Earlier this year, key economic data regarding China’s manufacturing sector was released strengthening the claims of many analysts that an economic slowdown in the world’s second largest economy is occurring. Reports that “The flash Markit/HSBC Purchasing Managers’ Index fell to 49.6 in January from December’s final reading of 50.5, dropping below the 50 mark that separates expansion of activity from contraction,” are confirming that China’s slowdown has carried into 2014 with no signs of easing.
To read more about the data and figures behind the slowdown check out this NY Times article here.
Other economic indicators such as the employment rate and annual GDP growth further support this trend of slower economic growth and have triggered concerns over potential global implication.
So what explains China’s economic slowdown and what could be the potential implications that this will have on the global economy and more specifically on China’s trading partners?
The explanation for China’s economic slowdown is directly related to the ongoing restructuring of the Chinese economy. Over the past several decades, China has been shifting its workforce from rural agriculture to urban manufacturing in an effort to boost economic growth, industrialization and prosperity.
Though largely successful, the diminishing returns from such a transition are expected to decrease as time goes by and as more and more Chinese migrate to urban centers in search of jobs largely in the manufacturing sector. The balance between the urban/rural divide shifted for the first time in the nation’s history in 2012 when official statistics revealed that 51.27% of China’s population live in urban areas. Such a dramatic social and economic transition leads to rising income levels and what Peter Orszag describes as the “middle-income trap.” This phenomenon typically occurs when per-capita income levels reach $10,000 and again at $15,000 and the economy moves from rapid to sluggish economic growth. As China’s per-capita income is projected to reach $10,000 by 2015 and combined with the fact that the country has a high old age dependency ratio, high investment rates with low rates of return, and an undervalued exchange rate, it is no surprise that China has already entered the middle income trap and can expect slower growth than before.
Another important aspect of China’s economic restructuring that can affect economic growth is its labour market. For decades China has been relying on an extensive growth model which involves constantly increasing the amount of workers in production of what are mainly export goods due to the abundant supply of low-cost labour.
However, as ongoing economic growth has led to demands for higher standards of living and wages, the cost of labour has increased. Such rising costs have affected export prices and corporate profits which has translated into a lower global demand for Chinese goods. Although China in economic terms has not reached the Lewis Turning Point, the moment when an economy with abundant labour moves to a labour shortage, the demography of the labour market points at a marked decrease in the labour force (15-64 year olds). Such a decrease in the labour force further adds to the rising cost of labour which in turn has dampened the demand for Chinese goods and slowed down the economy.
As China enters a phase of slower economic growth due to restructuring of its economy, the global implications of such a phase warrant examination. A slowdown in economic growth will affect not only production but also consumption. In this case, countries that sell commodities to China such as Canada (oil), Australia (coal, iron ore, natural gas), South Africa and Brazil (industrial metals), Chile (copper) and Southeast Asian countries (rubber and coal) will experience the negative effects of a drop in Chinese demand.
Moreover, the currencies of these countries will depreciate as less and less Chinese buyers will be looking to buy them in exchange for RMB. However, such a decrease in commodity demand will lead to excess world supply which will bring commodity and oil prices down and help boost growth in the US and Europe.
If China reacts to the current economic slowdown in the same way as it did during a brief economic slowdown last decade, steel and machinery industries can expect a drop in world prices for steel, machinery and other materials. During its last economic slowdown, China exported its excess steel and machine products at very low prices, flooding the market and entering into a standoff with the US and EU. A reenactment of this scenario would surely trigger the same results and also affect countries like South Korea, Taiwan, and Japan which supply heavy machinery and construction equipment.
Other export driven countries, such as Germany, which exports high tech goods for China’s manufacturing sector which represents Germany’s fastest growing export destination, will also be negatively affected.
In regards to the US, an economic slowdown in China would not dramatically affect the US economy. Although the US consumes a large amount of Chinese made goods such as textiles and plastics, similar goods from countries such as Vietnam and Thailand can substitute for the decrease in Chinese goods.
Furthermore, other than a few key industries such as agriculture and airplane production, the demand for US goods in China is nowhere near the level of demand for Chinese goods in the US. As the US economy is largely driven by domestic supply and demand, a decrease in exports to China due to an economic slowdown would have little effect on the country’s terms of trade.
China may be entering a long-term sluggish phase of economic growth that will end an era of 8-10% annual growth that the country has experienced over the last several decades. As statistical data reveals that the country is in fact experiencing rising per capita incomes, rising labour costs, changes in demography, and a shrinking work force, analysts should not be surprised that its economy is slowing down.
Policymakers and planners should instead focus on the effects that such a transition into an intensive, consumer driven economy will create. The effects of such a restructuring will significantly impact China’s trading partners such as Australia, Southeast Asia, and Germany as supply and demand of key commodities and products contract. In fact, such a contraction should convince these countries to seek to expand trade opportunities with other countries and emerging markets.