China's economic troubles spell woe for world

China's Qindao port.

Every year, the International Monetary Fund (IMF) sends a group of economists to Australia to survey the domestic economy, comment on the effects of government policy and make some suggestions as to what might best be done in the coming year. It is known as an “article IV consultation”.

The IMF executive board's latest report was publicly released in early October. After commending Australia's economic performance during the past two decades, the report noted some challenges ahead. Chief among them is the prospect of “slow growth” in the coming year.

With a 50% drop in commodity prices from their high point in 2011 causing a 30% fall in the terms of trade, per capita real national income contracting for five quarters in a row, and GDP growth at an anaemic 2%, no growth is just as likely as slow growth.

Last year's growth in global trade was 3.6%, almost half of the 7% growth that was the norm before the onset of the Great Recession in 2008.

Just a few weeks ago, the Organisation for Economic Cooperation and Development (OECD) forecast that global GDP would reach only 3% this year — marking the fifth consecutive year of declining per capita growth rates.

But the latest review of East Asian and Pacific economies by the World Bank says that the world's economy will grow at 2.5% this year, which is 0.4 percentage points slower than it forecast in April.

The World Bank also cut its growth rate for China from 7% to 6.3%. This seems to displace reason with optimism. Crude steel production in China fell by 3.5% last month. According to the country's National Development and Reform Commission, steel output in the first eight months of this year fell by 2%. Output from January to June this year recorded the first drop in nearly two decades.

Global economic growth has relied on China for the last seven years. Now that its growth is slowing, so too is global growth.

The domino effect is evident in Japan, the world's third largest economy and Australia's second largest export market. Japan's economy shrank by 0.4% in the second quarter of this year for an annualised contraction of 1.6%.

Japanese Prime Minister Shinzo Abe's latest plan for rejuvenating the economy is to announce a GDP target of ¥600 trillion ($US5 trillion). This is despite previous stimulatory policies having little effect in both Japan and Europe.

China is going through a troubling transition that at one level has a precedent in the previous spectacular growth rates in the rich world during the two decades from 1950. The four-fold rise in manufacturing output came with a tripling of carbon dioxide emissions.

One anti-pollution measure that China has announced is to cut national steel and iron production by 80 million tonnes in the next 18 months. This is likely to be achieved by closing hundreds of smaller, unprofitable steel plants. It's likely cost will be social unrest.

China has 155,000 state-owned enterprises, with assets valued at $24 trillion, in the hands of the central and local governments. The premier of the State Council and key driver of economic policy, Li Keqiang, recently said that state-owned enterprises were “in urgent need of reforms as languid mechanisms and poor management have resulted in declining profits”.

But “urgent” in this case means the matter will be dealt with in the next five-year plan, which will be launched at the annual National People's Congress in March 2016.

The contradiction inherent in China's economic policy is that the economy is controlled by the ruling Communist Party and the overriding consideration of party apparatchiks is political, not economic. This political self-interest extends to covering-up a level of corruption inside the party that resembles post-USSR kleptocracy.

Eliminating this corruption is said to be a priority for the party leadership under Xi Jinping. But according to one seasoned China watcher, “corruption is so rampant that the danger is that no one will be left in the party if all of the corruption is wiped out”.

The chief economist at Citigroup, Willem Buiter, calculates that the Chinese economy has all the preconditions that have led to recessions throughout previous business cycles. On his reckoning, China is headed for recession next year. This would be a new experience for China's leaders. How they might respond is anyone's guess.

With Canada, Brazil and Russia already in recession, a global recession would be inescapable if Buiter is right.

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