The big question for the world: is China growing, slowing, or in recession?

Summary: China is both the key driver of the world economy and the least well known of the major nations. With unreliable economic statistics, a rapidly evolving economy that defies easy analysis, and deep corruption, it defies analysis. But its growth or recession might determine the course of the world economy during the next decade. This post provides a realistic outlook, debunking the dreamy consensus expecting continued rapid growth.

“God takes care that trees do not grow to the sky.”
— Ancient German proverb.

From Evercore: China might already be in a recession (red line)

This graph is from a report by Evercore ISI), founded by Roger Altman (Asst Secretary of Treasury for Carter and Deputy Secretary for Clinton) — Excerpt…

“Our proprietary Synthetic Growth Index (SGI) fell 1.1% m/m in July, and was also down 1.1% y/y. No wonder global commodities are so weak. The most recent 18 months have been much weaker than the 2011-13 period. Even if we adjust our SG I upward (for too-little representation of Services — lack of data), we believe actual economic growth in China is far below the official 7.0% y/y. And, it is not improving, Most worrisome to us; the ‘equipment’ portion of Plant & Equipment spending is very weak, a bad sign for any company or country. Expect more monetary and fiscal steps to lift growth.”

A recession under way in China would explain the collapse of most industrial commodity prices (especially oil), and raise the risk of a global “recession” (usually defined as GDP growth slower than 2%). Fortunately, they are probably wrong about China’s current GDP. Such a fast slowing from 7% to -1% would create economics shocks impossible for even China’s government to hide. Like massive layoffs.

I believe their index shows the rising stress in China’s economy. See this anecdotal evidence in The Guardian: “China’s workers abandon the city as Beijing faces an economic storm. Labour disputes are rising and some workers are leaving for the country amid fears a crashing economy could cause political and social unrest.” However, I believe their underlying story is almost certainly correct: most estimates of China’s future growth are delusionally optimistic.

A recent paper by two eminent Harvard economists provides a more realistic forecast of much slower growth — which implies real recessions (falling GDP) for China, instead of just growth slowdowns. This is also likely for India. That would remove the steady wind that has helped power the world economy since 1990, with no obvious candidates to replace them as economic locomotives.

The top line in the below graph shows the common forecast that China will rule the 21st century, as its 6% or 7% GDP growth makes them number one. US GDP is almost $17 trillion, and growing at 2 – 3%, so China will equal us in roughly 10 years — if they can sustain such a high rate of growth. A transition to a slower rate of growth would change the world; doing so (as often happens) by a recession would rock the world.

“Asiaphoria Meets Regression to the Mean“

By Les Picker of National Bureau of Economic Research (NBER)
NBER Digest, March 2015 (red emphasis added)

Much analysis and forecasting treats a country’s past growth experience as the best source of information on its future growth prospects. Because of this tendency, Asiaphoria – a relatively uncritical enthusiasm for the growth prospects of Asian economies – has arisen repeatedly. This was observed with regard to Japan in the 1960s, and it is seen today with regard to China and India.

One OECD report forecasts per capita growth from 2011 to 2030 of 6.6% for China and 6.7% for India. The World Bank and the Development Research Center of the State Council of China project annual output-per-worker growth rates of 8.3% from 2011 to 2015, 7.1% from 2016 to 2020, and 6.2% from 2021 to 2025. In official projections through 2030, the U.S. intelligence community presents scenarios implying that China’s share of the world economy will grow from 6.4% in 2010 to between 17 and 23% in 2030. For India the estimates for the same periods suggest growth from 1.8% of the world economy to between 6.5 and 7.9% . Some other estimates of China’s and India’s growth rates are even higher.

In “Asiaphoria Meets Regression to the Mean“ (there is a later version for the NBER), authors Lant Pritchett and Lawrence H. Summers examine historical data on growth rates and conclude that with economic growth, as with investment returns, past performance is no guarantee of future performance. They demonstrate that regression to the mean is the single most robust and empirically relevant fact about cross-national growth rates. The lack of persistence in country growth rates over medium- to long-run horizons implies that a country’s current growth has less predictive power for future growth than many analyses assume.

It might be the case that China will continue to experience annual per capita growth for another two decades at a 9, or even 7 or 6% rate. Given the regression to the mean present in the cross-national data, however, where growth rates historically have averaged 2% with a standard deviation of 2%, the authors conclude that continued rapid growth would be an extraordinary event. China’s super-rapid growth has already lasted three times longer than a typical episode and is the longest ever recorded. Similarly, while it might be the case that Indian growth will continue at 6% per year, this would also require a relatively rare degree of growth persistence.

The authors’ findings suggest that in projecting a country’s growth rates over the long term, forecasters should give heavy weight to the growth rates of all countries, rather than to the historical growth experience of the country being studied. They believe that, historically, most economic forecasting errors have come from placing excessive weight on a country’s recent past. This can explain why official forecasts usually miss discontinuities in a nation’s growth trajectory.

While the post-financial crisis recovery in the United States has been slower than many initially expected, and the recovery in Europe is even slower and weaker, Pritchett and Summers note that the fallout for the global economy has been much less than feared. This has been due in large part to sustained growth in China and India, which has generated positive spillovers for other economies.

Though the prevailing view in many quarters today is that rapid global growth will continue with Asia as the engine, the authors point out that that Asiaphoria proved unrealistic following the rise of Japan, the growth of the Asian Tigers (Korea, Taiwan, Singapore, and Hong Kong), and the emergence of the Asian Dragons (Malaysia, Indonesia, and Thailand). Continuation of rapid growth in Asia is only one possible path forward, and the authors call attention to the substantial possibility that the global economy will follow another one.

Typical degrees of regression to the mean imply substantial slowdowns in China and India relative even to currently cautious forecasts. They also observe that high-growth episodes often end with full, and abrupt, regression to the mean.

For More Information

Other articles about China from great sources…

• This looks prescient: “When Fast Growing Economies Slow Down: International Evidence and Implications for China” by Barry Eichengreen et al, NBER, March 2011.
• “Why worries about China make sense” by Martin Wolf at the Financial Times — The question is about their ability to shift to a consumption-dominated economy.
• Ugly: “The Mortality Cost of Political Connections in China” from NBER — “Chinese firms with a former top government official in the C-suite had higher worker death rates, few if any safety inspections, and lower rates of environmental fines.”
• “Demystifying the Chinese Housing Boom” from NBER — “Large down-payments and sharp recent increases in household income mean the housing frenzy in China is unlikely to trigger a national financial crisis.”
• Important: “China Will Respond Too Late to Avoid Recession, Citigroup Says” by Bloomberg.

Please like us on Facebook, follow us on Twitter, and post your comments — because we value your participation. For more information see all posts about China, especially these…

• Will China become a superpower?
• Will China’s Asian Infrastructure Investment Bank begin a new world order?
• A China briefing from one of the West’s best-connected experts.