Of Q1'20 Economic Output and GDP Forecasts - Lessons from China


Sunday, April 19, 2020   / 12.57PM / By Capital Finance International / Header Image Credit: Bloomberg  



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For the first time in nearly half a century China's economy has stopped growing. The National Bureau of Statistics (NBS) reported a 6.8 percent drop in economic output over the first quarter of the year. Retail sales were down by 19 percent and export sales shrank by 13 percent. Fixed asset investment is down as well whilst unemployment jumped to 5.9 percent.


Though the Chinese NBS data usually require a pinch of salt, there is little doubt that the Chinese economy took a severe hit from the pandemic. However, in its World Economic Outlook, published earlier this week, the International Monetary Fund (IMF) predicts China to bounce back quickly and end the year on a positive note with GDP expanding by a modest 1.2 percent. IMF forecasters expect the country to get its mojo back into working order next year when the economy may grow by as much as 9.2 percent.


Though the IMF's outlook is peppered with caveats, the fund clearly continues to view China as the main driver of global growth. As far as the IMF is concerned, a serious re-evaluation of globalisation is not in the cards. It is, of course, not the fund's job to consider the political landscape as it analyses economic performance and distils trends from numbers. In fact, the IMF enjoys somewhat of a reputation when it comes to steamrolling over the concerns of politicians, reminding them that nations must, as a rule, live within their means.


Whilst the advice the institution dispenses is usually quite sound and sensible, the fund - by its own admittance - never before had to deal with a global recession of a magnitude comparable to the present crisis which struck with a speed and ferocity not seen before in living memory. The pandemic has materially changed political reality, resulting in a paradigm shift in our collective understanding of economic theory. The spread of a microscopically small virus has exposed the fragility of the very system that has generated considerable wealth.


Over the past 40 odd years, globalisation has lifted billions out of poverty in Asia, Africa, and elsewhere. By leveraging the comparative advantages of nations, as first codified by the British political economist David Ricardo at the start of the 19th century, the world entered an era of almost continued economic growth, interrupted only by relatively small hiccups as dynamic markets corrected distortions and eliminated pockets of inefficiency.


China's economic contraction, however brief, may be dismissed as atypical since it was caused by an unexpected externality and not by some major flaw of the country's development model. That model has yielded extraordinary results. In 1976, the year Chairman Mao passed away, the country boasted a per capita income of $167 - one of the world's lowest. After the Cultural Revolution had been derailed with the arrest of the Gang of Four, China embraced the Four Modernisations first proposed in 1963 by Zhou Enlai, then vice-chairman of the Communist Party, and implemented by the great reformer Deng Xiaoping in 1977. What happened next constitutes a miracle of sorts. Fast forward 43 years, the blink of an eye in the course of human history, and China presides over the world's second largest economy with a per capita income close to $10,000.



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The almost mind-boggling progress of the country took everyone by surprise. It had been deemed impossible. In 1988, Milton Friedman, the dean of economic liberalism, proclaimed that China could not possibly hope to attain any significant measure of prosperity since it lacked the requisite political freedom that underpins capitalism. "To get rich, China must be free," surmised the late professor of the University of Chicago who counted US President Ronald Reagan and UK Prime Minister Margaret Thatcher amongst his disciples.


In fact, Prof Friedman gave this advice to General Secretary of the Communist Party Zhao Ziyang whilst on a visit to Beijing at the invitation of Chinese top officials eager to discover the wonders of capitalism. However, Mr Ziyang did not at all like what he heard from the US professor. After he had left, China rewrote the textbook and chose its own path to riches - disassembling long-held theories about the crucial link between free markets and democracy as it rapidly emerged from poverty.


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The pandemic currently holding economies hostage all over the world also forces a rewrite of the economic cookbook. As China has proved, that need not stall growth. In Europe, and even in the United States, the primacy of the market is being questioned. Thanks to a senator from Vermont, young Americans have discovered that unbridled capitalism is not the only choice of offer. As if an entire generation suffered an epiphany, interest in social democracy has been sparked. Though this may not lead to immediate demise of the mastodons of the political establishment, the epithet 'card-carrying liberal' no longer represents instant dismissal as a swivel-eyed loon belonging to a curious fringe movement.


In Europe, even staunch liberals such as Dutch Prime Minister Mark Rutte now seem to take pride in their social democratic roots. During a debate in parliament, Mr Rutte caused consternation amongst friends and foes alike by calling the country 'socialist' and considering that trait a blessing in these troubled times. Across the continent, political and economic thinkers quietly advocate for a return to wealth creation by all as opposed to wealth extraction by a few. The very premises of globalisation and the teachings of David Ricardo are being questioned as are the concepts of small government, deregulation, and privatisation.


Writing in The New York Times, former US Secretary of the Treasury Robert Rubin, who served in both Clinton administrations, now pleads for a massive and structural increase in federal spending. He argues that there is ample room for extra outlays of cash given that the federal budget represents only some 16 percent of GDP. That may easily be increased to 20 percent or more, he says. Mr Rubin also warns that any savings made now will prove to have been false later on. Allowing the US economy to languish in a long-tailed recession results in a lower GDP, taking a bite out of federal revenue, and pushing the debt-to-GDP ratio up considerably. Mr Rubin argues that it is wiser to put the horse in front of the cart and issue vast amounts of new debt to keep the economy going.


For all its uncertainties, the post-corona world will want to revisit previously discarded concepts such as economic resilience. Supply chains will be shortened as societies awake to the dangers of depending on distant others for their security. This is bad news for China and a few others with trade-based growth models such as Germany and The Netherlands. In the medium term, China will need to spur domestic demand which remained repressed to a significant degree whilst the country sought to exploit its comparative advantage as a low wage nation. In northern Europe too, wages and its corresponding domestic demand have been kept artificially low as part of a mix of policies to ensure relative competitiveness.


As the pandemic continues to ravage economies, and the direct and indirect costs of the outbreak mount, individuals and businesses alike will clamour for ever greater measures of support from the only entity able to provide the level of succour needed - the state.


After the virus has been contained, that state will look, feel, and behave differently than before. It will also enjoy a much greater level of appreciation than before.


That may either open a can of worms or lead to a more benign form of capitalism and a renewed interest in social democracy which, although much maligned, did manage to rebuild a continent shot to smithereens by a world war. Not only that, it did so at a clip comparable to China's speeding down the road from rags to riches.




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