In Conversation with Michael Spence: On China's Growth Slowdown

Q: What are your expectations of China’s “new normal?”

At this stage of growth, its almost impossible to imagine that China would continue to grow at 9 to 10 per cent, because the way you do that isn’t available to you anymore. You’re not using up surplus labour, you’re huge in the global economy, you have big market share, you can’t grow by increasing market share. Take a small, poor country, even with a big population, when it starts out and if it grows at unbelievable speeds, it may see growth of market sharefrom 1to 2 percent. This small country doesn’t affect global prices.  Market size really  isn’t a limitation. China is way way past that stage. It has used up the surplus labor, in all the dimensions you know it has to change, and generate growth in part the way a developed economy generates it, through innovation and total productivity growth, and that doesn’t happen at more than 3+ per cent, even at the best of times. China’s on that road. It is somewhere in the middle between early stage developing country and high income country.

For every reason that I can think of, this is an important set of reforms that will sustain a high level of growth in what i call the middle income transition. But it won’t look like the early 2000s. I don’t think so. It will be a new normal in terms of the level of growth and also the structural characteristics of the growth patterns.

Q: So have China’s economists been looking at the wrong factors for growth all along?

After the global financial crisis, every single entity that produced a growth forecast was WRONG on the high side, and that’s been going on for six years. I don’t think the Chinese authorities, smart as they are, knew what kind of growth they could achieve. So the Global Financial Crisis came, they threw the book at it: a fiscal stimulus of 9 per cent of GDP a year for two years and a huge opening up of the credit.

They kept the growth up. and they can do it again. But it would be dangerous to do it. It took five to six years to declare the new normal in China, which is a lower rate of growth, a balanced, sustainable growth. If it had come earlier, had been perceived and announced in a five year plan, I don’t think you would see commodity prices go as high as they were before they came crashing down. There would have been an expectation that China’s growth was going to slow in a natural way, so there wouldn’t have been any confusion in the markets over whether this was a trend heading for zero or a transition. And you probably wouldn’t have had so much excess capacity built. so this is one of the very few occasions that they were late to get the message out. I think those 5-year messages have been, historically at least, pretty powerful guides to what is going to happen in the economy.

Q: What are your thoughts on shadow banking? Is this something China’s financial sector needs to worry about at all? Why or why not?

Parts of the shadow banking system, in fact important parts, have contributed to the development of the financial system in useful ways. Savings options are expanded and access to credit more broadly available.  However, it developed in a highly regulated system and hence the development was unbalanced. Municipal governments could not issue bonds  and we got the Local Government Financing Vehicles with an opaque mixture of public sector financing, SOE finance, real estate development and SME finance. And shadow banking developed while deposit rates were heavily regulated.  So the system is not perfectly balanced and under-regulated.  So the process now is to regulate and remove the distortions that helped shape it – deposit rate liberalization for example.  Shadow banking is also risky because of mis-pricing of risk. That comes in part from the implicit guarantees associated with State Owned Banks in the system. So another aspect of reform is to draw a line between Banks, especially state owned banks and the rest of the system, and get rid of the implicit guarantees.

Q: What do you see as China’s biggest problems and opportunities as it trundles toward the end of 2015 under “the new normal?”

It really comes down to implementation. The plan, as outlined in the 3^rd and 4^th Plenums is comprehensive and sound. But there is a tremendous amount to get done. Probably the biggest challenge is to concretely the idea of making well-regulated markets decisive, which means getting the regulatory framework right and then letting competition, innovation, and private investment do the rest. There is resistance to that. No one disagrees about the state having an important regulatory role.  But there is resistance to reducing the state presence in the territory where markets and open competition generally do a better job.