China’s Economic Miracle- The fall is near

One intriguing phenomenon in recent history is our perverse habit of slapping the label “miracle” or “model” on fast-growing economies right before they lapse into stagnation or implode. In the 1980s, Japan’s economic achievement gave rise to the notion of a “Japanese model,” shortly before its real-estate and stock-market bubbles burst. A few years ago, our obsession with China’s rise led many to believe that the Chinese had also found a secret path to enduring economic success.

The idea of a “Chinese model,” loosely defined as a mix of state capitalism and authoritarian rule, gained popularity, both in China and the West.   In retrospect, it seems that countries should avoid being labeled “miracle” or “model” at all costs because such recognition is a sure indicator of imminent economic catastrophe. Twenty years ago, Japan experienced the humiliation of going from world economic champ to chump within a few years of its financial meltdown. Today it seems to be China’s turn.

Recent data from Beijing indeed show a very rough patch ahead for the world’s second-largest economy. Industrial production, which roughly accounts for half of China’s GDP growth, rose only 9.3 and 9.6 percent in April and May respectively, far below the average annual rate of nearly 15 percent for the last decade, and about 25 percent below the pace for the last 12 months. The growth of electricity consumption, a more reliable indicator of economic activity, slumped to 3.7 percent in April, half of its usual rate. The June numbers were hardly better. China’s manufacturing activity, based on the official Purchasing Managers’ Index, showed the slowest growth since last November.

Foreign trade, one of the twin engines of Chinese growth (the other is fixed-asset investment), presented a mixed picture. While the trade data for April showed virtual stagnation, with exports growing at only 4 percent and imports grinding to a halt, May must have brought much-needed relief to Beijing, as exports grew 15 percent, far exceeding lowered expectations.

The only relatively bright spot in this dismal landscape is domestic consumption. China’s retail sales grew at an average of 14 percent in April and May. But since household consumption accounts for less than 40 percent of the GDP, the impact of rising retail sales on growth is modest at best.

The precipitous slowdown of the Chinese economy, caused by economic woes in Europe (China’s largest trading partner) and weak domestic demand attributed to stagnant growth in investment, has led the World Bank to reduce its forecast for Chinese growth to 8.2 percent for 2012 (China grew 9.2 percent last year) and forecast 8.6 percent for next year. Credit Suisse, the investment bank, has cut the Chinese growth rate even further, to 7.7 percent for 2012 and 8.2 percent for next year.

Obviously, struggling developed economies would do anything to have China’s growth rates. But for a country accustomed to double-digit growth for three decades, a transition to high single-digit growth presages not only the potential for political and social turmoil, but also a difficult period of structural economic change.

To put it differently, if not starkly, the recent deceleration means the end of the so-called Chinese economic miracle. The era of rapid economic growth driven by investments and exports is over for China.

To many veteran China watchers, China’s economic slow-down is all but inevitable. For the past decade, liberal economists, international financial institutions like the World Bank and the IMF, and China’s major trading partners have been urging China to change its state-led development model that has relied excessively on fixed- asset investment and export for growth, at the expense of household consumption.

They have repeatedly warned that channeling resources to projects favored by the state would crowd out the private sector and waste precious capital, while squeezing the income for average households and reducing their capacity for consumption. In addition, such a strategy was almost certain to raise trade tensions with the West since rapid growth in investment, by creating industrial overcapacity, would force Chinese companies to dump their excess production on the global markets.

Sadly, for many years, such warnings fell on deaf ears in Beijing. Giddy with the apparent success of the much-touted “Chinese model” and unwilling to undertake the reforms that would make growth more balanced and sustainable, Chinese leaders paid mostly lip-service to rebalancing the Chinese economy.

Macroeconomic indicators for the past decade show worsening domestic imbalances, with investment rates consistently in excess of 40 percent of GDP since 2004 and household consumption falling to around 35 percent of GDP in the same period, the lowest for a major economy (by comparison, household consumption accounts for 70 percent of GDP in the U.S.).

In the meantime, China’s external imbalances, reflected mainly in huge trade surpluses, have grown as well. In 2007 and 2008, China’s trade surpluses reached an astonishing 8 to 9 percent of GDP. In the last three years, as Western demand for Chinese goods fell and labor and material costs rose, China’s trade surpluses have dropped below 2 percent of GDP.