Early last month I published a report, written with Donghyun Park of the Asian Development Bank and Kwanho Shin of Korea University, in which we sought to pinpoint the per capita income threshold at which fast-growing economies slow down. We concluded that China will reach that threshold in five to seven years.
That piece went viral on the web. One potential explanation is that Nouriel Roubini simultaneously made some provocative statements about an impending Chinese crash. Another is that China’s 12th five-year plan, details of which were released just before our report, projected annual growth of only 7%, down sharply from the double-digit rates to which China-watchers have grown accustomed. But here it is worth recalling that the 11th five-year plan that ended in 2010 had projected 7.5% annual growth, something that decisively failed to transpire.
The best explanation for the attention we received is that our conclusions tapped into pre-existing fears. Everyone understands that China can’t keep growing at double-digit rates forever. When its growth rate falls, the implications for the global economy and, especially, Asia will be far reaching. Our contribution was to remind observers that China’s slowdown is coming sooner rather than later, and that the time to prepare is now.
Our report attracted criticism, too. Some argued that there was no unique level of per capita income at which fast-growing economies automatically slow down. Others challenged the notion that the prior experience of countries experiencing slowdowns tells us anything about China, since the country is sui generis.
In fact, our study documented that earlier slowdowns occurred at a range of income levels, of which $16,000 in 2007 international prices, the level at which China will be in five to seven years, is only the average. While there is at least one iron law of slowdowns – catch-up economies can’t stay in catch-up mode forever – country characteristics and policies can influence the timing of the slowdown for better or worse.
A high old-age dependency ratio makes a slowdown more likely, since it means that more savings must be directed toward healthcare and pensions, and less to infrastructure and capital accumulation. So does a high and rising inflation rate, which is a sign of frothy financial markets and overheating. And so, most importantly, does a chronically undervalued exchange rate, which encourages unproductive investment when a country holds on for too long.
Ageing, inflation and currency undervaluation are three of China’s macroeconomic signatures. This suggests that, accounting for China’s peculiarities, there is even more reason to worry about the country’s growth slowing.
Determining the exact hour at which Chinese growth will slow and by how much is beyond the capacity of economic science. But the direction of the change – slower growth, and sooner rather than later – is incontrovertible.
The implications for Asia and the world will be profound. But those implications will be very different for different emerging markets. Countries such as Indonesia that have been prospering by selling energy and materials to China will find life harder, as China’s demand for resources starts to grow more slowly. They will have to develop the manufacturing industries whose growth has lagged as a result of the global resource boom.
At the same time, countries such as Vietnam and Cambodia will be able to carve out more space for their assembly-oriented manufacturing industries. China will continue to experience double-digit increases in labour costs as its increasingly militant workers demand their share of the economic pie. This will accelerate the relocation of labour-intensive manufacturing to other lower-wage Asian countries.
And with higher Chinese wages will come more Chinese consumption. Countries like South Korea that have concentrated on selling China investment goods will have to shift to selling it consumer goods.
All this suggests the advent of a very different economic landscape in Asia. Commodity exporters must look forward to growing more slowly. Labour-abundant low-wage countries will have the opportunity to grow more rapidly if they can occupy the economic space vacated by China. The region’s more advanced industrial economies will have to move rapidly from the production of investment to consumer goods. This will require a better understanding of the tastes of the Chinese consumer.
In all cases, there will be a premium on economic and policy flexibility. Nimbleness will be everything. Continuing with the status quo will not be an option.
Or maybe the next decade will be just like the last one – except that the fast-growing economy around which Asia is organized will be India, not China.
Barry Eichengreen is George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley. His most recent book is Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the IMF (Oxford University Press)