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China's worryingly high growth target

China's worryingly high growth target

Reform necessitates slower growth

by Gabriel Stein

Wed 12 Mar 2014

Earlier this month, the Chinese parliament set a 7.5% economic growth target for 2014. The National People's Congress (NPC) is fairly toothless, but the goal is a statement of intent. It is, therefore, unfortunate that the target is too high. Not because it may be unachievable but because China needs weaker growth. Setting an excessive target implies that the Chinese leadership does not yet understand this.

In a world where output growth is still sub-par, it might seem churlish to complain about growth being too strong. Nevertheless, the target is worrying.

This goes back to the issue of Chinese structural reform. The current leaders in Beijing have pledged to rebalance the economy, moving away from export and investment-led growth and giving greater scope to household consumption.

Household consumption must grow faster than GDP if its share in total output is to rise. Household spending is currently around 35% of GDP. If it were to grow by 10% (a rate rarely achieved in the past), that would contribute 3.5 percentage points to GDP growth. But this means that the other components of GDP would need to contribute four percentage points, growing by 6.2% to achieve a total of 7.5%. (Note that this is a very sharp slowdown from the rates achieved in recent years.) After one year, household consumption will have increased its share of GDP to just below 36%. Assuming that the aim is to lift household consumption to 50% of GDP – very low by developed economy standards, still low by emerging economy standards – these growth rates have to be maintained for 17 years.

While not impossible, this sounds unlikely. More likely path is that household consumption will increase by less, while growth in the rest of the economy, including exports and investment, is considerably weaker. This means total GDP growth well below 7.5%, most likely even below 5% over the medium term (three to five years) and longer term (up to ten years). So it would have been better if the leadership had tried to massage down expectations by setting a somewhat lower growth target. This may perhaps be going on. Finance Minister Lou Jiwei has said that there is considerable latitude around the 7.5% goal and that 7.2% would be considered on target as well. But Lou is also the man who, in last summer said China could live with growth below 7% – only to have his comments redacted away from the official Xinhua website.

The worry here is that President Xi Jinping and Premier Li Keqiang, are either less committed to reform than they seemed to be or they are encountering stronger-than-expected opposition to their policies.

This could be important. The impression is that China has found a solution to the problem of how to achieve an orderly transfer of power in an all-controlling de facto one-party state. The idea is that a leadership pair gets two five-year terms. At the end of the first term, their successors are anointed and then serve a five-year apprenticeship before taking over the reins.

However, as Professor Michael Pettis of the Guanghua School of Management at Peking University has noted, this pattern rests on only two precedents. Both the previous pairs – Jiang Zemin and Li Peng (1993-2003) and Hu and Wen (2003-2013) – were in effect chosen by Deng Xiaoping himself. The current duo is the first not to have Deng’s blessing. If there is indeed strong opposition to their chosen path, the least disturbing time to replace Xi and Li would be at the end of their first five-year term in 2017-18. But that also means that if they are really committed to reform, they must ensure that China is firmly on that path before then. Announcing an unrealistically high growth goal for this year runs contradictory to this aim.

The lofty target could also be a sign that the authorities aim to loosen monetary policy. The People's Bank of China has recently tightened policy. This stance is linked to China’s programme of financial market reforms. Loosening policy could therefore be another sign that the reform drive is slowly losing impetus.

This is not to say that China won't be able to achieve 7.5% growth. The real problem is not so much this year but coming years. Continued excessive investment, an improving world economy and, no doubt, some creative accounting should ensure the growth target is hit. But this only increases the rebalancing that will eventually be needed. Add to this the fact that overhauling the financial system should entail weaker growth initially, and it is difficult to avoid the impression that the unchanged growth target indicates at the very least a disinclination to implement reforms just yet.

Gabriel Stein is Director of Asset Management Services of Oxford Economics and Chief Economic Adviser of OMFIF.

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