Andrew Batson
The Wall Street Journal, Asia
Those who point to falling corporate profits and sales as bearish cues miss the bigger, more bullish, picture.
China is grappling with an economic downturn, but there is more than the usual amount of disagreement about how fast it’s slowing down and what its future prospects are. The battle is not between the usual bulls and bears. The most interesting split this time is between those who focus on a “macro,” or top-down, picture of an economy, and those who zoom in on a “micro,” or bottom-up, picture of companies.
The macro crowd says that China is slowing, but not collapsing. They point to broad-based economic indicators like industrial output, which grew 9.6% year-on-year in May. Granted, this is much slower than the 13-14% gains recorded last year. But those searching for a real economic disaster story, they argue, would find more to work with in countries like Spain, where industrial output fell 6.1% the same month.
Those of a micro persuasion don’t believe these statistics, and instead prefer to look at more detailed corporate reports, many of which show falling profits and sales. They’ve seized on the fact that makers of construction equipment, which grew enormously during the building boom of the last couple of years, are now seeing a 30-40% fall in sales volumes and a rise in unpaid bills.
Another favored example comes from the port of Qinhuangdao, which handles much of China’s coal imports, and which is now reporting falling prices for and rising stockpiles of the fuel—just when the summer rush to turn on air conditioners usually leads utilities to buy more coal. This negative picture is backed up by the large industrial companies surveyed monthly by the National Bureau of Statistics, whose combined profits were down 5.3% from a year earlier in May, with the profits of chemicals firms plunging 23%.
The continued lack of transparency around China’s official data makes it necessary to check the numbers against experience. Yet the micro crowd’s rush to condemn these statistics risks missing a more important story. Parts of China’s economy that did very well over the last few years are indeed not doing so well now, and the companies that depend on those sectors are struggling. But it’s a fallacy to mistake the part for the whole.
While construction equipment, coal and chemicals have been important to China’s economic growth up to now, the economy is hardly so narrow today. Consumer spending is growing steadily. Car sales have picked up. Wages are rising. Even exports to some markets, outside struggling Europe, are not doing so badly.
The clash between the micro and macro views is then less evidence of terminal economic decline than it is of a necessary economic restructuring. Companies are adapting to the end of China’s investment boom and its transition to slower overall growth.
This structural change will be stressful for many companies. Both the World Bank and Chinese government scholars estimate that China’s potential economic growth rate will be closer to 7% over the next several years than the 10% of recent years—in other words, the pace of growth will be cut nearly in half. This would still count as fast growth by most countries’ standards, but it is a significant change from what Chinese companies are used to. A business strategy of rapidly expanding capacity and ignoring costs could have worked well in the past decade of high growth, but will face problems in the coming decade of slower growth.
Moreover, China will not grow in the same way over the next decade as it has over the past decade. Growth in fixed capital formation, the broadest measure of investment, averaged 16% a year over the past decade, after accounting for inflation. In 2011, real growth in fixed capital formation dropped to 10%, and will likely slow further this year.
With investment cooling, consumer spending will start playing a bigger role in China’s economy. This is not a bad thing, but will mean tough times for those companies—like makers of construction equipment—that have grown by supplying the investment boom.
So rather than take the current signs of corporate distress as a signal that it needs to stimulate the economy more, China’s government needs to embrace this turmoil. For China to achieve its macroeconomic potential in coming years will require a lot of micro-economic disruption, as uncompetitive companies close down and capital and labor flow to new, more productive uses.
There are some signs government leaders understand this. When Premier Wen Jiabao visited the eastern province of Jiangsu last weekend, he told business leaders that to survive they need to come up with new products and pay attention to market signals, and not just “tinker” with existing products or invest in fashionable sectors with a glut of capacity. If Mr. Wen can put in place policies to help this transition, such as improving funding for new companies and opening more markets to private-sector competition, China’s economy can keep changing, and thereby keep growing.
Mr. Batson is research director for GK Dragonomics, a Beijing-based research firm, and was formerly a reporter for The Wall Street Journal.
