Blog Post

Blogs review: The China slowdown effect

What’s at stake: As China moves from being an economy with surplus labor to an economy with labor shortages, the implications for the global economy could be far reaching. The required rebalancing of the Chinese economy appears challenging as it could reduce the income gains for ordinary citizen, destabilize the ruling elite that has benefited from an investment-driven economy and reveal the instability of the financial system.

By: Date: October 16, 2014 Global Economics & Governance Tags & Topics

What’s at stake: As China moves from being an economy with surplus labor to an economy with labor shortages, the implications for the global economy could be far reaching. The required rebalancing of the Chinese economy appears challenging as it could reduce the income gains for ordinary citizen, destabilize the ruling elite that has benefited from an investment-driven economy and reveal the instability of the financial system.

The end of cheap labor and the Lewis turning point

Mitali Das and Papa N’Diaye write in June issue of the IMF’s Finance and Development (HT Timothy Taylor) that fast-rising wages, worker activism, and intermittent labor shortages suggest that China, whose economic rise has depended on a vast supply of low-cost labor, is about to enter a period of widespread labor shortages. But the data shows that wage growth still lags productivity, resulting in rising profits, which suggests that China has not reached the so-called Lewis, at which an economy moves from one with abundant labor to one with labor shortages.

Paul Krugman writes that China has hit the “Lewis point” — to put it crudely, it’s running out of surplus peasants. The economist W. Arthur Lewis argued that countries in the early stages of economic development typically have a small modern sector alongside a large traditional sector containing huge amounts of “surplus labor” — underemployed peasants making at best a marginal contribution to overall economic output. The existence of this surplus labor, in turn, has two effects. First, for a while such countries can invest heavily in new factories, construction, and so on without running into diminishing returns, because they can keep drawing in new labor from the countryside. Second, competition from this reserve army of surplus labor keeps wages low even as the economy grows richer.

Jean-Joseph Boillot suggests that China has some tools available to delay the onset of the Lewis turning point. Given the increase in life expectancy, it shouldn’t be, for example, hard for the government to increase the retirement age.

Rebalancing in a Minsky world

Paul Krugman writes hitting the Lewis point should be a good thing. Wages are rising; finally, ordinary Chinese are starting to share in the fruits of growth. But it also means that the Chinese economy is suddenly faced with the need for drastic “rebalancing”. The question is whether this can happen fast enough to avoid a nasty slump. In ordinary times, the world could probably take China’s troubles in stride. Unfortunately, these aren’t ordinary times: China is hitting its Lewis point at the same time that Western economies are going through their “Minsky moment,” the point when overextended private borrowers all try to pull back at the same time, and in so doing provoke a general slump.

Source: FT data blog

Michael Pettis writes that for China to rebalance towards a healthier and more sustainable model without unrest, China does not need to grow at 7 per cent or even 6 per cent a year. This is a myth that should be discarded. What matters for social stability is that ordinary Chinese continue to improve their lives at the rate to which they are accustomed. If household income can grow annually at 6-7 per cent, income will double in 10 to 12 years, in line with the target proposed by Premier Li Keqiang in March during the National People’s Congress. It will not be easy though. A reduction in investment and GDP growth will almost certainly put pressure on employment and household income growth unless a significant transfer of resources from the state sector to the household sector counterbalances it. This will be strongly opposed by members of the political elite who have benefited from the strong state sector, but it is not clear that China has many alternatives. The arithmetic of rebalancing does not otherwise work.

The risk of a collapse in the financial system

Kate Mackenzie writes that there are many ways in which a crisis might not erupt in quite the way — or at quite the speed — that some commentators seem to be expecting.

Minxin Pei (HT FT Alphaville) writes that since 2008, Beijing has maintained growth with a massive injection of credit, much of it invested in speculative real estate, excessive industrial capacity, and infrastructure with dubious financial viability. In a highly leveraged economy, as China is today, a significant deceleration could quickly lead to cascading financial defaults. Deeply indebted real estate developers, local governments, and state-owned enterprises will not pay their creditors (both banks and suppliers), thus triggering chain default. This could throw the entire economy into turmoil. We saw a little preview of this during the credit squeeze in June.

Source: SoberLook (HT Marginal Revolution)

James Hamilton writes that despite the official explanations, recent moves in interbank lending rates (SHIBOR) could definitely be signaling some financial fragility. If there are significant disruptions to China’s system for funding credit, that could have implications for anyone borrowing from or lending to Chinese entities. And it may be a mistake in the world of modern global finance to assume that what happens in China, stays in China.

The distributive impact of a collapse in commodity prices

James Hamilton writes that a significant economic downturn in China could well mean a collapse in oil prices. One would think that, as a net importer, this would be an overall favorable development for the United States, and certainly it would be a significant plus for many individual U.S. firms and producers. But it’s worth remembering what happened after the collapse in oil prices in 1986. In the years leading up to that, just as today, there had been a dramatic economic boom in the U.S. oil-producing states, as oil producers invested heavily in more expensive projects. When oil prices collapsed, domestic producers took a significant hit. The labor and capital that had specialized for that sector cannot costlessly move to other regions and activities. Plunging oil prices were good news for much of the nation, but sent the U.S. oil-producing states and their neighbors into their own regional recession. 

Read more on China

China seeking to cash in on Europe’s crises

China’s financial liberalisation: interest rate deregulation or currency flexibility first?

Financial openness of China and India: Implications for capital account liberalisation

Developing an underlying inflation gauge for China

Are financial conditions in China too lax or too stringent?

How tight is China’s monetary policy?

The Dragon awakes: Is Chinese competition policy a cause for concern?

How loose is China’s monetary policy?

China gingerly taking the capital account liberalisation path


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

Pia Hüttl

Inflation's comeback

What at stake: After years of deflationary pressures and anaemic economic performance, inflation seems to be on the rise again, both in the US and the euro area. Does this comeback mark a return to target? Will it be sustained, and what should central banks be thinking? These are among the questions raised in the blogosphere.

By: Pia Hüttl Topic: Global Economics & Governance Date: February 13, 2017
Read about event More on this topic

Past Event

Past Event

Financing the Belt and Road Initiative

The Belt and Road initiative, recently embarked on by China, aims to improve cross-border infrastructure in order to reduce transportation costs across a massive geographical area between China and Europe.

Speakers: Alicia García-Herrero, SUN Mingxi, Jianwei Xu, Alessandro Carano and Sue Anne Tay Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 9, 2017
Read article More on this topic More by this author

Opinion

Alicia García-Herrero

China banks in 2017: No rebound in sight, rising risks for smaller banks

Alicia García-Herrero finds it unlikely that risk in the Chinese banking sector will abate any time soon. And the worries are strongest for smaller institutions. However, the chances of a total crisis are low, and proactive decisions now could pay dividends in the medium term.

By: Alicia García-Herrero Topic: Finance & Financial Regulation Date: February 6, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Is Germany a currency manipulator?

What’s at stake: the Financial Times reports that Peter Navarro, head of the US’s National Trade Council, has accused Germany of currency manipulation. He claims that the country uses a 'grossly undervalued' Euro to 'exploit' its trading partners. Angela Merkel replied that the Euro is managed by the European Central Bank, on which Germany does not exert influence. We review what the economic blogosphere thinks of this.

By: Silvia Merler Topic: Global Economics & Governance Date: February 6, 2017
Read article More by this author

Blog Post

Silvia Merler

Climate change and financial markets

What’s at stake: Ever since the 2016 Paris Agreement to reduce emissions was signed, researchers have been looking at the impact that moves towards a low-carbon economy might have on financial markets and financial stability. We review these contributions here. 

By: Silvia Merler Topic: Energy & Climate, Finance & Financial Regulation Date: January 30, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Tariffs and the American poor

What’s at stake: much has been said and debated — during the US election and beyond — about the distributional impact of free trade on the disadvantaged. But what would be the distributional impact of a new protectionism instead?

By: Silvia Merler Topic: Global Economics & Governance Date: January 23, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The economic effects of migration

What’s at stake: migration is currently a very hot topic in both the US and the EU. Immigration issues have come to the forefront due to the problem of rapidly ageing populations, the refugee crisis, and growing anti-immigration political rhetoric. But what do we know about the economic effects of migration?

By: Silvia Merler Topic: European Macroeconomics & Governance Date: January 16, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Compensating the “losers” of globalisation

What’s at stake: According to some, 2016’s political turmoil shows that the so-called “losers” of globalisation are striking back. There is, however, little agreement on how government should respond to this challenge.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: January 9, 2017
Read article More on this topic More by this author

Opinion

Nicolas Véron

Giving Asia its due in global financial regulation

With US inward turn, China should get a bigger role to bolster system

By: Nicolas Véron Topic: Finance & Financial Regulation Date: January 5, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

2016: The end

What’s at stake: 2016 is coming to an end. It will be remembered as an annus mirabilis and horribilis, at the same time. 2016 brought us some previously unthinkable political shocks, and admittedly took away some of our finest musicians. It also couldn’t help taking away Willy Wonka and Princess Leia, making this a much sadder Galaxy. This raises an obvious question: what are we in for, in 2017?

By: Silvia Merler Topic: European Macroeconomics & Governance Date: December 31, 2016
Read article

Blog Post

Alicia García-Herrero
DSC_0160

Is the UK’s role in the European supply chain at risk?

Will the UK’s engagement in European supply chains be at risk once the UK exits the EU?

By: Alicia García-Herrero and Jianwei Xu Topic: European Macroeconomics & Governance, Global Economics & Governance Date: December 20, 2016
Read article More on this topic More by this author

Blog Post

Silvia Merler

The American dream

What’s at stake: historian James Truslow Adams, in his 1931 book The Epic of America, stated that the American dream is "that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement”. Few ideas have ever been as powerful as the “American Dream”, and many recent political events hinge on the fear that this “dream” may be dead. Meanwhile, researchers have been trying to measure the reality behind the dream.

By: Silvia Merler Topic: Global Economics & Governance Date: December 19, 2016
Load more posts