Transitions in China's economy are to be embraced, not feared

The Chinese economy fared poorly in the first quarter if you look only at the growth rate.

GDP rose 7.7 percent from a year earlier, 0.3 of a percentage short of the market estimate. That rekindles debate about whether the world's second-largest economy can sustain the kind of growth it has enjoyed over the past 30 years.

The short answer is that that is unlikely, but that does not mean it is the end of the world.

As China goes through the painful transition that will help it climb the global value chain by reducing reliance on exports and low-level manufacturing, slower economic growth is inevitable.

Days of annual growth above 10 percent are being consigned to history, partly because the days of cheap labor are coming to an end.

Anyone who takes a close look at the first-quarter data will find signs that the country's economic transition is beginning to bear fruit.

The contribution of fixed-asset investment to GDP growth was 2.3 percentage points, compared with 3.9 percentage points for all of last year. Consumption in the contribution of both private and government sectors was 4.3 percentage points, compared with 4.1 percentage points last year.

These figures are a good sign, reflecting the fact that consumption is gradually making a bigger contribution than investment.

The tertiary sectors accounted for 47.8 percent of GDP in the first quarter, 1.6 percentage points higher than a year ago. This shows the reliance on manufacturing has fallen.

In addition, Sheng Laiyun, spokesman for the National Bureau of Statistics, says the government's frugality drive is hitting the hospitality industry, especially high-end restaurants.

What this shows is that the government is willing to sacrifice speed in GDP growth in favor of quality, a refreshing change in mindset.

Given these positive signs, slower economic growth is nothing to rue, especially now that the correlation between GDP and employment is not as high as it was.

For decades the Chinese government has been keen for GDP to grow a minimum of 8 percent a year, on the premise that anything below that would create huge job losses and trigger social unrest.

However, what happened last year proved that this thinking has been askew.

GDP grew 7.8 percent last year, but employment showed no sign of worsening. Rather, reports of labor shortages were common. In the first quarter of this year, too, the job market was in good shape.

Because China's official unemployment rate does not include the rural labor force, migrant workers or fresh graduates, it is better to look at independent surveys to get a sense of the labor market.

Research by Universal Consultancy of Shanghai showed that 61 percent of manufacturers and exporters in the Yangtze River Delta, a major manufacturing center, said they had recruited more workers after the Chinese New Year holiday in February. About 25 percent said their workforce remained basically the same before and after the holiday. Just 14 percent said they cut the number of workers in the first quarter.

About 400 small-sized companies, each of which recruits fewer than 500 workers, were interviewed in the survey. Compared with a year ago, those planning to hire more workers rose 8 percentage points while those wanting to lay off workers were essentially on par with last year.

In the Pearl River Delta, another manufacturing and export hub, wages in manufacturing are expected to rise 9.2 percent this year, compared with the 7.6 percent that respondents reported last year, Standard Chartered Bank said in a report.

The rise was because 88 percent of the companies surveyed believed labor shortages will be at least as severe as last year, the report said.

The fundamentals of China's labor market have obviously changed. The country used to reap a huge dividend because of its large and increasing pool of workers. But, for the first time, the working population shrank last year. That means landing a job should not be that difficult.

Given the stable job market, economic growth of 7 percent in one or two quarters is easily attainable.

That said, what should the government do to improve the economy?

First of all, it must stick to the quality-above-all approach and not swerve because of a temporary slowdown.

The government is known for its pro-growth policies, but its desire to shore up the economy, particularly underpinned by its massive fiscal stimulus and monetary loosening during the 2008-09 financial crisis, has been at the cost of delaying financial reforms, worsening the economic structure, increasing debt and damaging the environment.

If the economy is always driven by government stimulus, private-sector growth and household consumption will be dampened, harming sustainability.

In that sense, policymakers should get away from the old habit of putting major reforms on hold whenever there is a slowdown. In addition, they should accelerate much-needed reforms in fields such as foreign exchange, interest rates and private lending.

It is no exaggeration to say that the best time for China to reform its financial systems has already gone. It was not until last year that the country took a baby step to allow private lending to be legalized. It was also last year that lenders were given larger leeway to fix interest rates.

All these tasks should have been done immediately after the country reformed its exchange regime in 2005, when it started to value the yuan based against a basket of foreign currencies. Still, better late than never. What the government must bear in mind is that these reforms should be pushed forward regardless of how fast GDP grows.

Apart from these reforms, policymakers need to take concrete steps to encourage private investors.

By doing so the government can kill three birds with one stone: It can boost investment, cut the reliance on government spending and, most importantly, improve the efficiency of investment.

When stimulus policy is put into effect, government investment quickly boosts fixed-asset investment, but many of these projects either duplicate what is there or bring very little return. By comparison, private investment boasts higher returns and efficiency. What makes the difference lies in the purpose of investment. Governments sometimes invest to boost GDP figures while private businesspeople invest to make money.

To improve efficiency, the government must open up tightly state-controlled sectors such as railways, energy and finance.

That is the right path to small government and a big market.

But what should the government do if the economy goes through a greater-than-expected slowdown?

Of course, the government has to step in to prevent any hard landing. But that does not mean it can once again resort to massive stimulus and loose lending.

These fiscal and monetary tools have proven to be effective only in the very short term; the long-term negative effects on the economy can be even worse than an economic slowdown. Mounting local debt are just one.

China's local debt is estimated to be 15 trillion yuan ($2.4 trillion; 1.8 trillion euros), or nearly one-third of the country's GDP last year. Given the country's low real-term interest rate and its high savings ratio, the leverage is still manageable. Even so, local governments have faced mounting pressure to repay their debt.

The government should resort more to taxation to improve the economy. Compared with other fiscal and monetary measures, tax changes may take time to have an impact, but their effects are enduring and steady.

The author is a financial analyst in Shanghai. The views do not necessarily reflect those of China Daily.

(China Daily 04/19/2013 page8)