How hard will it be for China to move away from an industry and investment-led growth model to one more driven by the services sector and consumer spending?
Very hard, if events in China’s northeastern region are anything to go by.
The three provinces that make up the country’s northeast — Heilongjiang, Jilin and Liaoning — were the poster boys for China’s industry and investment-led growth model.
Industrial value-added output accounted for 43 per cent of the region’s gross domestic product in 2013, while gross capital formation took a huge 65 per cent share. During the boom years, this helped generate faster than average GDP growth.
But now that demand for industrial goods is slowing and credit is being tightened, economic activity in the region is disproportionally suffering. GDP growth fell to 3.4 per cent year on year in the first quarter of 2015.
What is concerning is that faced with the collapse of its old economic model, the northeast is failing to develop new drivers of growth, according to analysis by China Confidential, a research service from the Financial Times.
Take the services sector. Rather than expanding to fill the gap left by the industrial sector, growth is stuttering along with the rest of the economy. GDP growth in the tertiary sector in the northeast dropped 1.8 percentage points last year, far faster than the 0.2 percentage point drop recorded nationwide.
More startling has been a sharp slowdown in consumer spending in recent months. Annual growth in retail sales of consumer goods in the region fell from 12.1 per cent in 2014 to 7.1 per cent in the first quarter of this year. That was well below the 10.9 per cent annual increase recorded in the rest of the country.
In response to the slowdown, Beijing has called for increased infrastructure spending to aid the development of new industries. But the northeast is floundering on this front, too. As the economy has slowed so have tax receipts and local government income, crimping infrastructure investment.
Local government fiscal revenues fell 23.3 per cent year on year in the first quarter; infrastructure investment fell 4.7 per cent, compared with 23.9 per cent growth in the rest of the country.
In themselves, these trends are not surprising. As the core of an economy falters, so do its peripheries. But they spell out two truths regarding China’s transition to a new economic model that are often overlooked:
1) Dismantling old models of growth before new ones are developed raises the risk of a hard landing. This is what is unfolding in the northeast. While the traditional industry and investment-led growth model is fading, there are no new drivers on a comparable scale to take its place.
2) It is very hard to develop new drivers of growth in a downturn. The northeast has found it impossible to expand the services sector or consumer spending as its economy splutters. Funding investment in new industries during a downturn has proven equally difficult.
It is easy to dismiss the northeast as an extreme example of the challenges facingChina. After all, it adopted the old growth model on a far greater scale than elsewhere.
But it is not the only area seeing new growth drivers slowing in tandem with old ones. Those provinces that recorded the sharpest slowdown in retail sales in the first quarter of this year were also the ones that reported the fastest fall in industrial output growth.
All this helps to make sense of recent policy moves in China, which seem increasingly focused on reviving the old engines of growth. Banks are again being encouraged to lend to local government financing vehicles, while a policy-led recovery in housing markets now appears to be under way.
This is not desirable but it is hardly surprising. China needs time to develop new drivers of growth. Meanwhile, it must keep its old economic model ticking over, not least because a hard landing would make developing an alternative system even more difficult.
This is not a sign of failure, but of a pragmatic approach to a difficult task.
