Opinion

James Saft

China’s creaking export model: James Saft

October 15, 2013

Oct 15 (Reuters) – That creaking sound you hear just might
be the Chinese export-driven economy model about to break.

While most of the world’s attention is focused on the
interminable and badly sung opera in Washington, China just
released a set of data that indicate a serious slowing in demand
for its products, particularly from its emerging market trading
partners.

Chinese exports in September fell 0.3 percent from a year
ago, customs officials said. While demand for Chinese products
flagged in the European Union, the main culprit seems to have
been emerging markets, which have been hit hard by slowing
capital flows. Exports to Southeast Asia fell to a 17-month low,
while those to South Africa were also hit hard.

Emerging markets had a hard summer, as expectations, now
reversed, that the Federal Reserve would slow its purchases of
bonds made borrowing money internationally more difficult.

And yet, despite the fall in exports, the rest of China’s
economy, which is still predicated on demand from abroad, is
carrying on as if nothing has changed. Imports were sharply
higher in the month, especially of the sorts of raw materials
needed for export industries and to invest in infrastructure to
support more exports. Credit creation also rose, with doubtless
much of it going to support imports and property investment.

Imports of crude oil and iron ore set a fresh record in
September, while copper shipments jumped 18 percent to set an
18-month high.

For decades, China’s economic model has been relatively
simple: use a lower wage base to drive exports and re-invest
most of the profits into the infrastructure and factories needed
to create yet more exports. Though this approach worked
brilliantly for years, there were two big longer-term weaknesses
with this plan. Both of them may be coming into play just about
now, which would both explain decreasing demand for Chinese
goods and make it more difficult for China to cope.

Wage growth in China has far outpaced inflation, making it
less competitive. Wages in Chinese manufacturing have more than
tripled in 8 years, while the supply of rural workers streaming
to cities has slowed. Boston Consulting Group sees more
so-called onshoring of jobs back to the United States, driven by
wages, automation and energy and transportation costs.

The paired weakness is in China’s consumer economy, which
has been small and has suffered as the economy remains focused
on investment, often in houses, for which there is little
natural demand.

CHINA’S PLAYBOOK

It is unclear if slowing exports are being driven by
cyclical trends, like weakness in emerging markets, or secular
ones, like the migration of manufacturing. September’s figures
may also look worse than they were due to a crackdown this year
on phantom imports, which have been a popular way for companies
wanting to bring money into the country to skirt Chinese capital
controls.

If there is a sustained fall in demand for China’s products,
its options may be somewhat limited. Given the centrality of
investment and exports to China’s economy, the government has a
track record of reacting forcefully to slow-downs. The tactics
include easing monetary conditions, which stimulate loans and
investment even in the absence of strong demand for the end
product.

But such easing may be a bit difficult right now.

China’s annual consumer inflation rate rose to a seven-month
high of 3.1 percent in September, driven by food inflation, in
particular vegetables. While this was driven by weather, and
thus may subside, it will serve to limit the central bank’s
ability to loosen conditions.

In some ways, the biggest issue isn’t limitations on
government stimulus if China needs it. One of the advantages of
a single-party state with strong control over banking is that
the government can always foment credit growth.

The problem instead is what happens if exports don’t come
back, if change is long-term and mostly in one direction. That
will put a lot of pressure on China, not least because a lot of
the investment there since the great financial crisis has been
of very low quality.

It is not simply empty cities filled with “investment”
apartments. It is everything from the cost and wastefulness of
infrastructure investment to low-yielding research and
development.

An IMF study from 2012 estimated that China’s
over-investment is equivalent to between 10-20 percent of annual
output every year. ()
Not only does that imply very, very low returns on investment,
it almost certainly points to lower growth over time if, or
rather when, China is forced to move away from its export model.

That story, when it happens, may make U.S. political
dysfunction look like small potatoes in comparison.

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