contraction in 2009, it would not be much different than two earlier deep world recessions, in 1975 (1 percent growth) and 1982 (0.7 percent).

  I might be one of the only China optimists left. While I am hardly upbeat about prospects for the global economy, I think the world faces far bigger problems than a major meltdown in China.

  Yet I would be the first to concede that a post-crisis world economy without Chinese growth would be in grave difficulty. China bears need to be careful what they wish for.

  Stephen Roach, former chairman of Morgan Stanley Asia and the firm’s chief economist, is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management.

  Copyright: Project Syndicate
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