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Criticizing Chinese data has long been a pastime of those who are skeptical that China has racked up the strongest and longest period of economic growth in recorded history. The skeptics, quoted extensively in yesterday's New York Times, are now arguing that the change in China’s exchange rate policy announced on August 11, which has led to an almost 5 percent depreciation of the currency in the first three days of trading under the new system, is proof positive that China’s growth has slumped to a pace well below the official 7 percent number. China, they assert, is devaluing its currency to boost exports in a last gasp effort to avoid a hard economic landing.
There is no doubt China’s growth has moderated considerably from the average double-digit rate of the 2000s. This slowdown is largely because growth in housing investment has moderated for several years, reducing demand for industrial products such as steel and cement. The correction in housing investment should be welcomed, since China had been overinvesting in property, roughly in the same league as Ireland and Spain before their property markets collapsed.
But has growth fallen well below the claimed 7 percent rate in the first half, and is it likely to slump further? Critics argue that a sharp decline in overall industrial growth, very weak expansion of electric power, and declining amounts of freight movement show conclusively that growth cannot be anywhere near 7 percent. In the 2000s, industry expanded on average by almost 5 percentage points above the pace of expansion of GDP. But industrial growth slumped to only 6.3 percent in the first half of this year. Similarly, electric power production expanded by an average of 12 percent in the 2000s, but less than 1 percent in the first half of this year. Given these developments, how could GDP growth possibly be even close to 7 percent?
The first question for the skeptics is: If the Chinese economic situation is so dire, why did the authorities wait until the third quarter of this year to unveil a new exchange rate policy? If they plan to revert to the mercantilist exchange rate policy that prevailed during much of the 2000s, why didn’t they do so several quarters ago? The second question: Why didn’t the authorities devalue by a much larger amount? Depreciation is not likely to buy much growth unless it exceeds 10 percent on a sustained basis. As I have argued previously, the motive for the new policy is not to boost China’s growth but to meet the International Monetary Fund (IMF) expectation that the exchange rate of the renminbi be market determined in order to qualify for inclusion in the IMF’s special drawing rights (SDR) basket of currencies. The timing of the IMF report, released last week, seems the best explanation of the timing of China’s new exchange rate policy.
More importantly, the skeptics have taken insufficient notice of China's progress in transitioning to its new model of economic growth, one less dependent on expanding industrial output, investment, and exports and more dependent on expanding private consumption expenditure. After a decade of relative stagnation, since the first half of 2012, China’s services sector has become the main driver of its economic growth. The services sector has grown continuously more rapidly than GDP, and its share of the economy now exceeds that of industry. Expanding demand for services such as health care, education, entertainment, and travel generates little or no demand for industrial goods, electric power, or freight transport. The demand for passenger transport, in contrast to freight, is soaring as domestic tourism booms.
The expanded role for the services sector reflects a continuous four-year rise in the private consumption share of GDP. The cumulative increase is not yet large, but it is a sharp change from the previous decade when the share fell continuously. China’s average level of per capita income is now at a sufficiently high level that a growing share of consumption is for services rather than goods such as food and clothing. The rising share of private consumption expenditure is feeding off increases in disposable income—which have exceeded the pace of GDP growth for several years—and a slightly reduced household savings rate. The relatively rapid growth of disposable income is in turn the result of the continued rapid growth of wages and an improved rate of job creation in sectors with higher incomes than agriculture. All of this growth—in consumption, disposable income, wages—is hard to square with the skeptics' view that China is in an extreme slump. In effect, China is in a virtuous circle. Since the services sector is much more labor intensive than industry, the rising demand for services feeds into more rapid growth of nonagricultural employment, helping to sustain rapid wage growth despite the slowdown in GDP growth since the 2000s. In turn, these lead the growth of disposable income to outstrip that of GDP, feeding back into rapidly rising private consumption expenditure, particularly for services.
One reason skeptics mostly overlook China's transition to consumption-led growth is that there are no high frequency data to support the analysis above. At best these data are quarterly, some are annual, and some of the annual data are released with a very long time lag. The rising demand for real time analysis of the Chinese economy and growth performance has led to overreliance on industrial and investment data, which has long been published monthly. This was a reasonable approach in the 2000s when industry was the main driver of China’s growth, but not today when the sources of growth have evolved.
There are no monthly data on the aggregate growth of the services sector and very few monthly data that reflect activity in the many diverse components of the services sector. And some of the monthly data that are available, for example retail sales, are not necessarily a reliable guide to what is happening to private consumption expenditure. Retail sales data include purchases by government agencies, schools, and the military, among others. If the People’s Liberation Army buys less gas for its tanks, retail sales growth might moderate, but that reveals nothing about trends in private consumption expenditures. The slump in the sales of luxury goods reported by French multinational conglomerate LMVH and other foreign firms, cited by many skeptics of China’s growth, says more about China’s ongoing anticorruption campaign than about the underlying strength of consumption demand. According to estimates from global management consulting firm Bain, luxury goods sales in China in 2014 totaled RMB115 billion. That is a large number for the purveyors of these goods but only 0.2 percent of China’s GDP. Moreover, almost half of private consumption expenditures is on services, which are not covered in retail sales data at all.
China’s growth data are hardly flawless. They are compiled by a national accounts section of the National Bureau of Statistics that is woefully short of specialists in national income accounting. As in all major economies, China’s GDP data are subject to revisions, sometimes going back many years, as better data become available as the result of periodic economic censuses and as revised methodologies are adopted. But the case that China’s real growth today is a small fraction of the officially claimed pace has not been convincingly argued.
