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 Topic: Global Economics & Governance

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 about event More on this topic

Upcoming Event

Jun
24
08:30

China’s investment in Africa: consequences for Europe

How is Chinese investment impacting Africa, and what could be the consequences for Europe?

Speakers: Solange Chatelard, Maria Demertzis, Alicia García-Herrero and Abraham Liu Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More on this topic

Working Paper

China and the world trade organisation: towards a better fit

China’s participation in the WTO has been anything but smooth, as its self-proclaimed socialist market economy system has alienated its trading partners. The WTO needs to translate some of its implicit legal understanding into explicit treaty language, in order to retain its principles while accommodating China.

By: Petros C. Mavroidis and André Sapir Topic: Global Economics & Governance Date: June 13, 2019
Read article Download PDF More on this topic

External Publication

Effectiveness of cohesion policy: learning from the project characteristics that produce the best results

This study by Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza, and Catarina Midões analyses the characteristics of cohesion policy projects that can contribute to successful outcomes. Their analysis is based on a literature survey, an econometric analysis and interviews with stakeholders. About two dozen project characteristics are considered, and their association with economic growth is studied using a novel methodology. Based on the findings, the study concludes with recommendations for cohesion policy reform.

By: Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: June 11, 2019
Read article More on this topic More by this author

Blog Post

The inverted yield curve

Longer-term yields falling below shorter-term yields have historically preceded recessions. Last week, the US 10-year yield was 21 basis points below the 3-month yield, a feat last seen during the summer of 2007. Is the current yield curve a trustworthy barometer for future growth?

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: June 11, 2019
Read about event More on this topic

Upcoming Event

Jul
12
09:30

The 4th industrial revolution: opportunities and challenges for Europe and China

What is the current status of EU-China relations concerning innovation, and what might their future look like?

Speakers: Elżbieta Bieńkowska, Chen Dongxiao, Eric Cornuel, Ding Yuan, Jiang Jianqing, Pascal Lamy, Li Mingjun, Signe Ratso, Reinhilde Veugelers, Wang Hongjian, Guntram B. Wolff and Xu Bin Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Opinion

Too crowded bets on “7” for USDCNY could be dangerous

The Chinese yuan has been under pressure in recent days due to the slowing economy and, more importantly, the escalating trade war with the US. While the Peoples Bank of China has never said it will safeguard the dollar-yuan exchange rate against any particular level, many analysts have treated '7' as a magic number and heated debates have begun over whether the number is unbreakable.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: June 6, 2019
Read article More on this topic

Blog Post

A European atlas of economic success and failure

Economic growth was diverse across EU regions, yet it is crucial to control for region-specific factors in assessing growth performance. We find that there are rather successful regions in many EU countries, suggesting that the EU can provide a good framework for growth. Yet the worst performers are more concentrated in some countries, suggesting that country-specific factors can play a major role in regional development.

By: Zsolt Darvas, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: June 3, 2019
Read article More on this topic More by this author

Blog Post

The 'seven' ceiling: China's yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: June 3, 2019
Read article More on this topic More by this author

Opinion

Expect a U-shape for China’s current account

As the US aims to reduce it's bilateral trade deficit, China's current-account surplus is back in the headlines. However, in reality China’s current-account surplus has significantly dropped since the 2007-08 global financial crisis. In this opinion piece, Alicia García-Herrero discusses whether we should expect a structural deficit or a renewed surplus for China's current-account.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: May 28, 2019
Read article More on this topic More by this author

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 27, 2019
Read article Download PDF More on this topic

Policy Contribution

How to improve European Union cohesion policy for the next decade

This policy contribution investigates the performance of the design, implementation and effectiveness of cohesion policy, the most evaluated EU tool for promoting economic convergence. By analysing the effects of cohesion policy on economic growth through reviewing literature, conducting empirical research by comparing regions, as well as considering attitudes and expectations collected through interviewing stakeholders, the authors provide reform recommendations.

By: Zsolt Darvas, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: May 23, 2019
Read article Download PDF More on this topic

External Publication

Europe – the global centre for excellent research

This report, requested by the European Parliament's Committee on Industry, Research and Energy, analyses the EU’s potential to be a global centre of excellence for research as a driver of its future growth in a complex global S&T landscape, and how EU public resources can contribute to this.

By: Michael Baltensperger and Reinhilde Veugelers Topic: Innovation & Competition Policy Date: May 22, 2019
Load more posts