To say as the Financial Times did last week that China is undergoing significant transition is the understatement of the year.
A complex and interconnected reform agenda on this scale and at this speed has never been achieved before. It has scarcely even been attempted. It is only remotely possible with a central command economy and a compliant population yet, even then, it is far from without risks.
As the FT explains, China is attempting a shift away from an export-driven and investment-led economy to a more balanced consumption-oriented one. At the same time as trying to achieve those goals, it is also trying to double gross domestic product and GDP per capita by 2020 from 2010 levels, according to the Chinese leadership.
How to Transition China?
They intend to achieve this with an extensive reform agenda, including further financial market liberalization, privatization or at least liberalization of state-owned enterprises, fiscal, and rural land reform. The FT goes on to warn if reforms are implemented too quickly, the country risks a sharp slowdown. If reforms are implemented too slowly, or not at all, China risks an unsustainable increase in debt-to-GDP ratio, which could push the country past the tipping point into economic and, possibly political instability.
The transition is going far from smoothly. In the steel sector, the party is constrained by fear of mass layoffs in manufacturing, struggling to cope with a massive overcapacity and heavy debt burden.
Li Xinchuang, head of the China Metallurgical Industry Planning and Research Institute is quoted as saying the closure of so-called zombie companies alone, principally in the state sector, could mean 400,000 layoffs.
So, while the government is trying to reduce industrial overcapacity in industries such as steel, aluminum, cement and coal they are also fearful of pushing it too far, too fast. China is the world’s second-largest economy, generating 12.7% of global exports and 10.4% of global imports, and its demand accounts for 50 to 60% of the global production of iron ore, nickel, thermal coal and aluminum and a significant share of copper, tin, zinc, steel, not to mention agricultural commodities and oil.
What Central Planning Couldn’t Do
Fortunately for the rest of the world, Beijing has maintained its fixation with GDP growth targets — a measure few governments in the rest of the world set as targets to guide policy. So, while Beijing says it will achieve no less than 6.5% for the next five years, you can be sure it will use whatever policy levers it deems appropriate to at least continue with positive overall growth. Few believe the current number of 6.9%. Goldman Sachs suggests it closer to 5.1% but that is still a long way from the stagnation of Japan or the low growth of the Eurozone.
Perversely, while the country’s preferred solution to overcapacity in the steel industry has been exports — China’s steel exports grew more than 20% on 2015 to 112 million tons — the market may finally be doing what Beijing has failed to do.
Steel producers have begun to cut capacity. Battered by poor construction and heavy industry consumption, steel production contracted for the first time in almost 35 years in 2015, with raw steel production dropping 2.3% — the first fall since 1981.
China’s official manufacturing purchasing managers’ index for January fell to 49.4, from 49.7 in December suggesting the trend is continuing into 2016. It would be something of an irony if the market were to correct what the state had failed to do in communist, centrally controlled China but steel producers the world over, burdened with over a hundred million tons of Chinese steel exports, wouldn’t complain one bit if the flow slowed. Whatever the cause.