The Slow Boat from China

Is the world ready for Beijing's economic new normal?

The world is having a hard time accepting a slowing Chinese economy. Hooked on 30 years of 10 percent average gains in Chinese gross domestic product (GDP), growth-starved economies around the world are desperate for more of the same. But it isn't going to happen.

Some six years ago, China's then premier, Wen Jiabao, posed a paradox that came to be called the "Four Uns": though China's economy looked strong on the surface, Wen argued it was increasingly "unstable, unbalanced, uncoordinated, and ultimately unsustainable." The debate those remarks sparked is now over, and a new Chinese growth model is at hand. China's 12th Five-Year Plan, enacted in 2011, calls for a shift to an economy driven increasingly by domestic consumption, rather than one driven largely by exports and investments.

China's new generation of leaders, President Xi Jinping and Premier Li Keqiang, are now focusing on implementing this daunting structural transformation. During the U.S.-China Strategic and Economic Dialogue on July 10-11, an annual meeting between high-ranking officials from the two countries, the opportunities and the risks of this rebalancing will feature prominently in the discussions.

For its part, China's new leadership is committed to rebalancing. With GDP growth slowing to 7.7 percent in the first quarter of 2013, and data for April and May pointing to more of the same, previous Chinese leaders would have quickly announced a new infrastructure program or other stimulus policies to spur the economy. By not introducing new spending initiatives, the government of Xi and Li has sent a strong signal that Beijing is now willing to accept slower growth. 

That conclusion was reinforced by last month's liquidity squeeze in the overnight bank funding markets. Because the People's Bank of China, the country's central bank, didn't intervene as it normally does in such circumstances, the interbank lending rate shot up on June 20, reaching a record of 13.4 percent -- more than four times the average over the last 18 months (it dropped back a few days later.) This lack of intervention sent a strong signal to banks, especially China's "shadow banks," that the days of risky and undisciplined lending must end. 

The message from China's fiscal and monetary authorities is clear: the days of open-ended hyper growth are over. At the same time, Xi has been calling for a "mass line" education campaign aimed at addressing problems arising from the "four winds" of formalism, bureaucracy, hedonism, and extravagance. Though cryptic, his message appears to underscore a new sense of political discipline, to complement the discipline of China's fiscal and monetary policies. The Chinese Communist Party, Xi seems to be saying, must realign itself with the core interests of the people and their requisite economic fundamentals.

China is at an important juncture in its development journey. It's determined to move away from the quantity dimension of growth to a new focus on the quality of economic development. This is not only about a downshift in GDP growth: it is also a critical shift toward the long dormant Chinese consumer, opening up one of the largest consumer markets in the world to anemically growing Western countries.

This is especially important for the United States, which continues to languish in a weak recovery with unacceptably high unemployment. Washington needs to push hard for free and open access to these markets, an issue that will undoubtedly be high on the agenda for the Strategic and Economic Dialogue.

While China's previous administration recognized the importance of structural change, they made disappointingly little progress. Slower growth doesn't work for China unless its economy undergoes a fundamental transformation. The new policy discipline of Xi and Li is important because it effectively ups the ante on China's rebalancing agenda -- making implementation of the 12th Five-Year Plan all the more urgent.

For consumption to play its proper role in China's economy, three sets of reforms are essential: services-led job creation, urbanization, and a well-funded social safety net. The objective is to boost the consumption of Chinese citizens from its current share of 35 percent of GDP (by contrast, it is 71 percent in the United States) to 40 percent over the next three to five years, and to more than 45 percent by 2023.

The emphasis on services and urbanization should help increase personal income -- the mainstay of consumer demand for any economy. But a services-led China also holds the key to a sustainable slowdown in GDP growth, because services require roughly 30 percent more workers per unit of Chinese output than manufacturing and construction. In other words, China can accomplish the same labor absorption (i.e., employment of poor rural workers) with a services-led economy growing at 7 percent as with a manufacturing- and construction-led economy growing at 10 percent. With services comprising only about 43 percent of the economy -- the lowest share of any major economy in the world -- there is plenty of room for this sector to grow.

Urbanization is also an essential part of China's consumer-led transformation. Urban Chinese workers have per capita incomes of slightly more than three times their counterparts in rural areas. China's urban population reached 52.6 percent of the total population in 2012, up from 20 percent in 1981 and is projected to rise to 70 percent by 2030. As long as job creation, especially in the services industry, accompanies urbanization, a sharp boost in labor income generation is likely. But without a better safety net, Chinese families will keep saving too much and spending too little. The nation's vastly underfunded retirement system is a key aspect of this problem. China's focus has been on expanding the number of citizens enrolled in the retirement and healthcare plans; emphasis now needs to shift to providing more funding for the plans.

While this is a daunting agenda, the new policy discipline of the Xi-Li administration raises the probability of a successful consumer-led rebalancing. If it does succeed, there are three things the world should expect from China: First, Chinese GDP growth will likely hover at 7 or 8 percent over the next decade. The labor intensity of services suggests China can grow in this range and still generate enough jobs and income to maintain social stability.

Second, services-led growth means a move away from resource-intensive manufacturing. While this may pose problems for countries in China's resource supply chain -- especially Australia, Brazil, Canada, and Russia -- it offers the possibility of reduced environmental degradation and pollution, making for a cleaner and greener Chinese GDP.

Third, the emergence of the Chinese consumer is a potential windfall for the developed world. That's especially true in services, where China has little experience or expertise. China's embryonic services sector could increase from $3.5 trillion in 2012 to $15.9 trillion by 2025. Increasingly tradable in a connected world, this $12.4 trillion surge could translate into a $4 trillion to $6 trillion bonanza for foreign companies.

The transition won't be seamless, nor will it happen overnight. But like most of its accomplishments in the post-Mao era, China's development clock runs at roughly four times the speed of others. The Strategic and Economic Dialogue must recognize the opportunities arising from the coming transition to slower, better balanced, and more sustainable Chinese growth.

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The New Power Generation

Why the U.S. government's plan to coordinate and invest in African energy could light up the continent.

It's no secret that Africa is booming. Of the world's ten fastest growing economies of the past decade, six are in sub-Saharan Africa. In April, the World Bank predicted that, over the next three years, sub-Saharan Africa would grow more than twice as fast as the rest of the world. Africans are proud of this growth; they want partners who will invest in their continent outside the confines of foreign aid, and who provide business expertise as well as capital.

However, in sub-Saharan Africa, U.S. partners are surprisingly hard to find. As an editorial in Bloomberg View pointed out on July 7, Africa receives only 1 percent of U.S. foreign direct investment. China surpassed the United States as Africa's largest trading partner in 2012, and too many U.S. businesses view Africa as a destination for aid, not investment.

Thankfully, Washington finally seems to recognize that the U.S. economy is losing out on African growth opportunities. On a visit to the continent from June 27 to July 2, President Barack Obama touted a sustained commitment to energy as a way in which the United States could help sub-Saharan Africa, while also creating investment opportunities for U.S. businesses. It's a smart move. Currently, two-thirds of the population of sub-Saharan Africa lacks access to power. The World Bank estimates that, on average, manufacturers in the region experience power outages 56 days a year. These blackouts suppress sub-Saharan African gross domestic product (GDP) by 2.1 percent -- that's more than $25 billion per year. In Tanzania, where Obama visited a power complex developed with U.S. private sector involvement, only 14 percent of the population has access to electricity.

The problem in Tanzania and elsewhere is that state power companies see electric grids as their own private fiefdoms -- corruption is rife, and these companies have little incentive to extend coverage. In the end, it's the consumer that suffers: the average price of power in sub-Saharan Africa is nearly double that of the rest of the developing world.

But when a country privatizes its energy grids, it is usually able to decrease corruption, drop prices, and expand access -- while at the same time offering high returns to investors. Nigeria, for example, passed legislation in 2005 that enabled it to begin privatizing its electric grid. And yet, currently, Nigeria produces only one-tenth the power of South Africa, even though its population is three times as large and its GDP is only slightly smaller. By continuing this process of privatization, however, Nigeria could see significant economic gains. But restructuring an electric grid is a difficult and expensive process.

That is where the United States can play a positive role. On June 30, Obama announced the initiative "Power Africa," which aims to double the number of sub-Saharan households that have access to electricity. Starting in Kenya, Nigeria, Ghana, Tanzania, Liberia, and Ethiopia, Washington will provide $7 billion in government funds over the next five years, and facilitate the investment of at least $9 billion from U.S. businesses such as GE and Symbion Power. A source in USAID told me that the agency expects another $6 billion from private commitments, soon. Beyond financing, Washington will also contribute insurance and technical assistance. But its most crucial role will be as a "closer" -- guaranteeing that these projects actually get finished. As Obama said on July 1, "We can't have a seven-year time frame for building a power plant." Part of this initiative is to speed up the process, making certain that governments and companies collaboratively focus on eliminating the bottlenecks that impede or bar private sector investment in their power sectors.

But even with commitments from high-level government officials across Africa to proceed with this initiative, many governments simply do not have trained personnel with expertise needed to deal with these matters. The pace of policy and regulatory change, as well as the speed with which individual transactions are approved, needs to accelerate. That requires a change in mind set which can be difficult to achieve. And then, of course, there will be the entrenched interests -- from corrupt officials to businesspeople who sell fuel for generators -- who prefer and profit from the status quo.

But the need for more efficient and universal power generation is real. The hotel that Obama stayed on in Tanzania experienced a power outage during his visit, according to one of the journalists who traveled with him. On June 30 in Cape Town, South Africa, Obama said that "Access to electricity is fundamental to opportunity in this age," adding that it's the "energy that allows an idea to be transformed into a real business." If Obama succeeds, aid in Africa might undergo the same transformation.