Navigating Policies for the New Normal

January 14, 2015

Bert Hofman China Daily

Global growth in 2014 was yet again lower than initially expected, continuing a pattern of disappointing outturns over the past several years. Growth picked up only marginally in 2014, to 2.6 percent, from 2.5 percent in 2013. The global growth outlook for 2015 is not rosier either: it is expected to rise moderately to 3 percent, and an average about 3.3 percent through 2017.

Several major forces are driving the global outlook: soft commodity prices, persistently low interest rates but increasingly divergent monetary policies across major economies, and weak world trade. In particular, the sharp decline in oil prices since mid-2014 will support global activity and offset some of the headwinds to growth in oil-importing developing economies. However, it will continue to dampen growth prospects for oil-exporting countries, with significant regional repercussions.

Risks to this slow-moving global recovery are tilted to the downside. If the eurozone or Japan slips into a prolonged period of stagnation or deflation, global trade could weaken further.

So how will China navigate this ever-complex and fragile international economic landscape? The World Bank projects a 7.1 percent growth in GDP for 2015, followed by 6.9 percent in 2016 - still impressive, and contributing more than a third of global growth in 2015. The "new normal" growth rates reflect the government's desire to pursue structural reforms that would allow the country to maintain a fast-paced but more sustainable and equitable long-term growth. The agenda, set at the Third Plenum of the 18th Communist Party of China Central Committee, is capable of delivering such growth and the implementation thus far has been promising.

In implementing these reforms, China is facing a delicate balancing act: some of the reforms, notably those that slow down the rapid credit growth that China experienced in the past are desirable, as they reduce the risk of a hard landing in the future. They also prevent a further buildup of wasteful excess capacity in industry and ghost towns. But some fear that a too rapid slowdown would compromise growth and employment if no other sources of demand emerge. At the same time, reforms that would spur higher quality growth and create new jobs in the new economy may take time to bear fruit.

How should China strike this balance? First, it is important to observe that despite the lackluster recovery in high-income countries, China's economy will still benefit from growing external demand and lower oil prices - adding perhaps a percentage point in growth in 2015. This contrasts with the years right after the global financial crisis, when domestic demand had to carry all the weight for growth.

Second, by any measure, despite lower growth in recent years, employment conditions remain robust - with wages growing by slightly more than 10 percent for urban units in the first nine months of 2014, and 10.2 million new urban jobs created in the first nine months of 2014, exceeding the government's targets.

Third, those sectors that are likely to grow more rapidly as a result of reforms are more labor intensive than the heavy industry that has benefited from the credit boom after the global financial crisis. In the first three quarters of 2014, services grew by 7.9 percent contributing close to half of China's GDP growth. This is significant for the demand for labor, as for every percentage of growth in the services sector one can expect more jobs created than the same growth in industry.

Finally, credit growth has been less and less effective in boosting demand. Indeed, whereas before the global financial crisis 1 percent growth in credit was associated with 1 percent growth in GDP, in recent years it needed 3 percent credit growth for 1 percent GDP growth, because much of the credit leaked into asset price inflation rather than real activity. The upside of this fact, though, is that a slowdown in credit growth is likely to have less effect on growth slowdown than before.

What to do if this year's growth were to slow down below what is deemed desirable? China has the policy buffers to do more if needed to keep up demand, including sufficient fiscal space to accommodate a larger central government deficit to compensate for the expected lower local deficits. The country could also take measures to reduce costs for banks so they can better absorb the effects of deposit insurance and deposit rate liberalization. Irrespective, key for China's long-term economic success is that such measures complement rather than substitute for the reform agenda that will sustain China's relatively high, efficient and sustainable growth for the coming decades.

The author is World Bank country director for China.

(first published on China Daily on Jan. 14, 2015)