CDT Money: Likonomics and China’s Push for Reform

China watchers spent the week digesting the latest official quarterly GDP data released by the National Bureau of Statistics, which showed year-over-year growth slowing to 7.5% in the second quarter. Measured by international standards, which present annualized growth on a quarter-over-quarter basis rather than year-over-year, China’s economy grew just shy of 7%.

The official figure surprised no one but nevertheless evoked pessimism from a global community of academics, investors and pundits accustomed to seeing the world’s second-largest economy routinely eclipse official growth targets. The New York Times’ Paul Krugman wrote that “China is in big trouble:”

[…] We’re not talking about some minor setback along the way, but something more fundamental. The country’s whole way of doing business, the economic system that has driven three decades of incredible growth, has reached its limits. You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be. [Source]

Others disputed the data, including Forbes contributor Gordon Chang, who called it “The Biggest Fib of the Year:”

What is the real growth figure? Seeking Alpha thinks it is around 6.7%, but even that figure is high.  Among other factors, the severe contraction of aggregate financing in June, the marked fall in exports in May and June, and the evident shrinkage of the manufacturing sector throughout the quarter all point to an economy growing in the low single digits.

Moreover, it is unlikely that NBS, in releasing the Q2 number, had made proper adjustments to account for two phenomena.  First, Beijing’s official statistics have not been adequately adjusted for inflation, as Standard Chartered ’s Stephen Green has pointed out.  Second, fake trade invoicing substantially inflated GDP numbers.  Rampant falsification has resulted in the simply unbelievable report of 14.7% export growth in April, the first month of the just-ended quarter.  Although some say export growth was about 6% then, it seems like it was actually closer to 3%. [Source]

Even alternative data points – Premier Li Keqiang once told U.S. diplomats that he prefers to look at electricity consumption, rail cargo volume, and bank lending numbers instead – indicate that actual growth may have been worse. Patrick Chovanec, for example, tweeted that the so-called “Li Keqiang Index” suggests that the Chinese economy has slumped beyond 2009 lows. And as the Wall Street Journal’s Tom Orlik illustrated in detail on Thursday, private data “show the economy continuing to lose momentum:

Sequential growth is weak, and some low-profile indicators suggest it may be slower than reported. Consumption growth is disappointing and investment is playing a bigger role in driving the economy. Labor markets are holding up, with the services sector doing better than manufacturing. Inflation is subdued for consumer prices but with worrying signs in property. With debt levels high, the space for a stimulus is limited. [Source]

Orlik noted that China continues to rely on investment-led growth in the face of weak domestic consumer demand, despite the hopes of Li and other policymakers that consumption will fuel a rebalancing of the Chinese economy. And while some signs of rebalancing exist – the services sector continues to add jobs while manufacturers cut them – any meaningful correction seems distant as long as China continues to rely on capital spending and a bloated, undisciplined credit market to hit its targets.

Bloomberg columnist William Pesek last week urged readers to stop using the word “Likonomics,” calling it “a ridiculously premature nod to ideas that are, at best, still on the drawing board and might never come off it:”

In Japan, economists and a cheerleading media now seem to realize they bought into “Abenomics” too hastily, creating the myth that Prime Minister Shinzo Abe’s revival plan is succeeding when it has only just begun. Game-changing reform efforts take several years to implement. We are a long way from knowing if Li has the skill or political will to manhandle China onto a more sustainable growth path, led by domestic demand.

How will we know? There are three clues to whether Likonomics is more than a hollow slogan.

First, can Li avoid further stimulus? The premier’s supposed shock-therapy program already has its own myth: that China is engineering a sharp slowdown. Li doesn’t WANT growth to slide toward 5 percent — no Chinese leader in his right mind would at a time when protests are becoming commonplace. Rather, China’s export- and investment-led growth model is burning out on Li’s watch. [Source]

Pesek goes on to question whether Li can accept the pain needed to implement his desired structural reforms, and The Economist similarly claims that China’s growth prospects for the rest of 2013 “depend on whether the new leadership feels obliged to meet its growth target.” To do so may require the kind of stimulus measures that would sharpen the ultimate effects of rebalancing.

China’s willingness to address its debt problem and the leadership’s commitment to reform “are the crucial issues,” wrote Bill Bishop in DealBook. But while Li Keqiang told a meeting of businessmen, economists and top policymakers that short-term dips in economic data should not deter the Chinese government from pursuing a restructuring of the economy, he also said that the government could take action to ensure that growth doesn’t dip below a “reasonable range.”

Is there a tipping point? The Wall Street Journal’s William Kazer reported that “it’s still anyone’s guess” as to where policymakers will draw the line. The Diplomat’s Minxin Pei, however, doesn’t think that there is a magic growth number that will trigger panic in Beijing:

The truth is that Chinese leaders themselves probably do not know the magic growth number that will force a decisive response. The factors that go into the political calculations of Chinese leaders are complex and dynamic. They are not as simple as the number of unemployed workers or the amount of bad loans in the banking system.

In all likelihood, the most important factor determining Beijing’s response to a slowing economy is the level of confidence and security of its top leaders. Typically, less confident and secure leaders tend to respond with panic whenever the economy shows signs of weakness, as we saw in 2008-2009. More confident and secure leaders are more likely to show a greater tolerance of subpar growth. In the wake of the East Asian financial crisis of 1997-1998, the Chinese economy stopped growing altogether, but the premier at that time, Zhu Rongji, did not react with undue alarm. Instead of throwing good money after bad, he proceeded with a massive restructuring of hundreds of thousands of moribund state-owned enterprises, resulting in 35 million lay-offs. Of course, the level of social unrest rose. But the Chinese Communist Party (CCP) weathered the storm, with plenty of help from its anti-riot police and security forces. [Source]

If recent comments are any indication, the confidence level of China’s top leaders remains high. State media quoted finance minister Lou Jiwei as saying that none of his fellow delegates to last weekend’s G20 conference think that China will experience a hard landing, according to Reuters, and that he believed growth could even accelerate. As Chovanec told The Washington Post in an interview last week, “It’s human nature to do what works until it stops working.”