For years, economists have been saying that China needs to “rebalance” its economy, and the government is on board with this daunting project.
That means the country is attempting to move from an economy based on investment in industrial manufacturing to one based on domestic consumption driven by regular Chinese people working in the services sector.
That is, China has been moving toward fewer coal miners and construction workers in favor of more bankers and shopkeepers.
But what if we’ve got this all wrong? What if China is transitioning too early? That’s what HSBC economists Qu Hongbin and Jing Li have posited in a recent note, “China’s new challenge: Faster services expansion, slower productivity growth.”
From the note (emphasis added):
“Both economic theory and empirical evidence suggest that premature deindustrialisation in developing countries can be damaging. It blocks the main channel of productivity growth, and therefore reduces the economy’s potential growth rate and its prospects of catching up with more advanced economies.
“Based on the experience of some Latin American countries, a lack of adequate investment and a tendency of specialising according to short-term, rather than long-term, comparative advantage are common mistakes made by developing countries.
“This kind of development strategy can result in an underdeveloped industrial sector and slow productivity growth. Given that China’s GDP per capita is only 14% that of the US, we believe it is way too early to shift towards services-led growth.”
Work, work, work, work, work
What really worries HSBC is that the service sector’s jobs, while in general more labor intensive, are less productive for the economy than jobs in the industrial and manufacturing sectors. The bank’s analysts point out that workers in the former are just 80% as productive as those in the latter.
Arguing against a shift to service-led growth is a super controversial thing because the Chinese government has already made rebalancing a top project – if not in deed, then certainly in word. The reason for that is simple: debt.
China has a debt-to-GDP ratio of over 280%. Most of that is concentrated in the industrial and manufacturing sectors. In 2009, when the world was falling apart, the Chinese government decided to just open the money spigots to keep its economy running at full steam.
That, coupled with a general lack of global demand for materials like steel and coal produced in Chinese factories, has led to overcapacity in those sectors.
So, to combat that overcapacity, China would like to have fewer people working the jobs where they’re making the things that it seems the world has entirely too much of.
The rest of the world would love that, too. Last week, the US House of Representatives held a hearing on the Chinese economy, “Evaluating the Financial Risks of China,” and much of it focused on what that country’s economic slowdown has done to the American steel industry.
During the hearing, Thomas Gibson, president of the American Iron and Steel Institute, pointed out that 33 steel manufacturers have gone bankrupt since the 1990s. He also said that, between 2011 and 2015, the Chinese government claimed that 90 million tons of overcapacity in its steel market had been taken care of. In reality, 300 million tons had been added to China’s steel output.
So what Gibson would like is for China to slow its production and wind the steel industry down.
The problem with this solution, says HSBC, is that moving away from industry and manufacturing means that China won’t grow as fast – not just in the short term, but also in the long term.
From the note (emphasis added):
“The efficiency loss during such a ‘rebalancing’ can be huge. Between 2012 and 2015, the total number of migrant workers in the manufacturing sector declined by nearly 7m, compared with an increase of 5m in the three biggest services sectors (ie wholesale and retail, residential services, transportation and logistics). Based on 2015 statistics, each worker in the manufacturing sector generated RMB45,000 more output than their counterpart in the three biggest services sectors. Therefore, if all 5m workers had been employed in the manufacturing sector rather than services, China’s total output in 2015 could have been RMB225bn higher, which is around 0.3% of annual GDP.”
HSBC suggests that the country makes more targeted and productive investments in the manufacturing and industrial sectors. But, to be honest, the Chinese government hasn’t shown that kind of subtlety. Even now, banks continue to lend to unproductive corporations in order to keep workers employed and avoid a hard landing in the short term.
Meanwhile, the transition to the service sector continues.
Pretty controversial ideas, no?