China just won't stop growing
Aug 01, 2012
Publisher: Yahoo! Finance: The Exchange

Some recent media reports have seized on the fact that China's GDP growth rate is now below eight percent. The biggest concern is that, without eight percent annual growth, China will not be able to continue creating the jobs needed by millions of migrant workers. Rising unemployment rates will in turn lead to social instability.

The big question for China: Is there a life after growth drops to 7.6 percent?

Before answering, it is helpful to review some history. In 1993 the Chinese government set a goal of eight percent growth. Why eight percent, instead of seven or nine? Because that was the annual rate of growth needed for China to quadruple its 1980 GDP by the year 2000. Although there was no complex economic model behind the magic eight as the optimal rate of growth for the nation, it became China's growth target for about two decades. Is there a good reason to think the sky is now falling only because China now grows at less than 8 percent?

Granted, 7.6 percent year-over-year growth in the second quarter is the slowest since 2009, but is that really enough to support those who say that China "might already be in recession" (Trevor Moss, Foreign Policy) or ask "Will China push America into a recession?" (Paul B. Farrell, MarketWatch)? These fears are overblown.

A Lucky Number

For China, eight is a good number. The Chinese consider it a lucky symbol; it represents a growth target that is ambitious yet within reach, and it is a clearly defined goal that signals the direction of macroeconomic policies. Perhaps most important, by setting a stable GDP target and succeeding in meeting that target every time, Chinese policymakers provide investors and the general public with confidence that they have the ability and every incentive to offer an environment of stable economic growth.

But the magic eight is not always a blessing. It takes tremendous resources and efforts to meet such a growth target, often at the expense of efficiency and sustainability. Years of excessive focus on eight percent have left China with problems such as environmental deterioration, inequality and overcapacity. Downshifting from that mentality will allow the Chinese government to revisit their policy goals, evaluate policy options and set new priorities. If China can manage to rebalance its economy and address some of these challenges effectively, at the expense of one percentage growth per year, that is very good news for China and for the world.

An example: the recent measures taken to liberalize interest rates. By eventually removing deposit rate ceilings and lending rate floors, the Chinese central bank will provide Chinese banks with more flexibility when setting the interest rates they offer to their customers. This reform is a huge step toward improving the efficiency of China's capital market; however, it has negative impacts on the economy in the short run. The reform has the side effect of tightening both deposit and lending rates are expected to increase, translating into lower GDP. These reforms would probably have been further postponed if this year's growth rate had remained the policymakers' only priority. However, letting interest rates rise to match market demand means better allocation of financial resources, which will benefit the economy for many years to come.

Or take a look at China's housing market. In the past, efforts to combat speculative housing bubbles in regions were often abandoned when local governments scrambled to meet growth targets. When settling into slower growth, policymakers will be able to focus on other policy goals such as social equality and devote more resources to affordable housing, even though building skyscrapers will generate more GDP.

But Is This Growth Sustainable?

No country can grow at 8 percent forever, not even China. Barry Eichengreen of the University of California and a group of co-authors constructed a dataset of rapidly growing countries since 1957. They find these countries slow down by at least 2 percentage points when their per capita incomes reach around $17,000 (in 2005 constant international prices). China is on track to achieve this level by 2015, or soon after. In the course of a country's growth, slowing down is natural; it is not a catastrophe.

The global slowdown as of mid-2012 has become a reality. The world is not done with deleveraging. Demand from advanced countries will remain weak in the near future. To foster domestic demand requires years of structural changes which will translate into slower growth for the present. In this context, for the Chinese government to hold on to that magic number eight means excessive, inefficient investments. It is time for Chinese policymakers to rethink what they did right and what they still need to accomplish. The greatest merit of Chinese style growth target is policy certainty for the market. For that, a sustainable seven may be better than an impossible eight.

Tong (Cindy) Li is a senior economist at the Milken Institute, a Los Angeles-based think tank.