A key issue for China’s economic policy in 2013 is to correctly assess the growth dynamic, or more precisely its weakness, within the US, Europe and Japan. The practical importance of this issue was rammed home by 2012’s experience. At the beginning of last year China projected a 10% export increase, which was only possible if the developed economies significantly expanded. This did not occur. The US experienced modest growth, around two percent, but Europe and Japan slipped into economic downturn. China consequently failed to achieve its 10% export growth target.
Failure to correctly assess export prospects, overestimation of the degree of growth in the advanced economies, in turn negatively affected China’s overall economy policy. As external demand was lower than expected the degree of domestic economic stimulus required was underestimated, China’s overall economic growth was consequently weak by its own standards in the first part of 2012 – the annual increase in industrial production falling to 8.9% in August and GDP growth declining to 7.4% in the 3rd quarter. More rapid growth only revived after a rather too delayed domestic stimulus launched from the summer.
For economic perspectives it is therefore important to be clear from the outset that 2013 will be another depressed year in the developed economies. The US economy should continue to grow, but at a low rate by historical standards. It is already possible to predict growth will be negligible in the European Union and probably Japan – although there some results may be produced by the latter’s new government’s stimulus policies. Overall China will therefore face a difficult trade situation. Domestic demand will be all important.
The difficult prospect for the developed economies, and therefore for China’s trade with them, is clearly revealed by analyzing their investment situations. It is sometimes mistakenly believed that because consumption is a larger proportion of an economy than investment it is the former which determines whether an economy grows or contracts. This is an arithmetical error. Consumption is a larger percentage of the economy than investment but it is also comparatively stable – particularly when ‘Keynesian’ counter cyclical policies are operated . Fluctuations in investment are much larger than those in consumption and therefore determine growth prospects.
For example in the US during the ‘Great Recession’ after 2007 the maximum decline in US household consumption was 3.4% while US government consumption did not fall at all. But the maximum decline in US fixed investment was 26.4%. In money terms, the maximum decline in US household consumption during the US Great Recession was $313 billion in inflation adjusted terms. But the maximum fall in fixed investment was $558 billion, or more than three quarters greater. Econometrics shows over 50% of economic growth in an advanced economy is accounted for by changes in capital investment.
Looking at the advanced economies entering 2013 reveals a clear picture. In all three major advanced economic centers investment has not even recovered to pre-financial crisis levels and recent indicators are negative. Taking these three main economic centers in turn:
- In the US, private fixed investment peaked as long ago as the 1st quarter of 2006 - over six years ago. In the 3rd quarter of 2012 its was 16.2% below its peak. In the last quarter US residential investment recovered slightly, but from a state of semi-collapse – US residential investment is 52.7% below its peak. US non-residential investment declined in the last quarter.
- In the EU fixed investment in the 3rd quarter of 2012 was 17.3% below its pre-crisis peak and has been falling for the last five quarters.
- In Japan the peak of investment was in 1991 – fixed investment in Japan has been falling for an astonishing 21 years. After a temporary boost from reconstruction following the earthquake and tsunami Japan’s fixed investment turned down again in the 3rd quarter.
Japan’s new government is putting forward a moderate size stimulus package – although given the long term depression in Japan’s economy it remains to be seen how effective this will be. However in the US and Europe no such programs are being advanced. Without a substantial recovery in investment strong growth in the advanced economies is impossible in 2013.
The impact of this on China is clear. Not only are the advanced economies stagnant but their trade performance is worse than their growth. In October, the latest month for which aggregated data is available, imports into developed economies were 6.4% below pre-crisis peaks and had been falling since January. Only the rise of imports into developing economies, which are now 22.3% higher than before the financial crisis, stopped China’s export difficulties being greater. To give precise trends, in inflation adjusted terms Japan’s imports were 2.6% below pre-crisis levels, the US 5.2% below and the Euro area 9.7% below. In contrast imports by Latin America were up 13.5%, by Africa and the Middle East by 24.7% and by developing Asian economies by 25.8%.
While import trends by developing economies are encouraging, half China’s exports still go to developed economies. China’s exports to developing economies are insufficient to fully offset the depressed conditions in the US, Europe and Japan.
China will therefore continue to suffer negative headwinds from the situation in the advanced economies in 2013. Import growth by developing economies will partially but not fully offset negative trade trends in advanced economies. Domestic demand will be decisive.
So far China’ moderate investment led stimulus launched in summer 2012 has been sufficient to speed up economic growth. Hopefully this will be enough and a further stimulus to domestic demand will not be required. Current projections of China’s growth for 2013 of 8.0%-8.5% are satisfactory in present international economic circumstances. But given the situation in the developed economies surprises in 2013 are more likely to on the downside than the upside. At least some contingency planning for a further boost to domestic demand, if required, may be required.
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The article originally appeared in Shanghai Daily.
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