China’s slowdown is only to be expected for an economy that’s reached middle-income status after three decades of astonishing growth. But Beijing is now worried that, having raised average incomes to $3,000 a year, the world’s second-largest economy will slow down so much that it will never become more prosperous. In other words, China fears falling into the “middle-income country trap” where nations, like many in Latin America, never make it to the top tier of the world’s richest countries. Indeed, only a few, such as South Korea and Spain, have made it into this club since the war.
There are doubts over whether such a trap exists, but Beijing won’t take that risk. What’s more, relying on investment to drive much of its growth has pushed debt levels to worrying levels, so the Chinese government has embarked on an ambitious restructuring of its economy to raise productivity and innovation. It now relies less on old drivers like investment and exports, and more on market forces, as befits a country with a new middle class whose consumption of goods and services can drive growth. But re-balancing the economy and producing innovative companies takes time, and there is no guarantee of success. Compared with other countries that have become rich, China has the added problem of reducing the influence of the state-owned sector, which still dominates key parts of the economy.
No wonder there are doubts about the ability, and perhaps even the commitment, of the Chinese government to manage a challenging transition. That came to the forefront this week when a slump in Chinese share prices triggered panic in markets around the world. The slump may be a sign that the underlying economy is much more fragile than we thought. The ruling Communist party insists that the slowdown from annual growth of 10 per cent to 7 per cent is all part of the plan but others worry that the transition is out of control.
Beijing’s failure to stop falls in the stock market, despite recourse to heavy-handed measures like preventing the sale of shares, is proof for many that it cannot manage the broader economy. Others are more sanguine but still worry that China’s slowdown will not be a smooth process. In any case, a slowdown is inevitable and will not merely affect companies producing commodities such as oil and copper but also multinationals selling wealthy Chinese a host of consumer goods and services.
It has already affected us thanks to London’s importance as a financial centre. Around half the companies listed on the Stock Exchange are multinationals and many international commodity stocks are traded here. They were among the shares — and therefore investors — hit on Monday when the FTSE experienced its worst one-day fall since the 2008 financial crisis.
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Britain will also be affected by the health of the world economy, and China is an engine of global growth. According to the International Monetary Fund (IMF), China has contributed as much to world GDP growth as the United States since the early 2000s, and even more than the world’s biggest economy since 2008.
So, a prolonged Chinese slowdown will be widely felt. For western nations like ours, the sliver lining is that the countries worst affected are likely to be those in Africa and Latin America that export commodities to China. But it’s not just commodities. Imports of capital goods like industrial plant and machinery have also fallen, which will affect countries like Germany, one of our key trading partners.
Just as when the United States enters a recession, there’s not much that western companies or indeed countries can do about China’s difficulties apart from trying to reduce their dependence on it.
The next phase of China’s crisis is likely to be felt in the wider financial sector, not just in shares. That’s where Britain and other western economies can prepare themselves. As China promotes the use of its currency internationally and begins to integrate its financial system with the rest of the world, the risk of contagion from a crisis in Beijing is growing. At present, this is why China’s slump has nothing like the same effect a similar catastrophe in the US would have, as we saw when the collapse of Lehman Brothers in 2008 triggered a global recession. We must ensure safeguards protect us from future crises made in China.
This week’s stock market crash isn’t like Wall Street in 1929 or even 2008. But if interest rates in the US and Britain begin to rise in the next year, as many expect they will, while China’s economy continues its bumpy ride to lower growth, it could easily trigger a second wave of global economic weakness reminiscent of the catastrophic recession of 1937-8 that blighted the world and condemned millions to poverty.